Fickle markets can be like spring weather

By Kevin Fusco

The Daily Record Newswire

Traditionally March is the month that comes in like a lion, and leaves like a lamb. This year unusually warm weather and no real storms to speak of kept the lion caged, and we all rejoiced in the relative calm. The financial markets have also reveled in relative calm, as the "storms" have either been mild or never formed at all, and returns peaked at fresh four-year highs in early March.

The markets though, can be as fickle and unpredictable as the weather, and investors should be asking now if springtime will come in like a bull and leave like a bear.

Springtime selloffs have occurred in each of the past two years, and continued well into the summer. Many investors have been awaiting the return of volatility, and a number of key indicators that preceded the market drops in the springs of 2010 and 2011 may still be helpful in forecasting what awaits the financial markets in 2012.

Jeff Kleintop, chief market strategist at LPL Financial, recently spoke on some of these factors as well, and I wanted to take an opportunity to expand on some of the more prevalent concerns.

One of the first factors to focus on is the Fed. Much attention has recently been given to when interest rates will rise, or if another round of stimulus is needed. Investors should be more concerned about what happens when a round of stimulus ends. The past two years have seen Fed stimulus programs (Quantitative Easing 1 & 2) end in spring or summer, with equity market declines preceding the next Fed announcement. The Fed's last stimulus program, Operation Twist, is set to end in June, and speculation will continue surrounding future policy action.

Consumer confidence is another prime indicator on which investors should focus over the short term. The index, as measured by Rasmussen, is nearing a two-year high, which, coincidentally, was also approached in the springtime of both 2010 and 2011. Thus, one could draw the conclusion that a downturn in confidence may precede a drop in equity prices, which is exactly what happened in each of the last two years.

Another facet that could have a significant impact on both consumer confidence, and the equity markets, is rising commodity costs, and more specifically, the price of oil. Consumers have been feeling some pain at the pump, and crude oil has held consistently above $100 per barrel.

More important than the current price of oil, is the relative increase in price over the short term. In 2010 and 2011, oil prices rose almost $20 per barrel from February until the beginning of equity market declines. Since February, oil prices have only increased roughly $10 per barrel. A sudden push to higher prices above $115 could be a catalyst for a market pullback, while a decrease in oil prices may boost not only market returns, but consumer confidence as well.

There are a number of measures that preceded the pullbacks in the springs of 2010 and 2011 that are either inconclusive at this point, or may be working in the markets' favor.

First, inflation expectations have increased. Based on the University of Michigan consumer survey, inflation expectations through March were at a 4 percent annual rate. While this may not seem like a positive, inflation expectations have jumped in March and April of the past two years, and were met with actual readings much lower than expected.

This year, energy prices have contributed to the jump in expectations, but it remains to be seen if prices in other sectors of the economy will jump as well.

Next, the jobs picture, while not ideal to say the least, has remained resilient. Springtime has been accompanied recently by increases in jobless claims, with April 2011 showing a sharp jump in benefits requested.

This year we have experienced steady improvement in claims, which has also been accompanied by job growth. Assuming that the U.S. will avoid recession in 2012, it is unlikely that the employment situation in the country worsens significantly. Growth may not be as fast paced as investors would like to see, but initial claims should not be a catalyst for pullback.

Finally, there is volatility itself, or more appropriately, the lack thereof. The oft-used VIX (a measure used to forecast volatility in the equity markets) recently fell to a level that preceded the springtime declines of 2010 and 2011, which suggests that investors have again become complacent, and run the risk of suffering losses brought on by an intangible event, or sudden market movement.

What hopefully works in the market's favor is the same pattern that emerged from September of 2010 to March of 2011, when the VIX again reached its recent low. Following a six-month, and roughly 25 percent, upward move in the S&P 500, volatility returned and a selloff occurred.

Yet, even after accounting for the brutal volatility of the summer of 2011, and the declines that accompanied it, the S&P 500 still closed the year approximately 19 percent above the September 2010 reading. As is well known, past performance does not guarantee future results, but these are certainly factors to watch closely.

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Kevin Fusco is senior vice president of Fusco Financial Associates Inc. of Towson. He can be reached at 410-296-5400, extension 109, or Kevin.Fusco@LPL.com.

Published: Thu, May 3, 2012

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