Author: Tom Yorke, Oceanic Capital
Covestor models: Global Diversified Conservative, Global Diversified Moderate, Global Diversified Aggressive
The roller coaster ride continues. Volatility reigns supreme as the markets seem to be trying to dole out the most possible punishment to the most possible people. The last few weeks have completely debunked the conventional wisdom. Bonds have rallied to new highs (low yields), and despite the debt downgrade, the U.S. dollar is now the shinning star again in the flight-to-quality trade. Formerly glittering Gold seems to have hit an air pocket.
The Fed continues to try its hand at rejuvenating growth by reaching back to the 1960’s and reintroducing an old dog: Operation Twist. The goal of selling the shorter-term maturities (US treasury notes) and simultaneously buying the longer end is to force down longer-term US interest rates. The theory is to encourage longer term investment in things like plants and equipment. This type of “twisting” of the treasury yield curve is supposed to increase the longer-term employment growth prospects.
But, as Dennis Gartman points out, one would have thought keeping the yield curve steep with lower short-term rates would have encouraged regional banks to lend longer term to their customers and borrow shorter term from depositors, thereby enjoying the profit of wider spreads. This should have helped the economy to “ride” this steeper yield curve to quicker health.
The Chicago Board Options Exchange (CBOE) Volatility Index, which reflects a market estimate of future volatility and has averaged approximately 21 for the last year, spiked over 100% in three trading days from August 3rd August 8th. It currently remains above 40 (as of October 1), but has been gyrating between 30 and 45 for three weeks now, indicating extreme levels of volatility.
During this period, Gold initially held up and did what it was supposed to – balance our portfolios in tumultuous times – but eventually even it fell victim to tremendous selling pressure. Liquidations by large hedge funds forced many of them out of possibly their best trade for the year. Additionally, “pile on” traders or momentum-style trading approaches – those who were the latest long to the Gold party – had to liquidate, adding fuel to the proverbial fire.
As Halloween decorations are starting to appear and – as usual – the month of October is scaring people – what with the Great Crash, the ‘87 Crash, and various unnamed October mini crashes along the way. That said, even though the technicals don’t look too rosy for equities right now, any time we draw too many parallels across timeframes and trading patterns we can often look foolish. Could this October be a contrarian’s opportunity?
The dollar wins the flight-to-quality trade (by default more than conviction or fundamentals) in September, rising up to punish all those convinced by the last 15 months that it was headed to parity with the Real, Rupiah, Ruble or Rupee (take your pick).
What next? We still believe Gold will “win” and Silver will likely play a reduced role going forward. Equity index ETFs will lose their place-card status for equities in favor of lower volatility, dividend paying, category-killing names. Given the continued expectations for future volatility, those companies that can demonstrate long-term consistency in any aspect of their fundamentals should be the relative winners.
We believe the Dollar will gather some more votes as a portfolio buffer as Bonds seem likely to underperform from here on out. All the noise made in Muni markets about potential defaults seems to be muted now, and reminds me how hated the Real Estate sector is despite the housing affordability index being at an all time high and interest rates at a historical low.
Seems like it’s time to sniff around the wreckage.
