Volatility Concern – CAMS Weekly View from the Corner
Week Ending January 15, 2017
“Adding to this, the behavior of an old friend here at the Weekly View, simply called the VIX and known in slang as the “fear gauge,” is also drawing our attention. This is a volatility index which is confirming other observations of the low level of volatility that we have seen in the past couple of weeks. Low levels of volatility often begets increased volatility and it seems the VIX is pointing to an expectation of this.” – CAMS Weekly Views January 8, 2017
As markets continue trading here in early 2017, our developing focus is getting more centered on an expected increase in volatility. With an increase in volatility we can expect price swings to increase from what has become a very quiet market in the past few weeks. After the post-election spike upward, stocks in particular have become quiet on a daily and weekly basis. This type of price action is not unusual after a significant move up (or down) as markets typically calm and digest the prior move. This tightness speaks to the compression in volatility that our header quote addresses from our previous Weekly View.
Below is a daily chart for the Dow Jones Industrial Average (DJIA) dating back 5 years for perspective. The upper right corner depicted with the red box highlights the timeframe of the last few weeks. A casual glance of this time through the broader view of the last 5 years shows how compressed the DJIA has become. (click link for a larger picture: http://schrts.co/WRK58O)
In chart analysis there are a variety of tools and measures that can be used to accompany the price performance of an index. Adding a couple of basic tools to the picture above; the rolling blue line in the chart represents the average price of the previous 50 days. A casual glance through the years offers how the price and its 50 day average often converge as time rolls on.
The DJIA is more than 500 points above its 50 day average (again the blue line) reflecting just how fast the index moved upward post-election. At some point we will see the two meet again, whether it be the price comes down to meet the blue line, or perhaps, holds steady as the 50 day average rolls up toward current levels.
Adding to this is another volatility measure that is used in conjunction with the aforementioned VIX Index in our header quote. Bollinger Bands are plotted two standard deviations away from a moving average which essentially creates an envelope (not depicted) that is “wrapped” around the on-going price movement of an index. It offers numerous tools in-and-of-itself – one of which is as a volatility measurement. In the lower pane of the chart above, the simple line depicts how wide (if line is moving higher) or compressed (line moving lower) the Bollinger Band has become.
As we stand now, with the red arrow identifying the collapse of the Bollinger Band width, we see we are at a historic low point in daily volatility for the DJIA. In fact, I ran the above back 20 years (5 year chart depicted) and the study reflected we are nearly as tight as we have ever been in that two decade timeframe.
The overall concern is what is shared in our header quote that low volatility historically begets higher volatility. An expected increase in volatility does not speak to the expected direction of the market. It does offer the relatively quiet/calm trading days we have grown accustomed to over the last month will turn into something more volatile. With the DJIA’s 50 day average line still a distance away, while the VIX index addressed in our previous Weekly View grinds out near historical lows, it would not be a surprise to see stocks correct downward. Importantly, if this happens to the level of the blue line, the stock market, through the lens of the Dow Jones Industrial Average, would remain constructive looking with its overall chart.
Can the DJIA break upward through the 20,00 level with onset volatility or will it head lower and attempt a reconnection with its blue line on the chart? This is a focal point for us at this time as we watch with vigilance.
I wish you well…
Sincerely, Ken Reinhart Director, Market Research & Portfolio Analysis Portfolio Manager, CAMS Spectrum Portfolio
Footnote: H&UP’s is a quick summation of a rating system for SPX9 (abbreviation encompassing 9 Sectors of the S&P 500 with 107 sub-groups within those 9 sectors) that quickly references the percentage that is deemed healthy and higher (H&UP). This comes from the proprietary “V-NN” ranking system that is composed of 4 ratings which are “V-H-N-or NN”. A “V” or an “H” is a positive or constructive rank for said sector or sub-group within the sectors.
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