The first quarter of 2017 saw both U.S. and foreign stocks advance, with emerging markets leading the way. One of the best performing asset classes for the quarter were precious metals, with silver up 14% and gold up 8%. Crude oil fell 5% in the quarter with the S&P 500 energy index down 7%. Intermediate bonds, as measured by the Barclays Aggregate Bond Index, posted a return of close to 1%. As many asset classes rose to start the year, one could observe a corresponding fall in the VIX, or volatility index.
But why has volatility decided to take a holiday, leaving the financial markets cool, calm, and copacetic? There are several likely reasons.
- First, the Trump phenomenon. Since the presidential election last November, investors have embraced the notion that President Trump will enact a pro-growth, pro-business agenda leading to accelerating economic growth. Operating on this belief, many market participants are reluctant to sell stocks and are eager to buy them on any dip.
- Second, global central banks, especially the European Central Bank and the Bank of Japan, continue to pump enormous amounts of liquidity into the global financial system. These actions, along with the many previous actions since the Great Financial Crisis, have convinced investors that central banks will only allow financial markets to fall so far before re-starting their money printing programs in attempt to arrest any significant decline. In essence, markets believe in the central bank put.
- Finally, because volatility has been so low for so long, many investors, including institutional investors, have decided to sell volatility and collect the premium dollars. The more this is done, the more volatility is suppressed, until the moment when it isn’t.
It is interesting to observe the current setup of the U.S. equity market. The VIX, or fear index, as it is sometimes called, is on life-support at a time when expectations for President Trump’s policies, which have yet to even be passed, are being factored into stock prices. On numerous historically reliable valuation metrics, U.S. stocks are very expensive. In addition, the U.S. Federal Reserve is talking tough about tightening monetary policy, indicating two more interest rate increases are likely this year. This in spite of the Federal Reserve Bank of Atlanta’s most recent GDPNow forecast for Q1 growth of just 0.6%. Doesn’t seem like the time to be tightening monetary policy, does it? Having enjoyed one of the least volatile quarters in the last 30 years, investors may be succumbing to recency bias, assuming the future path of the market will closely resemble the past. Oh to live in a world of ever rising markets with no volatility. How nice it would be. But alas, that is not reality.
As 2017 unfolds, we expect financial market volatility to increase. As is always the case, there are many things for an investor to worry about. From rich valuations, to European elections, to credit growth in China, to geo-political worries, there is no shortage of events that could introduce fear into the market at any moment. In this environment, our strategy remains focused on building a diversified portfolio comprised of multiple asset classes, while executing our value discipline in how we allocate capital amongst competing investment alternatives, always focused on the risk/reward for you, our clients. While we would all love to have the VIX, or fear index, pinned to the mat and enjoy smooth, predictable returns, history reminds us this is not the ride investors should expect. But come what may, please be assured we remain diligently focused on helping you achieve your personal financial goals. Thank you for the trust you place in us.
Financial Planning Focus
Tax season brings with it a variety of stresses, one of which produces a question that unfortunately doesn’t end when you file your taxes—what if I get audited? But there’s good news when it comes to audits! Audit risk is the lowest it’s been in nearly 15 years. In 2016, the IRS audited only .7% of individual tax returns. That’s 7 audits for every 1,000 returns filed. Many can rest in those statistics, but there are certain things to be cognizant of that will put you at higher risk. Continue reading...