MorningWord 2/17/15: Volatility Will Rule

by Dan February 17, 2015 9:20 am • Commentary

The S&P 500 (SPX) closed Friday on the dead highs of the day, week, month, year and at a new all time high on investor enthusiasm that tensions between Russia and Ukraine would ease with a new cease-fire in place, and that Greece and its financial overlords in Western Europe would come to some sort of agreement to alleviate Greece’s impending liquidity crunch.

Well, this morning our markets are down a touch as violence continues in eastern Ukraine placing the recent cease-fire in a precarious state, and the late week enthusiasm about an extension of the current Greek aid package now looks like a total breakdown of negotiations.  Why are we only down a touch if it appears that this morning there is a greater likelihood that the two worst case scenarios could be converging in Europe? Well to be frank, U.S. investors have spent there share of panic currency on both situations over the last couple years and at this point it would take a perfect storm of Grexit and full blown war in Ukraine with the West arming the latter to cause a real market panic.  As many of you have become accustomed to, markets climb a wall of worry.

Was the volatility early on during Q4 earnings season merely the result of new year profit taking and the short term suspension of corporate buyback activity in and around earnings blackouts? It sure feels like it. At least for now it’s back to the playbook for the last couple years. Although this time around there is one big wrinkle and that will be magnified on Friday March when we get a look at the February Jobs data. If it shows mild wage inflation, as it did in January, the FOMC (at their March 18th meeting) may have no choice but to hint at rate hikes in early summer. This will be the main event, not more sanctions on Russia, or a managed exit for Greece from the EU.  I would be very surprised if the bull market in U.S. stocks and bonds was derailed by some sort of external event, as our currency, bonds and stocks have been treated as a safe haven asset on almost every dust up around the globe for the last five years.  It is my belief this bull run which was created and maintained by the Fed is likely the only institution that could cause its demise.

The Fed is in a fairly impossible situation, if they fail to raise rates and the economy continues its mild improvement, then equities and most other U.S. dollar denominated risk assets will melt up in a world where almost every other major central bank is focused on debasing their currency vs the dollar.  This scenario only ends one way in my opinion, a serious correction/ crash, and one that could include a protracted bear market like 2000 – 2002, not an immediate bull market like 2008/2009.

If they get to hawkish too soon then they threaten the pace of the recovery and possibly cause the next recession in which case we also see a serious correction, and one in which the Fed suddenly finds themselves with very few bullets to try to fix.  Not to bum you out, but there is money to be made in both scenarios, and I suspect we get the former, melt up and then crash at some point, and nimble traders will welcome this scenario, as volatility will rule.