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Market Perspective for 8/23/16

1) Investors have seen new highs from all of the major indices in August, but through last Friday the S&P 500 stands less than 0.5% above its July 31st close.<1>  The real action has been overseas.  Emerging markets are up 3.90% in August and developed international markets are ahead by 1.99%.  See Chart 1.   Latin America and Asia have led the way (Brazil is up 14.4% this quarter as everyone expected the Olympics to be a nightmare and that scenario did not come to pass). <2>  That said, I’m concerned that the Brazil story may be a “buy the rumor, sell the news” situation where the market sells off after the Olympics as investors refocus on the fundamentals. Chart 1 2) This Friday Janet Yellen gives a speech from the annual Jackson Hole conference in Wyoming.  The market will probably trade very cautiously this week as concerns grow that she will prepare the markets for a rate hike.  The trade that keeps working is to be short treasuries on the lead up to a rate hike announcement, then to get VERY long treasuries just before the Fed ultimately backs off. 3) The shift to “risk-on’ behavior in the market continues.  Low volatility funds and industries have performed the worst here in August and so far this quarter.  I believe the bulk of the opportunity to benefit from the low volatility factor has passed for the time being as traditionally low volatility sectors like consumer staples, real estate, and utility stocks are richly priced.  However, the time to be really underweight low beta is at the beginning of a bull market when the bear has crushed valuations.  This is definitely not that part of the cycle.  It is increasingly tempting to add risk now because the market is rewarding higher beta stocks, but that always happens near market peaks.  If a tactical manager is doing their work correctly, he or she should underperform at the top of the market cycle because they should be less willing to accept the risk/reward tradeoff at that point. 4) New money market rules – On October 14th, the SEC is imposing a floating net asset value requirement on institutional prime and municipal money market funds.  These funds will be priced to the nearest 1/100th of a cent (i.e. four decimal points).  Retail prime and money market funds will still have a stable NAV.  Other important changes:

  1. Institutional AND retail money market mutual fund boards will be allowed, but not required, to impose a liquidity fee of up to 2% or a temporary suspension of redemptions if a money market fund’s liquid assets fall below a certain threshold.

  2. Those funds will be required to impose a liquidity fee if liquid assets fall below 10%. These changes are what is behind the surge in LIBOR rates to 0.82% last week<3>.  LIBOR will probably go even higher in the next few weeks as corporate liquidity is constrained (in order words, there is a dearth of ultra-safe parking places for institutional cash).  Rising LIBOR rates often signal trouble in the global economy, but this is probably not the case this time. ________ <1> Source:, IVV (iShares Core S&P 500) <2> Source:; EWZ (iShares MSCI Brazil capped), VWO (Vanguard Emerging Markets ETF, VEA (Vanguard developed Markets ETF) <3> LIBOR per YCharts

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