Posts tagged Stock Market Volatility
Apple is a phenomenally successful company, and at $607 billion it is also the world’s most valuable enterprise. So it is probably not surprising that new product announcements would command Wall Street’s attention. But there is a level of showmanship and high drama to Apple’s product launches unparalleled in the annals of modern markets. The effect these feats of corporate kabuki have on the stock market should put the definitive nail in the coffin of the Efficient Market Hypothesis and the idea that the market is in any meaningful way rational.
Fanboys and Haters
This past Tuesday Apple convened a conference in its Cupertino hometown to announce a sequence of new offerings: new versions of the iPhone, a new payment application called Apple Pay, and its debut into the so-called “wearables” market with Apple Watch. How did the markets react? A picture says a thousand words.
“Don’t fall in love with a stock” is a timeless maxim, but one seemingly lost on the vast legions of Apple devotees as well as the less populous but still prominent haters of everything Jobs, Cook & Co. The skeptics had the upper hand as CEO Cook described the features of the new iPhone 6 and 6 Plus. Perhaps the market’s dour take on the new 4.7 and 5.5 inch screens is that they address a market where Apple’s rivals, notably Samsung, have an existing advantage. In any event, the bulls regrouped when Cook moved on to the second innovation, a payment system aimed at nothing less than consigning the credit card to the dustbin of economic history. Finally came the product tech blogs and fanboy sites have been chatting about for weeks: the Apple Watch. Some observers seemed to like it – the Financial Times correspondent Tim Bradshaw spent part of his liveblog coverage doing a selfie/demo of his Watch-adorned wrist. Oh, and U2 performed live! But Wall Street turned its nose up and the share price plummeted.
Intraday Ranges and Small Countries
Let’s put some quantitative context into that wild roller coaster of a price ride. The intraday spread between the high point reached after the Apple Pay announcement and the post-Watch low was 7.2%. Now, 7.2% of $607 billion is about $44 billion. By comparison the total Gross Domestic Product of Botswana is about $34 billion. Yes, more money changed hands in reaction to a single company’s product launch than the total economic worth of several dozen sovereign nations.
Did the net present value of Apple’s future cash flows really change by a magnitude of $44 billion in the space of an hour? After all, the fundamental value of any stock is nothing more or less than the sum total of the expected future cash generated by its assets, discounted at an appropriate cost of capital. Now, these new products will very likely make a significant contribution to Apple’s earnings for years to come. But there is plenty of uncertainty about the future for any business, including category-killing Apple. That uncertainty should in theory keep a lid on immediate changes in the stock price. But financial theory is often starkly at odds with financial practice.
The Wisdom of Crowds
Is there anything useful to be gained from this snapshot of the collective response to Apple’s new products? We do think the crowd got it right in one sense, which is that Apple Pay was probably the most interesting, and potentially game-changing, announcement of the day. Although the technical details are still coming out, one of the apparent features of this platform is a security function giving added protection to customers’ financial data. Neither Apple nor the merchant will collect user data during a transaction; payment approval will be transmitted by a unique code. Given the unsettling, and likely continuing, rise in cyber fraud, Pay could prove to be a very strong addition to the Apple product line.
But that remains to be seen. Apple is best known for sleek, engaging and user-addicting consumer technology. Apple Pay is a deviation from the standard playbook that Steve Jobs handed off to Tim Cook. We probably will not know for some time whether the crowds truly were wise in their insta-valuation of Apple Pay.
On Tuesday this week the S&P 500 closed above 2000 for the first time ever. When we say “above”, we mean “right on top of”: the actual closing price was 2000.02. On Wednesday the index inched slightly upwards to a close of 2000.12. Of course, there is nothing inherently special or magic about a round number like 2000 versus any other kind of number. But perception creates its own reality. Along with moving price averages, signpost numbers like 1900 and 2000 often act as important support and resistance levels for short-intermediate term asset price trends. We call these “event numbers”.
The Event Number Corridor
The following chart provides a snapshot of pullbacks in the S&P 500 in the current year to date. They have been fairly short, shallow and infrequent (only three with a magnitude of 3% or more). Interestingly, all three have occurred around an event number: 1850, 1900 and 2000 (there was a pullback of a smaller magnitude at 1950).
What seems to happen here is that the event numbers act as a sort of catalyst for investors to trade on whatever risk factors may be prevailing at the time. Consider the three 2014 pullbacks shown above. At the beginning of this year the S&P 500 had just come off one of its best years ever, leading to general chatter about whether the market was overbought. The market was trading in a corridor just below 1850. The release of a surprisingly negative jobs report early in the year gave traders the excuse to pull money off the table. A -5.8% pullback ensued taking the index to 1750, where it found support and sharply rebounded.
In April the market stalled for a few days just below 1900, then growing concerns about the situation in Russia and Ukraine helped fence-sitting investors to hop off. Again the fear period was brief, and this time support was found at the 100 day moving average level. In July, the risk factors swirling around in the market were for the most part the same as in April: Ukraine, Middle East, Eurozone…and an event number corridor just below 2000 broke in the last week of the month. That too found support around the 100 day average and rebounded sharply…right back up to 2000, where another corridor is playing out.
The current event number corridor is particularly interesting because we are heading into to the final months of the year, a time when a strong positive or negative trend formation can propel the market right through to the end of the year. Which way do the tea leaves point?
The short term, of course, is unknowable with any kind of surety: every rally and every pullback is different. Given how long it has been since the market last experienced a real correction, in 2011, each new pullback heightens fears of a slide from mere pullback to secular reversal. But we are still seeing daily volatility levels more typical of a middle-stage than a late stage bull market.
In both of the last two secular bulls, from 1994-2000 and 2003-07, volatility started to head higher some time before the market reached its respective high water marks. Late-stage bulls tend to be frenetic, with hold-outs piling in to belatedly grab some of the upside. It is only after those net inflows subside that the reversal tends to gather steam. Even in the immediate wake of the late-July pullback, though, we still appear to be in one of the calmer risk valleys, with the CBOE VIX index not far away from its ten year low.
Still, anything can happen. Summer is over. We expect trading volumes to pick up and, sooner or later, a late-year trend to emerge and test more event number support and resistance levels. We head into the new school year vigilant and focused.
The S&P 500 recovered ground this week, climbing from last week’s low of 1909.57 to high of 1953.45 at the time of writing this piece. It seems the market has continued to move onward and upwards, repeatedly shrugging off geopolitical worries as it has for the greater part of this year. While this is seemingly good news for investors, it is important to keep abreast of some of the troubles which are brewing abroad and may bring further volatility in days to come – namely a region which has continually kept investors’ anxiety on edge since the Great Recession, the Eurozone.
Rise up and hear the Bells: Troubling Numbers from Abroad
This week, economic reports from Europe showed that trouble still lingers for many of the countries within the region. Surprisingly, even the stronger economic powerhouses of the continent, such as Germany and France, are beginning to show signs of trouble. Germany’s economy has failed to show positive growth; in recent economic releases German GDP shrank by 0.2% - the first time that the country has shown a negative outlook in over a year – and France’s economy hasn’t shown any growth for the second consecutive quarter year to date. Other countries such as Italy and Spain, who are no strangers to negative economic data, continue in the same fashion with the prospect of steady growth still far off in the horizon.
Draghi: For You They Call
The European Central Bank (ECB) has had their work cut out for them since Draghi’s proclamation of “whatever it takes.” While the Fed continues to tighten the quantitative easing pedal here domestically, abroad it seems the ECB cannot do the same. The ECB, like the Fed, has taken measures to keep low interest rates, encouraging cheap bank loans and purchasing securities to beef up Europe’s respective economies; but it seems the ECB, unlike the Fed, may have to ramp up their efforts in the near future.
Draghi seems to be resistant to this idea however, voicing scrutiny directed towards the leadership of different nations, highlighting that reforms and policies must be enacted within the different Eurozone nations to become more competitive.
The Ship is Anchor’d – Safe and Sound?
So, all this data begs the question: what does this mean for capital markets around the world? The answer is yet to be determined. The US domestic picture continues to be strong; it remains the biggest engine of growth in today’s capital markets. How asset prices begin to reflect the lagging of the Eurozone depends on whether investors will continue to focus on positive US data or if the economies of countries abroad will become too heavy of an anchor for positive overall momentum.
Our outlook remains generally positive; however we will keep a watchful eye on markets abroad from Europe to China and everywhere in between. This year’s markets have been a story without much volatility, but for investors to fall asleep at the wheel now could prove dangerous.
It’s summertime, but the living has been anything but easy for the past couple weeks. A news cycle full of geopolitical flare-ups, health crises and dissension at the Fed has brought volatility and wild intraday price swings back onto center stage. Yet there appears to be less to the daily drama than meets the eye. For all the lead stories spilling out of the world’s trouble spots, the real force driving volatility is the low levels of activity typical of summer. Since the beginning of July, daily volume on the S&P 500 has been below its 200 day moving average 82% of the time. Low volume amplifies price swings. We think this environment is less about news, more about noise.
Geopolitics Priced In (For Now)
Of all the current flashpoints, arguably the escalating tension between Russia and the West is cause for greatest concern. This tension certainly has not helped Europe, which depends on Russia for the majority of its energy imports. Shares in broad Eurozone market indices are down nearly 10% from where they were at the beginning of July. But Russia’s role in the global economy is less impactful than China’s or Brazil’s. Even if economic sanctions between Russia and its main trading partners worsen, the effect is likely to more localized to companies with significant interests in Russia (major international energy companies come to mind) than widespread.
Events in the Middle East are likewise unsettling, but contained in terms of practical economic impact. Crude oil prices – often a barometer for tensions in the Gulf – are at their lowest levels for the year to date. Questions remain about the level of U.S. engagement as the crisis in Iraq creeps towards the oil-rich Kurdish state, but for now any potential use of ground troops is fully off the table.
Support, Resistance and Round Numbers
There is nothing particularly magical about round numbers or 100 day moving averages, but in the capital markets perception creates its own reality. The S&P 500 broke through the 1900 resistance level back in May, and was closing in on 2000 before gravity kicked in late last month. The Dow Jones Industrial Average topped 17,000 before the latest tumble. On the other side, though, the major indexes are all finding support around intermediate-term moving averages: the S&P 500 is currently trading right around the 100-day average.
Bear in mind that over 60% of the daily trading volume on U.S. equity exchanges is machine-driven, reacting to algorithms rather than human decision makers. Many of these algorithms are programmed to react specifically to things like round numbers and moving averages, and that is why they figure so prominently in observed trading patterns. Given the pace of the rally that started in mid-May, it is scarcely surprising that we see a brief pullback and perhaps an extended period of trading in a narrow support-resistance corridor. Whether it turns into something more remains to be seen, but for now the noise factor appears to predominate.
2013 was a very good year for U.S. equities. Even more impressive than the 32% total return on the S&P 500 was the very low level of risk that accompanied it. Based on the Sharpe ratio, a widely-used measure of risk-adjusted return, the S&P 500’s 2013 performance was in a class by itself, far outpacing even the heady days of the late-90s technology bubble (see chart below). In the world of investment performance measurement, a Sharpe ratio above 3.0 is just about as close as you can get to having your cake and eating it too. Is low volatility here to stay, or is this just an unusual period of calm before the next storm clouds appear?
Not Much Fear in the “Fear Gauge”
In 2014 to date there have been pockets of risk, notably in certain small cap growth sectors. But the story in the broader market hasn’t changed much: subdued baseline risk with a few intermittent spikes when unexpected X-factors briefly flash onto the radar screen. The following chart illustrates this story. On the leftmost side we show the standard deviation of daily S&P 500 returns over rolling 30-day intervals. The right side presents the daily closing price of the CBOE VIX index, which reflects a weighted average of puts and calls on the S&P 500 over a range of strike prices. Standard deviation provides a useful picture of intrinsic volatility, while the VIX gives us a good read on market perceptions of risk; for this reason it is popularly known as Wall Street’s “fear gauge”.
Stuck in the Corridor
It is perhaps somewhat surprising to see this continuing pattern of low risk in the broad U.S. equity market. After last year’s big gains the market has mostly traded in a narrow and choppy corridor this year. Lack of direction can often mean heightened volatility. But apart from one brief spike during the late January pullback, the VIX has not even come close to breaching its lifetime average closing price of 20.1. Investors have largely taken in stride whatever the world has served up: from a harsh U.S. winter that impacted many corporate earnings results, to geopolitical turmoil in Ukraine, to a Eurozone flirting dangerously with price deflation. Support has been remarkably firm around intermediate moving averages, as the chart below illustrates.
Ready for a Breakout?
On the other side of the 50-day moving average support level, the index has several times bumped up against a psychological “round number resistance” point of 1900. At some point we would expect to see a directional trend form one way or the other; either a resurgent X-factor that brings back volatility and another pullback of 5% or more, or a continued rally driven by the meta-narrative of continuing benign economic data, double-digit 2H earnings growth and no new surprises from Ukraine, China or elsewhere. We need to be prepared for either outcome; that being said, the volatility signals are for the time being at least nowhere to be seen. “Sell in May” may not be a particularly helpful strategy this year.