Friday’s Sell Off Likely Ushers in New Bout of Volatility

Stocks sold off hard on Friday (9/9). The market plunged in the first hour of trading, fell steadily throughout the day and closed with a rush of selling in the final hour of trading.

All told, the major market averages fell 2.5%. All ten S&P sectors declined on the day, led by utilities (down 3.8%) and telecom (down 3.4%). The best performing sector was financial services (down 1.9%).


The media attributed the selling mostly to comments by Boston Fed President Eric Rosengren, a dove on interest rate policy, who said that the gradual normalization of interest rates may be necessary now to prevent an overheating in the economy that could jeopardize the cumulative gains in employment.

Besides the plunge in the stock market, yields on long-term Treasury securities rose. The 10-year yield rose 6 basis points to 1.67%, its highest level since the end of June, and the 30-year yield rose 7 basis points to 2.39%.

Surprisingly, short-term Treasury yields, which would be most affected by a rise in the Fed Funds rate, were little changed.

Taken together, the moves suggest that a hike in short-term rates may not be imminent, but an end to this extended period of exceptional monetary accommodation is now on the horizon.

Although the stock market may have been spooked suddenly by the prospect of rising interest rates, there had been signs beforehand that a more decisive shift in Fed policy may be at hand.

On the previous Friday, long-term Treasury yields rose, even though many economists suggested that the weaker-than-expected gain in payroll employment would cause the FOMC to hold rates steady in September.

Perhaps in anticipation of Friday’s sell-off, long-term Treasury yields rose on Thursday (9/8) by 7-9 basis points.

Contrary to widely-held beliefs, I believe that many investors would welcome a steady, gradual normalization of interest rates, because it would raise confidence about the longer-term prospects for the economy.

Whatever the reason for Friday’s sell-off, it should not be ignored. Prior to the plunge, the S&P 500 had not recorded a daily move of 1% or more for 48 consecutive trading sessions (going back to the sharp recovery from Brexit-related losses on June 30).

Although it is very difficult to say whether stocks will trade up, down or sideways in the next few weeks, Friday’s sell-off will likely usher in another period of heightened volatility.

Given the advanced age of the current bull market, heightened geopolitical risks (including the U.S. Presidential election) and the fragile nature of the global economic recovery, I think that a more significant setback for stocks (and the rest of the global financial markets) is inevitable; but predicting the timing of the switch from bull to bear is always difficult.

On the other hand, the latest round of data do support the possibility of a sustainable of economic recovery. Besides the solid gains in employment and increases in personal income, industrial production has rebounded over the past two months, after a steady string of declines. However, the recent drop in the PMI’s below 50 raises the concern that rebound in industrial production may only be temporary, driven perhaps by the fall in the dollar earlier in the year. If so, GDP may struggle to reach consensus expectations for growth of 2%-3% for the balance of the year.

September 12, 2016

Stephen P. Percoco
Lark Research, Inc.
839 Dewitt Street
Linden, New Jersey 07036
(908) 448-2246

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