Some Thoughts on Market Volatility

The past few weeks have produced spasms of disorder in most major financial markets as participants plumb the depths of data to find the new neutrality of base rates from which they hope to divine or augment market strategies that will enhance their returns.

In our view there are too many variables built up since the Great Recession in global financial markets to undertake reliable forecasting thus we believe it’s best to see these market squalls through and wait until the new neutrality has shown itself as well footed before recalibrating our future expectations.

At present we are in the throes of a global interest rate reversal wherein some 60 central banks have used their various tools to either exit negative rates or hike artificially low rates. The combined effects of unwinding years of stimulus and forcing borrowers to confront the real cost of funding is hastening deleveraging in an environment of shrinking liquidity. The unexpected Russian invasion of Ukraine and the whirling dervish of global inflation are adding to the global economic stress largely through massive currency movements which drove the Euro, Swiss Franc, Japanese Yen and UK pound sterling to record ten years lows against the Dollar. In the past ten days we have seen a meaningful currency reversal where the dollar peaked and the Euro has gained 8% on the dollar and the Franc about 5%. The added market stress from currency volatility is a major challenge to global market liquidity and raises the risk of a major mismatch.

Despite inflation, deficit, and supply chain disruptions, the US economy remains resilient. Thus one can argue the glass is at least half full. Elsewhere around the world there are telling reasons to argue the glass is half empty. All told, there is a disparity in equity valuations between the US and other G7 nations and in emerging markets which are largely vulnerable to a strong dollar, the disparity is even greater.

Although the domestic equity market is down 12% year to date, we take comfort that dividend growth remains strong and in many cases is running ahead of inflation. Over time this will support improving valuations in well managed companies with healthy balance sheets. The important factor to watch is credit risk. At present some 15% of corporate credit is considered “junk.” Any rising sentiment tilting towards a slowdown or recession will likely see an increase in downward ratings which we believe are not priced into current market sentiment and will likely lead to selective equity re-ratings.

The forgoing are all factors that lead us to our present posture of standing fast with our equity positions balanced with strong liquidity balances in US treasury short term obligations.