Then there are days like last Friday and today.
The market narrative is relatively straight forward: Wages are firming, inflation is finally manifesting itself and, as a result, rates are going to rise. That, as you know, will be the end of the world as we know it. Thus the sell-off.
That sell-off narrative is also closely correlated with the rapid rise in rates. So, it must be true.
What Seems True May Not Be
But if you look a little deeper, what seems true on the surface may not be entirely true. The list of anomalies is quite large, in my opinion. Relatively speaking, currently:
- Utilities are doing quite well. Why would that be the case, if rates were the driver of the markets?
- Value is NOT doing very well. Why would that be the case, if rates were the only driver of the markets?
- Investment-grade credit spreads are holding steady, while high-yield spreads are getting hit hard. Typically, that is not the case in a rising rate-driven market.
I think what we had this past Friday is a relatively endogenous market event: An old-fashioned market risk-off related sell-off.
While the net result is the same, it is important to analyse the cause to see how the markets will react in the aftermath of Friday’s sell-off.
Given the likelihood of global economies doing quite well in the first half of 2018, the likelihood that global rates remain in a sell-off for some time can’t be ruled out. If higher rates are the primary driver, a lot of caution on the part of investors is warranted in the near to even medium term.
On the other hand, if it is a simple risk-off event and not primarily driven by rates going higher from a cyclical standpoint, the outlook for the markets is relatively sanguine.
While the next few days will likely prove the thesis one way or the other, I am voting for the second proposition: It’s a typical risk-off event, and this too shall pass.