October Ghosts?
Posted on Sunday, September 28th, 2014
For the last few years the time to take profits has been when volatility shows up. When volatility calms down it is time to ride markets slow grind higher. We have been warning for months that volatility would rise as the Federal Reserve exits its QE policy this month. We had this to say in our blog post back titled Riding the Waves back in July.
The central theme here is that investors should be expecting an increase in volatility as the Federal Reserve tries to exit its loose monetary policy. We expect trading bands to widen over the coming months as Fed officials warn of approaching volatility. The bankers are asking for it and the Fed is ready to let it happen. We intend to be prepared. http://terencereilly.wordpress.com/2014/07/07/riding-the-waves/
Our bearish thesis has been playing out over the last two weeks. Bears have pushed the bulls back as the Russell 2000 ETF (IWM) has reached an oversold level and support at 110. We have postured that the failure of small caps to confirm the new highs in large caps was precipitating a period of higher volatility and a move to the downside in equities. Friday’s oversold bounce helped the bulls take back some ground but I believe that the bears are still in charge. For now we are in a range between 110 and 118 on the Russell 2000 ETF (IWM). A close below 108 on the IWM will auger in a very quick move down to 96. That would be a move of 13.5% lower from current levels. Large caps will not fall by as much but it could change the trend of the market and that could last for months. A move above 118 on IWM is our stop loss and that would mean that the bulls are back in charge.
Beyond the recent volatility and downdraft in equities we think that the major story is in Foreign Exchange volatility. The changes in Central Bank policy around the world are causing more than merely ripples on the pond as central bank policy is getting investors all wet. The US Dollar has roared higher the last several weeks as the US Federal Reserve tries to get out of the money printing business while Europe and Japan ramp up their efforts. Mohamed El Erian former head of PIMCO and the Chief Investing Officer of the Harvard Endowment had this to say when recently queried on the subject.
Q: Meanwhile, the dollar has been soaring.
A: This is an issue that’s completely off the radar screen that should be of interest to all investors. I warned about this much earlier that at some point volatility will return to the currency markets. And it’s returning for three very valid reasons.
First, the U.S. is on a different economic track than Europe and Japan. The U.S. isn’t growing as much as we’d like it, but it’s growing and continues to heal. Japan and Europe are going the other way.
Second, policy is starting to diverge. The ECB is stepping harder on the stimulus accelerator while the Fed is slowly easing off the accelerator.
Third, the geopolitical tensions affect Europe a lot more than the U.S. So what we have seen is a major move in the dollar versus both the yen and the euro. This is key because it means the return of volatility in the foreign exchange market can undermine central banks’ effectiveness in limiting volatility elsewhere, which is one of their objectives. (Emphasis mine.)
Here is the link to the full interview that appeared in USA Today. http://www.usatoday.com/story/money/business/2014/09/13/bartiromo-mohamed-el-ehrian-scotland-vote-economy-pimco/15507249/
How to proceed? I came across this assessment of current markets by Josh Peters over at Morningstar. Josh holds his CFA and writes the Morningstar Dividend Investor which I find a very worthwhile read.
My chief strategy along these lines is to exercise patience, particularly while being compensated with yields that are well ahead of the market average. A speculative strategy that goes out of style might never come back, but when growing, moat-protected, soundly financed firms fall out of favor, they’re bound to rotate back into favor eventually. To let a prolonged period of underperformance from solid businesses drive us to chase bigger returns elsewhere would be a terrible mistake. Far better to wait things out. – Josh Peters CFA Director of Fixed Income/Equity
A rising dollar is going to hurt multinationals profits and put a damper on commodity prices. Watch the US Dollar. Watch the Russell 2000 for clues to equity prices. October is always a nervous month for investors. Hang on. It could be a bumpy ride as the FOMC exits QE.
I think we aspire less to foresee the future and more to be a great contingency planner… you can respond very fast to what’s happening because you thought through all the possibilities, – Lloyd Blankfein
To learn more about us and Blackthorn Asset Management LLC visit our website at www.BlackthornAsset.com .
A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty. – Winston Churchill
Disclosure: This blog is informational and is not a recommendation to buy or sell anything. If you are thinking about investing consider the risk. Everyone’s financial situation is different. Consult your financial advisor.