Research & Insights

Posts published in May 2013

MV Weekly Market Flash: From “Risk On, Risk Off” to “Risk Here, Risk There”

May 30, 2013

By Masood Vojdani & Katrina Lamb, CFA

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For the past three years the dominant paradigm in investment markets has been “risk on, risk off”. You know – if it’s Tuesday it must be gold and the Japanese yen, but come Thursday animal spirits are back and it’s full-on into small caps and frontier equities. Over this time the market has seemed bipolar as it pinballed back and forth between riskier exposures and perceived safe havens.

Where have all the havens gone?

As we approach the midpoint of calendar year 2013 that paradigm seems to be fading fast. What’s missing is the safe haven, a designation that seems to apply to fewer and fewer asset types. Currencies and precious metals – well, in truth they were never all that safe to begin with, and the recent gyrations of gold and the yen provide a clear demonstration of this. But it’s the fixed income market – the traditional epicenter of safety and predictability – that is the real story today.

Volatility in the bond market

Consider the past week. After reaching a record high of 1669 on May 21 the S&P 500 has seen higher than average volatility and by the close of trading on May 30 the index was a bit less than 1% off the 5/21 high. That’s typically perfect weather for the risk-off flight to the safest of fixed income assets. Not this time. The yield on the 10-year Treasury note – a bellwether for interest rate trends – shot up from just under 1.95% on May 21 to 2.1% on May 30. The total return for IEF, an exchange traded fund (ETF) that tracks the Barclays 7-10 Year Treasury Index, was -1.4% for the same period. Risk here, risk there, risk everywhere.

Taste of things to come?

Now, a nine day calendar stretch is not the defining word on where markets are headed in the immediate future. We think it is more likely to be a small taste of a larger problem that we may be dealing with for some time to come. That problem has a name – interest rate risk. The thing about bond market macro trends is that they tend to be very long. Here’s a little history to make the point: since the 1950s we have had only two such macro trends.

From Cheap Money to Credit Crunch

In 1945 the 10-year Treasury reached a low of 1.7% - its lowest yield since, literally, the founding of the Republic after the Revolutionary War. This was a result of deliberate monetary engineering – sound familiar? – to finance America’s involvement in the Second World War. After the war policymakers realized they had to bring an end to the era of cheap money in light of inflationary pressures. This decision was formalized in the Treasury Accord of 1951. From that point interest rates began a long, steep climb that lasted 30 years until the 10-year yield, reflecting punitively harsh credit conditions, reached an all-time high of just under 16% in 1981.

From Credit Crunch to Cheap Money

Now, 32 years later, that yield is again just over 2% after plummeting below 1.5% in 2012. The Fed is still printing cheap money, but the minutes of recent Fed meetings make clear that this policy is under pressure. We don’t know when we will see “Treasury Accord 2.0” – when the policymakers decide they have to formally acknowledge changing course. It may be awhile yet. But this is the giant elephant in the room, and we believe it is going to present a major challenge to portfolio managers. This challenge will require an innovative, active and flexible approach to managing risk.

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MVCM Weekly Market Flash: The Pullback that Still Isn’t

May 16, 2013

By Masood Vojdani & Katrina Lamb, CFA

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As of the market close on Wednesday of this week the S&P 500 had appreciated by more than 22% in price terms from November 15, 2012. What’s special about November 15? It was the date when the market pullback that began a couple months earlier reached its low point. From September 14 to November 15 of last year the S&P 500 lost 7.7%, bottomed out and began the steep, sustained climb leading to where we are today.

What Goes Up…

These ebbs and flows are what market analysts are looking at when they toss around terms like “correction”, “bull/bear cycle” or simply “pullback”. You’re hearing a lot of this these days, because when things go into the stratosphere the question on everyone’s mind is when they’re going to come back to earth – and how hard the landing will be.

We think it’s worth a look at the data. The question to ask is this: is the 22% run-up over the 180-plus days from November to May an extreme data point, one that is more likely than not to result in a huge pullback, even a technical correction of 10% or more? Or is it within the range of other bull runs? In questions like this context is everything.

How Long?

The 181 days from November 15 to May 15 is certainly on the long side of bull runs. From the beginning of 1990 the average duration for an uptrend (i.e. from trough to peak) after a drop of 5% or more was 75 days, so our 181 day run as of May 15 is more than double the average. But it’s far from the longest – that would be a whopping 533 days, from December 1994 to May 1996.

How High?

What about in terms of how far we have soared? Well again, the average run-up after a 5%-plus contraction over this 23 year period was just under 14%, so our 22% return to May 15 is on the high end. But again, it’s not an outlier. That 533 day run in 1994-96 ran up a return of 52% to the peak. And even then the subsequent pullback was a fairly modest fall of -7.6% over a two month period before things turned up again – for another 209 days!

Growth or Gap?

We’re looking at data points from the 1990s as well as the more recent environment because we are in a sort of limbo between growth and gap market conditions. We’re clear of the previous records on the S&P 500 (1527 in 2000 and 1565 in 2007), but we’re not yet sure we’re going to clear those bars for once and all. So we need to pay attention to how bull and bear cycles work in both environments and factor that into how we keep ourselves positioned. The fear impulse – running for cover when most of the damage has already been done – is never a good idea, but it can be especially harmful in a growth environment where the losses are more likely to be brief and contained – and where traditional safe haven markets look particularly unappetizing. For now, as far as equity markets are concerned, no news is good news.

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