Volatility Ahead
August 2024 - The U.S. economy has been a juggernaut since the pandemic ended, and while it’s still expanding, it’s beginning to show signs of stress. The highest levels of inflation in over 40 years, coupled with the highest interest rates in over 20 years, have dampened consumer spending, business investment and service provider activities alike. The Fed is widely expected to cut interest rates next month in response, and it appears to be not a moment too soon.
The rising Volatility Index, also known as the VIX, is indicative of increasing investor uncertainty or “fear,” as the index generally moves in the opposite direction of the broad U.S. equity market as defined by the S&P 500. Created by the Chicago Board Options Exchange in the early 1990’s, the metric’s calculation is complicated and uses the average weighted prices of complex financial derivatives. Regardless of its mathematical derivation, the VIX reached its all-time high in March of 2020 at the height of the COVID pandemic. With the recent stock market volatility centered around the level and direction of interest rates, the VIX has registered some significant spikes, on one occasion, closing up 64.90% from its previous day’s close. It’s impossible to say what that means exactly, but the index hasn’t experienced a gain like that since its historic high over four years ago.
Remarkable spikes in the VIX notwithstanding, there are glimmers of hope. August’s early selloff was so pronounced that it was likely a panic response divorced from fundamentals or any pragmatic line of reasoning. While the U.S. economic backdrop remains uncertain, according to the CME Group’s FedWatch Tool, the chances of a 25 basis-point (0.25%) reduction in the federal funds rate in September, have risen to 52.5%. The Fed could also react more aggressively if it decides to.
While we follow many analyst’s thoughts on the happenings in the financial markets, Joe Weisenthal of Bloomberg summed up many of the events from last week leading this month’s selloff. Here is a summary of what he said.
When I read the transcript of last Wednesday's Powell comments, I was struck by the lack of anxiety about the state of the labor market. The data has been slowing on this front for some time now. Various indicators, such as the Quit Rate, Initial Jobless Claims, and the employment sub-index of manufacturing surveys, have been weak. Wages are mellowing, and unemployment has been rising. However, Powell was still open to the possibility that we weren't seeing weakening per se, but rather normalization to a job market that resembles 2019 more than the post-Covid period.
Comparing the labor market to 2019 seems odd. Even if some levels are similar, the trajectory is not. In 2019, the unemployment rate was generally improving throughout the year, whereas in 2024, the unemployment rate has been rising all year.
Powell signaled that a rate cut could come in September but was not definitive. He didn’t declare the start of the rate cut cycle. He opened the possibility of no cuts at all, depending on the economy's evolution.
The Non-Farm Payrolls report showed unemployment jumping to 4.3%, triggering The Sahm Rule, which suggests that a rise in unemployment of at least 0.50 percentage points above its 12 month low has historically led to a recession, but this time could be different. Most of the rise in unemployment has been from new labor market entrants rather than people permanently losing jobs.
The phrase "normalization" in the labor market context is odd. The unemployment rate tends to trend in one direction. Right now, it's rising. The Fed didn’t seem to be in a risk management posture.
We have been discussing the coming market volatility in the financial markets in several of our recent updates, citing interest rates and the FED’s monetary policy vs expectations. We’ve also discussed election year drama generally and how this one has some unique characteristics due to the Biden/Trump history. Now that Biden has dropped out (or more likely been forced out), it has taken a truly surprising turn as Harris assumes the position of the presumptive Democratic nominee. Harris’ recent announcement of progressive Minnesota Governor, Tim Walz as her running mate, has solidified the divide within their party over the war in Israel. Democrats, long supported by the Jewish community are now extremely divided on U.S. support for the State of Israel following the country’s response to the terrorist attacks of October 7th last year. While more centrist Democrats support Israel’s right to self-defense, the far left, progressive and increasingly anti-Semitic wing of the party compare Israel’s defensive actions as genocide. Harris was widely expected to name Pennsylvania Governor Josh Shapiro as her running mate. Governor Shapiro is Jewish, and his selection would have served as an olive branch of sorts within the Congress. Her choosing Walz is a clear indication of which wing of her party she identifies with.
There are certainly enough things going on currently to add to the volatility menu. Some of the existing and more recent are:
Weak July jobs report, only 114,000 new jobs and 4.3% unemployment.
Weak July factory orders report.
Service sector is slowing down, a major component of our GDP.
Real Estate market still in grips of high interest rates and high mortgage rates.
FED seems “married” to the 2% inflation rate, while markets anticipate reductions.
Geo-political tension continues, with Iran, Israel, China and Russia.
Social agenda of the Government clashing with Corporate objectives, causing companies to relocate to “friendlier” territories to operate; Tesla and Chevron most recently.
AI technology is growing fast, and its application is limited by high interest rates for companies that cannot fund that infrastructure investment out of pocket. This creates gaps in sectors able to absorb the cost and benefit from AI.
Although it seems we are in a unique position at this point in time, there have been hundreds of situations wherein we would have felt the same way. The markets always adjust, elections never go as smoothly as planned and there will always be “bad players” in the world.
The media is always at the center of anything that will promote ratings, sell ads and emotionally addict us to them. We must be careful to discern between real information and politically charged entertainment. Some of us are addicted to sensational news just like kids on Halloween begging to go to the haunted house just to get scared again. We must be careful to not accept everything we hear, challenge everything and research what we question.
Financial Management, Inc. is a CEFEX®-certified Registered Investment Advisor