Markets don't like uncertainty, and risk assets typically trade lower and volatility increases as uncertainty rises. This is the environment driving market action in 2015.
Last week was very active for the markets, as volatility increased to a new level. We expected the 10-Year Treasury to hold key support at 1.86%; however, the market traded below that level last week, as low as 1.70%. Other markets -- such as equities, commodities including oil, and currencies -- all experienced heightened volatility as well. So what drove this heightened uncertainty?
The market was caught off guard by the announcement that the Swiss National Bank (SNB) is no longer going to support the cap on the franc versus the euro. The abrupt and unexpected action by the SNB created a contagion effect that is beginning to impact firms across the globe. This action has heightened the markets sensitivity to the European Central Bank (ECB) meeting this week, where it is expected that a quantitative easing program will be announced.
We believe that the SNB announcement, along with the collapse in oil prices, will have lasting implications on the market. Additionally, record low interest rates around the globe continue to raise worries about a prolonged period of deflation. For example, if you buy a German 5-year bond for $1,000,000 today, at the end of five years you will have received total payments of approximately $998,500. You read that right. You actually need to pay to buy German bonds because interest rates are negative. Add to this the uncertainty with Fed policy, and we are in a volatile environment for the foreseeable future.
We still hold to our view that "Main Street will outperform Wall Street" in 2015, but we may see more negative pressure than we initially expected on asset prices. We have been concerned about liquidity in the markets, and the lack of liquidity will only exacerbate market moves in the near-term. We do expect the ECB to announce quantitative easing next week, but the key question remains: Will their action disappoint markets? We believe the market is set up to be disappointed.
Bottom line: Keep some money in reserves to take advantage of volatility. Look past the current instability to find assets with strong long-term fundamentals at a discounted price.
This blog post is for informational use only. The views expressed are those of the author, Dave O’Malley, and do not necessarily reflect the views of Penn Mutual Asset Management. This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.
Any statements about financial and company performance of The Penn Mutual Life Insurance Company or its insurance subsidiaries (each, “Client”) made by the author is provided with a written consent from the Client. Penn Mutual Asset Management is a wholly owned subsidiary of The Penn Mutual Life Insurance Company.
Opinions and statements of financial market trends that are based on current market conditions constitute judgment of the author and are subject to change without notice. The information and opinions contained in this material are derived from sources deemed to be reliable but should not be assumed to be accurate or complete. Statements that reflect projections or expectations of future financial or economic performance of the markets may be considered forward-looking statements. Actual results may differ significantly. Any forecasts contained in this material are based on various estimates and assumptions, and there can be no assurance that such estimates or assumptions will prove accurate.
Investing involves risk, including possible loss of principal. Past performance is no guarantee of future results. All information referenced in preparation of this material has been obtained from sources believed to be reliable, but accuracy and completeness are not guaranteed. There is no representation or warranty as to the accuracy of the information and Penn Mutual Asset Management shall have no liability for decisions based upon such information.
High-Yield bonds are subject to greater fluctuations in value and risk of loss of income and principal. Investing in higher yielding, lower rated corporate bonds have a greater risk of price fluctuations and loss of principal and income than U.S. Treasury bonds and bills. Government securities offer a higher degree of safety and are guaranteed as to the timely payment of principal and interest if held to maturity.
All trademarks are the property of their respective owners. This material may not be reproduced in whole or in part in any form, or referred to in any other publication, without express written permission.