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Trying to Make Sense of the Increase in Volatility image

If one was out and about yesterday and unable to view the intraday action, the end result of the trading session may not have produced much of a reaction as the Dow fell 27 points, the S&P dropped 5, and the NASDAQ gave up just 3. However, anyone watching the day unfold knows that there was a lot more to the story.

The word of the day was volatility. Although analysts have bemoaned the lack of volatility seen in the stock market on a big-picture basis (there was just one 5% correction in 2014 and this remains the third longest period in history without a 10% pullback), the intraday action has been wild and woolly of late.

Take yesterday for example. The early futures action in the wee hours Tuesday suggested stocks would open higher. Traders then ignored a further drop in oil prices and doubled the pre-market gain within the first half hour of trading. And before you could pour that second cup of coffee, the Dow was sitting with a gain that was pushing 300 points (283 to be exact) and there was talk of stocks "decoupling" from the worries about oil.

But then things got interesting. Very interesting. From about 8:00 am eastern until about 2:15 pm, stocks proceeded to fall precipitously. While the move was clearly algo-driven at times, it did not appear to be entirely algo-induced. Suddenly the big gains were gone and the indices were in the red. And at one point, the Dow was down more than 150 points.

Why the Dive?

The question, of course, was why had stocks suddenly fallen out of bed? Oil, which had appeared to be the primary driver of intraday prices on Monday, was falling, but actually rebounded in the afternoon. And there weren't any headlines that would account for the big reversal in stock prices.

After digging around, we found a couple potential catalysts. First, we discovered that the Russian ruble, after stabalizing for a while during the holiday season, was crashing again. Why do we care? In short, the words you are looking for are "emerging markets currency crisis." Yep, we could be back to that.

In addition, there was word that officials at Germany's Bundesbank had said that they were not on board with the ECB launching a QE initiative. And with just about everyone under the sun expecting Super Mario to introduce a sovereign bond buying program - and soon - this news created doubt about the fate of the Eurozone as well as the overall global economic picture.

So there you have it. Just like that, the optimism from Alcoa's earnings beat was gone and fear was back. As such, investors were treated to a 425 point roller coaster on the Dow.

What Do the Charts Tell Us?

One of the takeaways from the charts is, so much for that V-Bottom that everyone was talking about late last week. It is now clear that stocks are in a more complex bottoming process with some suggesting that the bottom of the pullback which began back on December 30th, may not yet have been seen. The current price action is tracing out a "wedge" formation, which is traditionally a consolidation pattern. Thus, one can argue that the current action is merely a sideways digestion of the big move up seen in October and November.

The key however, will be the direction in which prices break the wedge. The textbooks tell us that a decisive break above the short-term downtrend line would suggest new highs ahead while a move below the short-term uptrend could produce additional "price discovery" to the downside.

S&P 500 - Daily

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Although intraday volatility has increased dramatically over the past month, the good news is that the major indices have not broken down into a meaningful decline. And from a short-term view, prices do indeed appear to be consolidating.

S&P 500 - Weekly

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However, from a longer-term perspective, the stock market doesn't appear to be overly concerned about oil, Russia, Europe's QE, China, etc. Therefore, the proper takeaway from yesterday's intraday hysterics might be, all's well that ends well. We shall see.

Turning To This Morning

Although the pre-market futures session has actually meant very little in terms of how the day ultimately shapes up lately, traders appear to have shifted their focus from oil to earnings this morning. Or put another way, with crude futures not plunging at this point, traders appear to be preoccupied with the earnings from JPMorgan Chase and Wells Fargo. Across the pond, the hope for a QE program got a boost from a favorable court opinion and ECB President Draghi told a German newspaper that expansionary monetary policy is needed for the central bank to achieve its mandate of price stability (i.e. avoiding deflation). In other news, the World Bank cut its forecast for global growth. The bank now expects the global economy to expand 3% this year, which is down from the June forecast of 3.4%. In addition, the World Bank suggests that the crash in oil prices may cause the Fed to push back the timing of the first rate hike in the U.S. However, the disappointing results from JPM have put stock futures on the defensive and a decline is anticipated for the open on Wall Street.

Pre-Game Indicators

Here are the Pre-Market indicators we review each morning before the opening bell...

Major Foreign Markets:
    Japan: -1.71%
    Hong Kong: -0.43%
    Shanghai: -0.41%
    London: -1.73%
    Germany: -0.25%
    France: -0.31%
    Italy: -0.05%
    Spain: -0.26%

Crude Oil Futures: -0.07 to $45.82

Gold: -$5.20 at $1229.20

Dollar: higher against the yen and pound, lower against the euro

10-Year Bond Yield: Currently trading at 1.873%

Stock Indices in U.S. (relative to fair value):
    S&P 500: -14.83
    Dow Jones Industrial Average: -137
    NASDAQ Composite: -25.50

Thought For The Day:

Every day holds the possibility of a miracle. - Elizabeth David

Positions in securities mentioned: None

Wishing you green screens and all the best for a great day,

David D. Moenning
President, Chief Investment Officer
Heritage Capital Research
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