The market wants you to know that volatility is not a static measurement. After three years of below-average volatility, stocks seem headed for increased levels in 2015. It is still very early in the year, and anything could happen, but the early indications are pointing in that direction.
Yesterday, the Dow Jones Industrial Average jumped 282 points in the first few minutes of trading. It then reversed directions and fell 425 points over the next four hours. From its afternoon low, the Dow then climbed 116 points to close just 27 points lower for the day. The net change of just 27 points gives the appearance of a rather uneventful and boring day. The 823-point journey it took to get there tells a different story.
Monday was calmer, but there was still a 222-point difference in the Dow’s high and low values for the day. Ordinarily, this would seem like a wide range, making for a volatile day. However, that was the narrowest range the Dow traversed in the past eight market days. In fact, only one day so far in 2015 has seen a smaller range, and that was the 221-point spread on the first trading day of the year.
Three years of any trend can lure investors into believing the trend could last indefinitely. Three years of below-average volatility has instilled some amount of complacency, which could lead to some negative surprises if the recent higher levels are sustained. In 2011, volatility for the S&P 500, as measured by the standard deviation of daily returns, was twice the level of 2014. In 2009, it was 2.3 times (+134%) higher, and in 2008 the S&P 500 was 3.6 times (+263%) more volatile than last year. How much volatility are you prepared for?
Changes in Federal Reserve policies often bring about market instability. Two weeks from today, the Fed will conclude its first FOMC meeting of the year. Analyst consensus points to 2015 being the year the Fed begins raising interest rates, which could be a volatility trigger. In the meantime, bond yields continue to fall, and the 10-year Treasury yield dropped below 1.8% in today’s trading. This doesn’t sound like a market concerned about interest rates moving higher, so the source of volatility probably lies elsewhere.
Earnings are another story. Firms are just now starting to roll out their quarterly earnings reports. There have been some positive and negative surprises, and there will be plenty more of both. Alcoa (AA) says demand for aluminum is increasing, while KB Homes (KBH) predicts softening sales. The falloff in oil prices is expected to have significant ramifications for oil company earnings. Turmoil in the oil patch could still be in the early stages.
Real Estate is at the top for a second week. It’s important to note that this sector is composed primarily of REITs as opposed to housing and construction stocks. Homebuilders, part of the Consumer Discretionary sector, went on a wild ride yesterday while movements in the Real Estate sector were muted in comparison. Health Care posted another good week and moved up a notch to grab second place. Utilities slipped to third, and Consumer Staples held steady in fourth. This puts the defensive trio of Health Care, Utilities, and Consumer Staples bunched together near the top of the rankings. Consumer Discretionary kept its fifth-place ranking despite the increased volatility among both retailers and homebuilders. Technology and Financials swapped positions, and both seem to be just treading water at this point. Telecom moved up a notch and shed its negative momentum, although it cannot claim having positive momentum yet. Industrials slipped a notch and flipped over to red, while Materials sits directly below. Energy lost more ground this week, remains in a steep downtrend, and is firmly in last place.
A quick glance at the style rankings suggests little change in the lineup this week. However, on closer inspection, Small Cap Value and Large Cap Value slipped lower, allowing Growth to gain an advantage. Micro Cap is in the driver’s seat for the third week, but it was on the bottom just seven weeks ago. Small Cap Growth is in second again and has been in the upper half of the rankings in all but one of the past eleven weeks, making it much more consistent than Micro Cap. Mid Cap Value is the only Value category to rise in the rankings this week, although this was primarily due to the decline of Small Cap Value, which previously held the fourth-place spot. Mid Cap Blend and Mid Cap Growth also improved a notch each. Large Cap Growth climbed three spots and Large Cap Blend moved ahead one. The two fallen angels are next. Small Cap Value fell five places and Large Cap Value slipped two. These changes may not be as important as they first appear since the separation between third-place and tenth-place amounts to only six momentum points this week. Mega Cap is on the bottom for the fourth week, but it managed to shed its red pixels for today’s snapshot.
China is on top for the sixth week and now boasts the largest margin of its current reign. Second-place U.S. is far behind, although it can still claim a positive momentum reading. The remaining nine categories aren’t so fortunate, as all are in the red again this week. World Equity heads up the “also ran” list and is trying to separate itself from the pack. There is a near three-way tie for fourth place as Pacific ex-Japan, Emerging Markets, and Japan all vie for contention. Emerging Markets posted a good week and jumped up from eighth to put itself in the race for fourth. Canada was the big decliner, losing more momentum and falling four places to tenth as the country’s large weighting in the Energy sector takes its toll. Latin America showed some signs of stabilization, but it has a long way to go before it can claim the elimination of its negative trend.
“For a while it was nothing but buyers, then it turned and it just hit an air pocket. People are starting to get jittery.”
Viren Chandrasoma, managing director of equity trading at Credit Suisse in reaction to market activity on 1/13/15
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