The Great Disconnect
Author: Portfolio Specialist Group
February 13, 2018
Equity markets continued to sell off in a big way last week, as the pullback that investors have been anticipating for some time has clearly arrived. The speed at which this unfolded has been surprising, however. The VIX spiked 84% on February 5th, the largest single-day increase on record, the Dow saw intra-day swings of over 1000 points during the week and the S&P 500’s impressive rally to start the year in January was effectively wiped out in a matter of days. The timing was also surprising, occurring in the same week that Washington agreed to nearly US$300 billion of spending over the next two years.
Importantly, despite what financial news outlet headlines might suggest with some comparisons between the recent damage to past market downturns, the ‘flight to safety’ trade one might expect has not occurred, at least not to a material extent. The yen rose around 1% against the U.S. dollar, not particularly notable, and high yield bonds were surprisingly stable for some time before selling off significantly towards the latter part of last week.
Until recently, the relationship between the S&P 500 and U.S. 10-year Treasuries was fairly pronounced, with higher rates and higher stock prices moving in tandem. In a world with benign inflation, higher rates were seen as being brought on by stronger economic growth. However with recent signs of inflation, this relationship has broken down, as Treasuries have held in fairly stable and even moved slightly higher, while equities have suffered a significant correction. This latest inflection point began at recent market highs on January 26th.
Source: Bloomberg, February 2018
Despite a positive start to the week for North American equity markets with most major indices up over 1% on Monday and relatively flat on Tuesday, bouts of volatility are expected in the days ahead. We maintain a firm belief that the economic backdrop and company fundamentals remain positively positioned and the current cycle has yet to reach its peak.