Thoughts on the Market

When I look at this market, I’m surprised by how strange it is. The market doesn’t seem to be committed to any trend or sector. If anything, it’s committed to a boring status quo. Every rally is met by a sell-off of the same amount and duration. This isn’t just frustrating, it’s bizarre. Here are a few random observations:
Volatility: The stock market’s daily volatility has plunged. Looking at this from an historical perspective, the decline in volatility is dramatic. The S&P 500 hasn’t had a daily move of 2% or more in over two years. A 2% day used to be nothing. It happened all the time. In the last six months of 2002, the S&P 500 swung by 2% or more 43 times—that’s about one out of every three sessions. This year, the market’s daily volatility has averaged about 0.68%, which is a fall-off of nearly two-thirds since the early part of this decade. Day-traders must be pulling their hair out.
What’s more, the volatility of every sector has plunged, except for one—Energy. The energy sector stands out from all the other sectors right now. The energy sector used to have about the same volatility as the rest of market, slightly more, but nothing like the tech sector. But now, the S&P 500 Energy Index is more than 2.5 times as volatile as the S&P 500.
Look what’s happened to tech stocks! At its peak, the S&P 500 Technology Index was averaging swings of 4.5% a day, which was also about 2.5 times the rest of the market. Today, tech stocks swing, on average, just 0.78% a day, a measly 15% more than the rest of the market. The tech sector has become like Henry Hill in witness protection at the end of Goodfellas. They’re schmoes just like everybody else.
The VIX (CBOE Volatility Index), which is a measure of implied volatility, has actually risen over the past few months, but it’s still very low. This summer, it reached some of its lowest readings in a decade. The impact of volatility is a heated topic among technical analysts. I’m in the camp that believes volatility is over-rated as an indicator of future performance. To the extent that low volatility means anything, it most likely means that the market is pleased with current valuations. Of course, this doesn’t mean it will stay that way. But for now, this is a market that has a hard time rewarding or punishing anything.
Here’s a good example of how bunched up the market is. From top-to-bottom, this is how the 10 sectors of the S&P 500 have done over the past two years:
Energy 81.67%
Utilities 41.59%
Industrials 21.31%
Materials 18.01%
S&P 500 14.48%
Telecom 13.79%
Financials 12.08%
Staples 9.96%
Healthcare 7.29%
Discretionary 4.23%
Tech 2.21%
That’s very strange. Except for energy (and to a lesser extent utilities), every sector is doing roughly what the market is doing. The market is usually far more judgmental in how it treats leaders and laggards. This is the non-judgmental market. It’s energy stocks, and everybody else.
Trading Range: Over the last year, the S&P 500 has spent about 90% of its time locked between 1167 on the low end and 1237 on the high end. There was a brief period in the spring when we tested the lower bound, and we were at the high end during part of the summer. Except for that, we’ve been in a flat line. For the last 272 trading days, the Dow has been boxed between 10000 and 11000. For much of that time, the Dow has been squeezed between 10400 and 10700.
Long-term interest rates have also been trapped in a range. Since the middle of 2003, the 10-year T-bond has yielded between 4%-4.5% most of the time. This past week, the yield finally jumped over 4.5% for the first time in seven months.
So what now? For a long time now, researchers have shown that stocks prices exhibit leptokurtosis. That’s a seriously geeky word that means that the stock market’s volatility is not normally distributed in the classic Bell Curve sense. (Warning: math ahead). Instead, the distribution of the market’s volatility has a “fat” tail and a “tall” peak. I’m going to skip over a whole bunch of stats (and get some stat professor somewhere angry at me) by saying that this means that the market goes from periods of stability to periods of freaking out. Right now, we’re very deep in a stable period.
I’m waiting for this stability to break down. By that, I don’t mean a bear market, but I want to see a new leadership group emerge. Anything but energy. Normally, when long-term rates rise, I would lean towards cyclical stocks. However, energy stocks are finally starting to get hit, and it could turn into a rout. Whenever Congress makes noise, it’s a nice contrarian indicator (i.e., Schumer and the yuan). For now, the best values are in a scattering of different areas like Frontier Airlines (FRNT) and Dell (DELL).
The theme is a lack of a theme.

Posted by on October 29th, 2005 at 3:04 pm


The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.