Turbulence Beneath Still Waters

Turbulence Beneath Still Waters

Posted On April 21, 2015 10:55 am

Tread carefully near new highs as signs point to a transition period.

The S&P 500 is up less than 1.5% so far this year and has basically been bound within a 3% range for the past two months. The VIX is flirting with six month lows near the 13% level. But these numbers don’t tell the tale of the turbulence that’s been occurring beneath the surface. There’s obviously been great divergence as energy got decimated while biotech has surged some 16% for the year. This type of reduced correlation is not necessarily a bad thing, as money managers can try make their bones in a “stock pickers” market and option traders can deploy complex dispersion strategies. But there are signs that the underlying shifting is creating a weakening foundation.

Despite those headline numbers of the VIX and range bound nature of the S&P 500 the index has actually seen an increase in volatility over the past few months in terms of both day to day and intraday price movement.   During February and March there were 9 days that recorded a daily change of 1% or more; 4 up and 5 down. That’s a measurable increase than the monthly average occurrence of 2.5x over the prior three years. This past week added to those numbers as Friday saw a 1.2% decline followed by Monday’s 1.1% surge.

There has also been an increase in intraday volatility as measured by the Daily Average True Range (ATR) which measures the range from a day’s high to its low or from the previous day’s close to today’s high or low.   Over the past month the ATR has lifted by 11%. ATR had already jumped by 33% from last December to February.

So what we have are increase in big one day swings all negating each other within a seemingly low volatility environment. All while we sit within 2% of all-time highs. Typically this type of action occurs at a transition stage. This could easily mean the market is setting up for a new leg higher. Or that it will finally give the bears the long awaited “bad ending” such as Stanley Druckenmiller recently said he “feels in his bones” is coming.

It’s a real tug of war as whether the weirdness of negative interest rates in which Spanish homeowners get paid by the banks for taking out mortgages and China funnels its real estate and infrastructure bubble into the stock market or companies such as Panera (PNRA) can borrow money to buyback stock and boost their market cap by 12% in a single day can continue to inflate asset prices. Or will it indeed “end badly?”

I’ve discussed some of the macro issues such as the strong dollar and the profits vs GDP ratio that has Warren Buffet worried and the various red flags that had been appearing.

I’m not predicting a crash. Just pointing out this recent internal turbulence suggests you tread carefully and think about using some of the ways to protect your portfolio I discussed here.

Photo: Thomas Mueller via photopin (license)

About author

Steve Smith

Steve Smith have been involved in all facets of the investment industry in a variety of roles ranging from speculator, educator, manager and advisor. This has taken him from the trading floors of Chicago to hedge funds on Wall Street to the world online. From 1987 to 1996, he served as a market maker at the Chicago Board of Options Exchange (CBOE) and Chicago Board of Trade (CBOT). From 1997 to 2007, he was a Senior Columnist and Managing Editor for TheStreet.com, handling their Option Alert and Short Report newsletters. The Option Alert was awarded the MIN “best business newsletter” in 2006. From 2009 to 2013, Smith was a Senior Columnist and Managing Editor for Minyanville’s OptionSmith newsletter, as well as a Risk Manager Consultant for New Vernon Capital LLC. Smith acted as an advisor to build models and option strategies to reduce portfolio exposure and enhance returns for the four main funds. Since 2015, he has worked for Adam Mesh Trading Group. There, he has managed Options360 and Earning 360, been co-leader of Option Academy, and contributed to The Option Specialist website.