Markets: Here's What's In Store for the Third Quarter

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Following three days of gains for U.S. stocks, investors were unable to see the month of June (and the second quarter) out on winning day, as the S&P 500 (SNPINDEX: ^GSPC  ) , and the narrower, price-weighted Dow Jones Industrial Average (DJINDICES: ^DJI  ) , fell 0.4% and 0.8%, respectively.

Despite this, stocks have just put in their best first-half performance since 1998, with a very respectable gain on the S&P 500 of 12.6% (13.8% on a total return basis.) The index also managed to establish a new (nominal) record high during the quarter at 1,669.16. (Note, however, that this level remains below the Oct. 2007 high, once you account for inflation.)

Conversely, bonds have suffered their worst first-half performance since the horrific 1994 bear market, with the Barclays US Aggregate Bond Index losing 2.55%. Back then, the market was a caught flat-footed by a rapid-fire series of interest rate hikes; this year, the Fed is the culprit also, but not via the Fed funds target rate, which the central bank now expects to keep at 0% to 0.25% into 2015. Instead, it's the prospect that the Fed will begin reducing its monthly bond purchases ("quantitative easing," or QE) this year, which first transpired on May 22, that has upset bond markets.

Volatility is here to stay
Last summer marked the start of a period of exceptionally low volatility, which lasted through the first quarter of this year. That environment ended in the second quarter, as Mr. Bernanke's Fed surprised investors with regard to the timing of QE's winding-down. Consider that the CBOE Volatility Index (VIX) (VOLATILITYINDICES: ^VIX  ) , Wall Street's "fear index," averaged 17.3 in the month of June, up from 13.5 in the first quarter. (The VIX is calculated from S&P 500 option prices, and reflects investor expectations for stock market volatility over the coming 30 days.)

I think investors ought to expect higher volatility -- whether in stocks or bonds -- to continue. The notion that Fed liquidity would float all asset classes was an unhealthy byproduct of the central bank's unconventional actions to mend the economy, one which has evaporated as investors begin to realize that bonds are not the one-way bet/ safe haven they had imagined. Investors were behaving as if the Fed's support was unconditional and eternal; that illusion has been shattered.

This is no cause of concern: A return to what are, after all, "normal" levels of volatility is a healthy sign. Volatility is an ordinary feature of asset markets and, for the value-oriented investor, it's a source of opportunity when securities deviate from their fair value.

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Related Tickers

9/29/2016 2:38 PM
^DJI $18209.43 Down -129.81 -0.71%
^GSPC $2158.56 Down -12.81 -0.59%
S&P 500 INDEX CAPS Rating: No stars
^VIX $13.61 Up +1.22 +9.85%
Volatility S&P 500 CAPS Rating: No stars