Uptrending volatility and mixed trading may persist in this holiday-shortened week as investors digest the next round of earnings reports. Indeed, with the CBOE Volatility Index (VIX), a sentiment gauge affectionately called the market’s “fear gauge,” at 12.5 and in the lower end of its one-year range, the risk of market complacency is growing.
The biggest broad market driver to start the week may be oil. Crude rose towards $108 a barrel on Tuesday as the International Energy Agency raised its forecast for global oil demand this year due to accelerating economic growth. Airlines (and their stock prices) could feel the pain of higher fuel costs. And, if higher crude prices persist, the impact could spread to consumer and business sentiment.
The 10-year note yield, a benchmark for some key interest rates, is another indicator for stock investors. Should it drop to 2.8%, look for bond sellers to emerge (remember, price and yield move in opposite direction, so higher prices at this level could trigger selling). And if that selling kicks in, the yield could head yet higher, potentially raising borrowing costs for consumers and businesses.
Since we don’t have much regularly scheduled economic news to work with this week (see figure 1), we can give the bulk of our attention to earnings. IBM (IBM), Texas Instruments (TXN), CA, Inc. (CA), and Xilinx (XLNX) report Tuesday. United Technologies (UTX), U.S. Bancorp (USB), eBay (EBAY), SanDisk (SNDK), and Western Digital (WDC) are on the docket Wednesday. Busy Thursday features McDonald’s (MCD), Discover Financial Services (DFS), Starbucks (SBUX), and Microsoft (MSFT). Procter & Gamble (PG) is among a handful of Friday releases.
Figure 1: Weekly U.S. economic report calendar. Source: Briefing.com.
As Correlations Go, So Goes VIX
During busy periods for corporate earnings, stock market averages sometimes seem to churn in uninspired fashion because the focus on profit reports sometimes leads to less correlation in the price action of individual stocks. There are some winners and some losers. The opposite can happen when macro news dominates the headlines and investors buy and sell stocks en masse.
The Implied Correlation Index (ICJ) from the Chicago Board Options Exchange (CBOE) offers a quick look at changes in overall market correlations (figure 2). It measures the correlation, or co-movement, among S&P 500 stocks. When macro news is driving trading order flow, correlations tend to increase and the index moves higher. On the other hand, when the atmosphere becomes more of a “stock pickers” market, correlations fall and the ICJ moves lower. As we can see, the trend over the past few months has been declining correlations and an uptick, or at least what might be the start of an uptick, in recent sessions.
Figure 2: Three-month view of Implied Correlation Index trending lower, then rising from the recent low of 54.83 hit in early January. Data source: CBOE. For illustrative purposes only. Past performance does not guarantee future results.
The VIX at 12.5 might seem low, but falling correlations are possibly one reason for the decline. Remember, the VIX tracks the implied volatility priced into S&P 500 options. Low stock correlations during the earnings reporting season might well result in aimless churning for the S&P 500 for the next few weeks.
And Next?
What might change the course of the broader market? Hard to tell. But perhaps the next big economic event is the Federal Reserve’s policy meeting on January 29, the last gathering with Ben Bernanke at the helm.
At the December meeting, officials announced plans to “taper” their monthly bond buybacks by $10 billion per month. Although most economists expect similar commentary from the January meeting, a few see some chance that the Fed may deepen its cuts. What then for markets?
Good trading,
JJ
P.S. Connect with TD Ameritrade’s Nicole Sherrod on Twitter and Facebook and myself on Twitter and Facebook throughout January for options strategies, market observations, and more. One a day for 30 days.
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