Volatility Dispersion Narrows Once Again

Stocks continue to be on a rip higher. The S&P 500 is now 13% above its 200-day moving average, the highest spread since January 2018. Meanwhile, volatility has begun to pick up as well. I’ve mentioned in my Thrasher Analytics letter and publicly on Twitter the rising correlation between stocks and vol; which is now at its highest level since January 2018. The VIX has been positive along with SPX for the last two days, catching many trader’s eye since these two typically don’t move higher very often for multiple days in a row.

All this seems has been developing while volatility dispersion has been contracting. For long-time readings of my blog, this concept should sound familiar as it was the topic of my 2017 Charles Dow Award winning paper, Forecasting a Volatility Tsunami. In the paper I discuss how spikes in Volatility are almost always preceded by a contraction in daily dispersion (i.e. standard deviation). However not every time dispersion contracts does volatility spike. I liken this to dark clouds forming in the sky signaling the potential for a thunderstorm but it by no means is it a guarantee it will rain.

I use this concept often within my writing at Thrasher Analytics, building upon it more nuanced approaches to volatility and risk management analysis. The chart below shows the current picture of volatility dispersion along with the 20-day standard deviation, which is the tool used within my paper. I’ve included green arrows to show prior occurrences of std dev dropping to its current level of 0.93. It’s definitely been lower than it is today, but it’s entered the territory that’s often marked a turning point for the VIX to move higher, most recently early January of this year. I talked about this in my segment this morning on TD Ameritrade Network.

This is just one tool among many that can be used to evaluate market risks. I believe it works best when paired with other forms of analysis. I view volatility dispersion as a sign of excessive confidence in equity volatility remained low, which often turns out to not be the case after all. I’ll repeat something I said earlier, just because dispersion declines does not signal the requirement for volatility to spike higher. Instead, it creates the environment for such a spike to occur, whatever the eventual catalyst may be.

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.

The S&P 500 Hits A New High But Few Joined The Party

Yesterday was a big achievement for the large-cap U.S. index. After a waterfall decline of over 30% in March, equities have been a steady climb higher to recover the loss from the first quarter. While new highs are historically bullish and rightfully so celebrated. Yesterday’s move leaves me scratching my head due to the very weird price action experienced in many other corners of the market.

I tweeted last evening while doing some of my nightly charting, how many other indices actually closed down as the S&P 500 hit its new high watermark. It’s not that we need to see everything move together, but it’s odd to have small caps, mid caps, Dow Jones Industrials, Dow Jones Transports, semiconductors (which have been a strong leader for most of the recovery), equal weight S&P 500, and the high beta factor all close down on the day. Meanwhile, under the hood the cumulative advance-decline lines for the small caps, mid caps, and large caps all took a step lower. There was an uptick in the percentage of stocks trading above their respective 50-day moving average for the Dow Industrials, Nasdaq 100, and S&P 500. What went higher along with the SPX yesterday? Oddly (again)…volatility. Now of course there were some corners of the market that joined the SPX in rallying yesterday. Communications, Tech, Consumer Staples, and Consumer Disc. were all positive too.

Looking under the hood, there’s a few charts that really stand out when plotting the record closing high for the S&P 500. Let me share a few…

First, yesterday was the first time since 2007 the index made a new 1yr high while less than half of the underlying stocks enjoyed a rising 50-day moving average. This happened quite often in ’98 and ’99 but was a condition that for the most part disappeared after the dot-com bubble popped.

While the index was hitting fresh air, only 6.5% of the underlying stocks were even making a 6-month high. We don’t need to set a high bar for participation in a new 1 year high but you’d expect at least 10% to be making a 6-month high right? The chart below shows when the index made its first new 52-week high in a month with less than 7% of stocks at a 6-month high. We haven’t seen this low level of participation since 2015 and before that, in 2000 and 1993.

The recovery off the March low has not been one with tremendous strength in small or mid cap stocks. The strength has solidly been found in mega caps, specifically the FAAMG names. But while the large cap index broke out, oddly the mid cap and small cap S&P indices began to fail at their prior June highs. Again, we don’t require all stocks to trend together, but to see a break down like this while the SPX makes a new high is just….weird.

So what’s it all mean? The main point I keep in mind with all forms of looking under the hood at market internals is that price confirmation is key! Trend is your friend and until price begins to ‘respond’ to the wacky nature of barely any participation yesterday, it simply doesn’t matter…yet. Finally, this was just one day. One day’s worth of data is not enough to discredit the breakout in SPX. It raises some yellow flags for sure and I’ll be watching of if the breakout can hold, but as long as those few names carrying the broad index higher sustain, then we can’t ignore the fact that’s all the market currently needs to maintain the up trend in place.

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.

Can The Stock Market Predict The Election?

Let me begin by saying this will not be a blog post on a my or anyone else political view. I view national politics as more of a sideshow of entertainment and while I do have my personal viewpoints, they are just that – personal and not something I’ll push on this blog.

With that, while we can attempt to have an a-political view, ignoring the relationship of political and the financial markets seems farsighted. History has shown us a strong connection to how the stock market performs several months before the election and the resulting conclusions that election comes to. I believe that many voters (not all) vote with their emotions and how they feel about the world going into that voting booth. One of the biggest catalysts to that emotional view is how their personal finances and economics currently are at that time and with that by extension – how the stock market is doing. It’s not that the majority of people are tied to their investment accounts but they probably know there’s some kind of connection from the economy to the market (a debate for another day!).

Ryan Detrick, CMT of LPL shared a great chart on Twitter noting the market’s performance three months leading up into the election has correctly predicted its outcome 20 of the last 23 years. When the market is up, the incumbent party has often been the victor. Most recently, in 2016 the S&P 3-month return was -2.3% and the Democrats lost the race to Donald Trump.

While the stock market may matter for the election, does the election really matter for the markets? I could make both a pro and a con argument for this but I think there’s some insights we can get into potential changes in government objectives based on who occupies the White House. Both Trump and Biden have plotted out their priorities, each being bullish or bearish for varies industries and sectors. Solita Marcelli, the American CIO at UBS Global Wealth Management shared her views on which corners of the market should benefit based on who wins in November. For example, she wrote that a Trump victory would be positive for financial tech, aerospace, the energy sector, and the financial sector. Meanwhile, a Biden win would be bullish for electric vehicles, the industrial sector, and materials sector. Is she correct in these views? I don’t know, they are simply one person/bank’s view, but I think they largely make sense and gives us something to work with.

I took Marcelli’s note and created custom Trump vs. Biden portfolios. This chart below shows the ratio of these two ‘portfolios’ as an almost real time view of on what the market’s expectation come November. This is assuming that investors will push up defense and energy stocks for instance should they expect a Trump re-election or show preference to the industrial sector if they believe Biden will be victorious.

Comparing these two ‘portfolios’ lines up pretty well with what the polling data shows. Below the Trump vs. Biden chart is a chart from Real Clear Politics of an average of several major national polls. You can see, when the Trump portfolio started to bottom out relative to the Biden portfolio in April is also when his poll numbers began to improve. Then in May Trump’s poll results began to weaken again, and in early June so did the Trump portfolio.

What’s interesting about the Trump vs. Biden portfolios today is they still are showing relative strength in Biden’s favor. Meanwhile, Trump’s average polling figures have strengthened over the last month. So are stocks right or the polls? There’s still plenty of time for us to find out but I find this a very interesting way to evaluate what the market believes will be the outcome when all the votes are cast in November.

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.