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The Market Corner: The Month in Review May 2017

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The Market Corner: the month in review

By: Filippo Lecchini, Phillip Capital Inc.

 

Volatility


The US equities market is experiencing a surprisingly quiet spring and nothing really seems to be affecting its direction. The US elections outcome was supposed to finally interrupt the positive trend, but it didn’t. Promises of infrastructure spending, deregulation and tax cuts created enthusiasm, but six months later everything remains vague. International politics also appeared to get more complicated with a travel ban, an airstrike in Syria and growing tension with North Korea. It all seems dissipated now, and throughout the unfolding of these events, volatility never really materialized. In the equities world people often reference the VIX, the CBOE Volatility Index, and even though the product is often misunderstood, S&P options skew and implied correlation drive it more than simple moves, it has been historically low aside from a few short lived and limited upward moves.


What is driving equities higher keeping volatility low then? The answer seems to be earnings. Corporate earnings have been pretty solid, growth seems to be accelerating a bit, and unemployment, after a brief spike possibly due to some people rejoining the work force, seems to be retreating as well.
In the near term politics and current events can sway equities one way or the other, but ultimately the fundamentals will determine where the market is going. The rally might not be over yet.


Gold


After recently enjoying a rally it appears that gold might now reverse its course. One reason is current events: concerns around the Euro have eased after the French elections and the more problematic US foreign relationship seem less likely to require a military escalation, at least for the time being. The other important driver is interest rates with the FED ready to raise further and at a faster pace.


Gold is still seen as a reserve of value, since the existing amount is limited people do not have to worry about one government or the other inflating their way out of debt by effectively diminishing its worth, as it happens with currencies. It also helps that gold is universally accepted, unlike currencies that can only be used in the country where they are issued, for the most part at least (It should be said that some foreign countries use dollars even though is not always legal.) Risk of war and political tensions make people look for safe places to store their wealth and gold historically had that function.


Next in line would be cash but as mentioned there might be concerns about inflation and when the interest rates are very low nothing is very attractive about it, beyond the need for daily transactions, or compensates for the risk that the government prints more of it. That changes as interest rates go up and the return on cash deposits improves.


With the FED ready to move again, at least twice before the end of the year, and the international situation easing at least temporarily, it should not come as a surprise that investors are moving away from gold, but that doesn’t mean that another reversal cannot happen whenever. The interest rates trajectory seems somewhat predictable in the near term but international affairs are much harder to forecast, particularly when non-democratic countries are involved. Not to mention that the election season in Europe has just started, and by the time it is over the midterm elections in the US will be on the way. Commodity moves can be sharp and unpredictable.


Looking ahead:


The Federal Reserve meets on June 13-14. The FED Funds Futures imply 97% chance of a hike. While a move is widely expected, it will be interesting to see what else the officials will share about the end of quantitative easing, which is going to significantly affect the fixed income markets.

 

 

RISK DISCLAIMER: Trading in futures products entails significant risks of loss which must be understood prior to trading and may not be appropriate for all investors. Past performance of actual trades or strategies cited herein is not necessarily indicative of future performance. The information contained herein is provided to you for information only and believed to be drawn from reliable sources but cannot be guaranteed; Phillip Capital Inc. assumes no responsibility for errors or omissions. The views and opinions expressed in this letter are those of the author and do not reflect the views of Phillip Capital Inc. or its staff.