2018 is off to a strong start for the major market averages. After setting record after record in 2017, the markets in 2018 are continuing to add to last year’s winning streak. Leading the way are transportation stocks, namely airlines. Since many investors consider the transportation sector on the “front lines” of the U.S. economy, some analysts are pricing in an aggressive rise in GDP growth for 2018. However, some investors think that “strange things are afoot” with Wall Street today.
The volatility index (VIX) rose alongside stocks last week, which is something that happened to signal the end of the last two great bull markets. Normally the volatility index and stocks do not rise together. Additionally, Bank of America, Goldman Sachs and Deutsche Bank are warning that the accounts of many smaller investors are overextended in exchange-traded funds that follow the volatility index. The fund bets that volatility in the markets will remain low or unchanged. If the fund closes these short positions in conjunction with a rise in the VIX, it could lead to a dramatic market reversal.
Another strange occurrence on Wall Street today is pressure on the bond market. The GOP tax cut that is now law will cause the U.S. Treasury to increase its issuance of debt to cover the lost revenue from the big tax cuts on corporations. Also, the Federal Reserve’s plans to continue raising target interest rates this year could fly in the face of stock markets that rely on low-cost credit through buybacks of debt-funded shares.
Although stocks are off to their strongest starts in history this year, it could easily be derailed with the Fed increasing target interest rates or China pulling back on the amount of U.S. debt it buys. Case in point, Japan has already decided to cut back on the amount of debt it buys, specifically U.S. Treasuries.