Should You Be Concerned About Rising Market Volatility? [Dow Jones Industrial Average, SPDR S&P 500 ETF Trust]

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January 30, 2015 4:19pm NYSE:DIA NYSE:SPY

technical bounceJon Markman:  Since Dec. 30, every single session has featured a move in the S&P 500 of greater than 1 percent, according to Jason Goepfert of Sundial Capital. That includes any session when the day’s high is more than 1 percent higher than the previous close,

the day’s low is more than 1 percent lower than the previous day’s close, or the day’s high is 1 percent higher than the day’s low.

Contrast this three-week span with the five months of August through December 2014, when less than 40 percent of trading days had a move of 1 percent or greater in the S&P 500, according to Goepfert.

A streak of 15 straight sessions with a 1 percent move isn’t all that uncommon over all of market history it turns out. But it is rare to see it when stocks were trading at a 52-week high not too long ago.

Since Dec. 30, every single session has featured a move in the S&P 500 of greater than 1 percent.

Goepfert notes that during highly volatile bear markets, 1 percent moves are more the norm than the exception as bulls and bears duke out their opinions by taking big roundhouse swings at each other.

Traders have become increasingly concerned about the rise in volatility, as the conventional wisdom holds that it is a harbinger of a trend change. Yet is this really so? Maybe not.

The table below, created by Goepfert, highlights other times when SPDR S&P 500 (NYSEARCA:SPY) moved 1 percent every day for three weeks, after having set a 52-week high at some point during the prior 30 trading days. It turns out that the SPY’s returns in the weeks ahead were actually better than average, even though it occurred prior to the market peaks in 2000 and 2007. Six months later, the results were statistically significant as the returns doubled an average six-month return during the study period.

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The biggest takeaway from this study is that a three-week streak of big moves is not a consistent omen of trouble ahead, and may instead actually hint at clear sailing over the following six months. Take that, conventional wisdom!

Big Thought for the Day

The most important development of the past 15 years may turn out to have been the suppression of the U.S. dollar since the 2000-2002 tech crash, and, you could argue, the 9/11 attacks. Since then, the Federal Reserve has generated a set of methodologies aimed at using monetary policy to lift asset prices. By pushing rates and the dollar incredibly low, vis-à-vis three QEs, the zero interest rate policy, “forward guidance” and the like, the central bank created conditions that led to higher commodity prices, an explosion in private equity, soaring issuance of high-yield debt and small-cap stocks.

But ever since the Fed announced that it would curtail QE after the third episode, the dollar has started to rise, volatility has increased, small caps and high yield bonds have cratered, and all manner of other illiquid instruments, including emerging market equities and debt, have been shunned.

When you look around, this has left megacap stocks, utilities and Treasury bonds the only strong instruments left. And you can most likely expect this to continue until the Fed decides not to normalize its interest rate policy or the dollar runs into resistance for some other reason.

In sum, expect to see the Russell 2000, emerging markets and high yield bond funds fail to get any traction again this year as investors seek out only the most liquid instruments. There could still be a double-digit move higher for the benchmark indexes, but with less participation from stocks with market caps under $5 billion.

This article is brought to you courtesy of Jon Markman.

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