On a week that saw the S&P500 rise by 3%, coming within one percent of the prior all time highs it is important to note that single stock volatility was the real story for some high valuation, speculative stocks. And it wasn’t all UPward volatility. The week was booked-ended with extreme moves, starting with once loved mini-bubble in tech, with 3D printer company Stratasys (SSYS) plunging 35% on Tuesday after issuing a disappointing qtr and outlook, while Friday was marked with dramatic moves, both up and down by internet services companies, like EXPE, P & YELP declining 11%, 17% and 21% respectively. Controversial high valuation Social Media stocks like TWTR and LNKD rallied 16% and 10% on the day, bucking the trend, but the maker of the flavor of the month mobile camera GPRO saw its shares decline 13% despite handily beating consensus estimates.
For those of you who like to track spot VIX and get a sense for market sentiment, I would suggest that at the movement in the names listed above, and the almost 10% gains on the week in stocks like BAC, COST and Ford, the VIX at 17 is not telling the whole story. As a trader I see little use in watching the VIX, rarely in my career can I say that the movements in the index, or in the options or futures on the index as a forward looking indicator. So the long term average in the VIX has been 20, during the last 5 years since the end of the financial crisis the average has been about 18.50, the last 3 years about 15.5. and 14.50 for the past year. So you get the point, it’s been grinding lower, and we know why. The Fed’s actions have depressed equity volatility as it seems any 3-5% selloff is immediately rescued by some sort of Central Bank action or rumor.
However, things could be changing. Since the end of QE in October the VIX has now had four spikes above 20, after having only six in all of 2014. This is likely one of the first consequences we get to witness since of the end of QE. Especially has the data dependent Fed wrestles with the timing of rate increases.
Regular readers know that this has been a thesis of ours for a the better part of the last six months. Once it became clear that the Fed would end its QE. It has not been our view that stocks would crash with the end of QE, merely that stocks would likely follow the volatility in risk assets like commodities, currencies and credit. We are starting to see that.
And one point I would make is to get comfortable with ways to protect your portfolio, or individual stocks. For example, last week prior to TWTR’s Q4 results we were worried about potential volatility for our long position and decided to collar it (selling a long dated call, and buying a short dated put at our purchase price, read here). Given the stock’s massive move on Friday this caution was obviously for naught, and the protection cost a portion of the gains in the stock. But NO ONE has a crystal ball into these binary events, and sometimes giving up some potential gains by limiting potential downside losses makes sense, especially in a market where single stock volatility is more pronounced than being displayed in some of your favorite fear gauges. This allows you to hold stocks thought these periods without puking them on selloffs and chasing them back to the upside on rallies.
Lastly, all bull markets are not created equal, and the failure of once mini-bubbles in 3d printing stocks and internet services may be a positive thing, helping the next potential stage of the bull market. If money flows out of speculative high valuation stocks/sectors and into more economical sensitive sectors like financials or industrials that could actually be a positive. But I don’t see that happening and things are never that orderly.
All I know is that the extreme volatility we are seeing is not exactly bullish in the grand scheme of things.