As I wrote on Tuesday, the question of the day (for me at least) remains the same on this fine Thursday morning. What is real and what is artificial?

Sure, stocks bounced right on cue after getting sucker punched by what I believe was a 12-standard deviation move in the volatility complex. In short, such a move just isn't supposed to occur - ever. And when it did, well, all kinds of bad things started to happen to anyone playing the short volatility game.

The bounce continued yesterday morning until about 11:15 am eastern. From there, it was mostly downhill and while there was some back and forth action in the afternoon, the final half hour was just plain ugly.

During times of market stress such as we are seeing now, it is normal for the market to lurch forward and then fall backwards repeatedly. I liken this action to a drunken sailor trying to walk out of the bar after an evening of imbibing. The key here is the market, like the sailor, is trying to find its balance. And based on my experience with market crises/panics, this type of action could continue for a while.

But from a bigger picture standpoint it is important to try and get a grip on what is "real" during all of this day-to-day volatility. As in, what is happening from a fundamental standpoint?

To review, it is the prospect of higher-than-expected inflation and, in turn, higher interest rates that is being cited as the reason for the "reset" in expectations - and stock prices. And I will opine that while it didn't make the headlines, this very issue was in play again yesterday.

With the Dow having bounced 1500 points off Tuesday's low, the action in the bond pits took on a different tone Wednesday. Gone was the early-week flight to quality move. No, by mid-morning Wednesday, the yield on the 10-year was movin' on up again and pushing toward the recent highs. In fact, the 10-year yield closed yesterday at 2.844%, which is just a smidge shy of Friday's cycle high at 2.854%.

While the talking heads continue to focus on the fallout from the debacle in volatility-land and analysts try to determine when the next wave of vol-based selling from the risk parity crowd begins/ends, I'm thinking that interest rates may hold the key to the bigger-picture.

So, at this point, I'm going to step away from the volatility panic and focus on the macro question of "how much is enough?"

In my mind, the key question here is if the current 6.6% decline (based on yesterday's close) from the January 26 all-time high for the S&P 500 represents enough "discounting" of stock prices for (a) the 10-year moving over 3%, (b) inflation breaking above the Fed's long-standing target, and (c) another rate hike (or two) from the new Fed Chairman this year.

While this is an off-the-cuff response, if asked the question, my answer would be, "Yea, that might be enough to get things back to equilibrium - give or take a couple/three percentage points."

But then again, nobody is asking me. And as I learned a very long time ago, Ms. Market doesn't give a hoot about what I think!

So, from a macro point of view, a correction of somewhere between 5% to 10% would seem about right to for what is being anticipated. And with the intraday decline from top to bottom coming in at 9.74%, one can argue that Tuesday's low is an important line in the sand.

But getting back to reality, first we have to get through the current freak-out phase. And while I do have the crash playbook memorized, I'm not really sure whether we are in phase one (the dive) or phase three (the retest). So, it will suffice to say that I will continue to watch the action closely and continue to try and make sense of it all. Wish me luck!

Thought For The Day:

It is impossible to speak in such a way that you cannot be misunderstood. -Karl Popper

Wishing you green screens and all the best for a great day,

David D. Moenning
Founder, Chief Investment Officer
Heritage Capital Research
Serving Financial Advisors since 1989
Serving individual investors since 1980
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Disclosure: At the time of publication, Mr. Moenning held long positions in the following securities mentioned: None

Note that positions may change at any time.

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The opinions and forecasts expressed herein are those of Mr. David Moenning and may not actually come to pass. Mr. Moenning's opinions and viewpoints regarding the future of the markets should not be construed as recommendations. The analysis and information in this report is for informational purposes only. No part of the material presented in this report is intended as an investment recommendation or investment advice. Neither the information nor any opinion expressed constitutes a solicitation to purchase or sell securities or any investment program.

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