Exponentially rising volatility in stocks, bonds, currencies, and commodities has left market pundits around the world scrambling to figure out what’s going on. As analysts search for reasons for the global volatility, what seems plausible one day is quickly disqualified the next when the market veers in a different direction. Scientists have a name for a state of disorder such as this:

Chaos — When the present determines the future, but the approximate present does not approximately determine the future.

You’ll remember that it wasn’t long ago that the plunge in oil prices seemed to be the biggest factor driving stocks lower. At this instant, however, the S&P 500 is down more than its energy subsector. And both oil-related declines have inexplicably been dwarfed by the plunge in financial shares. Market turbulence continues unabated, meanwhile, with equity orbits around the world quickly decaying.

Deterministic chaos – When future behavior is fully determined by initial conditions with no random elements involved.

Finding a grand unified theory to account for this strange behavior has proved elusive, leading to the rise of competing explanations – money moving at the speed of light, the seemingly random fluctuations of previously stable currencies, the steady deterioration of sovereign-wealth funds, and the non-linear pace of what used to be a predictable U.S. economy to name a few. All are unsatisfactory.

Chaos theory – When differences in initial conditions yield widely diverging outcomes, rendering short-term prediction essentially impossible

Coincidentally, scientists last week somehow looked to the collision of two black holes more than a billion light years away to confirm “gravity waves” predicted by Albert Einstein 100 years ago. A good reminder, maybe, to analysts and portfolio managers allocating assets in this unstable market: Gravity still works.

What the markets have been doing…

U.S. markets sold off steadily over the period amid concerns over negative bank headlines and negative interest rates. Stocks did manage to bounce off their lows toward the end, compliments of increased retail sales data and a recovery in oil prices, helping to limit the damage at least a bit. The technology-heavy NASDAQ fared least badly among the major benchmarks, though small caps overall suffered the most.

So far this earnings season, it’s reported that 76% of the companies are beating earnings estimates, while less than half are beating sales estimates. The blended earnings growth rate for this reporting quarter is a decline of -4%, making it the worst year-over-year earnings growth rate since 2009. Not helping the bullish cause was a cautious economic outlook from Federal Reserve, which clearly weighed on sentiment. If you’re a believer in the futures market, patterns indicate that traders don’t expect the Fed to raise rates for the duration of the year. Maybe not even till 2018. That’s the theory anyhow.

Index Friday’s Close Two-Week Point Change Year-to-Date Change
DJIA 15973.84 -(492.46) -(8.33)%
S&P 500 1864.78 -(75.46) -(8.77)%
NASDAQ 4337.51 -(276.44) -(13.38)%

As has been the case so far in 2016, buyers continued to emerge for Treasuries, taking the 10-year note as low as 1.53% before the period-ending retail sales report. The 30-year bond auction on Thursday, which barely avoided the dreaded 2.375% coupon, also helped stall the rally. Volatility remained rampant across the investment-grade corporate market, with banks and energy producers bearing the brunt. High-yield issues performed particularly poorly. The municipal market traded to modestly lower yields given the weaker readings on the growth of the economy.

U.S. Treasury Yield Two-Week Change
2-Year 0.71% -(0.13)%
10-Year 1.84% -(0.20)%
30-Year 2.67% -(0.14)%

Back to the Futures…

chaos

Quote of the Week…

“We see the price of major financial stocks, particularly in Europe, which are truly frightening.”
– Jeffrey Gundlach, founder of investment firm DoubleLine Capital

Number of the Week…

$350 million: The amount U.S. and Canadian oil producers are reportedly losing each day at current oil prices.

What Fund Architects is doing…

More of the same this period, with falling oil prices, diverging monetary policy, and concerns about the Chinese economy continuing to dog the market. The out-sized cash positions we’ve built in all the Fund Architect models, the last measure coming from the preferred stocks we liquidated last period, once again served us relatively well. So did our Treasury hedge, which acted better than cash for us.

On the equity front, the relatively good performance of global consumer staples also helped the Portfolios at least tread water in this very difficult stretch. Overall, the equity share of the Portfolios remains defensive, with no changes to our January allocations.

As we assess the battered investment landscape, we’re beginning to see real opportunities taking shape, most notably the corporate bond market, especially the high yield space. It’s hard not to think there’s real profit to be had there eventually — the trick, of course, is knowing when to get in. For now, we’re willing to be patient and wait for a more definitive signal.

It’s never fun to see the Portfolios struggling, even if they’re struggling less than their peers. But we know from experience the better we maintain assets now, the better our returns will be when the markets inevitably turn around. How far you go forward depends a lot on where you start.


The views in this commentary are those of Fund Architects. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product made reference to directly or indirectly in this commentary, will be profitable, equal any corresponding indicated historical performance level(s), or be suitable for your portfolio. Moreover, you should not assume that any discussion or information provided here serves as the receipt of, or as a substitute for, personalized investment advice from Fund Architects or any other investment professional. The information contained within this commentary should not be the sole determining factor for making investment decisions. To the extent that you have any questions regarding the applicability of any specific issue discussed to your individual situation, you are encouraged to consult with Fund Architects. Information pertaining to Fund Architects advisory operations, services, and fees is set forth in Fund Architect current disclosure statement, a copy of which is available upon request. Fund Architects, LLC is an SEC Registered Investment Advisory Firm.

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