Volatility Set to Be New Normal

As we approach the new year, the world of finance remains shrouded in uncertainty. The volatility that defined 2025 presents itself not purely as a flash in the pan but as a transformative new normal, one that compels investors and policymakers alike to rethink their strategies. This time last year, predicting the financial landscape for the upcoming year might have seemed audacious, with market analysts considering various factors that contribute to this instability—a volatility that may last for months, if not the majority of 2025.

Interestingly, the culprits behind this economic drama do not lie in external forces, such as wars, natural calamities, or even the fluctuations of uncontrolled consumer demand. No, at the heart of the turbulence is a multifaceted array of government policies. Drawing on the timeless wisdom of poets, “The fault lies not in our stars, but in ourselves,” we find ourselves pointing the finger at governmental actions—either those made by elected officials or bureaucrats. In the throes of stimulating demand, government spending and an increased money supply have ignited inflationary flames that seem to have no end in sight.

Thus far, attempts to reign in inflation have relied heavily on monetary policy rather than fiscal measures. The narrative of reducing government jobs or slashing wasteful spending—while theoretically beneficial for economic growth—has inadvertently added to economic fluctuations. The steadfast commitment to multiple interest rate reductions, contrasted with a vague prediction of a complete halt to these cuts by the end of 2025, has left markets staggering. Indeed, recent chatter has led to speculations of rising interest rates instead of the anticipated cuts.

Last week was not pretty for market participants. Investors found themselves engulfed in an atmosphere of confusion and chaos, as the potential for unchanged interest rates clashed with the need for stability. The hope was for the Federal Reserve to maintain a clear, unchanging stance, asserting that rates should reflect the economic growth without any further manipulations. But, as history suggests, clarity is seldom the fashion in the realm of economics.

Since the first interest rate reduction in September, the ten-year Treasury bond has seen a staggering increase of 100 basis points—a clear indicator of the widening gap between Fed policy and market reality. Every drop in the interest rate seems correlated with surging bond prices, yet paradoxically, this past week witnessed the ten-year bond yield hovering near 4.8% before experiencing a pullback. This irony illustrates the market's complex relationship with Fed policies, where a commitment to halt interest rate alterations might eventually lead to bond yields dropping.

Jerome Powell’s stewardship has thus far steered the U.S. clear of recession while striking a delicate balance to curb inflation. The rapid interest rate hikes have been aptly timed, and a prolonged pause could provide necessary breathing room for the economy. The question now looms: how much longer can rates remain low without rekindling inflation fears?

The landscape of interest rates remains a mixed bag, with external forces like oil prices also taken into account. The Standard West Texas Intermediate crude has surged recently, leading many to sound alarm bells. With the U.S. dollar maintaining its upward trajectory—evidenced by a break over the 1.09 mark in the dollar index—oil prices should logically drop, given the historical correlation between currency strength and commodity pricing. A stronger dollar typically means increased costs for non-dollar countries, thus dampening demand. Yet, paradoxically, we witness the opposite occurring, substantiating inflation concerns that seem to loom like a specter over the global economy.

The consumer price index (CPI) is once again a focal point for scrutiny. Prevailing inflation fears are compounded by the robust employment numbers, which, far from alleviating concerns about inflation, now spark worries that Powell may have to revisit interest rate cuts altogether. The lesson here is clear; a high employment rate does not inherently provoke inflation and can feasibly lead to stagnant wage growth—a symptom when labor supply exceeds demand.

Participants in the stock market are now aligning their focus with each incoming economic data point, especially in relation to inflation metrics. Comparably, the strong employment figures in December had contrasting effects on market behavior—while such data might have elicited enthusiasm just months earlier, it now serves as a harbinger of caution. The upcoming CPIs becoming akin to a financial pulse check, where disappointing results could rush investors to the exits while a moment of optimism might present a buying opportunity.

Amidst such fluctuations, the VIX index, an indicator of market volatility, remains an essential factor to consider. For too long, the VIX level has hovered around the higher end of the spectrum, a scenario that suggests potential turbulence ahead. If investors find themselves in scenarios where VIX increases while the market rallies, it underscores an imminent cautionary tail. The question remains: how should one approach investing in this volatile climate?

Common wisdom suggests a more measured approach; investing in stocks should never be an impulsive venture. Rushing to buy into a stock due to its initial surge could lead to unpleasant losses down the line. A gradual build-up of investment, particularly when waiting for favorable fluctuations, is far more prudent. The old adage of the “50% retracement rule” rings true—if a stock moves up substantially, allow it to correct before re-entering the position.

Identifying stocks that remain insulated from sell-offs or have already absorbed their downturns can also reveal promising opportunities. Those stocks that have been overlooked or disproportionately sold may just turn into a goldmine when positioned correctly. Moreover, rather than blindly purchasing stocks on the initial uptick, one should wait for significant pullbacks to appreciate the resilience of certain stocks before making a commitment.

As we usher in the new year, many investors are gearing up to allocate fresh funds into their portfolios. The recommended strategy involves biding time for significant downturns where the opportunity to buy presents itself. In this landscape, sectors deemed underperforming might reveal gems for the discerning investor. Take, for example, the housing sector or small-cap stocks, which, although perhaps overlooked, harbor potential.

Inflation fears are never far from the forefront, and the focus shifts back towards Federal Reserve policies. Keeping a close ear to the likes of consumer price indices and personal consumption expenditures becomes paramount. Additionally, oil prices, and their relationship with the fluctuating dollar, serve as critical indicators of future growth, especially for globally positioned equities. The prevailing thought remains: patience is vital; as these volatile conditions unfold, the wise will let opportunities knock before they answer.