3 Factors That Could Keep Markets Volatile

technical bounceMike Burnick:  Your email inbox, as well as mine, is likely to be chock-full of 2016 investment views in the weeks ahead, because it’s about this time when everyone publishes their fearless-forecasts for the year ahead.

So this year I thought I would get out ahead of the crowd and deliver my expectations for the New Year even before Christmas. This, I hope, will help give you a chance to prepare your investment strategies early and to brace yourself for another volatile year in the markets. So here goes …

Expect more volatility in the New Year!

2015 will go down as a year with fairly low average volatility readings. Ah, but it had its moments. Such as in August, when the CBOE Volatility Index (VIX) spiked from below 11 to above 50 in just three weeks! That was the 2015 “flash crash” brought on by a witches-brew of worries about …

  • China
  • Europe
  • Corporate profits
  • Widening credit spreads
  • Fed interest-rate hikes

Take your pick as the culprit for the dramatic August selloff that saw the Dow shed 2,400 points in just four weeks, and then miraculously bounce back. And I’m probably leaving out a few worries from this list.

August saw a perfect convergence of items on the worry list and although stock market volatility quickly subsided, bond- and currency-market volatility remains elevated. And so far this month, in what is seasonally a bullish month for stocks, VIX has ticked higher once again.

I expect many of the same worries on the list above will give a repeat performance in 2016.

The world’s central banks are walking a tightrope in setting policy. It’s risky business.

First, the People’s Bank of China (PBOC) followed up on its big, one-off yuan devaluation in August with yet another devaluation of similar magnitude over the past several weeks. And as long as the dollar remains strong, the PBOC may feel the need to adjust the yuan lower in response, injecting more turbulence into markets, as was the case in August. And the PBOC isn’t alone.

The European Central Bank (ECB), Bank of Japan (BOJ), Bank of England (BOE) and many other global central banks are walking a tightrope too; trying to “devalue” their own currencies using various forms of monetary stimulus — or money-printing if you prefer. The trick is to do so without going so far as to trigger a massive crisis of confidence and capital flight out of their own economies. It’s risky business.

Expect more currency volatility in 2016!

Second, and on a related note, the Federal Reserve kicked off its first interest-rate tightening cycle in nearly a decade, and just in time for the holidays. December’s tiny 0.25% increase in the Fed funds target rate was the first, but certainly won’t be the last.

The Fed has always moved in mysterious ways, but historically speaking you can expect a series of rate hikes not simply a one-and-done move as many investors hope. The questions investors are wrestling with now are: How much and how soon?

The Fed’s famous “dot plot” indicates four more rate hikes are possible in the year ahead. That’s double the trouble expected by financial market professionals, who have only “priced in” two more rate hikes for 2016, most likely in June and again in September.

That’s a big potential disconnect between the markets down on Wall Street and the academics at the Fed in Washington. And it means that every couple of months throughout 2016 investors can look forward to a rising tide of anxiety as the Fed gathers for another policy meeting.

Will they or won’t they? Inquiring minds, and money managers, want to know.

Expect more interest-rate volatility in 2016!

Third, all of the above factors are likely to trigger more stock market volatility in the New Year too. After all, stocks have made very little progress since late 2014.And the market has been locked in a trading range for most of this year, but with no shortage of sharp volatility between the highs and lows.

Click image for larger view

To some technical analysts, this trading range looks more like a broad topping formation as shown above. Or as my colleague Jon Markman more colorfully refers to it: “a dome of doom” for the stock market.

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