Dividend Café

The Week Volatility Said, "Remember Me?" - Feb. 9, 2018


Dear Valued Clients and Friends,

No one is going to tolerate me exclusively devoting this week’s Dividend Cafe to stories outside the vein of our recent volatility/panic attack.  And yet, that is probably what I should do.  After all, we said most of what we could say about the panic earlier in the week.  There are plenty of things we need to discuss regarding the municipal bond market, the jobs market, the state of 2018, and more.  So we will do all of that, and cover this week that surely represents the craziest market week since Brexit.  Jump on into the Dividend Cafe!!  And if you read nothing else, read the final section before the Chart of the Week …

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Breaking down the week that was

Even as January represented the 15th month in a row of a positive total return for the S&P 500, and was one of the best performing January’s in history, the very end of the month into the first few days of February saw market volatility return as interest rates continued to move higher.  The “good news” of significant wage growth last month caused markets to go all abuzz around higher inflation expectations.  By Monday of this week the ten-year Treasury yield was sitting at 2.85% and stocks began to collapse.  Down 500 turned to down 700, and then bids began being pulled en masse, sell orders flooded the system, and at one point the system broke down into a 1,600 point drop before becoming a 700 point drop before becoming an 1,100 point drop for the day (which on a percentage basis was the 108th worst day in market history, but felt quite different due to the point levels).  On Tuesday the market opened down 500 before closing up 500, and going back and forth between up and down 29 times.  And then Wednesday, markets opened down 300 before going up almost 300 before closing flat.  So volatility, technical, algorithms, ETF complexities, and all sorts of other things made for a very dramatic first few days of the week.  The link we provided in the opening paragraph gives our full perspective on wisdom in such panic attacks.

Good news is bad news again!

For those who are not as excited as we are about a reintroduction to the lifelong reality of market volatility (though we really do mean “normal” market volatility, not 1,000 point per day volatility), or the causation of this recent bout of market volatility, let’s review a few things.  Technicals aside, what fundamentals caused the initial market reversal before things got silly … Bond yields spiking higher.  And what has caused bond yields to spike higher?  Growth, employment, higher earnings, higher wages, etc.  So what is not to love?  The fear is that all this growth increases demand for money which drives interest rates higher.  Higher interest rates and higher wages in particular compress margins.  And the law of economic cycles turns unfavorable on risk assets.

What is the antidote to fears of higher rates and inflation impacting profit margins for equity investors?  PRODUCTIVITY.  There should be no surprise – NONE – that in the face of this kind of economic “heat,” bond yields have moved higher.  The question is whether or not the economic growth will be productive enough to absorb it all.  There are a lot of monetary ramifications to the present lay of the land, and one of the most confusing but real elements of a highly interventionist central bank is that good news becomes bad news for risk assets, and vice versa, in the most mysterious of times and ways.

“Navigating” through volatility

I remain at a loss as to how one “navigates” through volatility other than “not doing anything dumb” and “buying high quality assets at lower prices when there is cash with which to do it.”  But in saying that I am at a loss, implying that I don’t really know what is behind that impulse, which is disingenuous.  I do.  It is the immutable human nature that forever and ever gets in the way of successful investment outcomes, and it is entirely understandable, though dangerous.  Getting out of quality and suitable investments for no other reason than a highly fallible view of their price level begs for a big mistake on the exit.  Then, getting back into quality and suitable investments at the right highly fallible guess of a “bottom” doesn’t just beg for a mistake in re-entry timing; it almost assures it.  Investors cannot call tops (obviously).  They cannot call bottoms.

All they can do, is know that corrections are temporary, and that principal capital they need should never be exposed to them anyways.

A full absorption of the various principles in this little section I just typed is probably worth more than anything we have ever added to the Dividend Café, combined.

Themes for 2018 redux

Entering 2018, our major investment themes and outlook included:

  • Potential market “melt-up” situation
  • Elevated market volatility
  • Significant pick-up in socio-political pressure on new tech companies
  • Inflation expectation adjustments; rising rates

Themes for 2018, evaluated 36 days in

So far, 2018 has essentially been defined by:

  • Potential market “melt-up” situation
  • Elevated market volatility
  • Significant pick-up in socio-political pressure on new tech companies
  • Inflation expectation adjustments; rising rates

It may be better than we thought

One of the untold parts of the 200,000 jobs report for January is how consistently January has been a negative outlier in recent years.  The fact that the number was as strong as it was in a month that normally does that we see below, really does indicate continue labor market health.

* Jones Day Trading, U.S. Labor Department, Feb. 2, 2018

If this is bad then sign me up

Stocks drop over 2,000 points from their all-time high.  The market has its worst intra-day price drop in history (though only 108th worst percentage decline in history).  The VIX blows out by over 200%.  This can only mean armageddon, right?  Just one problem:

The SPREAD between corporate bond yields and government bond yields SHRUNK.  Put differently – investors demanded LESS return to compensate for the risk of corporate debt vs. treasury debt than they did before the market swoon.  Does that sound like the kind of systemic and macro risk aversion you would expect?  It certainly doesn’t sound like fear of the financial health of these companies, does it?  That is because, it isn’t.

Washington D.C. did it?

The announcement Wednesday that the Republicans and Democrats in the Senate had agreed to a budget deal pushed bond yields higher yet again.  This bipartisan budget announcement to blow through previous budget caps by $300 billion had a little something for everything (besides fiscal hawks).  It boosts military/defense spending by $80 billion this year and $85 billion next year.  But it increases non-defense discretionary spending by over $60 billion each of the next two years as well.  It has $90 billion of hurricane relief in it.  The President has said he wildly supports this.  It is unclear what will happen with the House.  But what is pertinent here for markets, as opposed to the normal occurrence of markets not caring what happens in Washington D.C.?  Greater spending means greater deficits; greater deficits have to be covered by greater issuance of Treasury debt; and greater supply of debt pushes prices down and yields UP.

You can see how important it is that GDP growth be lifted …  Growth is not just pivotal to dealing with debt and deficits; it is the only tool we apparently have.

* Strategas Research, Poliy Outlook, p. 3, Feb.8, 2018

What could Washington D.C. do to really make this worse?

First and foremost, aggressive acts of protectionism would be catastrophic right now.  They could reverse their very positive moves towards deregulation (we don’t think they will). But all things considered, market volatility is not really policy-sensitive but technical right now.

Is this all going to spook the Fed?

We really cannot authoritatively answer how the “new Fed” will respond to all of this.  Will they adjust their path to reducing their own balance sheet (hyper slow “quantitative tightening,” if you will)?  Will they stick with two rate hikes this year, or will three or maybe even four happen?  My best projection is that their path will play out unless a shock to system takes place, and a week of elevated stock market volatility, or even a 3% ten-year treasury yield, are not going to qualify as that!

Tax-free cousins with better fiscal discipline?

As bond yields have risen doing their normal expected math to Treasury bonds, etc., it is interesting to see that the impact in muni bonds has been less detectable.  Yes, prices were down a bit over 1% in January, but on a relative basis to Treasuries and Corporates (their taxable cousins), munis have actually held up much better behind very light supply and strong technicals.  Issuance of new muni debt is expected to be 25% less than last year.  So when it comes to bond investors, supply matters.  And supply is driven by need for debt (so when it comes to government finance, spending).  The disconnect between a city with strong fiscal discipline and a federal government passing a new $300 billion spending bill can be quite dramatic.  And opportunistic.

Picking on my European friends

One of the most popular things for Wall Street folks to say the last two years (I hear it from some money manager nearly weekly) is that, “as U.S. stocks have done better the last couple years, the outperformance of U.S. stocks over European stocks over the last eight years has really expanded, making the case for owning European stocks relative to American ones that much more compelling.”  It is essentially an attempt to make sophisticated this argument: “Well, U.S. went up more than Europe, so now it’s Europe’s turn to catch up.”  And of course, the U.S. has outperformed Europe, and we would argue the reasons are rather easy to quantify around fundamentals.  Better earnings.  Healthier economies.  Less dysfunctional fiscal and monetary systems.  But here’s the thing: Is Europe right now a “diversifier” to U.S. equities if inflation is the fear that would drive risk in U.S. stocks?  Let me put it this way?  Do you believe Italy and France will be benefitting if we see global bond yields fly higher?????  These countries have barely been able to generate any nominal GDP growth with negative or flat bond yields!  If the way it played out was that U.S. economics were pretty benign (not the inflationary pressures that spooked markets this week), and yet valuations got too high so investors rotated to Europe, where economics were also benign but valuations lower – fine.  That scenario could be plausible (though we don’t buy it).  But should the catalyst be something more dramatic in U.S. equity markets, it is hard to fathom a scenario where it didn’t impact Europe as badly or worse.

I will not say anything more important than this, ever

Forever and ever, it will never be fun, comfortable, or peaceful to experience panic attacks in the market.  Run-of-the-mill volatility, and extreme accelerated volatility, both cause anxiety and stress, and we understand why.  We really do.  And yet, because we collect fees from clients to tell them the truth, no matter what, and to earn their trust at all times, it is imperative that we point something out especially in times like this: The sole risk investors face has nothing to do with “up and down movements” in the value of their portfolios; it has to do with a failure to achieve their financial goals.  If your goal is a certain current income from your portfolio, this week’s volatility did not remotely disturb the successful achievement of that goal.  If your goal is a certain future value (for a purchase), or a future cash flow, this week’s volatility did not disturb it.  Risk is failure to achieve a financial goal, and we live on planet earth to keep that from happening.  Volatility is not the same as risk, other than when too much volatility causes a pain threshold to be violated and then capitulate to real risk.   A fluctuating account value for one receiving current income or one saving for a future objective is not a risk; and it never will be.

Delineating between these two things is among the greatest nuggets of wisdom any investor will ever comprehend.

Chart of the Week

2003 saw a huge tax cut pass, a big market rally, and then a correction.  It the saw the year end with a big gain.

2018?  So far, we have seen a big tax cut pass, a big market rally, a correction, and from here …  ???

* Strategas Research, Policy Outlook, p.8, Feb. 6, 2018

Quote of the Week

“”If you would only recognize that life is hard, things would be so much easier for you.”

~ Louis D. Brandeis

* * *
For all of the noise, all of the media attention, all of the panic, and indeed, even all of our own writing and addressing of this, as of press time the market is actually still positive on the year.  Of course, that may or may not hold, but allow that to sink in.  Thousands of points of  volatility.  All of this drama.  And stocks aren’t even (so far) down from where they were just five weeks ago as 2018 began.  Does this mean the events of this week were irrelevant?  Frankly, for long term outcomes, we absolutely do believe this week’s events are irrelevant.  But that is different than saying the events do not matter.

‘We believe some valuable lessons have been learned and reinforced for many investors.   That those lessons be the right ones, is the end unto which we work.

With regards,


David L. Bahnsen, CFP®, CIMA®
Chief Investment Officer, Managing Partner

The Bahnsen Group, HighTower
The Bahnsen Group is a team of investment professionals registered with HighTower Securities, LLC, member FINRA, SIPC & HighTower Advisors, LLC a registered investment advisor with the SEC. All securities are offered through HighTower Securities, LLC and advisory services are offered through HighTower Advisors, LLC.

This is not an offer to buy or sell securities. No investment process is free of risk and there is no guarantee that the investment process described herein will be profitable. Investors may lose all of their investments. Past performance is not indicative of current or future performance and is not a guarantee.

This document was created for informational purposes only; the opinions expressed are solely those of the author, and do not represent those of HighTower Advisors, LLC or any of its affiliates.

The Bahnsen Group is registered with HighTower Securities, LLC, member FINRA and SIPC, and with HighTower Advisors, LLC, a registered investment advisor with the SEC. Securities are offered through HighTower Securities, LLC; advisory services are offered through HighTower Advisors, LLC.

This is not an offer to buy or sell securities. No investment process is free of risk, and there is no guarantee that the investment process or the investment opportunities referenced herein will be profitable. Past performance is not indicative of current or future performance and is not a guarantee. The investment opportunities referenced herein may not be suitable for all investors.

All data and information reference herein are from sources believed to be reliable. Any opinions, news, research, analyses, prices, or other information contained in this research is provided as general market commentary, it does not constitute investment advice. The team and HighTower shall not in any way be liable for claims, and make no expressed or implied representations or warranties as to the accuracy or completeness of the data and other information, or for statements or errors contained in or omissions from the obtained data and information referenced herein. The data and information are provided as of the date referenced. Such data and information are subject to change without notice.

This document was created for informational purposes only; the opinions expressed are solely those of the team and do not represent those of HighTower Advisors, LLC, or any of its affiliates.