July Domestic Market Recap
As July comes to a close, the markets have continued to push higher, albeit with some recent sputtering of that rocket, despite a cornucopia of geopolitical tensions and a weak, but (fingers crossed) strengthening domestic economy. All the major averages are up for the year… except what’s that little green one down there? You’ll notice that one tracked quite closely with the rest until recently. Hmmmm, that would be the Russell 2000 which is a subset of the Russell 3000 Index and represents approximately 10% of the total market capitalization of that index; it’s the small publicly traded companies in the U.S. equity world.
It is probably somewhat intuitive that smaller companies are pretty much by definition riskier and less liquid. Just think about how many shares of Apple trade a day versus some very small company of which you’ve never heard. So we can see here that recently there has been a move away from less liquid stocks into more liquid, which are the larger capitalized, more widely traded stocks. If we look at bonds, we see a similar move away from riskier, less liquid bonds. The chart below shows the performance of an iShares ETF for investment grade bonds (in red) and the performance for an iShares ETF for high-yield bonds (in blue), otherwise known as junk bonds.
You’ll notice the same pattern here in which the performance for both was rather closely aligned until recently, when the high-yield bonds suddenly began a significant decline, as the concerns for increased liquidity started to appear. Much like the difference between small cap and large cap in the prior chart, high yield bonds are considered higher risk bonds (thus the higher interest rate) which means they are considered less safe and tend to be less liquid than the lower risk “investment” grade bonds, particularly when investment markets get nervous.
Bottom Line: The markets appear to be preparing for the ending of the Federal Reserve’s quantitative easing programs. These programs were designed to increase liquidity, thus a move towards those products that provide more liquidity in anticipation of the end of this program should come as no surprise. The Fed has stated that it will end this last round of QE in October. If that does in fact happen remains to be seen, but the market is clearly taking steps to prepare for its impact.
