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Volatility Is Our Friend

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Daniel Laboe
·3 min read
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Volatility is our friend, and it appears to be on the horizon. The S&P 500 volatility index VIX is trading down to its lowest levels since the pandemic began, poised to bounce. After blowout earnings and a massive 20% rally in the S&P 500 since November, the markets are starting to look a little overheated. Analysts across the board anticipate a 10-20% pullback in the coming months, weeks, or even days (no one knows for certain). I am hoarding cash in anticipation, just waiting for my favorite stocks to start trading at a relative discount. You will need to move fast on a market correction because I have no doubt that the dip will be bought quickly.

What Could Catalyze a Correction?

I have pontificated what could cause this looming correction and have come to a few potential conclusions.

The economic reopening isn't as rapid as the seemingly overzealous markets have priced in.

I see this as a plausible scenario, with the market seemingly pricing in a full economic recovery by this summer. I do not think that this will be the case. Dr. Fauci has even said that herd immunity isn't expected until the fall, and 'normality' won't resume until the end of this year. 

If there are any hiccups with the vaccine or a new resistant strain of the virus spreads, the economy risks a double-dip recession, which would be much more devastating than the one we experienced in 2020. 

We need to keep in mind that we are going to be entering a new normal that may look very different economically than the one we left behind in 2019. 

Inflation will force the Federal Reserve to raise rates much more quickly than they are estimating.

Inflation is going to be a big concern once the pandemic is over and spending picks up. Households have $2.9 trillion in added capital from the prior year, an additional stimulus check on the way, and stir-crazy consumers are going to lead to massive spending surge once the US economy reopens. This forthcoming spending is going to catalyze upward pricing pressure (aka inflation), and Biden's new $15 minimum wage will sustain the inflation if it gets passed.  

The reopening spending is already mostly if not fully priced into the stock markets, but the impact of higher rates is most decidedly not. If Jerome Powell and his band of dovish regional governors even hinted at any hawkish act (aka raising rates or letting assets roll off their balance sheet), this rally would quickly get deflated.  

The US Treasury yield curve is steepening, with the economic outlook looking more positive. Still, any rapid movement in the bond market could induce the stock pullback investors are waiting for. 

An entirely unexpected catalyzer, or a combination of what I discussed above, will likely drive the looming correction. This stock market is climbing a wall of worry, just waiting to slide down a slope of hope, but as I have said, I remain cautiously optimistic about the 2021 stock market.

Remember that a correction is going to be a net positive for our portfolios, allowing us to buy well-positioned enterprises for the Roaring 20s at a relative discount.

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