If you’ve read my post on SP500 technical analysis of the New Year, you did anticipate higher volatility in the past many trading sessions, and perhaps benefited from it. But volatility, like waves on water, rises and falls; the knowing trader rides a wave up, and surfs it down. I think we may be headed into a period of subsiding volatility, and wanted to be sure to provide you with my thoughts.
Volatility whipped up early last year as well, and continued higher toward the end of the month. January provided negative returns (for index funds such as those based on the SP500) in 2014. Will 2015 be the same? I think not: here’s why.
Fear, in the short term at least, appears to be diminishing. I spoke of a heightened sensitivity to a market fall late last year, indicated by the VVIX, the volatility of volatility index. Following that analysis, observe, in the image above, that VVIX (blue) is significantly lower for comparable peaks of the VIX (orange). I think the increased sensitivity seen in December has diminished in the short term.
Do we see a similar pattern for VVIX in the same plot? Look at the early March 2014 to early April 2014 time frame. Coming after a duration of increasing VIX and VVIX, diminished peaks of VIX and VVIX in early April (as compared with early March) were followed by a period of consolidation, or settling down, of both these market psychology indicators. Granted other conditions may not have been quite the same – economic indicators and global events, the plunge in commodities such as oil and natural gas in particular – but the prior period was an earnings cycle start as is the present time period. There is, surely, reasonable correlation.
Besides, with input costs (energy: oil, natural gas) significantly lower, many companies, and industries in general, are expected to do very well this quarter. Alcoa (AA), that traditionally kicks off the earnings season, may, despite softness in aluminum (its end product) pricing, beat its earnings expectations. The stock has seen a strong run up in the last few sessions in the run to its announcement on Monday. AA was up 1.32% in a significantly down market on Friday (1/9/15). The week is also filled with other key earnings announcements as Jim Cramer detailed in his recent Mad Money session.
Sure, the market appeared to take a tumble on Friday, and also at the beginning of the year. It fell by more than 1% on the DOW and 0.84% on the SP500 to ~2045. But it is important to take measure of where we’ve come from: the SP500 fell to ~1996 in the middle of the week, and rose to ~2060 before pulling back on Friday. A swing of more than 3% up before giving back a bit – something considered healthy after such a rapid move up.
All told, subject to the usual disclaimer that past history is no guarantee of future behavior in the market, I think we’ll see an earnings-driven week ahead, and likely one that sees the market moving higher. In the short term, therefore, volatility may settle lower.
Full Disclosure: I hold a small short VIX position for the coming week.