Sunday, June 19, 2016

Week In Review (6/13 - 6/17)

Domestic Index Performance (Past Week)

Domestic Index Performance (June)

Domestic Index Performance (Year-To-Date)

Below is an excerpt from our latest monthly letter to investors & friends that we think sums up the current state of affairs:
If one were to give a theme to the market action and data points we saw over the course of May and so far in June, the word indecision would play well. In early May, it was all but a given that the FOMC and Chair Yellen were not likely to touch interest rates until much later in the year and fed funds futures prices were reflecting that belief. As the month carried on though the market seemed to make an about-face after a number of Fed officials came out and suggested that an increase at their June policy meeting could be warranted. In fact, the minutes from the committee’s April meeting (released in mid- May) echoed that same sentiment:
"Most participants judged that if incoming data were consistent with economic growth picking up in the second quarter, labor market conditions continuing to strengthen, and inflation marking progress toward the Committee's 2.0% objective, then it would likely be appropriate for the Committee to increase the target range for the federal funds rate in June."
As a result, over the course of a week the fed funds futures market’s probability of a June rate hike jumped from 8% likelihood to over 30%. And the likelihood of a July increase leapt all the way to 55%. And the market appeared to cheer all of this news as it coincided with the rally that held through the end of May and into the beginning of June. Then we got the latest Non-Farm Payroll report on Friday, June 3rd and it was a real stinker. Only 38,000 new jobs were created versus an expectation of 170,000. The April and March numbers were also revised lower by a total of 59,000 jobs. These developments left the trailing 3-month job creation average at 116,000 versus the 12- month average of 212,000 jobs. Not exactly a glowing endorsement of the economy or the Fed’s hope to move forward with a near-term rate increase. And now with the June Fed meeting having come and gone, we know that the jobs report along with other recent economic data was enough to push off a rate hike until July at the earliest.
As the Fed has been doing its job of throwing more confusion into the crowd, there’s been a clear ramp in volatility over the last several days. In fact, the VIX aka the fear index made a near 60% surge over the course of the last week. One could have normally expected the market to wilt in the face such increased volatility yet the S&P was down less than 1% over that span. This stands in complete contrast to historical precedent as the market has averaged a drop of nearly 7% when the VIX has risen 55% or more in a given 6-day period. In addition to the Fed’s lack of movement, the rise in volatility has been aided by investor nervousness in advance of the “Brexit” vote (the British referendum to exit the European Union). It appears investors are doing their positioning on whether Britain will stay or leave via the options market and this has made the VIX even more spastic.
One thing is clear, when we examine the chart below we see that the market has held a great deal of angst ever since the end of QE3, onward through the first rate increase in December 2015 and to present day as we wait to see what will finally push the Fed into action for rate hike #2. There’s been essentially zero price progress made by the S&P in the last 18 months.

Further, besides the charts, there are plenty of other data points that show the level of indecision held by investors and fund managers right now. Bank of America/Merrill Lynch’s latest global fund manager survey shows that despite corporate bond prices and US stocks being at or near all time highs, there appears to be great amount of unease. In fact, BAML’s June measure of fund managers’ allocation to cash in their portfolios was at its highest mark since the post-9/11 panic in November 2001. Higher even than at the depths of the 2008-2009 financial crisis. At the very least, this measure shows that fund managers worldwide are simply running out of ideas for where to invest capital and would rather hold cash. Couple that with the survey’s respondents voting “long quality stocks” (think US Large Caps) as being the most crowded trade and you get a better idea of just how hated the recent moves of the S&P 500 might be. But be aware, these data points have a tendency of being contrarian in nature. BAML’s measure of fund managers’ cash levels sits at 5.7%. It was at 5.6% during the year-to-date lows in February and the S&P proceeded to rally 17% from that level. The same goes for November 2001, which was not a bear market low, the S&P managed to rise 10% over the next 2-months. The difference today being that we’re within earshot of all-time highs yet cash levels are abnormally high.
Have a great week.

Ryan Worch is the Managing Director of Worch Capital LLC. Worch Capital LLC is the general partner of a long/short equity strategy that operates with a directional bias and while emphasizing capital preservation at all times.

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