Nine sessions, eight gains for the S&P.
Another day, another record high for US equities.
And a partridge in a pear tree.
This is shaping up to be a much merrier Christmas for investors than 2018’s holiday bloodbath.
Sunday marked the one-year anniversary of Steve Mnuchin’s infamous “liquidity” check calls to Wall Street. “The CEOs confirmed that they have ample liquidity for lending to consumer, business markets and all other market operations”, Mnuchin proudly declared, in a totally inexplicable December 23, 2018, tweet.
It was true that markets were coming off their worst week since 2011 and that the VIX had spiked to 30, but Mnuchin made it seem as though the government was in Defcon 1.
Minutes after Mnuchin’s press release, we called the move “an example of a man doing the exact opposite of what he should do when it comes to reassuring nervous investors”. We continued:
Even if, by some Christmas miracle, it manages to bolster sentiment, this was an extremely ill-advised move. While there are unquestionably concerns among market participants about liquidity, it’s not clear that anyone is worried about banks’ ability to extend credit to consumers and businesses in the very near-term.
There was no Christmas miracle. Or, actually, there was. Four days later, rebalancing flows helped a battered and bruised market recover some lost ground, but not before Steve’s epic own-goal sparked a small panic.
Relive Christmas 2018
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Donald Trump’s Christmas Eve day tweet about Jerome Powell’s golf game was the icing on the cake.
“The only problem our economy has is the Fed. They don’t have a feel for the Market, they don’t understand necessary Trade Wars or Strong Dollars or even Democrat Shutdowns over Borders”, Trump lamented, in an absurd tweet that blindsided nervous markets at 10:55 in New York. “The Fed is like a powerful golfer who can’t score because he has no touch — he can’t putt!”, the president shrieked.
Stocks, which were trying to recover, knee-jerked lower on their way to a 2.7% loss for the session, the fourth consecutive down day.
From the time Trump struck a trade truce with President Xi in Argentina to the closing bell on the shortened Christmas Eve session, US equities plunged more than 15%. Ultimately, it was the worst December for stocks since the Great Depression.
And yet, a bear market was averted by the slimmest of margins, thanks almost entirely to the rebalancing flows that came calling later that week. The bull lived on. And, in 2019, it raged, goring skeptics and confounding those who pulled money out of equities in favor of bonds (although fixed income was no performance slouch this year either).
Just as the bull market lived, so too did the expansion. Both are the longest in history.
As we celebrate the anniversary of the comedy of errors that transpired this time last year, it’s worth noting that volatility is unlikely to find its way back to the 2017 bubble lows, if we are, in fact, late cycle.
“Fundamental risks arguably still do matter at some level for the future outcome of volatility — though it’s been hard to see how they have directly driven volatility in this era where markets have been slaved to central banks”, BofA’s equities derivatives strategists muse, in a note looking ahead to the new year.
“However, with the US now in its longest economic expansion in history (since 1900), it’s hard to argue we aren’t late in the economic cycle”, they continue, adding that “from a volatility standpoint, going back to 1928, we find that volatility tends to rise in the last quartile of a bull market, when equities are still rising, by definition”.
(BofA)
You could easily point to the power of the printing presses and the lessons learned in 2018 by those who operate them, in the course of arguing that only a fool would be long vol. at a time when central banks are keen to prove that while their ammo may be low and their powers commensurately diminished, they are not to be trifled with.
And yet, as BofA writes, “there are reasons to believe that if we are either late cycle with risk of a recession rising or even witnessing the last stages of this bull market, volatility should be supported”.
We’ll leave you with some food for thought from Goldman:
For most of 2019, falling real yields globally have supported risk appetite and helped buffer volatility. But over the summer the correlation of the VIX with US 10-year TIPS yields turned sharply negative. The same was the case during the Tech Bubble Burst (2001/02), the GFC (2008), the Euro area crisis (2011) and the EM/Oil crisis (2015/16). Lower real yields from here could signal the Fed shifting away from its mid-cycle narrative, and increase concerns on ‘monetary impotence’, i.e., no growth pick-up despite easing financial conditions.
(Goldman)
