Most investors must have heeded my advice last month to enjoy the rest of the summer. August was the second lowest volume month in the last five years, so there wasn’t much trading going on. The stock market was weak in August primarily due to the concerns brought on by Syria in the Middle East. The S&P 500 was down 3.1%, its worst month since May 2012. Bond investments lost value as well with interest rates continuing their climb that started four months ago.
The good news? Stocks are still up strong for the year, and a few months of ebb and flow is welcome if overall volatility can remain tame. When we see the volatility index (VIX) rise above 20, then we may begin to have some concerns. For now, we see August as yet another knee-jerk reaction and are hopeful that the Dow will regain its 15,000 point status in the near future. Syria is just part of the news cycle.
In fact, Ned Davis Research did a study where they tracked the performance of the Dow Jones following the start of major wars,short wars, and crises that did not result in war. The results showed that only in cases of major wars was the market lower over the subsequent nine months (by around 4.5%). Following crises that do not result in war (the category I expect the current Syrian situation to fall into), the Dow was up an average 5% after nine months. Past results do not represent the future, but we still believe that stocks have more upside than down at current levels.
Last month, I discussed how the fear of the Fed slowing down its quantitative easing (QE) programs has caused rates to increase and, in general, dampen markets. Well, let’s assume that the recent jump in interest rates has nothing to do with tapering concerns. Could it is just be another QE bounce? As the chart shows, the change in interest rates since the start of QE3 is in line with the rate change seen shortly after the announcement of QE2 in 2011. Surprisingly, our most current rate spike hasn’t yet reached the magnitude of the rate change seen in 2009, which came after the original quantitative easing measures were put in place (QE1). After both of the first two QE measures, rates eventually reversed course and hit new lows, just as the Fed had hoped.
Could the same thing happen again? Are interest rates giving us a Heisman head fake on their way back to historic lows? It is doubtful, primarily because our economy has improved on so many fronts. For arguments sake, let’s assume some combination of events drive rates back down. Then bondholders would be right back where they were last year; little upside potential with a lot of downside liability. So regardless, investors need to be wary of interest-sensitive investments.
September is traditionally a challenging month for stocks. I hope yours will at least be pleasant, if not profitable!
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