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Expect MORE Volatility 240220

The Market is starting to second guess an imminent interest rate cut.  Core inflation is not receding as housing and labor costs continue to rise.  Headline inflation is also creeping back up as missile attacks in the Red Sea drive oil and shipping costs higher.

Stock market volatility is starting to pick up, but it remains relatively modest.  What’s historically unusual is the extended period that interest rates have remained oddly volatile.  Bond traders are considered the “adults” in the market, less prone to kneejerk emotional trading.  So whenever bond volatility picks up, it often foreshadows turbulence in the stock market. 

Note the below chart which illustrates the daily variance of the 10 Year Treasury.  The 10 Year Treasury is the financial standard by which all other debt is measured.  It’s generally very stable…but hasn’t been since the pandemic.  The past 5 year average (blue line) has been much more volatile than the long term 20 year average (green line).  What I find interesting is that so far in 2024, as the stock market has regressed to lower than average volatility, interest rate volatility is even higher than the 5 year average. [Red line is the year-to-date daily variance.]

Considering seasonality (note the volatility spike in March) things could get even worse over the coming weeks.  So as the euphoria of earnings season winds down, watch to see if bond volatility spreads to the general stock market.  Small Cap stocks remain especially vulnerable to a setback.  Last week when the inflation report came in “higher than expected” the RUSSELL2000 index plunged nearly 4%.  That was the largest single day drop in over 21 months.

If interest rates stay HIGHER for long, then I expect the stock market to move LOWER.