​As Sam Sees It: Does Volatility’s No-Show Signal a Risk-On Market?

Sam Stovall  |

Each week, we tap the insight of Sam Stovall, Chief Investment Strategist, CFRA, for his perspective on the current market.

EQ: Over the past week, the S&P 500 has bumped up against the 2400 threshold, but has failed to close above the level. You’ve described this phenomenon as like a rusty door, in which it typically takes a few tries to break open. Assuming nothing unforeseen happens here, what would closing above the 2400 level mean for the market in the near term?

Stovall: I think it would be a very good sign because the S&P 500 is treading water just below the surface of 2,400. It’s really awaiting a catalyst that will buoy the index above this stubborn century mark, and then ultimately justify the optimism that propelled prices 12% higher since election day, and up 6% since inauguration day.

I think it’s really going to be earnings growth that will end up being the propulsion. Earnings for the first quarter of 2017 is coming in 500 basis points better than initial estimates, meaning we’re likely to see earnings up 14.9%, versus the initial estimate of 9.9%. I think if we should start to see an upward creep in forward earnings forecasts, then that should allow investors to embrace a risk-on trade once again.

EQ: Oil prices have been on the down trend over the past month, but the broader market has continued to move higher in spite of that. Is this something that warrants more attention or is this just typical oil price volatility?

Stovall: I think it’s something that warrants continued monitoring because, if you recall, early on we had no problem in 2015 regarding the sharp drop in oil prices. It was simply attributed to a supply imbalance. But then the worry became that maybe it was pointing to a global economic slowdown. So, questions started to arise around the health of China.

This time around, I think it still has more to do with the supply-demand imbalance, and a technical giveback. We’re not forecasting a global recession, but as they say, fool me once, shame on you. Fool me twice, shame on me. So, it definitely warrants monitoring.

EQ: In this week’s Sector Watch report, you pointed out the lack of volatility we’ve seen thus far in 2017. Year to date, the market has only experienced three days in which the market closed up or down by 1%. How does that compare to the historical average?

Stovall: It is very, very low. Going back to Dec. 31, 1999, the average rolling 12-month count was 73. Going back to 1960, the average rolling count was 53. So, whether you’re dealing with 50-plus years or simply 15-plus years, we’re still looking at a count of volatility that is substantially lower than the long-term averages.

EQ: Investors tend to get a bit nervous when volatility is too low. Is this a calm before the storm or should investors anticipate smooth ride ahead?

Stovall: Well, history would say that investors should expect a smooth ride ahead. Going back to 1950, whenever we had five or fewer 1% days in the first five months of the year—meaning from the start of the year to May—the market was higher 100% of the time and was up an average of 9.5% for the remaining seven months of the year. So, that is obviously a very favorable indicator but it certainly is not a guarantee that we’re going to be higher.

I think that basically those people who are nervous are already on the sidelines waiting for that bad news that caused them to get out, whereas the bulls are going to stick with their risk-on trade. They’re staying in because they still think that there’s the potential for tax reform to make its way through Congress sometime this year, and are hoping for an improvement in earnings based on organic economic growth.

EQ: We’ve discussed the possibility of the return of volatility for a number of years now during this bull market. What is the likelihood that the market has entered a new environment in which volatility will remain low?

Stovall: That’s certainly a possibility. I always like to say that one style does not last forever. We usually end up experiencing a reversion to the mean. So, with us seeing very, very low volatility, the implication to me is, like the undulation of the tides, that sooner or later we will see a pickup in volatility along the way. It doesn’t mean that we have to experience a significant decline in prices to, in a sense, do penance for such low volatility over the past year-plus, either. I just think it simply means that more of the bulls and bears will engage in a tug of war like they have in the past.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer.


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