06/04/14   Markets Like Low Volatility, But The Fed Doesn’t

Editor’s Corner

Ron Rowland

As skeptics continuously cry out warnings of the inevitable collapse, the market slowly marches higher and higher.  New highs are the norm now, at least for the S&P 500, and failing to close at a new high is probably more newsworthy than actually accomplishing the task.  Many investors tend to get scared or worrisome about the market being at new highs, somehow failing to grasp that the Dow’s climb from below 50 points in 1932 to nearly 17,000 today consisted of numerous new highs.  New highs are a common occurrence.

The recent climb has been accompanied by low volatility.  Again, this is typically a good sign, indicating a high probability of continuation.  However, a Wall Street Journal article today claims that Federal Reserve members are worried about the market’s calmness.  Their fear is that investors have become complacent about risk.  Such complacency could eventually lead to bubbles and increased volatility, or so the thinking goes.  Indeed, it is possible to conclude that risk increases every time the market goes up because it then has further to fall.

Market volatility, as measured by the VIX Index, has been below its long-term average for 17 months.  The last time it saw a run like that was in 2006-2007, before the financial crisis ushered in huge price declines and nearly incomprehensible levels of volatility.  William Dudley, president of the Federal Reserve Bank of New York said last week, “Volatility in the markets is unusually low.  I am a little bit nervous that people are taking too much comfort in the low-volatility period.  As a consequence, they’ll take more risk than really what’s appropriate.”

The Fed is probably correct in thinking that current volatility levels can go only one direction from here.  However, that is not a certainty.  Records are not immutable stopping points; they can be broken at any time.  Just as prices can make new record highs, it is entirely feasible for volatility to make new record lows.  We are not predicting new lows for volatility measurements but are merely pointing out that it is possible.

Much of the feel-good atmosphere for investors is the direct result of actions and statements from the Fed.  For years, the Fed has assured us after every FOMC meeting that interest rates will stay near zero for a “considerable time” after the completion of its quantitative easing (bond buying) program, which is on-track to wind down later this year.  Many analysts have been warning us for years about the indirect consequences of the Fed’s actions.  If the Fed is finally worried about the indirect effects of its policy, then we could start to see some changes in the policy statement when the next FOMC meeting concludes on June 18.

Investor Heat Map: 6/4/14


Eight of our sector categories produced momentum scores that resulted in ties this week.  Two sectors tied for first place, four are tied for third, and two are tied for seventh.  Leading the entire lineup are Real Estate and Energy, which have been in that position for three weeks running.  Technology is again in third place, but this week it essentially shares the position with Materials, Consumer Staples, and Utilities.  The relative rankings indicate a slight improvement for Materials and Consumer Staples.  Utilities was the top performer, surging from ninth place last week to tied for third this week.  Industrials and Health Care are the two sectors tied for seventh place and are in the same relative positions as last week.  Telecom took a tumble, dropping from fourth to ninth, although its uptrend still appears to be healthy.  Financials and Consumer Discretionary remain the sector laggards.


Among the style categories, the strong got stronger while the weak were unchanged.  Mid Cap Value climbed two spots to retake the lead after a two-week absence.  Large Cap Value held its second place position as Large Cap Blend and Large Cap Value each climbed a spot to put all three Large Cap categories in a 3-way tie.  Mega Cap increased its momentum over last week, but it wasn’t enough to keep it at the top, and it fell from first to fifth.  All the remaining categories are in the same relative positions and with similar momentum scores as a week ago.  Small Cap Blend, Small Cap Growth, and Micro Cap are the only three categories with negative momentum readings.  The huge surge by Small Cap Growth and Micro Cap two weeks ago failed to produce an immediate follow through.  However, they have not given back much of their gains and appear prepared to make another run.


Sometimes there is a shake-up in the rankings, and occasionally that shake-up can be dramatic.  A week ago, China was second-to-last, a position it held for three weeks after climbing out of the basement.  Today, China is at the top, surpassing nine categories in the process.  China posted good performance for the week.  Not outstanding – just merely good.  However, given that many other world regions had so-so or negative returns for the week, China’s “good” was good enough.  Japan also had good performance, even better than China on a total return basis.  Japan was in last place a week ago and is now tied for third with the U.S. and World Equity.  World Equity climbed three spots, and the U.S. climbed four places to form that 3-way tie with Japan.  As you can imagine, China and Japan’s great strides in the rankings, along with the nice improvements for the U.S. and World Equity, pushed nearly all other categories lower.  Emerging Markets was the former leader and only fell one spot to second.  Pacific ex-Japan was also fortunate enough to hold its ranking decline to one spot.  The U.K., Canada, and Latin America are a different story, with each losing enough momentum to cause significant drops.  The U.K. fell seven places from second to ninth.  Canada gave up six positions on its way to tenth.  However, it was Latin America that had the largest drop, falling from third to last.


The charts above depict both the relative strength and absolute strength of various market sectors, styles, and geographic locations on an intermediate-term basis. Each grouping is sorted (top to bottom) by relative strength. The magnitude of the displayed RSM value is a measure of absolute strength, which is our proprietary method of measuring and reporting the intermediate-term strength as an annualized value.


“Low volatility I don’t think is healthy. This indicates to me a little bit too much complacency that rates are going to stay at abnormally low levels forever.”

Richard Fisher, president of the Federal Reserve Bank of Dallas, June 3, 2014


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