The S&P 500 plummeted 1.7% Tuesday, its greatest one-day falloff in two months. The index has now tumbled 3.5% since hitting an all-time high just over one week ago. Meanwhile, the euro fell to 1.07 against the dollar, the lowest level in 12 years while U.S. Treasury yields – anchored by the yields in Europe - are back in that recurring 2014 “bullish trend channel,” settling at 2.10%. Crude oil continues its weakness, with WTI (U.S. crude) down -2.5% on Tuesday not to mention gold and copper down 50 basis points and 200 basis points respectively.
While dawdling in the supermarket checkout line on Tuesday, I took notice of a glossy magazine cover vividly displaying a chocolate cappuccino pie. The featured articles of the month are “Trim your Waistline: 5 Ways to Curb Your Cravings,” and directly below it, “Irresistible Chocolate Desserts.” Similar to how this food-obsessive mixed message may do wonders in keeping obesity rates soaring so in kind, do todays short-term market movements construct mixed messages which ultimately produce periods of irrational market knee-jerks – a direct result of weeks, months, or even years of pent-up compressed expressions of fear.
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Although it’s soothing to hear a “reason” for the most recent price action, it’s ultimately impossible – not to mention rather obtuse - to boil the grand notion of randomness that surrounds us down to a one-size-fits-all explanation.
History of Markets – Markets of History
I’ve traced my family lineage in America back 325 years to northeastern Pennsylvania and am particularly awestruck to learn I have direct relatives who fought in both the Revolutionary and Civil Wars yet, truth be told, I undoubtedly have a lot less in common with an ancestor six to ten generations back compared with perhaps my own father or grandfather.
Like humans, markets have bloodlines as well - genealogies encapsulated by vast networks of interconnectedness via generations of perpetual and interwoven action and reaction. For example, we can look back at the severe dollar strength of the early-to-mid 1980’s and draw a hugely broad conclusion that perhaps this time (2015) around, “this too shall pass” may eventually apply yet, if we attempt to dissect charts and graphs of February, 1985 (British Pound vs. U.S. dollar hit bottom at 1.05) with the idea that perhaps it will provide profound clues on tomorrow and beyond is purely fictional.
Perhaps a valid assumption when forecasting short term horizons, but the theory falls short when creating medium and long-term forecasts. The further out we attempt to forecast, the less certain we become of the forecast.
Holding Lightly any Market Catalyst
My best thinking leads me to suppose that Tuesday’s sell-off was a combination of two separate and distinct forces. First, I was bewildered for days following the equity enthusiasm resultant of the “Greek news” on February 20 and “Yellen” just four days later, both of which forced the S&P 500 above 2100. I have no problem with the market going up yet, with earnings estimates dwindling lower, in concert – I couldn’t comfortably reconcile an S&P 500 2015 multiple of 19x earnings without dollar stability or much better economic metrics.
The second force is a combination – or possible chain reaction resulting from continued U.S. dollar strength and its implications on forward U.S. corporate profits, risk of emerging market instability, or bond and/or oil stability.
With full acknowledgment that there is no reliable way to state what the future markets will be with any degree of certainty and, with full admission that even some science-fiction writers have described future events with uncanny accuracy, I implore you to read the most recent market narrative as knowing where we’ve most recently trodden may give clues on not so much where we are headed by why.
U.S. equity markets spent February and some of March recovering all of January’s losses, rallying to fresh all-time highs (S&P500 +5.5%) in February. Energy stocks led the rally early in the month as rising energy prices helped ease profitability concerns that have plagued some of the energy sector’s most highly-leveraged companies. Fears around the Greek debt crisis eased on news of a potential debt restructuring and a moderation in the anti-austerity rhetoric from Prime Minister Alexis Tsipras. German GDP surprised to the upside and the ECB continued to take steps toward its planned purchase of sovereign bonds—all positive influences on equity markets. As a result, the CAC 40 rallied by 7.5%, the FTSE added nearly 3% and the DAX jumped by 6.6%, closing the month at an all-time high and up more than 15.0% year-to-date.
Interest Rate Markets
Bond markets fell throughout much of February as the Greek debt crisis, the European Central Bank’s bond-buying program and the timing of a potential interest rate hike in the U.S. captured the attention of market participants. Yields rose sharply in the U.S. as personal income growth, improving jobs numbers and the ISM manufacturing index, which registered its 26th consecutive month above 50, indicated an expansionary economic environment.
Yields also rose in Europe, but the move was much more muted as investors weighed the impact of the ECB’s bond buying program. Compared with their European counterparts, U.S. Treasuries are relatively attractive with a number of Euro-area sovereignties currently able to issue debt at negative yields. Yellen’s late February speech indicated that committee members were pleased with recent economic growth but remain patient with regard to a potential rate increase. Despite this guarded language, the yield on the 30-year bond saw its largest monthly increase since May 2013 and its greatest percentage increase since the height of the global financial crisis in January 2009. In the U.K. the 10-year yield saw its largest increase in more than 5 years.
After falling against the U.S. dollar for seven-consecutive months, the British pound rose by 2.5% on inflationary concerns raised by a hawkish Bank of England Quarterly Inflation Report. The Canadian dollar rose by 1.8% against the U.S. dollar after falling by more than 16% over the previous seven months. The move was driven by rising oil prices and increasing skepticism that the Bank of Canada is set to deliver another rate cut. The euro fell for the eighth consecutive month on central bank policy, but the move was relatively small and gains were overshadowed by losses in other currencies.
Although production has yet to fall oil markets reversed course as the number of oil rigs and new drilling in the U.S. have declined precipitously. In February, the U.S. oil rig count saw its largest weekly drop in more than 25 years and new drilling fell to its lowest level since 2011.
OPEC’s decision to hold production levels steady and let prices determine supply seems to be having an impact as North American producers, burdened with a relatively high cost of production, have begun to reduce investment in new oil wells. After falling by more than 18% during the previous three months, copper prices rallied by nearly 8% on fears that demand may outpace slowing supply growth.
Gold and silver prices fell as investors favored equities and other risky assets. Soybeans accounted for the majority of agricultural losses as prices rallied by more than 7%. Despite abundant supply, temporary transportation issues caused by a trucker strike in Brazil and the reluctance of South American farmers to sell physical goods in exchange for their depreciating currency drove prices higher.