The markets this summer have been uncharacteristically quiet – low trading volumes and low volatility. Kim Parlee speaks with Michael Craig, Senior Portfolio Manager at TD Asset Management about whether this is the new normal or the calm before the storm as we head into Fall.
I'm Kim Parlee.
So great to have you with us tonight.
These are, of course, the dog days of summer, where so many of us are taking some time off to relax and do very little.
And, well, it looks like the markets have had the same idea lately.
It's been pretty quiet with low trading volume and low volatility.
But is this just the lull before the storm as we head into the fall?
Joining me today is Michael Craig-- he is Senior Portfolio Manager at TD Asset Management-- to tell us what he is seeing in the markets.
How are you?
Great to be here.
We were joking before the show started this is kind of like Seinfeld.
It's the show about nothing today.
So tell me a bit more about that.
Why do you think it's the show about nothing?
I'll try to give you some Costanza moments.
The summer's been very quiet.
A few years ago we did some work on volatility.
And what's changed with vol since the '90s is the absolute level of vol today is much lower than the '90s.
In the '90s it's very consistently high.
But what's different today is vol is almost like a heartbeat, where you go through periods of just nothing followed by absolute terror.
So we go back a year's time to last August, when the volatility index in the US was 15.
It rapidly went to 50 when the Chinese devalued their currency-- which was like a multi standard deviation event.
Never should have happened, but it did.
And I think we're still in that kind of world where we get lulled to sleep, and then all of a sudden something happens and we go right back to the higher volatility regime.
I would imagine that will likely occur in the next month or two, with so much event risk.
But right now it's been quite slow.
We'll come back to the event risk.
I just want to talk a bit about that because the one thing that-- I was speaking with someone else about this-- is that Brexit, it happened.
There was a lot of lead up to Brexit, a lot of angst on Brexit.
I mean, I remember reading the headlines.
And then it happened.
And then I think the FTSE ended up on the month.
It was just kind of like, what?
What just happened there?
Down for 10 minutes, and then rapidly rallied.
So there was two things that occurred.
And it's very important to dissect the financial markets and the economy.
So in the financial markets, massive sell-off, stocks down 5%, 10%.
And right away, the market started pricing in more accommodation.
And what happens?
A month later the Bank of England cut interest rates 25 basis points, and they also increased their QE by 60 billion GBP.
So the market loved that.
Stock prices rallied because of that.
On the other side, though, if you look at purchasing manager indices or the sentiment of the economy, these are good proxies for earnings.
They fell precipitously in July to levels that we haven't seen since May of 2008.
And so while the markets, or the economy-- or the financial markets in the UK have done quite well, the economy doesn't look so hot.
And so it's important to think about the long term.
Now you've got assets that are now much more expensive with an economic backdrop that's quite a bit weaker.
Right, but I guess the idea being that the Fed, or the Central Bank, or Bank of England-- whoever-- will do what they need to do to accommodate the economy and keep things where they are, which has been the thesis.
Let's pull up here-- we've got a chart that we have here that you brought in taking a look at S&P 500 monthly volatility.
And I think it just shows what the historical average has been, and what we've actually seen in 2016.
That's pretty low.
It's a very vol depressed world.
And a lot of this is because financial conditions in the US have eased dramatically in the last six months.
And so going into December of last year, Fed's going to hike.
They're going to hike four times this year.
Money supply is tightening.
The cost of money is increasing.
And this is very much a headwind for financial assets.
We had our hike, and right away the market started pricing out hikes.
As a result, market's been quite sanguine because of that after the initial sell-off in January.
Let me-- OK.
So let's-- OK, we know what's happened.
We know in a big picture where things are going.
But September is just around the corner-- literally.
I think 31st of August today.
We have jobs numbers coming out on Friday.
Is this the beginning of something?
Will that chart I just saw start to ramp up in volatility, do you think?
September and October traditionally more challenging months for investors.
The probability of a hike next month has increased.
If we get a solid payrolls print on Friday, say north of 200,000 jobs, I think September becomes a very live meeting.
And if that happens, and the market starts pricing in a second hike in December, then equities are going to be very challenged.
A number, call it sub 150 to 100, probably is the Goldilocks scenario where the markets start to price out, hiking.
Stocks do OK.
And then a number sub 100 will get the markets worried about recessionary-type risks rising again.
And again, that would be bad for equities.
And so it's a very important number.
I think it will set the tone for September absolutely.
And we'll see where we go next week when people come back from holidays.
Let me ask you, though, what about the fact that I remember people saying, oh, you would never see a rate hike right before an election or around the election.
I mean September, December, you're kind of bookbinding it.
But I mean, is that just not valid?
Yeah, I mean there's a lot of conspiracy theorem.
A lot of the Fed governors were appointed by Democrats.
It's probably likely that if Trump won, he would replace Janet Yellen.
So there's a lot of theories that they want to make sure things are all cool before the election.
I don't really buy it.
I don't think that-- I think if they have an opportunity to hike rates, they really want to hike rates because they want to be able to have some ability to cut if they have to in the future.
So if the Fed could hike and no one noticed, they'd love to do it.
The problem is people notice.
And I think that's the issue.
It's the only thing people notice right now, quite frankly, is the Fed.
Companies say whatever they say and it's kind of amazing.
Let me ask you-- we have only what, 90 seconds.
Equities, you see more volatility coming in the fall as per regular seasonality with what's going on with the jobs, too.
Bonds, gold, what do you see there?
Gold's had a bit of a rough go in the last month or so, as it's been light trading.
Again, we're going into higher rates.
I think this is a bit of a cyclical pullback.
These are levels where for an investor with a long horizon of 12 to 18 months, these are decent levels to be buying gold.
For bonds, it's an interesting scenario.
The shorter-term bonds are definitely suffering with the increased likelihood of hikes.
But 10-year time treasuries have actually rallied.
So you've got a flattening of the curve, which is very ominous for the economy, by the way.
I mean, the flat curve is not good for any type of financial institution because it can't make money on the spread.
Yet they seem to.
But anyway, that's-- And so that 10-year bucket is probably going to do OK.
You're not going to get rich, but I don't see a huge precipitous fall in bond prices anytime soon.
Thank you very much.
Michael Craig, he is Senior Portfolio Manager with TD Asset Management, and he joined me here in studio.