Too Quiet for Comfort
After an unusually long spell of low volatility, stocks and bonds sold off in tandem to end a week that was previously on the quiet side following the Labor Day holiday. Coming into Friday, stocks had essentially earned out the high single-digit returns we foresaw for 2016. Low levels of economic growth globally should renew profit growth in future quarters, but neither stocks nor bonds are cheap at this point. Accordingly, they are more susceptible to periodic setbacks despite accommodative monetary policy.
As for the Fed, it remains one of the few central banks globally that is trying to raise rates amid a flood of central bank bond buying in Europe and Japan. Such monetary largesse overseas is increasingly making its way into our fixed income markets, as foreign investors starved for yield seek out better deals in U.S. bonds and dividend-paying stocks. If the Fed moves too fast, it risks renewed dollar strength that could threaten an already slow domestic expansion, and at a time when our central bank is still struggling to meet its 2 percent inflation goal.
Overseas, the European Central Bank met this week and decided to keep its commercial bank deposit rate at -0.4 percent and 80 billion euro/month of bond buying in place. Following surprisingly strong gains in stocks post-Brexit, investors seem to have been disappointed that the ECB didn’t announce the extension of its QE program past next spring or liberalize its choice of assets to buy. Draghi & Co. are clearly seeing the effects of unconventional monetary policy, as not only are German Bunds trading with a negative yield, but now, so are 20 percent of European corporates! Strange times indeed. . .
Stateside, a bullish oil inventory report put a strong bid into oil prices as traders cheered a 14 million barrel draw over the past week. We knew this weekly inventory report was going to be skewed lower by Hurricane Hermine that blew through the eastern Gulf of Mexico, but estimates into numbers hadn’t properly accounted for shut-in production and import disruptions. Once the inside scoop got discounted, oil reversed most its gains from Thursday. We would observe that while the volatility in oil this year has been dizzying, the industry austerity engendered by sub-$50 oil is slowly but surely being reflected in higher prices - prices that are also responding to persistent demand growth. Our overweight to energy stocks and the oil service / independent producer segments within the sector position our client portfolios to benefit from rising prices.
Our Takeaways for the Week
- Volatility returned to the capital markets this week
- For oil prices, it’s a three-steps forward, two-steps back affair