What Financial Markets Are Telling Us: Volatility Will Do Same Damage Until The Fed Tells Markets It Hasn’t Lost Its Senses

News from Russia catalyzes markets moves in both directions but the underlying trend of equities is actually dependent on the course of interest rates and Federal Reserve policy. The volatility risk premium points to a higher market over the next few days (though volume may be light since the VRP could easily reverse and catch investors offside), but my technical reading of key stocks in the S&P 500 is neutral. Yesterday's cross-asset action brought several positive factors for US stocks. The US yield curve is falling and in the current context that is bullish. Inflation expectations are stabilizing based on measures of Treasuries and TIPS. But there was also one negative factor across global asset classes. Gold is trading as a risk-off asset. Expect the S&P 500 to be range-bound over the next few days.

Markets are telling us that global growth is mild and steady but at risk of a policy mistake, which while unlikely would be devastating since it would push the global economy into near-recession. The real economy follows the volatility of markets and should the Fed move by 50bps in March that would increase already-elevated volatility and damage global business and consumer confidence. Fortunately the fixed income markets are hedging for the worst and setting us up for positive news when the Fed does raise rates in March by its normal starting move up 25bps. Unfortunately that move occurs in mid-March and that leaves equity markets to zig zag on alternating fear and optimism until then. I expect the S&P 500 to simply test the lows of January rather than move significantly lower since broad financial market indicators remain robust. Most critically hedging in equities via deep out-of-the-money put options is down since the correction began, despite high volatility. Interest rates are going yet higher but the $US is mixed against the majors and EM. Commodities are up and signaling both safe haven buying but also rising demand from the real sector. Equities thus have reason to rise on continued growth but will fluctuate wildly until the Fed shows its hand in mid-March.

My current positions include a sizable cash position, Amgen (AMGN), Goldman Sachs (GS), Johnson & Johnson (JNJ), 3M (MMM), Pfizer (PFE), Starbucks (SBUX), Titan Machinery (TITN) and the levered ETF UPRO.