As many of you may have noticed, equity markets experienced a sharp increase in volatility and negative performance between September 9 and September 13 as the S&P 500 fell 2.49%. Most of the losses can be attributed to the 2.45% drop last Friday. Prior to the drop on Friday, the S&P had been in a historically narrow trading pattern with the most recent 40 closes finishing within a 1.75% range. This was the narrowest 40-day trading range in the history of the S&P 500 dating back to 1928. The sudden negative breakout raises some important questions:
What caused the negative breakout from the recent narrow trading range?
The S&P 500 opened trading almost 1% lower on Friday due to the unexpected decision of the European Central Bank to keep interest rates unchanged instead of lowering rates and increasing monetary stimulus. Prices continued to fall throughout the day as Eric Rosengren, a voting member for the Fed, made comments hinting a rate hike may happen sooner rather than later. Rosengren stated that a “reasonable case” can be made for a rate increase due to the recent positive labor data and the slow climb towards a 2% inflation rate. These comments scared many market participants because stocks have been benefiting from low borrowing costs since 2009. Higher interest rates could lead to a slowdown in economic activity as it becomes more expensive for individuals and businesses to borrow money, leading to lower levels of consumer spending and lower expectations about the growth of companies and stocks as a whole.
What do we expect going forward?
Though most individuals would agree that rates are expected to increase at some point in the future, the timing of a rate hike decision from the Fed is still unclear. Dan Tarullo, another voting member for the Fed, stated there is still “room for robust discussion” over what may happen in the coming months. Since there is still a large amount of uncertainty remaining about the path of interest rates through the end of 2016, market speculation is expected to increase as investors eye the upcoming Fed meetings. A 0.25% rate hike wouldn’t necessarily impact the economy too much over the course of a couple of months, but the remaining uncertainty leading up a decision could cause an increase in volatility until a more clear path is formed. As of now, the expectation for a rate hike before the end of 2016 remain relatively low with 15%, 22%, and 51.8% implied probabilities for September, November, and December.
How are our models currently positioned to remain successful moving forward?
Our models remain well positioned for success in the near-term and long-term:
- Tactical Growth has a 33.33% exposure to the gold, real estate, and US stock asset classes, providing a strong level of diversification between traditional growth and safe-haven assets
- FFI US Equity (FFILX) has the potential to hold 50 individual stocks but is only 70% invested, reducing overall equity exposure while retaining the ability to achieve strong gains if markets see an upside movement
- Flexible Growth is currently invested in 50% broad US equities and 50% short-term treasury bonds, creating a strong intra-model hedge
As illustrated by the above examples, our blended portfolios are cautiously optimistic about near-term growth in the markets. We have slowly been increasing overall exposure throughout 2016, but still maintain some safe-haven assets (such as gold and short-term treasuries) to mitigate downside risk. Markets can fluctuate a considerable amount day-to-day, especially if there is a large amount of uncertainty surrounding seemingly important catalysts such as the Fed rate hike decision. By keeping a non-biased, emotion-free, and consistent investment philosophy we believe our portfolios are well positioned for long term success regardless of the short-term market conditions.
Source: Phil Calandara