Volatility Eases Making Way for Equity Rally

By Scott Poore, AIF, AWMA, APMA - Chief Investment Officer, Eudaimonia Group

The S&P 500 Index has rallied 9.2% off March 14th lows.  Equities are now within 3.3% of reaching the January 4th highs and erasing this year's losses.  For the time being, volatility has dampened.  The VIX Index (measurement of equity volatility) has declined 45% since February 24th.  Two sectors - Basic Materials and Utilities - joined Energy as the only sectors that are positive year-to-date.  As we enter rebalancing season, where institutional money managers will actively bring their portfolios back in-line with target allocations, expect equities to potentially move higher as managers purchase beaten up equity positions.

Meanwhile, the economic picture is slightly improved.  The Atlanta Fed is projecting GDP growth in the 1st Quarter, when just a few weeks ago they were projecting negative growth.  Both the Markit Manufacturing and Markit Services indices improved substantially month-over-month.  The Richmond and Kansas City Fed manufacturing indices for February verified the improvement.  Jobless claims declined last week and Continued Claims reached a new 5-decade low.  It’s still not all rosy on the economic front.  As mortgage rates have risen 45% since December of last year, mortgage applications are down 7 of the last 9 weeks.  Last week, both New Home Sales and Pending Home Sales were down month-over-month.

Something we are watching carefully is the movement in the 10-year Treasury Yield in relation to the 2-year Treasury Yield.  When these two measurements invert (2yr > 10yr) it tends to be a sign that recession is somewhere in our future.  So far, the two have not inverted, but have moved closer.  In more recent history, this happened in December of 2018 (as we were also experiencing a considerable S&P 500 pullback).  The two yields got within 11 basis points of one another, but did not invert.  Instead, the curve did invert 8 months later in August of 2019.  Right now, the 10-year yield and the 2-year yield are 21 basis points apart.  If history follows a similar patter, we could see the two points slightly widen only to invert down the road.

Meanwhile, the latest futures on the Fed Funds rate hikes for the May 4th meeting suggest a 50 basis point hike.  This would be in-line with Fed Chairman Powell's testimony last week that 50 basis points hikes may be necessary.  The market did not like that news.  It will be interesting to watch equities going forward in light of Fed policy.  If the Fed were to pump the breaks too hard, that could push the economy into recession.  However, should the Fed not act strong enough in response to inflation, that too could push us into recession.  It's a tight rope to walk.