Macro Overview

Volatility was rampant throughout the markets as fear of inflation and rising interest rates pilfered gains that had accumulated from the beginning of the year. Some see a fundamental trend is in place as a normalization of interest rates evolves.

The release of a jobs report in early February was the catalyst for volatility, as the pace of wage growth was greater than expected thus raising the specter of more aggressive Fed tightening to combat inflation. The Federal Reserve communicated that it is on track to raise rates three to four times this year, stating that “substantial underlying economic momentum” exists for further rate increases.

Historically when markets experience a volatility spike as we experienced in February, a strong economy is a buffer against any long-lasting downturns. Regardless of the catalyst, both stocks and bonds tend to regain their footing following such an environment.

The abrupt rise in bond yields over the past month is in anticipation that the Fed will continue to raise short-term rates this year. The 10-year Treasury yield, which is established by the markets, rose to 2.87% in February from 2.46% at the beginning of the year. The higher yield on U.S. debt is starting to attract additional foreign assets relative to lower yields from other developed countries. The increase in rates is beginning to affect consumer loans from homes and autos to credit cards, and quite possibly offsetting the initial benefits of the recently passed tax cuts.

The roughly 50 percent increase in crude oil prices from lows in June 2017 has helped push inflation higher over the past few months of which oil is an integral component. Economists do not consider inflation a threat to economic prosperity as long as it is gradual and controlled, of which inflation is measured by the Consumer Price Index (CPI).

The Labor Department said the cost of employing the average American worker rose 0.5% in the final three months of 2017 and was up 2.6% in the 12 months ending in December. That’s the biggest 12-month gain for the employment cost index in almost three years. There was a 2.9% jump in average hourly earnings over the past year, the highest increase since June 2009. The average work week fell to 34.3 hours from 34.5 hours.

(Sources: Labor Dept., BEA, Federal Reserve, Bloomberg)

The Return Of Volatility – Equity Overview

Volatility drove all major equity indices lower, prompting a broad increase in trading activity. Regardless of negative news affecting the equity markets, optimism still exists among various analysts and economists.

Some analysts are revising their earnings estimates upward, which means that they believe companies will start to earn more. The benefits of a lower corporate tax rate and the onset of inflation will benefit various companies in different sectors. Inflation will benefit those companies that are capable of raising prices on their services and products, also known as pricing power.

Companies buying their own shares might provide additional fuel for the U.S. stock market following a wave of strong quarterly earnings reports and tax cuts that have left more cash on balance sheets.

Favorable earnings reports lifted equity prices in late February as U.S. companies reported that earnings were improving. According to Thompson Reuters, 77% of companies in the S&P 500 that had reported earnings as of the end of February had exceeded expectations, an optimistic sign.

Many believe that technology has led the market in adjusting much quicker to a changing rate environment, albeit with a higher level of volatility.

Volatility is an inherent part of the market that occurs when the markets undergo the digestion of new data and or occurrence that alters basic fundamentals and expectations of economic growth and company earnings. Volatility has existed for years and will continue to exist for years to come.

Market volatility is measured by the VIX® Index, which is owned and compiled by the Chicago Board of Exchange (CBOE). The index is calculated by estimating expected volatility for the S&P 500 index.

As of the close of business on February 28, 2018, the VIX Index stood at 19.85, up from 9.77 on January 2, 2018. For the past ten years, the VIX index has averaged a daily closing price of 20.02, almost identical as to where the index closed at the end of February. Different factors bring about volatility, this time it’s primarily the concern surrounding rising rates and inflation. Market volatility is a function of various factors such as a change in fiscal policy, monetary policy, trade policy, geopolitical events, weather, natural disasters, and currencies.

Historically, volatility has always existed and will undoubtedly continue to exist. Investors seeking to shelter their holdings from market volatility take different actions and use various strategies. Volatility is viewed from different perspectives as some see volatility as a hindrance while others view it as an opportunity. Regardless of how it is perceived, being prepared for future volatility is essential in sustaining valuations.(Sources: Bloomberg, Reuters, S&P, CBOE)