Stock Volatility Up As Market Sells Off After A Long Calm

Yahoo finance ^ | Thursday May 18, 2006 | Ed Carson

[expat_panama]

Investor's Business Daily
Stock Volatility Up As Market Sells Off After A Long Calm
Thursday May 18, 7:00 pm ET
Ed Carson

After sleepwalking toward multiyear highs, the market sell-off has put a little bit of fear back into investors.
"People were saying we are in the end of volatility, but guess what, it's back," said Jim Cramer, host of CNBC's "Mad Money."
The CBOE's volatility index, or VIX, spiked to 16.99 on Thursday, its highest close in a year as inflation fears boiled over.
The S&P 500 hit a 3-month low on Thursday, while the Nasdaq slid to its worst level in 6 months.
Cramer suspects "pile on" selling of exchange traded funds is pushing down equities, especially many commodity highfliers.
While many leaders have found trouble, the overall market moves look severe because of stocks' gradual uptrend in prior months.
The S&P is still just 4.9% off its five-year high, while the Nasdaq is down 8.2%.
So far in May, the S&P 500 has had four days where it's moved up or down at least 1%. There were 16 such days in October 2002, when the bear market bottomed.
But over the six months to April, the S&P 500 averaged just 1.17 big days per month. The VIX, known as a fear gauge, was at the lowest levels in a decade.
Investors were confident. And why not? The economy and profits were growing fast and the Fed seemed ready to end rate hikes.
Then surging commodity prices and Wednesday's core CPI reading revived inflation fears.
Investors are wringing their hands, but that's not a bad thing.
"Volatility is good because it shakes that optimism out as you go along," said Don Hays, chairman of Hays Advisory.
Cramer agrees. "It creates far more opportunities and people need to recognize this and not get scared away."
Volatility may seem low next to the outsized hopes and fears of 2000, but it many ways the trend has been a return to normalcy.
During the 2000 peak and subsequent crash, the Nasdaq averaged intraday swings of more than 3%. But swings now are about 1%, back where they were in the early '90s.
Hays expects stocks to struggle for the next few weeks or months.
But he believes markets' fears are overblown. He predicts commodity prices and inflation will ease over the next several months and that the Fed will keep its key lending rate at 5%.
So Hays expects stocks to eventually rebound. But he sees growth companies leading the market instead of energy and metal firms.

[expat_panama]

OK, all you pros have known about the VIX for years but for me today it's hot stuff --seems like when the VIX was around 12 was when I did the best and every time it hung up at say, 15 then everything tanks. 

I plan to follow it everyday everyday for a while --it's down somewhat this morning to 16.23.   History of the VIX here, and daily data here.

[the invisib1e hand]

vix extremes can point to turning points. taken with other observations.

[expat_panama]

vix extremes can point to turning points. taken with other observations.

Apparently it can.  The tool's been around since '93 but this is the first I'd heard about it. 

Never to old to learn I guess...

[expat_panama]

oops, that post was meant for you...

[Moonman62]

The Federal Reserve is in destruction mode. It's best to stay outside while the bull is in the china shop.

[groanup]

Don't use the VIX by itself. It can be helpful when taken with other factors.

[expat_panama]

The Federal Reserve is in destruction mode. It's best to stay outside while the bull is in the china shop.

I wouldn't blame everything on Bernanke, he goes out of his way to cushion and sugar coat everything he says and the traders still go loopy.  IMHO this is that famous 'wall of worry' everyone likes to climb.  The spikes are momentary and it's the 'boring' troughs that are the norm. 

[the invisib1e hand]

Don't use the VIX by itself. It can be helpful when taken with other

especially volume extremes, apart from other factors, technical and otherwise.

[B4Ranch]

Agreed, I just pulled back to 80% cash.

[Attention Surplus Disorder]

The VIX in the very low teens is an all-time low: ridiculous, unnatural, absolutely no-fear whatsoever.

[expat_panama]

Don't use the VIX by itself. It can be helpful when taken with other   especially volume extremes

Also the fact that the VIX does it's own version of the 'random walk' too.   It was down to 16.2 for a half hour and now it's hung up at 16.7.   Looking back is easy.  Predicting trends is hard.

[expat_panama]

The VIX in the very low teens is an all-time low: ridiculous, unnatural, absolutely no-fear whatsoever.

Aw, I donno; seems more like it's just back to business as usual after a few years of the Clinton/9/11 bear market.

What the long term trend tells me is that this is still a very healthy bull market with a spiking correction.

I could be wrong.

[the invisib1e hand]

its about extremes...not decimal places and not counting minutes.

[expat_panama]

Agreed, I just pulled back to 80% cash.

Interesting, that's right where I'm at too.  I keep 'sticking my toe in' just to see how things are I keep getting bit by piranha...

[groanup]

I like to use it as a contrarian indicator. When it's low and put/call ratios are low, the market may be changing direction from up to down but I have to have confimation from the charts. Taken altogether you can place a high probability on the change.

This happened recently except p/c stayed high. I take this to mean the sell-off may soon terminate.

The good thing about volatility is that it is usually highest when the most people are wrong and lowest when the most people are right or just out of the market period.

[JasonC]

The article is wrong about the scenario it paints, as the likely continuation. It says commodity prices and inflation will ease and the Fed will keep rates at 5%. Only the first of those is correct.

Commodity prices had an enourmous, parabolic move. It was bubble intensity speculation, not justified in scale by fundamentals, and much of it will be unwound. But it was correctly signaling the direction, that inflation is real and has arrived. The Fed is going to keep raising rates because the economy is going to keep growing anyway, while inflation could easily hit 4-5% per year over the next 1-3 years.

5% long rates are not compatible with low inflation when the nominal economy is growing 8% per year and upward. Real interest rates are still very low. The stock market will not like the IR increases, but it will like the growth. Bonds will not have the latter to help them, and are the worst place to be right now. The best short on the board is the 10 year note. You can pull in horns at 7%; it might not stop until 8%.

[expat_panama]

The Fed is going to keep raising rates because the economy is going to keep growing anyway, while inflation could easily hit 4-5% per year over the next 1-3 years.

We've already been topping 4% (cpi yr/yr) but it would seem that to expect us to hang around there for a while would require that today's economy would be a lot like that of the early '90's. 

Off hand, I'd have thought we were in better shape than that, but if inflation actually did hang in at a solid 4-5% then the fed would most probably do what it could to hammer it back down --providing economic growth stays strong.

My bet is the article was good with both commodity prices and inflation easing, but I'm with you on having a few more fed funds hikes.

[JasonC]

Money supply up 10% a year and nominal economy up 8%, is not compatible with the 2-3% general inflation that is still being forecast by inflation adjusted treasuries.

If inflation remains 4%, the real after tax cost of capital to corporate borrowers is zero. (Pay 6% as a spread over 5% treasuries, deduct 2% as tax savings, real assets rise at least 4%, etc). There is a reason it takes ~9% rates to stop even 4-5% inflation.

The 10 year at 5% and the long bond at 5.25% are screaming sells. They are being bid by foreign central banks, who are getting creamed on the currency as well as price, and not making it back on the rate itself.

The closest past analogies are late 1980s - inflation 4-5% pushed IRs to 8-9% - or the late 1960s (bigger surprise to the bond market, but still sent yields to 7% by 1970).

Another analogy is the long financial cycle peak from 1968 or so. The Dow hit 1000, but was overvalued on bull market optimism. It went sideways on a roller coaster as the general price level soared. That socialized the losses incurred by excessive previous optimism.

I don't expect the same scale this time, though. Our monetary policy won't be as stupid as it was in the 1970s. Stocks were even more overvalued in 2000 than they were in 1968 or 1972. But I doubt we will see the bargains of 1982 again, or the IRs that created them. We will see rates in the 8-9% range before the economy rolls over, though.

Since that much is pretty clear, the best bet on the board is that the 10 year note will fall in price and rise in yield. Over 2-3 years that may go all the way to 8-9. But 6-7 is in the bag, one doesn't need to ride the last half of the move.

Maintenance requirements to be short 10 year note futures run $600 per $100,000 face amount. A move to 6-7% would see the future drop 7-15% on that capital value, or $7000 to $15000 per contract as the upside potential, even riding only the first leg of the move. Since it can move against you in the short term, in practice it takes more capital and less leverage can be used.

But it is a killer trade right now. Those foreign central banks pretending they have an endless appetite for long treasuries, at some point are going to cough, and when they do the payday will be sweet. And because the yield curve is flat, there is practically no "carry" to put it on.

[expat_panama]

Money supply up 10% a year and nominal economy up 8%, is not compatible with the 2-3% general inflation that is still being forecast by inflation adjusted treasuries.

From what I've been able to find, m3 growth may have spiked at 8% but it's been higher before without much inflation. 

Same with gdp growth --it's up right now but it's been higher.

What you're saying makes a lot of sense but it hasn't seemed to make any difference in the past so I'm having difficulty understanding what's different now.