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A Storm Is Brewing

Prepare for the tail to wag.

I’m talking about the statistical tail, the one at the far ends of any bell curve. For residents of the East Coast this week, that meant dusting off those shovels that have sat idle for the past few months.

For investors, it means re-examining your appetite for risk and paring your portfolio accordingly.

Statistics work because data typically reverts to its mean. And volatility in the stock market today is far from its mean. It’s bumping along a 5-year low and possibly readying to charge upward. 

The CBOE Volatility Index, or VIX, measures investors’ expectations for choppy movements in the S&P 500 over the next 30 days. The VIX is currently trading at 12, well below the 10-year average of 21 and down significantly from its Brexit spike to 25 and its Sep. 2015 high of 40 when global markets were collapsing.

The stock market has been happily marching upward since the presidential election. A brief increase in volatility swirled through the indices right around the election, but the market quickly corrected itself and volatility quieted back down. As with news of the Brexit vote, the market quickly digested the unexpected election results and moved higher.

Last week marked the first down week for the S&P 500 since early January. All told, the market enjoyed almost eight weeks of calm bullish behavior. That is unusual.

Leo Grohowski, chief investment officer at BNY Mellon Wealth Management, sums it up like this, “I’ve been very surprised at the market’s complacency. Many assets classes are pricing in a fair amount of hope. Hope is never a good investment strategy.”

The Federal Reserve meets this week to enact what most market participants fully expect to be a quarter-point increase in interest rates. Although the rate hike has been widely broadcast to investors, it’s worth noting that the market has gained 16% since the rate tightening cycle began 15 months ago. It helps that rates are inching up from record lows. However, volatility tends to increase as rates move higher.

Several European events this week could also inject some risk into the market. The surprising rise of anti-Muslim candidate Geert Wilders in the Netherlands could upend its election for a Prime Minister this week.

U.K. Prime Minister Theresa May will kick off her country’s exit from the Euro this week as she looks to sign Article 50, the administrative action to begin the U.K.’s divorce. Scotland, who recently voted to reject leaving the Euro, is also digesting the news that a second referendum to exit the Euro might happen in late 2018.

Investors don’t need to fret too much. Increasing volatility doesn’t mean a down market, just a dynamic one. Sharp downward jolts in the market can be a trader’s best friend. Also, option prices tend to increase in value as volatility picks up.

Just as Bostonians and Manhattanites must suffer through a blizzard before the daffodils emerge, investors may have to weather some gut-wrenching twists to reset the gage on the market’s demeanor.

In between shoveling shifts, I’m watching from my helm at Profit Catalyst Alert to pinpoint new trading ideas.


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