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All Together Now

Posted on September 13, 2016

“...it's worrisome that global markets are moving together as much as they have been.” - Lisa Abramowicz, Bloomberg

2016-09-13_follow_leader.jpgIt’s hard to believe that it’s been over three years now since the summer of 2013 when Ben Bernanke, in a routine press conference, cautiously laid out a hypothetical timeline for tapering off the Fed’s asset purchase (quantitative easing) program. What followed was a synchronized global meltdown of virtually every global asset class, an event that quickly became known as the “Taper Tantrum”. Our Insight the following week unpacked the market’s reaction and described how the Fed had essentially become a “victim of its own rhetoric”. Having spent the previous four years selling the markets on the merits of quantitative easing, it had inadvertently fostered an addiction that would not be easily broken. Weaning the financial markets off extraordinary monetary stimulus was going to be a challenge. 

One conclusion we made back then was that, “Clearly the knee-jerk reaction revealed what very few rational investors would disagree with: that there is at least some artificial value in asset prices as a result of the Fed’s aggressive monetary stimulus of the past four years. Well, here we are three years later and this statement is just as true today as it was back then.

Last Friday we caught a glimpse of the extent to which financial markets are still addicted to monetary stimulus when, in spectacular fashion, stocks, bonds and commodities all tumbled in response to comments made by Federal Reserve officials. First, let’s look at the comments themselves.

Boston Fed President Eric Rosengren said the following to a local chamber of commerce,

“My personal view, based on data that we have received to date, is that a reasonable case can be made for continuing to pursue a gradual normalization of monetary policy.”

That’s it? Yep, that’s it…pretty straightforward. Meanwhile, a little further south, Dallas Fed President Robert Kaplan made these statements to a group of reporters,

"I think the markets have gotten plenty of notice that we are looking for opportunities to remove accommodation…the Fed can afford to be patient and deliberate in its actions…the likely path of rates is going to be flatter, much flatter than we’ve ever experienced historically.”

Again, pretty benign if you ask me. To be fair, however, these two comments weren’t made in a vacuum. Earlier in the week other Fed officials made comments implying that rates could be bumped sooner rather than later and that the case for another rate hike had been strengthening. Additionally, across the pond the ECB disappointed markets by failing to announce an extension to its current quantitative easing program, a program that is not even slated to run out until next Spring which means they still have plenty of time to announce such an extension.

Even so, I simply don’t see how any of the statements made by Fed officials or the ECB provide any new information. They appear to be well thought out comments implying on the margin that policy makers would prefer to move in the direction of less accommodation as long as the economic data supports such a move. This is exactly what they’ve been saying all along!

But the market didn’t see it this way. Stocks (SPDR S&P 500 ETF) were down 2.4%, bonds (SPDR Lehman LT Treasury ETF) were down 1.6% and commodities (iPath Bloomberg Commodity ETN) were down 1.3% on Friday. Virtually everything on our screens was bleeding red, a situation which is relatively unusual but one that clearly reveals how addicted to monetary stimulus the financial markets still are.

One of the interesting dynamics that surfaced during the Taper Tantrum as well as last Friday was a strong correlation across all asset classes. Bonds, in particular, are supposed to be inversely correlated with stocks over time – and especially on big down days. But when the addict is threatened with a reduced dose of monetary policy stimulus, watch out! Nobody wins in that scenario. Bonds get hammered because interest rates are expected to go up, and stocks and commodities get bludgeoned because, well, the incredibly low interest rates are about to be slightly less incredibly low, which is apparently a very negative thing.

The Bloomberg graph below, courtesy of The Daily Shot, illustrates how far outside the norm Friday’s market action was. Each of the yellow dots on the scatterplot reflect the daily performance for S&P 500 futures (vertical scale) vs the long-term US Treasury bond ETF (horizontal scale). The downward sloping red trend line is reflective of the fact that two tend to move inversely, meaning when one is up the other one is down on average, and vice versa. Look at how unusual Friday’s performance was, with the closes comparison being early December of last year which was just prior to the Fed’s first rate hike.

2016-09-13_chart.png

Describing the likely outcome from a marked shift in global monetary policy, Lisa Abramowicz of Bloomberg said,

“Developed-market sovereign bonds would certainly suffer some significant losses, sending ripple effects through stocks, currencies and riskier bonds…it's worrisome that global markets are moving together as much as they have been, leaving investors with few hiding spots.”

It is worrisome indeed, as traditional methods of diversification and risk reduction may be rendered useless amidst some of the most tumultuous market environments in the coming years. When everything is grinding upward, moving All Together Now is not a problem – and quite honestly few people even take notice. But that sentiment changes quickly when asset classes turn over and begin to nosedive in tandem.

As with most of the potential problems we identify on this blog there is no silver bullet. However, some of the things we’re doing to address the known risk are to reduce exposure to rising interest rates in our bond portfolio, allocate to Alpha Strategies managers that theoretically can profit from downward trending asset prices and to search far and wide for investment opportunities subject to more idiosyncratic risk and return drivers. The performance of such investments may not be negatively impacted by broad based selloffs in publicly traded markets. We call this approach Diversification 2.0, and when coupled together with MarketVANE, we believe we have a robust risk management approach that will protect our client portfolios from deep and sustained drawdowns in the stock, bond, or commodity markets.


david_headshot_bw.jpgAuthor David Houle, CFA is a founding member of Season Investments. He serves as the firm's Chief Compliance Officer as well as sitting on the investment committee overseeing the management of client assets. David spent nearly ten years in various roles primarily managing individual client assets prior to co-founding Season Investments. David graduated with a degree in Finance from Colorado University in Colorado Springs in 2003 and earned the Chartered Financial Analyst (CFA) designation in 2006. David and his wife Mandy have three children and spend most of their free time with friends and family.


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Transparency is one of the defining characteristics of our firm. As such, it is our goal to communicate with our clients frequently and in a straightforward way about what we are doing in their portfolios and why. This information is not to be construed as an offer to sell or the solicitation of an offer to buy any securities. It represents only the opinions of Season Investments. Any views expressed are provided for informational purposes only and should not be construed as an offer, an endorsement, or inducement to invest.