By Wallace Witkowski, MarketWatch
SAN FRANCISCO (MarketWatch) -- Investors are becoming more
accustomed to holding firm during market drops, making it more
likely that it will take a true "black swan" event to usher in a
return to stock volatility.
After a near 30% run-up in the S&P 500 Index (SPX) in 2013,
many strategists were calling for a return to volatility in 2014.
Instead, the CBOE Volatility Index (VIX) has generally held to low
levels, with the occasional spike past 20, just like in 2013.
As volatility has dropped, stocks have moved sideways: The
S&P 500 is up 1.6% for the year and the VIX is down 9.3% for
the year.
Russell Rhoads, senior instructor at the Options Institute at
CBOE, said investors are expressing a "justified complacency" given
that recent jumps in the VIX don't remain at those levels for too
long. One-off events, like Ukraine, command investor attention for
a while and then fall off the radar, enough to cause the VIX to
spike but not enough to sustain the level.
A black swan event in the economy and markets would have a more
far-reaching, deeper impact. Author and trader Nassim Taleb used
the term to describe rare, hard-to-predict, and high-impact events
like the terrorist attacks of September 11, 2001.
For sustained volatility to return to stocks, we'd have to have
two crises hit right around the same time, something like a really
unpopular Federal Open Market Committee meeting and a fresh
Ukraine-like threat to geopolitical stability, without an apparent
resolution, Rhoads said.
"We just haven't had that double whammy," said Rhoads. "The
smart guys aren't necessarily panicking at small selloffs, and
since 2013 they've been right."
Over the past 12 months, the 200-day moving average for the VIX
has been essentially flat, currently at 14.38, compared with 14.90
a year ago.
One common misconception is mistaking choppy markets with
volatile ones. While markets have been choppy lately, don't expect
that to show up in the VIX, Rhoads noted. When trading is
directionless, or choppy, it's actually not volatile as measured by
the VIX, he said.
Last week, the Nasdaq Composite Index(RIXF) rose 0.5%. It's
moved between weekly gains and losses for six straight weeks.
Large-cap indexes are making similar zig-zag moves. The Dow
Jones Industrial Average (DJI) declined by 0.6%, reversing from
gains the prior week. The S&P 500 ended the week down less than
0.1%, while the VIX declined 3.7% on the week.
What this means for investors is that holding onto those winning
broad-market positions from last year has worked --so far. But
folks who have tried to hedge with VIX-linked investments aren't
smiling. Barclays Bank PLC iPath S&P 500 VIX Short-Term Futures
ETN (VXX.U.T) is down 14% this year and 50% over the last 12
months. Low volatility also isn't great for very active traders,
who have a harder time finding good opportunities in a dull
market.
Bear market grumblings
Debate is still lively whether a bear market is lurking around
the corner. Some argue that the meandering market is the grumbling
of a bear market that will start with a whimper. Then, there's also
a historical precedence for weak markets before the midterm
elections during a presidential cycle. And over the past few weeks,
there's a been a spike in worry that the selloff in small-cap
stocks, reflected in the 10% pullback in the Russell 2000 (RUT) ,
was the harbinger of a broader retreat.
Read: Stocks are telling you a bear market is coming.
But many have a hard time figuring out what will spark a
sustained selloff.
"There's very little evidence that people are positioning for a
bear market," said Randy Frederick, managing director of trading
and derivatives at Charles Schwab.
Frederick said there aren't too many foreseeable catalysts that
will derail the current bull market. There's always the maxim that
recessions end bull markets. But few people are predicting one any
time soon. There are genuine concerns about China and low inflation
in Europe, but without a major negative catalyst bursting on the
scene, a drop in stocks is not likely.
Investors have become so desensitized to Ukraine that it will
take some big escalation likely involving the United States to make
it market-relevant again, Frederick said.
The kind of pullbacks we've seen so far represent good buying
opportunities as long as investors aren't chasing the bottom and
wait a few days after the turnaround to buy, he said.
Even though the VIX might jump more than 10% in one day, as it
did twice in April, snapbacks are just as common the next day,
leaving volatility levels low in general.
Low volatility the norm for now
That theme of desensitization was repeated in a recent note from
Nicholas Colas, chief market strategist at ConvergEx Group. Colas
notes we've become accustomed to central banks moving in quickly to
address systemic volatility, so any given 15% drop in the S&P
500 in a month becomes the start of a snapback rally.
"We talk about the CBOE VIX Index quite a bit as a measure of
near-term expectations of volatility," Colas wrote. "By that
metric, options traders think near dated price action in the
S&P 500 will have all the unpredictability of a Los Angeles
weather forecast."
But, as Colas is quick to note: "At the same time, it's not the
weather in LA that will kill you; it's the earthquakes."
Outside of occasional spikes, Goldman Sachs said in a recent
note it expects volatility to remain low for some time. While that
makes it harder for traders to seize opportunities, the upside is
that it makes options cheaper for directional views and a better
replacement for cash positions.
The low volatility forecast for Goldman Sachs, however, is
rooted in the assumption that there is more "room to grow" for the
U.S. economy after a shaky five-year recovery.
That appears to carry with it a chicken-and-egg effect. Goldman
Sachs notes that a sustained period of low volatility encourages
U.S. companies to use their massive cash piles to start investing
more in their businesses and hiring, as well as engaging in more
mergers and acquisitions, all positives, and prerequisites for the
economy to grow.
Earnings season drawing to close
Another prerequisite for the economy to grow is sustained
earnings and revenue growth. With nearly all of S&P 500
companies having reported results, earnings growth is on track for
a 2.1% gain, according to John Butters, senior earnings analyst at
FactSet.
While not as high as the expected 4.4% at the beginning of the
first quarter, it's much better than the expected earnings decline
of 0.4% at the end of the first quarter. Revenue is lining up with
the 2.7% growth expected at the end of the first quarter.
For 2014, earnings are expected to grow by 7.8%, with near
double-digit earnings growth expected in the third and fourth
quarters, according to FactSet.
Only one Dow component, Home Depot Inc. (HD), reports this week.
Twenty-three S&P 500 companies release results.
Notable companies reporting this week include Campbell Soup
Co.(CPB) , TJX Cos.(TJX) , Medtronic Inc.(MDT) , Salesforce,com
Inc.(CRM) , Target Corp.(TGT) , Lowe's Cos.(LOW) , Gap Inc.(GPS) ,
Dollar Tree Inc.(DLTR) , Ross Stores Inc.(ROST) , Hewlett-Packard
Co.(HPQ) , Best Buy Co.(BBY) , L Brands Inc.(LB) , and GameStop
Corp. (GME)
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