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What’s Behind the Recent Market Volatility?

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RANDY FREDERICK: After six weeks of mostly sideways-moving markets, volatility has returned with a vengeance. Liz Ann Sonders, Schwab’s chief investment strategist, joins me for the September 19 Schwab Market Snapshot to discuss what it is that has caused so much uncertainty to creep back into the equity and bond markets. Welcome back, Liz Ann.

LIZ ANN SONDERS: Thanks, Randy. And thanks, everybody, for tuning in.

RANDY: So, Liz Ann, I’ve been warning our traders for weeks to not become too complacent this time of year because it has a nasty reputation for high volatility and market pullbacks. And I know that you wrote in mid-August that you also believe that the summer slowdown would not last forever. So from your perspective what is it that caused all this uncertainty and this volatility to come back into the market?

LIZ ANN: So I think there were a couple of important issues that have been brewing recently, but before I get to those I think there’s a broader sentiment issue that was at play here. If you go back to the June period when we had the surprise Brexit vote—you saw a tremendous amount of volatility and a huge plunge in investor optimism—and you went deep down into extreme pessimism territory, and as you know, Randy, we’re both students of the market from a behavioral perspective, and the market tends to go in the opposite direction of extremes in sentiment. So you didn’t need much of a catalyst, given how pessimistic investors were to set up this summer rally.

And then I think the opposite is really what kicked in, as the market was hitting all-time highs. You mentioned complacency. Some of those same sentiment measures showed extreme optimism. So you didn’t need much of a catalyst. But I think the catalysts that we did get were not only Fed policy uncertainty—and we still have plenty of that this week as we head into the Fed meeting—but just broader global central bank policy uncertainty, and the fact that global bond yields started to move up, some from negative territory back into positive territory. And I think this may be a bit more of an existential thing going on, because we have, I guess, enjoyed the fruits of global central banks’ labor—in that they have come up with this unbelievable easy policy through negative interest rates, through quantitative easing. And I think we’re at the beginning of the realization that central banks are neither omnipotent, nor likely to continue this excess ease ad infinitum. And that’s just something that markets have to digest, and I think that’s probably the big catalyst or reason that we’re dealing with right now.

RANDY: Liz Ann, you mentioned the Fed. Now, so let me bring this up. It seems like major shifts in the market often are caused by a specific catalyst, and a good example of that of course is the FOMC meeting this week. So what is your perspective on what the Fed might do this week and on their policy maybe through the remainder of this year?

LIZ ANN: So personally, I would love if the Fed were raising interest rates. I would love for the conditions to support that—I think that would be a good thing particularly for confidence, which I think has been somewhat suppressed by the Fed’s ongoing very, very easy monetary policy. That said, it’s unlikely the Fed will move this week, largely because the market is not expecting it—not that they are necessarily at the mercy of the market. But in the post-Alan Greenspan era of increased transparency, and the Fed liking to give the market a bit of a heads-up, right now the futures market only has built in about a 20% likelihood that the Fed moves this week. It’s always been at least 50% heading into Fed meetings over the last 80 or 90 meetings. And if the Fed were to raise interest rates they would be going against the market—and it is not typically what they like to do. So I therefore think that they will hold off on raising interest rates, but just as important, if not maybe more important, will be what they say in the accompanying statement and probably what Chairwoman Janet Yellen says in the attendant press conference. And I think if they opt not to raise interest rates you’re probably going to see some more hawkish commentary, which in turn could mean some volatility in the markets, but we do think one more rate hike is in the cards for this year.

RANDY: We know that economics always has two hands. So if you look at, on the one hand we have a labor market that’s pretty strong, inflation is low but not too low, and the housing market’s doing quite well. But on the other hand, productivity is low, corporate earnings are low, and we’ve seen the ISM numbers all of a sudden take a dip. So what’s your perspective from an economic outlook for the remainder of this year?

LIZ ANN: So my net over the medium term, I guess you would say, is that I think we stay in this muddle-through kind of environment—much as we’ve been in really this entire recovery. And if there’s a benefit to that—and there aren’t many, it’s that you don’t build the excesses that tend to tip you into a recession. We have to remember that expansions don’t simply die of old age. They die because of excess—excess monetary policy, or inflation, or capital spending or capacity utilization—and we don’t have that right now. So I think the best bet is sort of this muddle-through.

But you mentioned a couple of recent economic data points which I think are important: the ISMs, the recent jobs report. All of those were August data, and you never want to just explain away because of seasonality. But August is a particularly tricky month, because of back to school and other issues. And it’s a month where economic data tends to be revised more often than most other months, and generally revised to the better. So I think we ought to hold off using that data as a signal of some new more negative trend in the economy, and I think the next month or two’s worth of data will either support the idea that it was a bit of a blip, or potentially reinforce problems in the economy, and that’s something we’ll have to contend with.

RANDY: Yes, there’s no question about that. Well, believe it or not, we’re out of time. Liz Ann, thank you so much, again, a lot of great information. If you want to get more information from Liz Ann, you can read about it in the Investing Insight section of Schwab.com. You can follow Liz Ann on Twitter @LizAnnSonders, and you can follow me on Twitter @RandyAFrederick. We will be back again. Until next time, invest wisely, own your tomorrow.

Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. Please note that this content was created as of the specific date indicated and reflects the author’s views as of that date. It will be kept solely for historical purposes, and the author’s opinions may change, without notice, in reaction to shifting economic, business, and other conditions.

Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed. Supporting documentation for any claims or statistical information is available upon request.

Past performance is no guarantee of future results and the opinions presented cannot be viewed as an indicator of future performance.

Definitions
The Institute for Supply Management (ISM) Manufacturing Index is an index based on surveys of more than 300 manufacturing firms by the Institute of Supply Management. The ISM Manufacturing Index monitors employment, production inventories, new orders and supplier deliveries.

The Institute for Supply Management (ISM) Non-manufacturing Index is an index based on surveys of more than 400 non-manufacturing firms by the Institute of Supply Management. The ISM Non-manufacturing Index monitors employment, production inventories, new orders and supplier deliveries.

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