Stocks Continue To Be Volatile
I’m almost willing to say we’re entering a new normal where swings occur more often. Technically, that normal is how equities have existed throughout history besides the last two years. If the increasing interest rates caused the volatility, it could be here to stay. If it was caused by the volatility ETPs, it will be over after this week. As you can see from the chart below, the assets under management on leveraged ETPs has fallen sharply from about $4.5 billion to about $1 billion. The trading vehicles, which started to become prominent in 2012, look like they’re being eliminated. The end of the business cycle is when the most absurd trends and decisions are made. When the cycle ends, we’ll see what other crazy actions were going on. From a psychological perspective, the thought process goes from ‘what could go wrong?’ to ‘what will go wrong?’ I knew the VIX short position was overcrowded, but figuring out that it would unwind in February was impossible.
Since the leveraged ETPs have now cleared out, this latest volatility is related to fundamental changes in the market, namely the increase in bond yields. The stock market had a volatile day on Wednesday as the S&P 500 closed down 0.5% after being up 1.2% at one point in the day. This was the sharpest reversal since February 2016. The Dow was up 381 points at one point and fell as much as 127 points before closing down 19 points. This was the sharpest reversal since August 2015. As I mentioned, if the yields increase along with stocks falling, it likely means the rising interest rates are the problem since the volatility derivative indexes are done. The 10 year bond yield hit the problematic point that hurt stocks last week as it increased about 3 basis points on Wednesday to 2.8359%.
High Yield Bonds Also Selling Off
Interestingly, the VIX was down 7.51% to 27.73 on Wednesday even though stocks fell. This is a reversal of earlier this year when stocks rose along with the VIX. If the 10 year bond yield being above 2.8% can break the VIX, this is a problem because it will likely go above 3% in the next few months. Even though I discussed in a previous post that the volatility was centered around stocks, it appears there has been some weakness in the high yield bond market. As you can see from the chart below, the high yield options adjusted spread is spiking. If you zoom this chart out, this movement will look small, but all trends need to start somewhere. It appears a new risk off trade is blossoming with increasing rates being the catalyst of this.
C&I Lending Growth Is Falling
The Austrian money supply growth fell below the nominal growth rate. This has historically been the signal of a major asset crash. I was researching why the money supply growth was falling even though the economy seems strong as it has decent GDP growth and a full labor market. Usually, money supply growth is slow when lending growth is low, so I checked the C&I loan growth. As you can see from the chart below, the loan growth was 1.1% in December. C&I loan growth is only this low when it’s either coming out of a recession or going into a recession. The economy clearly isn’t coming out of a recession, so this is disconcerting.
Stocks Are Oversold
I’ve discussed some negative catalysts in this article such as increasing yields and the decelerating C&I loan growth because the market has decided to pay attention to the negatives. The goods news is stocks are no longer overbought. As you can see from the chart below, the percentage of S&P 500 stocks above their 50 day moving average has fallen from about 85% to 28%. The CNN fear and greed index has fallen from 75, which was extreme greed, a month ago to 16 on Wednesday which is extreme fear. When stocks fall, it’s usually quick and disorienting. It has been especially so because the market had lulled investors to sleep. I’m bullish on the short term performance of stocks because they’re so oversold. Even if the next bear market is about to start, there will be a rebound before a decline.
Consumer Confidence Weakens
Getting a good understanding of the consumer sentiment has been difficult since the Conference Board survey is so optimistic, while the University of Michigan survey, which you can see in the chart below, has been falling sharply. This decline might be nothing, but it’s slightly disconcerting to see the current conditions index fall from 113.8 to 110.5 which is the lowest point since November 2016 which was the month of the presidential election. I’m expecting both consumer confidence indicators to fall in February because of the correction in the stock market. Prolonged declines hurt consumer spending because consumers get nervous about the economy and need to make up for the losses in their investment accounts by saving more.
The chart below explains my point. As you can see, the household net worth has been negatively correlated with the savings rate. If stocks fall, the household net worth falls which causes the savings rate to increase. Generally, stocks fall because of an economic issue, so you can argue, it’s the economy and not the stock market. My response to that is if you look at an example situation, you can see how saving a few hundred dollars is immaterial to changes in net worth.
If a person has $300,000 in the stock market and it increases 10%, the person makes $30,000. If that person saves 3% of his $75,000 salary, he saves $2,250. As you can see, variations in the savings rate are much smaller than changes in wealth values. If the economy looks good and stocks are going up, people can get away with barley saving anything. Once the bear market starts, people get nervous and save more. This fulfills the virtuous cycle as consumer spending declines hurt the economy.
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