Peter Cecchini Comments: More wild days headed for US stock market

December 22, 2014, Bloomberg News

Don’t let last week’s rebound fool you, strategists say. More wild days are coming in the stock market.
While calming words from the Federal Reserve were enough to soothe investors this time, sending the Standard & Poor’s 500 Index to its biggest three-day rally since 2011, equity volatility is picking up and upheavals will become more common next year, according to strategists at JPMorgan Chase & Co. and Bank of America Corp. Three weeks into December, the Chicago Board Options Exchange Volatility Index has already risen 99 percent and fallen 30 percent.
It’s the second time in two months that the gauge of trader anxiety known as the VIX jumped above 20, only to erase more than half its gain within three days. Bouts of volatility are likely to plague investors more in 2015 as the Fed gets closer to raising interest rates.
“We do think the dominant feature of U.S. volatility will be these excessive, localized shocks that will continue to repeat,” Benjamin Bowler, Bank of America’s co-head of global equity derivatives research, said by phone.
Market storms
Fluctuations in stocks, dubbed “storms in a teacup” by Bowler’s team, have been exacerbated by participants such as high-frequency traders pulling away from the market when equity swings begin, causing a liquidity vacuum, he said.
The explosion in popularity of exchange-traded wwwucts tied to futures on the VIX has also led to erratic behavior in the volatility gauge, Bowler said. The three biggest securities that usually appreciate as market turbulence increases attracted the most inflows in 16 months in November as investors added to bets on more stock swings.
Market liquidity has also dried up as the U.S. central bank has slowly tightened monetary policy. In October, the Fed concluded its $85 billion asset-purchase program, which has helped nearly triple the value of American equities since March 2009.
The same pattern of volatility shocks will continue as the Fed nears liftoff for increasing interest rates, according to equity derivatives strategists at JPMorgan. The team led by Marko Kolanovic projects the VIX’s average level will rise 15 percent in 2015 from its mean of 14.1 this year.
Stark reversal
“Our view is that volatility across assets in 2015 will look more like the fourth quarter than the first half of 2014,” Kolanovic, global head of quantitative and derivatives strategies at JPMorgan, wrote in a Dec. 15 note. “October’s shock is an example of the market volatility we are likely to see in 2015 as the Fed increases rates and the market adjusts to lower levels of liquidity.”
U.S. stocks slid 5 percent from a record Dec. 5 as a plunge in oil prices and debt concerns from Venezuela to Russia raised speculation that global economic growth is at risk of being derailed. The selling was a stark reversal from the calm in November, when swings in the S&P 500 narrowed to the smallest in at least 10 years.
The VIX jumped 78 percent in the week ending Dec. 12 for its biggest gain in four years. For five days through Dec. 16, the gauge of S&P 500 options prices closed 20 percent above two- standard deviations of its average price in the past four weeks, data compiled by Sundial Capital Research Inc. show, for the longest stretch of such stress since October 2008.
Traders rushed back into equities Dec. 17 after the Fed pledged to be patient on increasing interest rates, boosting the S&P 500 5 percent in the last three days of the week. The VIX dropped 30 percent in that period, falling more than seven points.
Trader panic
The panic last week was similar to a bout in October, when the S&P 500 plunged as much as 9.8 percent on an intraday basis amid slowing economic growth in Europe, Ebola anxiety and escalating conflicts in the Middle East and Ukraine.
During that selloff, the VIX more than doubled to the highest intraday level since 2011, then dropped back down at the fastest rate since 2009 as commitments to monetary easing from the European Central Bank and Bank of Japan propelled U.S. equities higher.
The Fed’s gradual increase in borrowing costs will be minimal and shouldn’t have a substantial impact on stocks’ upside potential next year, according to Alan Gayle, who helps oversee about $45 billion as a senior strategist at Ridgeworth Capital Management.
More symbolic
The rise in interest rates next year “will likely be more symbolic than meaningful,” Gayle, who is overweight U.S. equities in his holdings at Ridgeworth, said by phone. “We might see an increase of a quarter of a percent. It’s not likely to have any financial impact on corporations and therefore not likely to derail the expansion in equities.”
Speculation around the VIX’s future whiplash has led to higher demand for bets on stock-market volatility. The VVIX Index, tracking options whose value is tied to whipsaws in the VIX, jumped to the highest since May 2010 on Dec. 12 as traders piled into the contracts.
The gauge of implied VIX volatility closed last week at 99.17, 21 percent above its 12-month average. The VIX slid 22 percent for the five days, to 16.49.
“Despite arguments to the contrary, the Fed is changing its stance from highly accommodative to marginally less accommodative, and it is likely next year to move to a tighter stance,” Peter Cecchini, the New York-based chief strategist and global head of macro equity derivatives at Cantor Fitzgerald LP, said by phone. “When liquidity tends to diminish, volatility picks up, even on margin.”