Globally, risk assets have taken a hit: domestic and international stocks, REITs, bonds, the dollar, bitcoin, and the like in a matter of a few days have investors nerve-racked. As risk assets sell off, volatility (VIX), a measurement of fear, virtually doubled overnight. What triggered the scare? Interest rates rising from unprecedented low levels are cited as the primary culprit. Were there hints ahead of time that may have tipped the hat of nervous investors? Perhaps.
At face value, the Fed has unambiguously telegraphed its intention to normalize rates, meaning interest rates were going to be rising. The Feds dual mandate is to maximize employment and assist in keeping inflation in check. The primary tool the Fed uses to achieve its objectives is lowering or raising short-term rates (federal funds rate, i.e. Fed Funds). Short-term interest rates stood at 5% in 2007, before the ’08 -’09 great recession and were aggressively reduced to zero to support and revive the economy. Rates anchored at zero-bound until December 2015 when the Fed raised fed funds 25 basis points (a quarter percent). Since World War II, excluding the period of hyperinflation during the 80s, short-term rates averaged around 5% up to the housing crisis. Will rates return to historically normalized levels? It is doubtful. Inflation is tame and economic growth is moderate. The Trump administration is linked to the stock market and with Jerome Powell as Chairman of the Fed, it is likely that monetary policy stays stimulative. From a macro level, asset values and prices are byproducts of growth and inflation expectations, which are in turn related to interest rates.
Volatility is considered a measurement for risk; the riskier the asset, the more volatile it is. From the end of the WWII until today, the Dow Jones Industrial Average has been open 18,461 trading sessions; it has posted gains 9,667 times, losses 8,723, and closed unchanged 71. The daily percentage change has averaged ± .60%, during this time frame. The DJIA averaged 30 points per day change on the upside; it averaged -30.7 points daily on the downside. The market has produced winning days 53% of the time versus 47% for losers. There have been 944 more plus days than minuses totaling 292,164 points up and 267,981 down; the sum difference is 24,183. Add back the DJIA index value on September 5, 1945, of 174, and you arrive at the Dow’s current price of 24,357. For investors seeking above average real inflation adjusted returns, risk and volatility come with the territory. DJIA stock owners averaged 7.1% annually in price appreciation, excluding dividends, since WWII.
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