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Volatility Reality Check

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Don’t look now, but it may be time for a market history lesson. Conditions have become notably more volatile than a month ago. Let’s just say that volatility is on the move, and while it’s still low compared to other market cycles, the vol charts, especially a measure of historical volatility over implied volatility in the S&P 500 index, are starting to wake up.

That means the thin, whipsaw trading of last week could continue. It’s true, too, that light volumes are possibly exacerbating volatility as many participants, especially those in Europe, vacation during August. What’s that mean for investors still glued to their screens? Thin volume can lead to exaggerated market moves.

Next Catalyst?

After a week of heavy news flow from abroad, including the ebb and flow of violence on several fronts, the domestic economy comes back into focus with retail sales data due out Wednesday and jobless claims Thursday. Friday is the busy day for economic data: manufacturing, inflation, and industrial production will set the tone (see the full economic calendar in figure 3 at blog’s end). All told, thin trading, increasing volatility, a back-loaded economic calendar, and August options expiration at the week’s end are possible catalysts for another round of choppy trading.

The pace of earnings slows this week, but some notable companies are due to report over the next few days, including Macy’s (M), Deere (DE), and Cisco (CSCO) on Wednesday. Wal-Mart Stores (WMT), which is a helpful barometer of North American consumer health, issues its results on Thursday.  Kohl’s (KSS), Applied Materials (AMAT), and Nordstrom (JWN) are also among the names releasing Thursday. Finally, Estee Lauder (EL) and JD.com (JD) are the only two sizable companies reporting Friday.

With most S&P 500 companies already reporting, total earnings are up 9% from a year ago on 4.6% higher revenues. Two-thirds have posted better-than-expected earnings per share, and more than 60% topped revenue estimates. Said research firm Zacks, “This is a better performance than we have seen at this stage in other recent reporting cycles.”

The tumultuous few weeks have left the technology, health care, and utilities sectors as top performers; all three tend to outperform, at least over the short term, when yield-hungry investors shun lower Treasury yields, currently at their lowest for the year. Bond yields move lower as prices rise, in this case because of a “risk off” shift spurred by geopolitical uncertainty.

Reality Check?

Notably, market volatility seems to be picking up as focus shifts from earnings back to the macro economy. For instance, on July 3, the CBOE Volatility Index (VIX) fell to seven-year lows of 10.28 after a quiet June (see figure 1).

The 30-day historical volatility for the S&P 500 is plotted in the bottom section of the chart in figure 2. It’s a measure of annualized standard deviation computed using closing prices over a period of days. Essentially, it’s a measure of what the S&P 500 actually did—not a measure of expectations, as with the VIX.

After moving to 2014 highs of 16.7% in early February, volatility dropped to multi-year lows of 5.5% through late June before climbing back toward 10. That means S&P historical volatility is now in the middle of this year’s range. Although still not elevated, it’s clear that market volatility is ticking higher as the S&P 500 begins to make larger price swings from one day to the next. The trend is certainly worth watching in the week ahead.

Good trading, JJ @TDAJJKinahan

 

Figure 3: Weekly U.S. economic report calendar. Source: Briefing.com.

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TD Ameritrade, Inc., member FINRA/SIPC/NFA. Commentary provided for educational purposes only. Past performance is no guarantee of future results or investment success.

TD Ameritrade, Inc., and Zacks Investment Research are separate, unaffiliated companies and are not responsible for each other’s content.