After the mid-month volatility spike, stocks moved broadly higher last week. No, your eyes did not deceive you. An up-week for the first time in a month. Even the laggard, small cap-loaded Russell 2000 (RUT) logged a weekly gain of over 3%. Now a heavy dose of economic and earnings news, as well as a mid-week Federal Reserve meeting, loom for this final week of a true-to-form volatile October.
Corporate earnings reports will be an important theme after largely upbeat results to date seemed to help offset other concerns that roiled markets in the first half of October. On Friday, for instance, Procter & Gamble (PG) helped pace the Dow Jones Industrial Average’s triple-digit advance after profit at the consumer products giant topped Street expectations.
Of the first 115 companies to release Q3 results through last week (that’s 35.5% of the market cap of the S&P 500), total earnings are up 6.9% from a year ago on a 4.9% gain in revenue, according to Zacks Investment Research. That’s significantly better than expectations just two weeks ago, which called for earnings and revenue growth of less than 2%.
Against this backdrop, the CBOE Volatility Index (VIX) is now well off the multi-year high set on October 14 (figure 1) and shed some 30% last week. The concerns that sent the market’s “fear gauge” beyond 31 for the first time since late 2012 have receded and the index is back in the mid-teens. The precipitous decline in VIX reflects a rather dramatic shift of sentiment in just the past two weeks.
Let’s not forget our “sentimental” friend, the bond market: head-spinning week for Treasuries again last week. In fact, I read an interesting anecdote that said if the stock market had experienced the same percentage-change jerks in both directions as those logged by bond yields in recent sessions, we’d have seen front-page, shove-everything-else-over headlines every day. Not everyone holds bonds, but the potential implications for interest rates and stocks plays out right in front of us, every day.
Figure 1: The CBOE Volatility Index (VIX) spiked above 31 for the first time since late 2012 and now... [+]
And From Here?
Consider the dramatic reversal in the VIX term structure, or curve, in less than two weeks (figure 2). Notice that on October 15, the level for short-term November VIX options was north of 26 and the highest of any term. December, meanwhile, was at 25.
This so-called backwardation in VIX options, where near-term contracts are higher than those out on the calendar, is atypical. It can suggest a moment of market panic as short-term risk perceptions become elevated and rattle the broader market, but aren’t necessarily sustainable.
Figure 2: Chart and table show a spike in the December 2014 VIX reading (mid-chart), a fall-off in... [+]
It’s more common to see contango in the VIX term structure. See figure 3 from Friday afternoon, in which shorter-term volatility is lower than more distant expirations. The steepness of the curve reflects the fact that there is typically more uncertainty over longer-term options. In that sense, VIX options are hinting a return to normalcy. (Note that VIX is designed to track the implied or expected implied volatility of short-term options on the S&P 500. CBOE offers the term structure information to provide a look at implied volatility over later expiration months.)
Figure 3: Example of upward-sloping volatility chart in contango shape, where shorter-term... [+]
That’s the Thing about Surprises…
Although better-than-expected earnings seem to be offering support, the volatile market action in the first half of October is a reminder of how rapidly macro concerns can re-emerge and suddenly rattle global financial markets. Keep this in mind as we dig in for another week of rapid-fire earnings from Twitter (TWTR), LinkedIn (LNKD), Kellogg (K), Starbucks (SBUX), Buffalo Wild Wings (BWLD) and others, including several health care and energy companies.
Data on durable goods, consumer confidence, and GDP could also add fuel to the fire (see figure 4 for the full calendar). In that respect, Wednesday’s Federal Open Market Committee (FOMC) meeting—at which the Fed is expected to wrap up its economy-stimulating, bond-buying program and potentially shed a little light on upcoming policy plans—could move markets, especially if officials signal a more cautious stance.
An interesting Reuters article noted that corporate-bond funds are adding to their Treasury positions at twice the rate of their corporate bond positions based on worldwide economic concerns. In fact, their Treasury holdings as a broad group were up 15% year-to-date through September, Reuters reported. This caution in fixed income is one more reason that I believe even if stocks rally anew and return SPX levels to those seen earlier this year, volatility will remain higher. You may want to keep SPX 1972 under watch for a near-term line of resistance; 1951 for support.
Good trading,
JJ
TD Ameritrade, Inc., member FINRA/SIPC. Commentary provided for educational purposes only. Past performance of a security, strategy, or index is no guarantee of future results or investment success.
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