2018 has rekindled fear among investors that a recession might be on the horizon. The year began with a small decline in stock market prices, and this was effectively dismissed as a normal market correction after a period of sustained bullish pressure. But when volatility returned in recent weeks, there has been real fear in the market. Fear causes contagion, and it can have an immense impact on the market as investors will always want to assess what is going on. But is the recent volatility simply an emotional issue, or is it rational?
Fed and Interest Rates
February 2018 saw the benchmark US S&P 500 wipe off 3.9% of its value, the first monthly decline in over 11 months. President Trump’s proposed trade tariffs have been a convenient scapegoat, but the main concern is the Federal Reserve. Now led by Trump’s nominee Jerome Powell, the Fed is keen on accelerating the hiking of interest rates, with 3 rate hike penciled for this year alone. Naturally, higher rates will limit credit opportunity for both businesses and consumers and will lead to overall slow economic growth. And as they say, bull markets are not killed by old age, but by the Fed hiking interest rates. As investors continue to fear what the Fed might do, their anxiety will reflect in the market in the form of increased volatility.
But the Fed has to do all this so as to rein in on rising inflation. Ever since the global financial meltdown, quantitative easing and lower rates have dominated the Fed’s policy. Now, however, the effects of that policy direction have hit virtually the entire economy. Prices have risen in practically every industry, while the value of the US dollar has declined. With the labor market now preforming admirably, it seems just about the right time to implement a tightening schedule. If inflation is not dealt with now, it might lead to catastrophic effects later. Still, Fed tightening will mean that both the economy and stocks will feel the pinch in the medium term as liquidity is sucked out of the market and investment derailed.
Meanwhile, as investors continue to speculate on how far the Fed will go to intervene in an economy that is now being considered as overheated, stock market volatility will increase. Some investors will draw comparisons to past crashes and will seek to exit citing higher rates and rising inflation as well as the likelihood of increased trade tariffs. Others will take the view that the broad macro image is bright and will expect any shocks to be well countered by massive government spending, GDP expansion, tax cuts and increased economic activity as well as overall positive sentiment. Varied opinions will lead to the consequences of higher volatility which are price whipsaws. The impact of the latest Fed policy decision will take some time to trickle down to the entire economy, which is not good news to the equities market as it means that a period of high and unsustainable volatility will ensue. This is scary.
But when investors are scared, they do not need to run. They just need a hug, a bear hug, as the old adage goes. This means flocking to safe haven assets such as bonds and precious metals. The logic for bonds is pretty simple: as the Fed seeks to curb inflations by sucking out liquidity, it hikes rates and makes bonds attractive. Nonetheless, historically, investors have always preferred trading gold, the primary safe haven, during times of prolonged market downtime and economic crashes as well as when the threat of inflation looms.
Gold has always been an important portfolio diversifier for investors. It serves not only as a safe haven and a store of value during crises, but also guards against broader systemic risks. For smart investors, it is vital to track and understand the price dynamics of gold. This will help in anticipating and profiting during economic recessions.
Recent volatility has made investors very jittery. It may be a signal that a recession is around the corner, but it could also be just a hiccup. As we wait to find answers from the market, trading gold and closely watching gold price dynamics appear to be the best solution for traders seeking to cash in on the current volatility.