Saturday, 17 December 2016
Weekend readings, 2016/12/16
Fed Turns Hawkish, by Tim Duy: The FOMC raised the target range for the federal funds rate by 25bp today, as expected. But the tone of the press conference and the summary of economic projections were more hawkish than I anticipated. The Fed is shifting gears, a shift I did not expect until more data piled up in the first quarter of 2017.
Fed surprises market by turning more hawkish faster resulting in a pause in the rally.
However, the purchase of $VIX calls doesn’t have that problem. We usually recommend that one buys $VIX calls about 33% out of the money. $VIX Jan futures are trading at 15.53 (see table above), so 33% OOM would be the 21 strike, roughly. Those calls cost 1.00, but they will be “in play” even if $SPX rallies. Suppose that $SPX rises to 2300 and then corrects, $VIX should easily surpass 21 in any sort of correction, so these calls are much more dynamic than $SPX/SPY puts.
The article explains in an easy to understand manner how to determine if buying volatility protection is actually cheap or not.
Even more concerning for the stock market are current valuations. Right now the S&P 500 index trades for roughly 20.5 times estimated earnings for the calendar year 2016. The average trailing 12-month price-earnings multiple over the last 50 years is 16 times. Market bulls are quick to point out that interest rates are sitting at below average levels, so stocks deserve to trade at above-average prices. That may be true, but interest rates are on the rise, and over the last five years, as interest rates reached record low levels, the S&P 500 index traded between 15 and 20 times trailing earnings. As interest rates rise, stock valuation multiples should go down, not up.
A balanced analysis of where the S&P 500 might end up for 2017.
The popping of the 2015 stock bubble, and the subsequent devaluation of their currency in August of 2015 had major reverberations in our markets that lasted for months and resulted in two 10% declines in the S&P 500. And then to start 2016, fears of slowing global growth, particularly China, and the popping of a credit bubble caused mayhem in our markets in Jan and Feb. Translation, any pick up in volatility in Chinese stocks is worth keeping an eye on.
Some warning signs in land of manufacturing seen on the charts and in headline news.
The disastrous history which has accompanied EVERY extended Unified Republican Government (or control of Congress) since 1900.
A sign of things to come longer term?