Market Volatility Expected to Increase in 2016

by the Curmudgeon with Victor Sperandeo

A Volatile Trading Week in Review:

Stock market volatility is increasing, which plays havoc for many short to intermediate term trend followers while rattling longer term investors. Let's look at the week that was for U.S. and Japan stocks, the dollar and gold.

The U.S. stock market was up strongly Monday, Tuesday and especially Wednesday after the FOMC's long anticipated 25 bps rate rise was announced. The three-day rally ran out of steam after the DJI advanced from Monday's DJI low of 17,138.47 to Wednesday's high of 17,784.36 (a 3.8% gain). The triple digit gains in the DJI turned into triple digit losses on Thursday and Friday. The DJI was down (-367.89 or 2.1%) to close at 17,128.55 on Friday -- a level below Monday's intra-day low. [Source: Yahoo Finance]

Friday's losses may have been accentuated by “quadruple witching” when December stock options, index options, futures contracts and options on futures all expired. In any event, the ^VIX volatility index for the S&P 500 closed at 20.70 on Friday -- up 9.29% that day.

Plunging oil prices continued to play an important role in driving equity markets lower. Brent crude touched a seven-year low of $36.33 a barrel at the start of the week, while January 2016 crude oil contract closed at $34.55 – close to a 7-year low and the fourth consecutive weekly loss.

Japanese stocks, suffered a wild ride after the Bank of Japan (BoJ) unexpectedly announced its latest stimulus policy changes. The BoJ said it would begin buying exchange-traded funds that include firms making investment in "physical and human capital." The BOJ has approved purchases at an annual rate of 300 billion yen ($2.46 billion). In addition, the BoJ said it would start buying government bonds with longer maturities.

The Nikkei 225 stock index initially rallied as much as 2.7% on the BoJ policy changes before going into reverse and closing 1.9 % lower on Friday. That left the indicator down 1.3 % for the week. The U.S. dollar climbed as high as Y123.58 before it too turned tail to trade 1 % lower on the day at Y121.34.

Gold also experienced very volatile trading on Thursday and Friday. The yellow metal sank to within a whisker of its recent five-year low of $1,045 an ounce on Thursday to close at $1050.60 in New York trading. Gold temporarily reversed its steep downtrend by climbing almost $15 on Friday to close at $1,066.10. Some say gold's action is a reflection of the U.S. dollar rises and falls, but the Curmudgeon doesn't buy that argument. Although gold is priced in dollars, if it is really money, then it should NOT follow and amplify every wiggle movement in the greenback.

Forbes - Stock Market Volatility is Increasing:

High levels of stock market price volatility are a reflection of investor anxiety which serves as a self-reinforcing mechanism. As volatility rises, investor anxiety tends to rise, which leads to more volatility.

Recent stock market activity has driven the Ned Davis Research (NDR) Crowd Sentiment Poll to a high level of volatility. This poll hit a low (low level of bullishness means people are more bearish than normal) recently at 45.8%. That low reading was followed by an upward spike in bullishness to a read well above 65%. Recently the poll fell back to a reading of 58% bullish. While this is typically a volatile index, normally it isn’t quite this volatile.

Victor's Comments:

Volatility increases when financial markets go through any kind of important transition, whether the change is imagined or real. The Fed's 25 bps increase in interest rates this week, after 7 years at zero, is a real transition. The increase in volatility was highly predictable after the Fed clearly signaled it was going to raise rates, and then finally did so at long last.

The stage was set when the stock market (S&P 500) tested the 11/16/15 low of ~1990 on Monday 12/14/15, which was the day before the start of the two day FOMC meeting.

The Curmudgeon has previously reported the work of Stifel Niicolaus in a chart showing a "highly significant" positive stock market uptrend on the day before AND the day(s) of an FOMC meeting. It happened again this week on Monday (the day before) and Tuesday-Wednesday (the days of the FOMC meeting).

The Fed either believes or is instructed (by whom?), to keep the equity markets up, by the powers that control it¹, to prevent a recession. The best way to do that is to BUY STOCKS -- via the S&P 500 futures -- when needed². Stock index futures settle for "cash" (not delivery) at the "special" opening price on expiration date.

Note 1: Who controls the Fed? President Obama and or the Secretary of the Treasury (who Yellen meets with every week) and/or the people who own the Fed -- The BANKERS!

Note 2: The Curmudgeon and I have previously provided lots of anecdotal evidence that Fed (or Fed surrogate) buy stock index futures and/or index ETFs, but we can't conclusively prove it.

So buying stocks that never have to be "sold" and then turn into cash is a manipulator's dream. The Fed wants the market to think that what they do is BULLISH, so it is empirically proven that they buy stocks to make markets believe that lowering rates and raising rates are always GOOD? They did the same when the ended QE3. Stocks rallied!

Yes, QE's can have a lagging effect, but rounds of QE combined with zero interest rates have not created above trend GDP growth or inflation in the last seven years. Thereby, to assume they will this time around is highly illogical or wishful thinking.

The Thursday and Friday sell-off days this week were the two days after the Fed's widely anticipated rate increase. The Fed always tries to make themselves look good. But after the FOMC day in which the Fed speaks, they implicitly suggest that other news is affecting the markets. That's what the Fed wants us to believe! All equity indexes except the NASDAQ composite closed at two month lows on Friday.

Other than a possible yearend rally, I believe the market will decline. The mean forecast in Fed Funds rates for 2016 is 1.25%-to-1.50%. The U.S. and global economies are weak. Raising short term interest rates after seven years of ZIRP, combined with the weakest economic recovery since 1789, is not going to miraculously stimulate U.S. economic growth! One would think that would sooner or later be reflected in stock prices. But of course, some may argue “this time is different.”

The words of science fiction author Philip K Dick³ are worth noting at this time:

“Reality is that which, when you stop believing in it, doesn't go away."

Note 3. Philip K. Dick, in "How To Build A Universe That Doesn't Fall Apart Two Days Later" (1978)

Good luck and till next time...

The Curmudgeon
ajwdct@sbumail.com

Follow the Curmudgeon on Twitter @ajwdct247

Curmudgeon is a retired investment professional. He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996. He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.

Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies and government policies. Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.

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