A December to Remember: A Look at Fed Action from Last Year

Most investors remember a year ago -- last December -- as highly volatile and illiquid. The S&P 500 dropped 16% from its high point to its bottom. And, more disturbingly for many, high yield exchange-traded funds fell 5% and traded at a discount to net asset value of almost 1%. This showed just how much the bond market lacked liquidity. The high yield ETFs had sold off 1.5% in November. Credit default swap investment grade indexes went from 62 basis points in November to 75 bps in December to 95 bps at its widest level. Now look: That index, the Series 31, is at 38 bps today, which should put that fear in perspective. The Bloomberg Corporate Bond Index Spread went from 113 bps in November to 137 in December and peaked at 157 in January. There was, I should note, a lag between where bond market pricing services were pricing bonds and where they were really trading. Credit led the way last year. This isn't happening right now, except for CCC-rated junk bonds and a segment of the leveraged loan market rated single-B or lower. The Fed Was Not Our Friend In 2018, the Fed seemed intent on ending the Fed Put. Chair Jerome Powell's desire to end the Fed Put was well known, and he gave it the old college try, but eventually gave up. He stumbled along with rate hike after rate hike -- while there should have been more pauses in between. He also really bungled the balance sheet reduction. His answers to questions at the December meeting about balance sheet reduction tipped the scale decidedly to the bearish side for all asset classes. Odds of Trade Truce Vs. Tariffs I am now officially a broken record on the chances of getting a trade truce vs. tariffs. My view remains: 80% Trade Truce 19% New Tariffs 1% a 'good' deal On the bright side, by Dec. 15, we should know whether I'm right or wrong. If I'm wrong, then we will impose new tariffs and markets should react violently in a classic risk-off move. Hedging for this possibility is the main reason why I believe so many invest. If I'm right and no new tariffs get imposed, but no comprehensive deal is announced, either, I think we see bonds sell-off and broad stock market indexes do little. But certain sectors may have large positive and negative moves. Bond yields would drift moderately higher, because fear of a global, trade-driven recession, would be reduced. Stocks and credit might initially do better, but I would expect them to fade, as the market starts truly pricing a Fed that will sit on the sidelines. But within stocks and bonds, I would expect to see a rapid, and potentially painful, reversal, in which many of this year's laggards catch up -- and catch up quickly. VIX Vs. VIX Futures The difference between the second Volatility Index futures contract and VIX itself is now at the biggest gap we've seen this year. It has been steadily increasing since August, when stocks had their brief 6% dip. The market is pricing in an inflection point, but between what I see in options activity and long-dated treasuries -- the market is pricing in far more concern about risk to the downside than the upside. Where Are All of the High Volatility Funds? A quick look brings up these three: lots of low volatility funds, lots of high dividend funds; and some high dividend, low volatility funds. But I could not find a single high-volatility fund. Isn't there a world where high volatility is what you want to own? Like the Dogs of the Dow? Not much to base a big bet on, but as a contrarian, I can't help but think that next year, we are likely to be surprised to the upside on risk, and the performance will come from those stocks, bonds and asset classes that have been left for dead. I expect December to be a month to remember, but in a good way -- unless you own long-dated treasuries or bond proxy stocks, then, not so much.

A December to Remember: A Look at Fed Action from Last Year

Let's look back to a year ago this month, when most investors saw volatility and a lack of liquidity; and then turn to now, as the tariff deadline looms and the VIX vs. VIX futures gap widens.

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