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.

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