Up the stairs, down the lift

In­creased volatil­ity goes hand in hand with spikes and corrections

Financial Mail - Investors Monthly - - Analysis: Technical - GARTH MACKEN­ZIE www.trader­scorner.co.za

The sharp sell-off on global eq­uity mar­kets in Oc­to­ber was rather bru­tal. It was the sec­ond such sell­off of the year. The first hap­pened in Jan­uary and Fe­bru­ary, mak­ing for a volatile first quar­ter. The sec­ond and third quar­ters were calmer for eq­uity mar­kets, as can be seen in the chart of the S&P 500.

The start of the fourth quar­ter saw another sharp cor­rec­tion, equal in mag­ni­tude to the drop-off in the first quar­ter.

Both corrections in Q1 and Q4 were about 10% in mag­ni­tude. Both were quick and ag­gres­sive. The say­ing “The bull climbs up the stairs and the bear goes down the el­e­va­tor” was true in both these corrections.

What is notable about the most re­cent 10% cor­rec­tion is that it has left more tech­ni­cal dam­age in its wake. The up­ward trend that was ev­i­dent through 2016, 2017 and most of 2018 has been bro­ken to the down­side.

When tech­ni­cal dam­age of this sig­nif­i­cance oc­curs, it is worth pay­ing at­ten­tion to as it in­di­cates that the typ­i­cal strat­egy of buy­ing ev­ery dip in a ris­ing trend is no longer valid. Buy­ers are no longer as dom­i­nant as they were and sell­ers have ar­rived to spoil the party.

In the case of the S&P 500, the break be­low the up­trend at 2,800 saw fur­ther sell­ing pres­sure all the way down to 2,600. That lat­eral sup­port level has held and was met with buy­ing pres­sure in mid-Oc­to­ber. A bounce has sub­se­quently un­folded in the re­cent weeks to re-test the un­der­side of the prior up­trend line at 2,800. Whether this will be a “good­bye kiss” be­fore another leg lower re­mains to be seen.

What­ever the out­come, it is clear that at best the up­ward tra­jec­tory of the world’s largest eq­uity in­dex has be­gun to slow. At worst it has be­gun a process of rolling over and mark­ing the peak of a ma­ture bull mar­ket.

With fun­da­men­tal risks ris­ing, this tech­ni­cal pic­ture ties in to a view that sug­gests some tem­per­ing of re­turn ex­pec­ta­tions in the year(s) ahead.

Along with the two 10% corrections, we have seen in­evitably higher volatil­ity. This is mea­sured by the Chicago Board Op­tions Ex­change volatil­ity in­dex (VIX). It is a mea­sure of the volatil­ity that op­tions traders use to price op­tions on the S&P 500. The VIX is of­ten re­ferred to as Wall Street’s “fear gauge”. High volatil­ity is as­so­ci­ated with greater un­cer­tainty, so traders are will­ing to pay a higher price for op­tions pro­tec­tion. The op­po­site oc­curs when mar­kets are calm and volatil­ity is lower.

Spikes in the VIX can be clearly seen in 2018: one in Jan­uary and Fe­bru­ary, and another in Oc­to­ber. Un­sur­pris­ingly, these spikes in volatil­ity oc­curred when each of the 10% corrections hap­pened on the S&P 500. What is also notable is that the gen­er­alised level of the VIX has been higher dur­ing 2018 than it was dur­ing 2017 and 2016 when the S&P 500 was trending higher. High and ris­ing lev­els of volatil­ity at this point in time are notable.

Along with the tech­ni­cal dam­age that has oc­curred on the S&P 500 and the fun­da­men­tal risks that con­tinue to build, it ap­pears mar­kets are show­ing signs of in­creased ner­vous­ness. This is not un­com­mon in the fi­nal stages of a bull mar­ket.

Newspapers in English

Newspapers from South Africa

© PressReader. All rights reserved.