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A Focus On Volatility - Providing Clarity

| September 28, 2021
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Equity market volatility generated headlines last week as global stocks retreated from their record highs. Although we would classify the movement as uneventful and completely normative to the short-term market cycle, investors can undoubtedly feel differently. After all, the recent backdrop of weaker manufacturing growth, and supply chain issues, can certainly justify short-term volatility amidst the ongoing COVID variant. It’s also important to note that data tied to labor market shortages and raw material constraints remained very tangible last week and pushed up the backlog of work to nearly record high levels. As a result, supply chain issues, coupled with unwavering consumer demand, are likely to continue to push prices higher (i.e., inflation) and possibly cause further short-term equity market volatility. Despite such plausible and realistic rhetoric, however, we want to urge caution on how investors gauge their equity market participation. The likely reality may be one of notably higher risk in the bond market than in the stock market. We believe it remains imperative to accept the fact that the bond bull market that started in the early 1980s may be now entering a secular bear market. Let us explore why.

We must recognize the fact that most issues tied to inflationary pressures, as well as short-term equity market volatility, are nearly all visible. We know why there’s a record backlog of ships at California ports. We know why consumer demand remains at record high levels. We know that the broad fiscal health of consumers remains historically unscathed. We know of the many transitory short-term factors impacting inflation. We know that the fiscal health of corporate America remains robust, with a record-high number of companies beating earnings estimates. We also know that systemically important financial institutions today do not carry the risks visible during the Great Financial Crisis (not even remotely close!). The point here is that we can quantify key measurables that would otherwise produce systemic issues capable of generating excessive and sustained downside to stocks. There’s nothing presently that would suggest global equity markets are set for an elongated secular cycle of weakness – especially over the next three years. This is unlike the path of investment-grade corporate bonds, or that of U.S. treasuries! In fact, we covered this topic during one of our December 2020 commentaries where we urged caution against the usage of bond portfolios in 2021. You can visit that commentary here. We’re now nearing the end of 2021, and the same message we covered in late 2020 continues to dominantly apply today. It’s even applicable for 2022! The key takeaway is that equity market participation carries notably higher probabilities of long-term success than any combination of stocks and bonds. Alternatively, we believe the ultimate usage of bond allocations should be to tactically purchase equities amidst opportunistic volatility. We remain adamant about this assessment due to the numerous visible positive attributes of consumers, their fiscal health, and the overall propensity to sustainably consume (relative to disposable income). Added fiscal measures are only likely to boost short-term sentiment, which may aid stocks.

In the context of the above key takeaway, it’s important to address the simplistic argument that stocks carry more absolute volatility than bonds. This is a true, observable, and quantifiable fact that will always be the case, no matter the secular growth cycle of equities. For those investors targeting a minimum of a 3–5-year horizon, however, the argument becomes diluted, and the decision should be solely guided by one’s financial plan. The plan’s ability to distinguish between the ability, and willingness, to forego bonds in lieu of stocks is critical, especially in an environment where global equity market volatility is not likely to remain absent. On the contrary, we believe it is likely to resemble historical norms, which are classified as multiple 5-10% corrections throughout the year. Moreover, as that activity ultimately transpires, the impact on economic growth is likely to be reflected in higher yields. It is an inevitable fact of economic growth and we’re now witnessing the Federal Reserve indirectly reaffirming the relationship of a stronger economy to higher yields. Not only was this evident in last week’s minutes of the Federal Open Market Committee (FOMC) meeting, but the bond market reflected such a belief in higher yields. Despite the equity market volatility last week, bonds lost value and finished in negative territory. Conventional wisdom would suggest otherwise.

The reality is that we’re not living in a conventional wisdom world.

 

Edison Byzyka, CFA – Chief Investment Officer – Credent Wealth Management

9/24/2021 Commentary

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Investment advice offered through CX Institutional, a registered investment advisor.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly. The economic forecasts set forth in the presentation may not develop as predicted.

All other data, including returns, soured from Bloomberg, through the release of monthly figures from the Department of Labor, Bureau of Economic/Labor Statistics, U.S. Census Bureau, or from the Federal Reserve and any of its affiliated regional locations. 

Small Business Optimism sourced through NFIB.  Small business hiring plans sourced through NFIB. Consumer sentiment sourced through the University of Michigan. 

Earnings data sourced through Bloomberg Intelligence and through Bloomberg’ earnings analysis composites.  Interest rate cut/rise probabilities are sourced from Bloomberg’s tracking of futures contracts tied to the Federal Funds interest rate.

The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changed in the aggregate market value of 500 stocks representing all major industries.

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