Trade war talks rattled the markets last week.
This is from CNBC (emphasis mine):
‘Investors bailed out of U.S. stocks at a near-record pace in the last week, as money flowing into Treasury bills surged to a 10-year high.
‘Outflows from U.S. stock funds and ETFs totaled $24.2 billion, the third-highest ever, and the $30 billion that came out of global stock funds in total in the past week was the second-highest ever and largest since the financial crisis, according to Bank of America Merrill Lynch strategists. The outflows from U.S. stocks were the highest since the stock market correction in February. Bonds, at the same time, saw small inflows of $700 million…
‘[Michael]Hartnett [BofAML chief investment strategist] said there was a “pervasive euphoria” about the U.S. at the beginning of the year and that has faded.
‘“To get a big selloff from here, you’re going to need negative developments. The new negative developments could be tariffs on European autos or tariffs on U.S. tech. They could be Chinese currency issues resurfacing,” he said. He said the S&P 500 could rally a little but it’s not likely to break out of its range, for now.’
You probably still remember the market correction from back in February.
Funnily enough though what rattled the markets back then wasn’t bad news…but good news.
Investors got jittery back then after the US released a strong jobs report.
The report showed the economy had created 200,000 jobs, 20,000 more than expected.
But the big surprise was in wages.
Over the year, average hourly earnings had risen by 75 cents, equivalent to 2.9%. This was the best year on year wage increase since 2009.
Higher wages will mean higher inflation…and higher interest rates.
After months at low levels, volatility spiked back then too.
The VIX or ‘fear index’ is a good way to measure how investors view risk
Low volatility means that they are willing to pay low fees to protect their portfolios. In other words, investors are confident that stocks won’t fall.
A higher VIX means investors are starting to worry.
Until February, when volatility spiked, stock indices had been edging higher and higher and volatility had been hitting record lows.
Things had been good for so long that investors had started to believe they would always stay that way.
Some even made quite a bit of money betting that volatility would not be making a come-back…for a little while.
Take a look at the Velocity Shares Daily Inverse VIX short-term ETN [NASDAQ:XIV] below. It was one of the popular tools used by investors to bet against risk.
It gained about 200% from January 2017, until volatility spiked back in February of this year and crashed down by 96%. Yep, 96%. That’s not a typo.
Source: Yahoo finance
The thing is, betting against volatility is just madness.
The February correction has brought on a change of sentiment, the realisation that there are risks in the market.
The truth is that since February, markets haven’t moved much, as you can see below. The Dow and the S&P are still trading lower than their February levels.
Volatility has also been treading higher in the last week.
Investors are starting to realize that things can’t stay good indefinitely.
Take a look at the American Association of Individual Investors (AAII) survey below.
Since 1987, AAII asks its members the same question each week, that is, if they expect stock prices to rise over the next six months. The survey can give an indication of investor mood.
Here are the results from this week:
After last week’s market jitters, bullish sentiment dropped by 10.3% to 28.4%, well below the 38.5% historical average. Meanwhile pessimism is above 40% for the second time this year.
As AAII wrote: ‘at its current level, pessimism is unusually high (more than one standard deviation above its historical average).’
The stock market has been flying high for almost ten years now. Yet something changed last February.
We are starting to see the effects of the end of easy money. And, there are a lot of perils associated to years of easy money.
The US Federal Reserve has started to increase rates and decrease their balance sheet.
If easy money has meant a free flow of credit and high asset prices, tightening could very well mean quite the opposite. That is, asset prices tumbling and credit tightening.
Tax breaks…infrastructure spending…tariffs…high employment rate these are all inflationary.
And an inflation return could mean that the Fed starts tightening the screws quicker.
Tariffs, strong wages…any news — good or bad — could rattle this market.
Editor, Markets & Money