That was fun.
The past two months have provided a good reminder about risk for all kinds of markets. First, volatility is back in the equity markets after hiding for all of 2017. Regardless whether the catalyst was the breakdown of a VIX exchange traded note (potentially front-run and punished by high frequency trading machines) or the realization global central bank balance sheets may actually start to unwind, the markets were long overdue for a correction having had 15 straight months of positive returns. Foreign equities continue to provide better relative valuation than US counterparts. But then again, value seems subjective these day. Applying traditional financial valuation methods to Amazon would generally tell you to avoid the company. But the man on a mission methodology that is still working for Jeff Bezos and Amazon looks like it is trying to be replicated by Elon Musk and Tesla. Neither Bezos nor Musk are building companies, they are building brands that people can identify with, can relate with and want to associate with. How does this get valued? Do the traditional models need to broaden their time horizon and scope? Certainly, Nike has been brand building for a long time, as have other brands, but usually the companies generate a profit at some point.
Is the long-awaited rate change here?
The current interest rate environment appears to be similar to 2016; with some important caveats.
In 2016 the bond market had its biggest selloff since 1990 when the narrative changed from steady, low interest rates to the futures market predicting 3 or 4 rate hikes in 2017 and the certain recession the hikes would cause. Bonds rallied throughout 2017 and the agreed upon narrative is that we are further away from recession now than we were then.
Narratives change quickly now that the world reacts to these new “truths” with amazing speed. The 30-year treasury has been in rising price/lower yield trend since 1983. Many careers have been lost betting on the change in this trend. The 30 year is once again bumping along the upper bounds of that channel. A meaningful break in that channel would be more significant worldwide than any comments from the various central banks. The channel is very formidable resistance. If this happens we should know very quickly if the fed drives the bond market or does the bond market drive the fed. The current narrative is that the fed drives rates and only fools would say otherwise.
The short end of the curve is rising and this is creating a lot of tension as short rates rising puts pressure on longer rates to do the same. If there are 4 rate rises this year we will likely either have an inverted yield curve or longer rates will break their 30 year channel and will be in territory that they haven’t been in since the 1970’s.
As the dollar is still in a downtrend and as our rates are still much higher than in Europe and Japan there should be continued demand for US dollar denominated fixed income even as the Fed unwinds its balance sheet throughout 2018.
A post on this blog in 2017 discussed my fascination with valuations. Does the internet itself have societal value, similar in nature to the interstate highway system in the US? What about open protocols build on top of the current internet? These new protocols have a byproduct: cryptocurrencies. The amazing rise and subsequent hype surrounding the largest cryptocurrency in late 2017 was spectacular. Bitcoin started 2017 around $1,000. While the value of it and other coins may fluctuate wildly, far more important details like governance, regulation and scalability of blockchain protocol are still being sorted out behind the scenes. Some are comparing it to the early stages of the internet when TCP / IP was being tested, developed and adopted.
As these new protocols evolve, there will be fits and starts and the current leaders may not be in the top spots in 2-3 years. If you decide to invest is crypto currencies, it is important to understand the risks. They are highly speculative in nature and can be stolen if proper vigilance isn’t taken.
If you have questions about this recent volatility, or anything presented here, please reach out to us.