Volatility is Back and Good, Old Trading Fundamentals May Get a Play

Let the market fundamentals kick in. Today’s triple-digit drop among the Dow Jones components at the open may be considered a return to good, old-fashioned trading based on real market issues rather than speculative remarks. After a yawn of a summer in the markets, are traders finally getting back to the nitty-gritty of trading?

Today’s rollercoaster ride appears to have been fueled by the International Energy Agency’s closely watched monthly report. In it, the IEA alerted markets to a drop in global oil demand that could stoke a global oil glut. (See below.) That appeared to tank oil prices, wiping out Monday’s gain and then some. At the open, October West Texas Intermediate crude (CLV6), was down better than 2.5%, below $45 a barrel again, after yesterday’s close of $46.29, and flirting with a further dip.

About Yesterday’s Trading Action
Let’s chalk Monday up to the One Percenters. All three major benchmarks crossed the 1%-mark in gains during a rapid-fire trading day that recovered a big chunk of Friday’s market losses. Like Friday’s ugly meltdown, and, really, like many sessions in recent months, it was the Federal Reserve that fueled Monday’s moves.

Three Fed members—only one carries a vote—all offered dovish comments about stepping up interest rates too quickly. That appeared to give the interest rate-sensitive markets something to rally about, much like Friday’s hawkish remarks from a Fed member gave the markets something to cry about.

The Dow Jones Industrials (DJIA) sprang 239.62 points, or 1.32%, to 18,325.07 at the close after jumping as high as 273 points in intraday trading. On Friday, it lost nearly 400 points. The S&P 500 (SPX) saw all 10 of its sectors rebound, finishing the session at 2,159.04, up 1.47%, or 31.23 points, recovering much of Friday’s 2.5% fallout. The Nasdaq Composite (COMP6) took in the biggest percentage gain, advancing 1.73%, or 88.76 points to 5,211.89.

What was all the glee about? After Boston Fed President Eric Rosengren said Friday in a speech that a “reasonable case can be made” for hiking interest rates, Fed Gov. Lael Brainard hit back Monday with a call for “prudence” in raising rates in her speech in Chicago. (See below.) And in his speech Monday, Atlanta Fed President Dennis Lockhart acknowledged that the economy justified a “serious discussion” about an increase, but noted that he didn’t “feel that we are incurring the costs of patience that put a lot of urgency on the question of raising rates.” His cohort at the Minneapolis Fed, Neel Kashkari, said “there doesn’t appear to be a huge urgency to do anything, frankly” in a CNBC interview.

There appears to be a Federal Reserve on the brink of making a decision on whether to raise interest rates in a quandary of great proportions. They just can’t all agree to agree. But remember this: It is Chair Janet Yellen who gets to make The Call. At Jackson Hole in late August, she said, “In light of the continued solid performance of the labor market and our outlook for economic activity and inflation, I believe the case for an increase in the federal-funds rate has strengthened in recent months.” Has that changed in two weeks? Hard to tell from a Fed Reserve point of view, given all the dissenting opinions. But the Fed goes silent now ahead of its meetings Sept 20-21. Until then, the fed funds rates still sits in a range between 0.25% and 0.50%.

On Monday, the Volatility Index (VIX), the measure of market uncertainty, retreated 13.37% to 15.16 amid Wall Street’s stabilization and after its 40% surge Friday. As noted yesterday, the VIX typically turns higher when stocks are falling, largely generating extreme readings during times of market uncertainty, negativity and panic.

Treasury bonds lost a little yield gusto Monday as prices inched up. The yield on the 10-year note slipped a little more than half a basis point to 1.67%.

What She Said. The Wall Street conspiracy theorists had it wrong: Lael Brainard has been and apparently still continues to be a dove on the issue of raising interest rates. “The case to tighten policy preemptively is less compelling,” she said in a speech to the Chicago Council yesterday. The Wall Street rumor mill—or was it the wish-list pro rate-hike group?—had her giving a hawkish speech as a message to Wall Street that, indeed, a rise in interest rates was in the cards for later this month. Her speech was not in the least bit hawkish and appears to have added more uncertainty to an already murky picture.

“Seven years into the expansion and with little sign of a significant acceleration in activity, the low neutral rate looks likely to persist,” she said. “Indeed, developments over the past year confirm that the underlying causes will be with us for some time. Foreign consumption and investment are weak, while foreign demand for savings is high, along with an elevated demand for safe assets. Productivity growth, which increased at an average annual rate of nearly 2½% from 1950 to 2000, has increased only a half percent on average over the past five years, and demographics also suggest a persistent slowing of the labor force.

“Several econometric models and estimates from market participants suggest the current real neutral rate is at or close to zero, and any increase is likely to be shallow and slow,” she added. “These estimates imply that it may require a relatively more modest adjustment in the policy rate to return to neutral over time than previously anticipated.” The markets appeared to like her comments, given the Monday rally, but the uncertainty still remains.

Goldman on Fed Odds; SPX. In the wake of Brainard’s comments and a clear signal that a move higher on interest rates was imminent, Goldman Sachs’ economists, led by Jan Hatzius, slashed expectations of a Fed rate hike in September to 25% from 40%. In a note to clients, the group also upped its odds that a rate was on tap for December to 40% from 30%. “The lack of a signal is meaningful because if action were likely, the committee would normally make an effort to nudge the market toward anticipating a hike,” the note said.

Meanwhile, its equity strategists, led by David Kostin, are warning that the SPX is on a downward path to close the year out at 2,100, about 2% lower than yesterday’s close on Friday. “’Fat and flat’ is a catchy phrase, but ‘sideways, down, and up’ more accurately describe the path of the US equity market during the past two months (sideways), our forecast through year-end (down 1%), and recovery during the subsequent nine months (up 4%),” that report to clients noted. “We forecast the S&P 500 will follow a ‘fat and flat’ trajectory over the next 12 months and finish at 2,175, roughly 2% above” the current level. How meaningful is that projection when the SPX has moved that much in two days?

About That IEA Report. Here’s what the International Energy Agency said about an oil glut on the horizon, according to the Wall Street Journal: “The IEA—which advises oil-consuming countries on their energy policies—blamed “wobbling” Asian oil demand and falling oil consumption in Europe for much of the change. The Paris-based agency downgraded its global oil-demand predictions by about 100,000 barrels a day for this year—although it is growing by 1.3 million barrels a day. It also reduced the forecasts by about 200,000 barrels a day in 2017, with consumption increasing more slowly at 1.2 million barrels a day.

“The tapering of demand growth comes despite oil prices remaining below $50 a barrel for much of the year, over 50% below 2014 levels.

‘The stimulus from cheaper fuel is fading,’ the IEA report said.”

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