When the S&P 500 shed nearly 40 points last Thursday, logging its second largest one-day plunge so far in 2014, the CBOE Volatility Index (VIX) moved north of 17 for the first time since April 15. Trading had been relatively orderly through the second half of July and the heart of a mostly upbeat earnings reporting season. But the unexpected broad-market pullback, stretching to all 10 sectors of the S&P 500, seems to have stoked fears about a potential larger market correction.
That begs the question: Will anxiety spread?
What’s perhaps more significant than the intraday spike is that VIX, known to some as the market’s “fear gauge,” is up some 70% since the low near 10 was hit in early July (see figure 1). Now, it’s still way low by historical standards. But the recent move is reminiscent of a three-week, 76.6% jump in VIX that ended on February 3—the day that the S&P 500 tumbled 40.7 points to suffer its biggest loss of this year. VIX hit a 2014 peak of 21.48 at that time. The recent jump in risk perceptions seems to reflect macro concerns rather than individual stock news. Indeed, earnings news has mostly been better than expected, and some 80% of the S&P 500 has now reported.
Figure 1: The CBOE Volatility Index (VIX) last week was up some 70% from the early-July low of 10.28—the index’s lowest level since early 2007. Data source: CBOE. For illustrative purposes only. Past performance does not guarantee future results.
Highest for the Year
A spike in the total equity put-to-call ratio late last week may also reflect an uptick in bearish sentiment. A put is an options contract for the right, but not the obligation, to sell an underlying security at a set price and time. A call, on the other hand, is the right, but not the obligation, to buy the underlying security at a set price and time.
The math behind the put-to-call ratio is straightforward: it’s simply the day's put volume divided by call volume for trading of a particular name across all options exchanges. (The numbers are updated daily at the Options Clearing Corporation’s optionsclearing.com.) The ratio hit multi-month highs of 1.20 at the end of last week—the highest for 2014, and a level not seen in more than a year (see figure 2). It’s a potential sign that some investors were nervously scrambling to hedge portfolios short term with put options. Indeed, fear and anxiety appeared to have reached an extreme. And whenever we see an extreme move in either direction, we ask: is this a knee-jerk reaction that will smooth out when cooler heads prevail? Or, is there change under foot?
More Tests Ahead
Broad-market volatility will face a fresh round of challenges this week as earnings news continues and the very real chance that non-U.S. events rattle markets continues to hang over Wall Street.
Among the 361 S&P 500 companies that have brought home their Q2 report cards, total earnings are up 8.9% from a year ago on 5% higher revenues, according to Zacks (an unaffiliated third-party research firm). More than two-thirds of those reporting have beat Wall Street’s EPS estimates, and nearly 60% have come out with positive revenue surprises.
Groupon (GRPN) will be among the names to watch early in the week when the web-based deal company reports after the bell Tuesday. AOL (AOL), Dish Network (DISH), and Time Warner (TWX) release results Wednesday morning. Indeed, it’s a busy week for earnings from the entertainment sector, with 21st Century Fox (FOXA), CBS (CBS), Disney (DIS), and News Corp. (NWSA) on tap this week as well.
The economic calendar is light after a heavy dose of numbers last week. Reports include the July TD Ameritrade Investor Movement Index® (IMXSM) released Monday (refresher: IMX tracks holdings/positions, trading activity, and other data from a sample of our 6 million funded client accounts. It is not a tradable index and should not be used as an indicator or predictor of future client trading volume or financial performance for TD Ameritrade). IMX has been little changed in recent months after hitting its all-time high in March. Meanwhile, retailers are in focus on Thursday. Individual companies ranging from Gap Stores (GPS) to Costco (COST) will be releasing July monthly same-store sales numbers (see the full economic calendar in figure 3, below).
Eyes will be on events overseas as well. Although much of the focus was on the Argentinian debt debacle and ongoing Middle East and Russia/Ukraine violence last week, Europe will be in focus Thursday when the Bank of England and the European Central Bank wrap up meetings that could hold policy announcements. The Bank of Japan holds a monetary-policy meeting this week as well. Will the gap between U.S. interest rate policy and that at its central bank counterparts widen? Stay tuned.
As for the charts, the big test may lie with 1900 for the S&P 500. If SPX 1900 can hold, it could prove to be a springboard for the bulls to drive the index straight to 2000 over coming sessions. Likewise, a stall at near 1900 could invite fresh selling.
Good trading, JJ @TDAJJKinahan
Figure 3: Weekly U.S. economic report calendar. Source: Briefing.com.
TD Ameritrade, Inc., member FINRA/SIPC/NFA. Commentary provided for educational purposes only. Past performance is no guarantee of future results or investment success.
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