In this month's issue:
European Stocks Belie Economic Conditions
Mark Luschini
Economic activity in the Eurozone is weak. GDP for the whole year expanded just 0.4%, with the bloc’s largest economy, Germany, narrowly avoiding recession, and the hard data so far this year is not evidencing a material change for the better. To be sure, inflation has decelerated meaningfully, but it remains above the European Central Bank’s (the ECB) target of 2.0%.
Additionally, wages (a prime driver of consumption-driven demand) are falling, but from a very high level, and with the unemployment rate at a historic low of 6.4%, they could remain sticky and keep inflation elevated. Inherently, that combination complicates the picture for monetary officials. While the underlying economy is growing at an anemic pace, which probably warranted a rate cut already, if not soon, the ECB fears inflation may not subside sufficiently if it loosens policy too far in advance of its amelioration. Nonetheless, market participants are looking ahead to a possible reduction in the overnight rate, and ECB President Christine Lagarde has strongly hinted that one may occur at the central bank’s June meeting.
Interestingly, surveys of the business and investor communities point toward expectations that business activity is poised to improve. Indeed, the Euro Stoxx 50, an index comprised of 50 blue chip stocks representing 11 different Eurozone countries, is up smartly this year and pacing the similarly robust gains generated by the large-cap U.S. equity indices. Since it is reputed that stocks discount future expectations, the rally in European equities may very well be foreshadowing an improving fundamental backdrop in the future quarters.
Volatility Finally Declining
Guy LeBas
Interest rate volatility is one of those under-the-hood aspects of the bond market that seem irrelevant but end up mattering a great deal for markets. We typically write an Investment Perspectives note on volatility about once every two years—and apparently, the markets are keeping us to that schedule. In 2022, the last time we focused on the topic, our attention was on rapidly spiking volatility measures into an unpredictable Federal Reserve (Fed) rate hike cycle. Today, the reverse is true. Measures of volatility are receding as the outlook for the economy and Fed policy becomes at least a little clearer. Falling volatility has implications for demand in the bond markets and returns in fixed-income assets that are directly sensitive to volatility.
While we think about volatility as a historical measure, there are two ways to view the topic: realized historical and implied future volatility. In the first quarter of 2024, the yield on the 10-year Treasury note has spanned a 0.5% range, which is much narrower than in the back half of 2023. More statistically robust measures of realized volatility, such as standard deviation, are also trending down.
Implied volatility (IV) is a measure of the expected future volatility of an underlying asset’s price, as implied by the price(s) of its options. In one sense, IV reflects market participants’ expectations of potential price fluctuations, but in another sense, it just reflects supply and demand for options. When there are options buyers, IV rises, and when there are more options sellers, IV falls. The fixedincome options market is overwhelmingly institutional in nature, but billions of dollars of notional value trade in those markets every hour of the day. Arguably, the most accessible measure of implied volatility is the MOVE index, which extracts volatility from traded options on Treasury notes and bonds.
The Best Is Ending — or Not
Gregory M. Drahuschak
March 2024 went into the record books with the S&P 500 28% above its October 2023 low after setting 22 new all-time closing highs. The S&P also had its fifth quarterly gain in the last six quarters while posting the 12th-best first quarter since 1945 and the best first quarter since 2019. Gains this strong, however, led to concern that a consequential pullback might be just ahead.
These concerns were somewhat set aside with the March 20 Federal Reserve Open Market Committee policy release that gave the market confidence that a cut in interest rates is on the Federal Reserve’s 2024 agenda. However, the amount and frequency remained in doubt.
April has generally been favorable for stocks. Since 1950, on average April has produced the second-best average monthly gain. The S&P 500 also has ended higher in 52 of the 74 Aprils from 1950 through 2023. Since 2000, the S&P 500 has had a loss in April seven times and only one loss in the most recent 10 years, with the sole loss (-8.8%) produced in 2022 in the aftermath of the pandemic. April, however, ends what often is the best six-month period for stocks.
On the heels of the market’s performance, a common sentiment has been that the market must endure a pullback relatively soon, particularly considering the recent five-month streak of gains. Five consecutive monthly gains most often, however, have not led to market weakness. Typically, the S&P 500 was higher 12 months later.
You can read the full Investment Perspectives here.
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