Investor Alerts

21 February 2013

Not So Dull Market Anymore


Not So Dull Market Anymore


February 21,


Week After February Expiration Week, Dow Down 10 of Last 14

Dow: 52.4% S&P: 47.6% NAS: 38.1% R1K: 47.6% R2K: 33.3%

"Financial markets will find and exploit hidden flaws, particularly in untested new innovations—and do so at a time that will inflict the most damage to the most people."
—Raymond F. DeVoe, Jr. (Market strategist Jesup & Lamont, The DeVoe Report, 3/30/07)

 Volatility Gives Bears & Traders Something To Talk AboutBy Jeffrey A. Hirsch & Christopher Mistal

Low market volatility has been the talk of the town recently, at least on Wall Street. We have also expressed concerned with the market’s continuing lofty levels and excessive bullish sentiment. Market seasonality has been rather true to form with stocks rallying so far in the Best Six Months from the mid-November low through the end of January. February is often the weak spot for the market during the Best Six Months (November-April). Stocks have been typically consolidating thus far in February and now that volatility has picked itself up off the mat stocks are pulling back.

The one thing we feel that could take the market down considerably is if the Fed takes away the punch bowl. This extended period of quantitative easing with near-zero interest rates and massive bond purchases has been the major factor pushing stocks higher. The U.S. economy has improved but it’s not robust. Preliminary fourth quarter GDP was negative. Japan and the Euro Zone have had negative GDP for the past three quarters. (Let us be one of the first to blame an early Easter for any recent and upcoming less than rosy economic or corporate data and results.)

So of course when the FOMC minutes revealed that “many participants” are considering taking the punch bowl away sooner than Bernanke has promised, the market cried, “I can’t quit you!” While we showed you, as has the market the past two days, that selling a dull market short is not forbidden, further research shows that low volatility or the end of a low volatility period does not necessarily indicate a market top or the beginning of a bear market.

But several things have us concerned.

Jobless claims jumped this week. The renowned Economic Cycle Research Institute (ECRI) believes the U.S. is in recession. ECRI website states, “Indicators used to determine official U.S. recession dates have been weakening since mid-2012.” The market is also struggling to the break through long term resistance around DJIA 14,000 and S&P 1,500. Upcoming political battles over the dreaded sequester and debt ceiling are likely to spook the market we think we’ll get a comeuppance later and this current bout of heightened volatility will give way to more gains before any deeper correction occurs. We picked up a little ProShares Ultra VIX Short-Term Futures ETF (UVXY) as trade on a continuation of a rise in volatility in the near term.

Larry McMillan’s ( analysis today was quite clear. “If $VIX closes above 15, we will begin to take on bearish positions, and we will add to them if $SPX closes below 1495.”

Alec Young, Global Equity Strategist at S&P Capital IQ (, had some cautious analysis yesterday, “U.S. equities are now fairly valued on a near term basis. Despite better than expected Q4 EPS, weak guidance is fueling negative EPS revisions…. And while we think better U.S., Asian and EU news flow has the potential to drive new all-time highs later in the year as it offsets EPS jitters, for now, much of the recent improvement in global news flow has already been discounted, in our view, leaving investors likely to re-focus on looming fiscal and political risks.”

Higher is Not Always Trouble

Some say low volatility is bad while others will tout its benefits. In an effort to separate fact from fiction a higher resolution study of historical DJIA volatility since 1900 was performed.

In this first chart the DJIA’s absolute average daily range was calculated using daily closing prices with DJIA’s annual percent return plotted below. The solid horizontal line represents the average of all data and is approximately 0.7%. Immediately the first observation that can be made is, volatility so far this year has been low (0.4% in February as of Monday’s close), but it is not as low as it has been at other points in history.

Click image to view full size… 
DJIA Monthly Average % Daily Trading Range Since 1901 Chart

This chart challenges the notion that low volatility is a prerequisite for gains. Note that volatility was well above average through much of the late 1990s while the millennium super bull market was still providing stout annual gains. In fact, DJIA’s best yearly performance, 1915, was also accomplished with volatility much higher than average. Above average volatility is not always a negative.

Conversely, below average volatility does not preclude a market decline. It just unfolds at a slower pace and tends to be milder. Full-year losses in 1957 and 1966 are two examples of below average volatility accompanying a market decline. In conclusion, depending on the timeframe referenced it is possible to make a case for high and low volatility being either positive or negative. However, in the past decade elevated volatility has been most common during periods of market weakness and lower volatility has been present while the market was climbing.

Transitions Bring Opportunity

In this next chart, the 30 trading days before and the 60 trading days after low and high volatility months have been plotted. Low volatility is defined as a month with an average daily DJIA percent change lower than 0.4% while 1.2% was used as the threshold to define high volatility. When a streak of consecutive months existed the last month was used as the turning point. The longest streak of boring low volatility was 14 months ending in January 1965. The longest streak of high volatility lasted 27 months and came to an end in December 1932. 

DJIA % Performance During Low & High Volatility
The return to typical volatility does not appear to have an overly negative influence on the market. When low volatility ended, DJIA declined mildly on average, but was still higher 60 trading days later. However, when high volatility comes to an end, DJIA typically enjoyed even greater gains. Waiting for signs that recent volatility is beginning to abate could prove to be an excellent opportunity to add to or pick up new long positions.