In a holiday-shortened trading week ahead, the S&P 500 weekly expected move is now $47. That might seem like the market will express less volatility than the previous week (which held a $50 weekly expected move), but I wouldn’t hold fast and hard to that expectation given the quantitative nature of the market. We could rip sharply in either direction to start the week and retrace some of that early directional trend by the end of the week. While the trend indicates this should be the expectation investors and traders hold, when I look at dispersion I’m forced to accept the probability of holding within the SPX weekly expected move, again.
There are a couple of ways investors can review dispersion or its synonymous market definition, correlation. One is volatility dispersion. The Volatility Index (VIX) has historically seen above-average spikes higher once its daily dispersion (measured by standard deviation) has fallen to a very low-level, which it has done again in November.
The chart below shows that the weekly dispersion of the VIX has fallen below 1 for the first time in five weeks, a level that as of the previous week we’re very close to breaking under. This narrowing in the weekly dispersion was one of the early warning signs before the massive volatility spike in February. That’s not to say we will see a repeat of the February spike, but it does lend itself to the idea that complacency has flooded the volatility market as it did earlier this year.
I emphasize that volatility dispersion should be paired with other analysis and pieces of data. Other analysis should include the SKEW Index and/or the volatility of volatility index, both are not indicating outsized fear in the market or outsized levels of “black swan” hedging. That’s not to suggest hedging isn’t happening inside the marketplace, but neither index are currently setting off warning signals. The current put/call ratio indicates there is a good deal of market hedging at the moment. With that being said, since I’ve reviewed volatility dispersion, let’s take a look at what’s causing such dispersion levels to proliferate underneath the market’s surface.
The screenshot above is of the S&P 100, advance/decline line. What one can extrapolate from the S&P 100, advance/decline line is that there is no real correlation in the market. It’s otherwise called the “whack-a-mole” market. One sector rises because another sector has been whacked lower. This is the nature of a quantitatively driven market. A correlated market would have an 80/20-90/10 advance/decline line reading. As shown above, we’re not seeing that and we generally haven’t seen that for much of the year unless the market has pulled back as it did in February and more recently in October, when all or most sectors have fallen together. In 2017 we witnessed a very correlated market, one that found stocks going higher and higher and higher through year-end and into January 2018. That was “good” market correlation. This year, we’ve had quite the opposite and on occasions.
Friday Specific
Last Friday was a very interesting trading day, headlined and likely buoyed by Federal Reserve Vice Chairman Richard Clarida. The S&P 500 Futures were set-up for continued selling pressure that deepened during Clarida’s on-air interview with CNBC. However, Clarida’s Q&A session outlined the probability of a more dovish Fed in the near-term.
Some of the biggest headwinds for equities in late 2018 have been surrounding the fear of an inverted yield curve, rising rates and a slowing global economy. Past rate hikes implemented by the Federal Reserve had indicated the central bank didn’t believe it was near the neutral rate and the verbiage of being data dependent had all been removed from its meeting notes. Clarida, however, reintroduced that verbiage, on Friday.
“As you move in the range of policy that by some estimates is close to neutral, then with the economy doing well it’s appropriate to sort of shift the emphasis toward being more data dependent,” Clarida said during a “Squawk Box” interview, his first public comments since being confirmed in September.”
Clarida’s remarks continued the process of softening the Fed’s message that almost insisted it was on autopilot when it came to raising rates. His remarks emphasized the need for the Fed to be data-dependent, as interest rates move close to the lower end of the range of estimates for the neutral rate. Clarida’s comments came on the heels of Federal Reserve Chairman Jerome Powell’s comments in Dallas that seemed to recognize that global growth was indeed slowing and the central bank was sensitive to this dynamic and how it might lend itself to slowing growth in the future, domestically. Combined, Powell and Clarida’s comments went a long way toward suggesting that after a December rate hike is implemented, there could be a PAUSE before implementing a rate hike that would otherwise be scheduled for the 1st quarter of 2019.
