25 Apr Is the Stock Market About to Rollover Again?
- Poor liquidity due to Fed balance sheet contraction, widening high-yield spread in an expensive market suggests poor returns for equities.
- The global yield curve has restored its positive slope compared to a year ago, suggesting monetary easing and re-ignition of the global growth engine.
- There will always be conflicting information, but volatility can be reliably forecasted. Managing volatility systematically gives you an edge.
Is the tank empty?
While the equities markets recovered strongly in March, the data suggests there is cause for concern. For instance, one highly predictive factor for risky asset performance is liquidity. And it is as tight as back in December 2000 and December 2008. For instance, the US 10-year high yield spread over treasuries is sitting at 330 bps, a huge increase over the 250bps this time last year. And the Fed balance sheet, which typically expands 8-10% a year in non-crisis times, is currently flat. Valuation-wise, US equities are not cheap from both a book value stand point (Q ratio) and a 10-year earnings standpoint (CAPE). Tight liquidity in an expensive market tends to produce below average returns.
Global easing may re-ignite global growth
There are also some bright spots. Real hourly wage, which is predictive of future economic growth, continues to expand. Yield curve spreads around the world also indicate an easing of policy to support a re-expansion of global growth. Finally, there does not appear to be risk of a US-led banking crisis on the horizon according to the St. Louis Fed Financial Stress Index.
So what should you do?
Look, there will always be conflicting data about market direction. So it’s best to manage your portfolio according to what can be forecasted with accuracy. Volatility. The key to quality long term returns, as we consistently preach at Cassia, is to manage risk effectively. Based on Cassia’s forecast, annualized volatility of the S&P 500 is back to normal at 13% — this is favourable with Emerging volatility at 20% and EAFE at 16%. So if you want to protect yourself from the poor liquidity and valuation but don’t want to miss out on the upside, why not dial back on risk without getting out of equities, and consider a minimum volatility index like the USMV? With a forecasted volatility at 10%, you get the best of both worlds.
This is why you need to continuously scour the market for changes in risk. Cassia can provide you with the tools to tweak hundreds of portfolios at once, tamping down risk before it becomes a bigger long term problem. So you can get back to winning more clients. Learn more and get in touch.