Why volatility may be a bigger threat than rates
Investors are growing anxious. Most of the angst is focused on interest rates and the Federal Reserve (Fed). However, although that fear is not irrational, it may be exaggerated , as I discussed a few weeks back. All else equal, stocks can withstand modestly higher rates. The obvious rejoinder is that all else is never equal. Rather than a marginally more aggressive Fed, the bigger threat may be the side effect of tighter financial conditions leading to more volatility. In other words, stocks can probably withstand yields of 3% on the 10-year Treasury, but a VIX stuck in the 20s may create a real headwind for equities. Why should volatility be such a threat? Even after the recent spike, the VIX Index is only back to its long-term average. Furthermore, equity markets did quite well in the late 1990s, a time when the VIX frequently was above 20. [storytout]Read more stories from Russ .[/storytout] There are at least three counter arguments. This bull market has been largely built and sustained on cheap money; conditions are changing. In addition, the change is happening against a backdrop of extended valuations in U.S. equities. High valuations and high volatility did coexist in the late 1990s, but that did not end well. Finally, in the post-crisis world multiples are much more correlated with volatility.
The takeawayRuss Koesterich , CFA, is Portfolio Manager for BlackRock's Global Allocation team and is a regular contributor to The Blog .