Fifty-Eight Days and Counting


Prior to today’s opening bell, futures contracts on the S&P 500 Index (SPX) indicated the index was set to open lower by nearly one-percent. However, the SPX rallied for most of the day to close lower by 0.41% to 1964.68. A one-percent move (on a closing basis) last occurred on April 16th, when the index rose by 1.05%. Not since 1995 has the index sustained a longer streak. Additionally, June 2014 marked the third lowest month of realized volatility for the S&P 500 Index during the month of June since 1950 and the lowest realized volatility in any month since January 1995. A low realized volatility environment will establish complacency among market participants. The FOMC released their June Minutes on Wednesday with the following:

Measures of uncertainty in other financial markets also declined; results from the Desk’s primary dealer survey suggested this development might have reflected low realized volatilities, generally favorable economic news, less uncertainty for the path of monetary policy, and complacency on the part of market participants about potential risks.

Naturally, that environment will end at some point and today’s early move sharply lower may be an indication that a higher volatility environment is around the corner. The FOMC stated the following with regards to tapering the asset purchases under Quantitative Easing (QE3):

If the economy progresses about as the Committee expects, warranting reductions in the pace of purchases at each upcoming meeting, this final reduction would occur following the October meeting.

That may be a contributing factor to future volatility. Of note elsewhere in their statement:

The Committee again stated that it currently anticipated that it likely would be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continued to run below the Committee’s 2 percent longer-run goal, and provided that longer-term inflation expectations remained well anchored. The forward guidance also reiterated the Committee’s expectation that even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.

In my opinion, equity markets are at the intersection between poor seasonality and accommodative monetary policy. Given the poor seasonality for the S&P 500 Index during the months of August and September and the definition with which the FOMC stated ending QE3 purchases, rallies on the SPX are opportunities to reduce and/or rotate equity exposure.

Posted in Portfolio Strategy | Leave a comment

Notable Economic Releases: July 7 – July 11

Monday, July 7, 2014:

  • 08:30 AM ET Gallup US Consumer Spending Measure (June)

Tuesday, July 8, 2014:

  • 07:30 AM ET NFIB Small Business Optimism Index (June)

Wednesday, July 9, 2014:

  • 02:00 PM ET FOMC Minutes (June)

Thursday, July 10, 2014:

  • 04:30 PM ET Stanley Fischer Speaks
Posted in Portfolio Strategy | Leave a comment

A Calm, Above Average June


June 2014 marks the third lowest month of realized volatility for the S&P 500 Index during June since 1950. The graph above plots the returns (x-axis) and realized volatility (y-axis) for the 65 months of June since 1950. The “above average return, below average volatility” area is indicated in the lower right quadrant. The 19 previous instances generally occurred during bull market periods (e.g. ’93, ’95, ’96, ’04). However, the subsequent month of July–even during those bull markets–the SPX performed at a slightly below average pace, averaging +0.34%.

With the S&P 500 gaining +0.67% today, it is ahead of what we might expect to see for the entire month. With the shortened holiday week and the current momentum, a low-volume push is likely to carry the index higher into next week. But keep in mind the potential for a mean-reverting second half of July followed by the two worst months for the S&P 500 (August & September).

Posted in Investment | Leave a comment

SPX Seasonality for the Month of July


Posted in Investment | Leave a comment

The First Quarter of 2014 Grew at a Negative 2.93%


Economists and the media spent most of the day making excuses (e.g. weather) for the final revision to Q1 GDP as “old news”. In fact, some investment banks have already increased their Q2 forecast for GDP because, well, the first quarter was so bad. That’s not a joke; that is the actual rationale. In other words, an increase of $100 billion (for instance) in GDP is a larger percentage of $15.8 trillion (actual SAAR Q1 GDP) as compared with the same $100 billion increase on a $16.1 trillion (consensus estimate for SAAR Q1 GDP at the end of March) economy.

There may very well be a bounce back in Q2 GDP, but let’s not forget about the opportunity cost of a declining economy. Not only did the economy not grow, it lost ground–ground that can only be recovered at some point in the future and must be recovered prior to advancing from the Q4 2013 level. To think of it another way, assuming the next three quarters grow at an Seasonally Adjusted Annual Rate of 3.0% each (which, by the way, hasn’t happened since Q3 2004), the aggregate U.S. GDP increase for 2014 would be under 1.5%. The FOMC currently estimates that 2014 GDP will grow at about 2.2% (see previous post). For a 2.2% aggregate growth rate to occur, the U.S. economy would need to grow at ~4% in each of the next three quarters. That is a tall order in a weak economy.

Financial markets are a tale of two forces: a fragile economy and an expansive monetary policy. QE3 is winding down and should conclude in the fourth quarter of this year, but until then, expect the equity market plateauing to continue.

Posted in Portfolio Strategy | Leave a comment

Historic Levels After the FOMC Meeting

The S&P 500 Index climbed 15 points, or 0.77%, to close at a record high of 1956.98. The 10-year Treasury Note yield fell 42 basis points to settle at 2.61%. The VIX dropped 12.02% to close at 10.61; a level not seen since February of 2007.

There are several factors to consider here. First, the Volatility Index (VIX) is a measure of implied volatility for the S&P 500 Index (SPX). The VIX is a real-time measure of the amount of premium investors are willing to pay for options on the SPX; the more premium, the higher the VIX. While the premium is calculated on both Put and Call Options, the VIX is sometimes viewed as the “fear gauge” because of the premium investors are willing to pay for “Put Protection”. However, this can be misleading and misinterprets the larger implication: the VIX is a measure of market participants’ expectation of the future range of the SPX. That is, as of the close today, the VIX suggests the 12-month return of the SPX will be +/- 10.6%. Of course, this is an expectation and prone to error. As noted before, this is the smallest range in more than 7 years. It also suggests there may be limited upside remaining in this bull market.

Second, investors have overcome their 2008/2009 financial market “shell shock”. The biggest risk to an investor’s portfolio is always behavioral risk. Looking back at the past 5 years, the biggest risk to an investor’s portfolio was that of being too cautious and reducing (or eliminating) equity exposure from her portfolio. That was a behavioral response to losses incurred in 2008 and/or volatility experienced in 2009. The same statement can be made for the period following 2001 and the exact opposite statement can be made for the periods just prior to 2008 and 2001. It ebbs and flows in cycles. It is human nature. And now that investors are once again more focused on the upside, rather than the downside, the cycle is likely to change once more.

Those comments were not meant to suggest a coming correction. In fact, I’ve blogged on numerous occasions about our plateauing equity market thesis. And I believe the economic data and equity market price movement continue to point to that. For instance, earlier in the year, the SPX dropped 5.975% from its 2013 close; currently, the index is 5.875% above its 2013 close. I expect any additional moves to the upside to be a grind with the SPX ultimately following a flat-to-slightly-positive trajectory for 2014.

Today, the FOMC announced that they will taper an additional $10 billion from their monthly bond purchase operation, also known as QE3, reducing the total monthly purchases going forward to $35 billion. They also released the Committee’s projections for 2014 GDP. Below is a chart of their estimates over time. (The bars represent their “central tendencies” while the lines represent the high and low projections for that period).

FOMC Estimate 2014 GDP

It is rare for economists to underestimate GDP (among other things). Now that the final revision to 2014-Q1 GDP will likely decline by more than one percent, full year estimates need to be reduced. As I’ve stated in a previous post, I highly suspect that 2014-Q2 GDP will fall short of the 2.8% – 3.0% estimates currently published.

Posted in Portfolio Strategy | Leave a comment

10-Year Treasuries Yield Their Lowest in 11 Months

The S&P 500 Index closed at 1909.78, -2.13 points or -0.11%, after struggling to hold onto gains late in the session. The index is higher by 3.32% on the year. The bigger story today is the 10-year Treasury yield, which closed at 2.438%; its lowest level in over 11 months. Bond yields and prices have an inverse relationship (i.e. as yields fall, prices rise).

It is commonly thought that equity markets and fixed income markets should move in opposite directions. As such, many are suggesting that Treasury yields are indicating a forthcoming equity market correction. Sometimes, this relationship is true. However, U.S. financial markets are currently distorted by the ongoing purchases of the FOMC known as QE3.

There are two dynamics to consider when thinking about yields: Level and Trend. Lower yields (e.g. Level), as opposed to higher yields, are stimulative to the economy; primarily because they will generate increased loan demand (all else being equal). Higher yields–again, all else being equal–will reduce that loan demand. Falling rates (e.g. Trend), on the other hand, are an indication that there is not (yet) enough demand in the system. In other words, growth is slowing and/or expected to slow.

The Bureau of Economic Analysis will release its second estimate of Q1 GDP on Thursday, May 29. The BEA previously estimated that the U.S. economy grew at 0.1% in the first quarter of this year–a palty growth statistic for which analyst estimates were far too high. The consensus has since revised its estimate of Q1 GDP to -0.7%, indicating the economy contracted in Q1 2014. Their estimates for Q2 2014 GDP are once again nearing 3.0%, but those estimates are also likely to be too high. The BEA will release its advance estimate of Q2 growth on July 30th.

The big picture is that the U.S. is still in a deleveraging process and stimulative measures by the Federal Reserve are not effective on a permanent basis. And five-plus years of a near-zero Fed Funds rate and multiple rounds of quantitative easing nearly fits that “permanent basis” definition. These measures have not generated the economic growth of the mid-2000s. Instead, these measures created a scenario in which investors and businesses seek out other avenues to invest capital: equity markets. We are once again faced with an equity market that is dislocating from the underlying economy, but low interest rates will only contribute to this perverse feedback loop.

The conclusion is that equity markets will be constrained to the upside because of the weak underlying economic conditions, but bolstered by the Fed’s easy money policies. Investors should expect equity markets to continue to plateau.

Posted in Portfolio Strategy | Leave a comment

S&P 500: New All-Time Closing High at 1896.65

The S&P 500 Index closed at an all-time high on March 31, 2013 after a five and a half year hiatus. Since then, the S&P 500 has made 53 new all-time closing highs, including today; rising 20.87% in the process. But what does closing at an all-time high indicate for near-term returns? Below is a chart that graphs the forward 10-day return (y-axis) against the number of days since last achieving a new all-time closing high (x-axis).


The chart indicates a weak, but indirect relationship between the number of days since last achieving an all-time closing high (ATCH) and the near-term future return. Twenty seven trading days have passed since the last ATCH on April 2, which may mean that a period of digestion for equity markets is in order. Perhaps it is worth noting that the seven day range following the April 2nd ATCH saw only minor upside (+0.34%) but a decent amount of downside (-4.05%).

As equity markets continue to plateau, momentum on either side should be faded.

Posted in Portfolio Strategy | Leave a comment

Chart of the Day: Sector Rotation

The chart below shows the ongoing sector rotation in U.S. equity markets. Highlighted in green are the best performing sectors on a rolling three month basis; red spheres are, relatively, the worst performers. Several trends emerge from this chart; Consumer Discretionary, Financial, Healthcare, Industrial, and Technology sectors have all fallen out of favor recently, while Utilities have outperformed.


Basically the sectors that pushed equity indexes to new highs in 2013, have slowed their pace in 2014. Continued sector rotation will lead to additional “plateauing” in equity markets, but too much rotation out of the Discretionary, Financial, and Technology sectors will certainly create downward pressure. After all, the Utility sector is only 3.09% of the S&P 500 and can only accommodate so much inflow.

Posted in Portfolio Strategy | Leave a comment

April 21, 2014: Thin Tape

The S&P 500 index rose by 7.04 points today to close at 1871.89, or +0.38%. The index is now +1.27% for the 2014 calendar year, but -1.34% below its all-time high achieved on April 4. The 10-year Treasury Note currently yields 2.72%; unchanged on the day. As the headline suggests, equity volume was light today. Several factors, including a return from the holiday weekend, may have contributed to the light volume. Nevertheless, light volume almost always suggests that momentum has stalled–whatever the direction–and a reversal may be in order.

As a proxy for total volume for the S&P 500 index, I analyzed the daily volume transacted on SPY over the course of the last year (i.e. April 22, 2013 – April 21, 2014, non-holiday shortened trading days). Today ranked 15th in lowest volume transacted on SPY over that time period with ~59m shares traded during regular market hours. See graph below. As a reference point, the average daily volume over that time period is about ~97m, or ~64% more than today. As for seasonality, today marked the lowest volume transacted in any of the April dates included in the study and the third lowest volume transacted in 2014 (1/16 & 1/22).


The 5-day forward return for the 14 dates that transacted less volume on SPY over the course of the last year: -0.72%, with 10 of those 14 periods resulting in a loss. It is important to understand that within the context of the situation: when accounting for both magnitude of positive return and lack of volatility, 2013 ranks among the top five of the past 63 years for the S&P 500. And as I’ve noted before, 2013 is no 2014. As a reminder, the two lightest volume days of 2014 (1/16 and 1/22), preceded the Jan/Feb equity decline by four days and one day, respectively.

There is the possibility that this is not an indication that equities will roll over, however, “equity market plateauing” is still in effect and if you have the opportunity to lighten your equity exposure with the S&P 500 up YTD and poor seasonality months (May-Sept) fast approaching, it’s probably a good idea to do so.

Posted in Portfolio Strategy | Leave a comment