One of the great market mysteries of the last six months has been the lack of equity volatility during an endless march to new high after new high. That’s been despite a backdrop of crashing commodity prices, a surging dollar, and Treasury yields having violent movements in a fairly tight range. On March 20th in this space (It’s a Vol World After All) I highlighted the fact that despite greater than average movement in almost every other risk asset, thirty day at the money implied vol on the S&P 500 index (SPX), was reflecting less than 1% intra-day moves, and was in line with realized vol, and concluded:
we are likely to either see a major cooling in movement of almost every other risk asset in the world, or a marked pickup in volatility of U.S. equities.
This is not really a non-consensus view, but I am hard-pressed to think that the massive strength of the dollar, the continuation of abnormally low interest rates and crashing commodity prices won’t cause either a melt up or a melt down in U.S. equities very soon.
Which brings me back to equities, surveying yesterday’s damage leads me to believe that the V reversal we all have become accustomed to could be more elusive in the coming days. There are a couple reasons for this. First, as we limp into quarter end, with the S&P 500 now flat on the year, there is little reason to try to mark up the close of the period. Second, as we head into April and the start of Q1 earnings, we potential lose of a natural buyer of stocks as we get into Q1 reporting season staring in early April, companies will enter blackout periods of buying back their own stock, which we know has offered massive buoyancy to the stock market.
Over the past year, the first few weeks at the start of a new quarter has offered a bit of downward volatility.
From April 4th to April 14th 2014 the SPX dropped nearly 4.5%
From July 3rd to Aug 7th 2014 the SPX dropped a little more than 4%
From Sept 30th to Oct 15th 2014 the SPX dropped about 7.5%
From Dec 31, 2014 to Feb 2nd 2015 the SPX dropped nearly 4%
So in a world where it appears that geo-political risk is rising and the health of the global economic recovery is debatable, investors may have cause for caution heading into Q1 reporting season. It’s a season that could be marred by weak forward guidance resulting from the adverse affects of a strong dollar offsetting the benefits of lower input costs.
In an effort to not sound redundant, I would add that the damage done in U.S. equities yesterday was not insignificant. Stocks like INTC and MSFT down 3%, after already being down 15% from their recent highs, WMT down 2% after already declining 9% from its recent highs, FB down 3% from an all time high, and the IBB (iShares Nasdaq Biotech index) which BIIB, AMGN, CELG & GILD make up 30% was down 4%, down 9% from an all time high made Friday. That’s some serious declines in some of last year’s biggest gainers. A pick up in equity volatility is far from bullish. Investors have grown unaccustomed to large moves in their most beloved stocks and the slightest reminder that they are possible could force a race to the exits.