The Return of Volatility

First real volatility in over a year and the markets seem to be in a tailspin. The sense of dread that gripped equity markets earlier in the week suddenly re-emerged mid-Thursday as the Dow slid over 1,000 points on concern that rising interest rates will drag down economic growth. Thursday’s 3.8% loss took the S&P 500’s decline since its Jan. 26 record past 10%, meeting the accepted definition of a correction. The Dow finished the day down by 1,032.89 points, or 4.15% at 23,849.23. Ten-year Treasury yields fluctuated near their four-year highs. Traders remain on edge after the resurgent threat of inflation and higher bond yields had helped trigger the burst of volatility and a pullback across the overheated global equity market.

Bulls may have to question the wisdom of buying the dip when more selling by speculators may be imminent. This week’s Treasury auctions have underwhelmed, raising the prospect that the debt selloff could steepen. Investors are also facing the prospect of Fed tightening, which could cool growth.

Above was the lead story on CNN Money this evening and it sums up what is happening, but the real question is why the selloff is so steep so quickly? After running up over 18% in one year it seemed the markets could do no wrong. And with tax cuts, less regulation and earnings growing in the double digits many forecasts for the economy show it could accelerate to 4-5% growth this year and into next. So, what could cause the markets to react so quickly to the downside?  Well, in a word “bonds”. Money has been so cheap for so long now going on almost a decade at under 3% on the 10-year U.S. Treasury bond, markets are finally waking up to the fact the Fed is poised to raise interest rates this year and possibly into next. Depending on how fast interest rates rise it could slow down economic growth and put us into a recession. Of course talk of a recession is premature as the US economy is set to expand this year with numbers looking good from almost every area.

So, if the concern is rates increasing and the market is already expecting 3-4 rate increases this year why is the sell off so steep?

The second part of the problem is computer driven program buying and selling. Gone are the days where individual investors and large institutions control the volume and daily movements of the market. This is the first real downturn we have seen where program selling is driving the vast majority of the selling to the downside. Due to the large amount of dollars being put to use inside this type of environment it’s almost like a self-fulfilling prophecy as markets go down more program trading kicks in and wash, rinse and repeat. However, this same will happen at times on the upside as we saw earlier in the week when the Dow opened down 600 points at the open only to rally 1,000 points in the first hour of trading.

We still believe in the strength of the economy and foresee markets doing better throughout the year as earnings increase and markets do not rally too much and get overvalued too quickly. We continue to monitor and control risk. Earlier this week we sold some equities in a few of the models and bought a short hedge to the S&P 500 to give us inverse exposure to the equity market. In the income portfolio we also added a bond short to off-set the interest rate risk in that interest rate sensitive portfolio. Only two days after our original trades we are close to needing to rebalance again and if the selling continues tomorrow we could be adding even more short hedges to the portfolios. The good news is we constantly monitor the risk we are taking in the portfolio on both the equity and fixed income side. The Algorithmic Virtual Advisor (AVA) is doing what it should by lowering risk in times of volatility and taking that risk off the table when volatility decreases and there is more opportunity to the upside.

We know times like this can be frustrating when the losses seem so quick and severe but we have protections in the portfolio to limit those losses when they happen and to adjust when needed. We thank you for your continued trust and confidence and we can ensure you we are doing everything in our power to protect the portfolio and make good decisions that do not harm us when the market turns around.

Dan Bauer is the CIO of Altruistic Investing LLC, an Algorithmic Virtual Advisor, based in Colorado Springs, CO. www.altruisticinvesting.com Altruistic Investing LLC is a Registered Investment Advisor (Firm CRD# 289016 / SEC#801-110892) with the Securities and Exchange Commission.

This article does not represent an investment recommendation or endorsement of any kind. Please consult with your advisor regarding your specific situation. Investing in securities does involve risk of loss that clients should be prepared to bear. The risks can range from failing to keep pace with inflation to losing some or all of the money you invest.