Surging Volatility in Stocks Signals Restraint Even for Bulls

By Lu Wang

Never get too high or too low. It’s advice the U.S. equity market refuses to heed.
Amid the biggest selloff in energy in six years and rallies in biotechs and airlines, an indicator tracking shares that have risen or fallen to 52-week records on the New York Stock Exchange recently reached the highest level in three decades. Individual stocks are swerving as volatility in indexes revisits levels last seen in the selloff of October.
The surge in the NYSE High-Low Logic Index is a reason for caution to Doug Ramsey, the chief investment officer of Leuthold Group LLC who has been one of the market’s staunchest bulls since 2011. Evidence emotions are getting the better of investors as they pile into winners and cut losers has characterized past market peaks, he said.
“That momentum-chasing mindset really manifests itself very late in the bull market,” Ramsey, who helps oversee $1.5 billion, said by phone from Minneapolis. “The market is a relatively safe place to invest as long as the entire list of NYSE stocks is essentially in gear. The situation that’s dangerous is when it’s not in gear.”
The 10-week average of the NYSE Logic index, which
measures the extent of simultaneous highs and lows on the exchange, rose last month to the highest level since at least 1980, data compiled by Leuthold show. Such readings occurred at the start of the last two bear markets in 2000 and 2007.

Worst Start

Volatility is surging as stocks have the worst start to a year since 2009. Roiled by oil’s slump and a surprise move from the Swiss National Bank to abandon its currency link to the euro, the Standard & Poor’s 500 Index (SPX) has fallen 1.9 percent in 2015 and declined in 10 of the last 13 days. Futures on the gauge expiring in March climbed 0.3 percent at 9:24 a.m. in London today.
The gauge posted its 12th consecutive single-day swing of 1 percent or more on Jan. 16, the longest burst of intraday volatility since October, data compiled by Bloomberg show.
On Jan. 13, the equity gauge advanced 1.4 percent before falling and ending the day lower. The reversal, the fourth of that size in three years, was partly triggered by a homebuilder’s forecast sparking concern that lower oil may be hurting the real estate business in Houston.
Crude’s biggest decline since the 2008 financial crisis is dividing the market as investors seek safety in stocks that offer stable earnings and dividends, such as drugmakers and power producers. Money is flowing out of energy stocks as West Texas Intermediate crude, a benchmark for U.S. oil, has plunged 55 percent since June.

Performance Gap

While the S&P 500 climbed more than 10 percent for a third straight year in 2014, the gap between gainers and losers widened to levels not seen since 2007. Utilities and health-care companies rallied more than 23 percent while energy shares dropped 10 percent. Airlines led the market as the NYSE Arca Airline Index jumped 49 percent.
“It’s a tale of two markets,” Michael Ball, the president who oversees about $800 million at Weatherstone Capital Management in Denver, said in a phone interview. “It reminds me more of an environment that we were getting in the late 1990s in terms of the overall market profile, where it’s just becoming increasingly narrow.”
The NYSE Logic index’s readings exceeded 5 percent for three straight weeks in January 2000 and two months later, the technology boom started to bust. The same stretch of readings occurred in November 2007, one month after the S&P 500 peaked.

Market Cracks

Ramsey’s indicator identifies when industries are cracking in otherwise buoyant markets. In 2007, financial companies began to hit 52-week lows starting in February even as the S&P 500 rose through October. As the dot-com bubble expanded toward its March 2000 peak, consumer-staples and drugmakers began to slip 12 months earlier.
This time is different, according to Cory Krebs, a portfolio manager who helps oversee about $700 million at CooksonPeirce Investment Management. Unlike 2000, when investor enthusiasm pushed computer makers to more than a third of the S&P 500, energy companies like Exxon Mobil Corp. represented only 11 percent at its June peak. In 2007, banks and insurers commanded 20 percent.
“There has been damage,” Krebs said by phone from Pittsburgh. “But I don’t think we’ll see a magnitude of selloff that will elicit great concerns.”
Investor anxiety is growing as oil’s drop raises concern that companies will cancel investment and credit markets and banks will suffer from debt defaults. At the same time, speculation over central bank policies is breeding volatility.

Diverging Policies

Stock volatility will stay high because the Federal Reserve is preparing to raise interest rates for the first time since 2006 while central banks in Europe and Japan are expected to boost stimulus, according to Dan Morris, a global investment strategist at TIAA-CREF Asset Management in New York.
“You have the out-of-sync monetary policies and that promotes volatility,” Morris said by phone. His firm oversees more than $600 billion.
The S&P 500 has fallen more than 4 percent from a record in two separate retreats since the start of December, the closest back-to-back pullbacks of at least that size in three years. The index’s average daily move so far this year is 0.95 percent, 80 percent higher than the 0.53 percent in 2014, the calmest year in U.S. stocks since 2006.

Bearish Signals

While acknowledging that not all bearish signals from the NYSE Logic index lead to market routs, Ramsey said stocks have begun a topping process and will endure a decline of 25 percent to 30 percent either this year or next.
His bear case incorporates rising stock valuations, excessively bullish sentiment among newsletter writers and yield spreads on junk bonds that are showing patterns similar to peaks of past bull markets.
The S&P 500 is valued at 17.9 times reported income, about 10 percent higher than its average in the past decade. Health-care is the most expensive among 10 industries, with a multiple of 23.4. That represents a 30 percent premium to the market, the widest in 13 years.
“Late in the bull market, you have these groups where people just really pile on to a trend that’s in place, and probably ride these stocks beyond their valuations,” Ramsey said. “There is always a sector that’s out in front leading the way down and this time it happens to be energy.”