Bull Market with Higher Volatility

• After a volatile February, investors asking if this is the end of the bull market
• The correction might have been only the appetizer
• The bull market is still in force but the days of super-low volatility are over

Investors went overly bullish into 2018. Despite the macro risk factors of high asset valuations, rising interest rates and perpetually increasing debt, investors’ sentiment peaked at the highest level in almost five years in January 2018. Even Bloomberg asked: The Stock Market Never Goes Down Anymore? Volatility, measured by the VIX, dropped below 10. But when everybody is a bull, who is left to buy? And this is exactly what happened.

In February, the equity market corrected. Within ten days the S&P 500 Index lost almost 12% and eventually closed the month with a loss of -2.7%. Volatility returned in a big way. The VIX spiked so hard that two banks, Credit Suisse and Nomura, announced the shuttering of their respective Exchange Traded Note (ETN) products that bet on lower volatility. Also our Returnboost portfolios saw drawdowns between -7% and -10%, the largest ones since 2015. However, they recovered quickly.

Despite all the negative press, the bull market in stocks remains in force and our portfolios continue to be long in U.S. and international stocks as well as in commodities. The weakest asset classes are U.S. REITs and U.S. Bonds. We already exited these asset classes in Q4/2017. Some of our portfolios hold 10% to 20% cash. For now, the February drop seems to be only the appetizer, not the main course — which is still to come.

With Real Federal Fund Rates (Fed Funds minus Core CPI) remaining below zero, a potential inflection point could be in the second half of 2018 when Real Fed Fund Rates climb above 1%. For many strategists, Real Fed Fund Rates have more influence than the yield curve.

The S&P 500 had only eight down days in excess of -1% in the last 12 months. We do not expect this to continue. Investors need to be prepared to stomach higher volatility, which means larger drawdowns. This year’s boom in financial markets has taken things to “late cycle” but the cycle has still some gas left in the tank.