The Lack of Volatility

The S&P500 climbed another 1.2% last week, but on ultra-low volume, which was partly due to the holiday shortened week. Volatility in equity markets, as measured by the VIX index, closed almost unchanged for the week.

Technically, the S&P500 is now as overstretched than as it has been in about 100 years (using a proxy for the S&P500 in the first part of this 100 years). This includes the peak periods just prior to the 1929 collapse, the post-2000 meltdown, and the 2008 crash. John Hussman and Jeremy Grantham both estimate negative stock market returns for all time horizons under 8 years for everyone holding stocks at these prices. Both of these long-time market analysts correctly called the bubble peaks of 2000 and 2007. What’s worrisome, technically, is that many measures of market internals are not matching the peaks in current prices. New highs minus new lows, for example, are far lower than they were at lower highs on the S&P. The same applies to the percent of stocks above their 150 day moving average. What this means is that while overall index prices are rising led by strong performance of some key stock leaders, fewer and fewer of the average stocks are participating in the rally. Almost always, such a breakdown of market internals leads to bad outcomes for the overall market down the road.

US macro results continue to disappoint. Both the Richmond Fed and Dallas Fed manufacturing surveys missed. Pending home sales missed, as did both personal spending and personal income. Consumer sentiment disappointed. And the big surprise result of the week was the revised 1st quarter 2014 GDP result, which plunged from positive 0.1% to negative 1.0%, meaning that the economy registered its first contraction since 2011. Sure, durable goods orders beat expectations, as did initial jobless claims, but that doesn’t change the picture of the US economy—since first “recovering” in 2009, it has never reached escape velocity. or growth fast enough to put back to work the millions of jobless folks who’ve left the workforce because there are not enough jobs for them.

Meanwhile, another interesting development is taking place in the world of volatility. We’ve already mentioned that stock market volatility is near decade lows (2007 to be more precise), but what we haven’t yet mentioned is that volatility for most major asset classes has also collapsed over the last several months. This includes volatility for Treasuries, corporate bonds, foreign exchange and even commodities.

Why does this matter?

Because when this situation developed in the past (and yes this is not the first time), it has tended to coincide with peaks in prices for those asset classes—especially equities and corporate bonds. And that’s exactly where equities and corporate bonds are priced right now… or near peaks.

What usually happens after volatility bottoms and asset prices peak?

Simple—volatility usually spikes, and asset prices retreat.

So let’s add this to the long list of measures that suggest that key asset prices are stretched, and that when they’re stretched, they are prone to serious snap-back corrections.



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