Volatility Returns Update – Markets Enter Correction Territory

Read the original article here – Volatility Returns – Exploring the Reasons and What Happens Next

The S&P 500 index (Large Caps), S&P 400 index (Mid Caps), and the S&P 600 index (Small Caps) have all violated their 100 day moving averages, but look as if they may be finding support as they near their 200 day moving averages. A “tell” that the sell-off may be overdone is the high in the NYSE new lows did not exceed the highs they set earlier in the week suggesting the sell-off may have run its course. The below chart shows NYSE new lows, you can see they peaked two days ago.

NYSE New Lows Index

It is interesting to note that the Small Caps are showing recent relative strength versus their Larger Cap brethren since the sell-off began in February, as we can see from the relative strength chart below. This suggests that selling is in the bigger more liquid names, more a hallmark of transient sell-off rather than a longer-term one driven by economic worries.

S&P 600 Small Cap Index / S&P 500 Large Cap Index

We do not think that this is a credit event as spreads have not widened meaningfully. Credit spreads on BB-rated Bonds widened more, on a relative basis, than the riskier CCC spreads. This suggests that investors are focused on interest rate risk rather than credit risk, as well as any liquidity needed by investors to meet margin calls is being derived by selling the more liquid names, the BB.

Rates have been rising on fears of higher inflation because of a stronger economy and a potentially more aggressive Fed regime of hiking rates. But we feel that the fears of higher inflation, and a more aggressive Fed are overdone. One current “tell” is Utilities, a sort of canary in the coal mine for rate sensitivity. Recently they have been the best performing sector on a relative basis since January 26th, suggesting the rate rise may have run its course. Also, the fact that the Materials and Energy sectors have been the first and third worst performing sectors since January 26th suggests that inflation fears are overdone.

One current “tell” is Utilities, a sort of canary in the coal mine for rate sensitivity.

US Dollar index has also been showing strength since the February sell-off began. This is suggestive that the US economy is sound and that US markets may be an attractive place for foreign investors to consider putting their money to work. US markets have lead on the way down and should lead on the way back up, or at least lead the way to a halt in the declines.

US Dollar Index

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