Declining Market Volatility Signals Growing Optimism About Equity Recovery

Market volatility is collapsing to levels not seen since February, the latest sign of optimism about a stock rally that has lifted major indices to new highs this week.

Stocks rose to record highs, fueled by excitement over an upcoming coronavirus vaccine as well as relief that the election – widely awaited for months – has passed. These expectations give more investors confidence that social and business activities have the potential to return to some normalcy after months of lockdowns, restrictions and rising cases.

The Dow Jones Industrial Average rose 2.2% this week, crossing the 30,000 mark for the first time. The blue chip index was up 13% in November, its strongest month since 1987 The S&P 500 rose 11% this month, while the Nasdaq Composite jumped 12%. Both indices closed at record highs on Friday.

The Dow Jones’ phenomenal run this month underlines a widening of this year’s rally to include high-tech non-high-tech stocks, giving investors some confidence the gains could continue. Beaten stocks, including airlines and cruise lines, have jumped higher, while the Russell 2000 Small Business Index is on track for its best month on record.

“Hopes lead realists: they believe that the economy will return to equilibrium with a high growth rate. They look beyond the shock, ”said Sébastien Galy, macro-strategist at Nordea Asset Management. “It’s a matter of time though; there are still deep underlying issues with the Covid spikes in the US ”

A measure of stock market volatility has also declined. On Friday, the Cboe volatility index closed at its lowest level since February and briefly fell below 20 intraday for the first time since then, before coronavirus fears ended the 11-year bull market. for actions. A measure of bond market volatility slipped to its lowest level since early October on Wednesday.

Still, the VIX rebounded from its Friday low and settled at 20.84, marking its 195th consecutive trading session where it closed above 20, a streak not seen since 2009, during the financial crisis. , according to Dow Jones Market Data.

Although the rise in stock indexes suggests that investors have breathed a sigh of relief, the run above 20 for the VIX indicates that investors remain somewhat cautious and concerns persist that the volatility that has plagued them will return. markets earlier in the year. It also reflects the high prices of option bets linked to the S&P 500, which investors often use to hedge their portfolios or make directional bets on stocks.

The recent stock market rally has been unusual. According to Dow Jones Market Data, in six of the past eight periods when the VIX has exceeded 20 for at least 100 sessions, the S&P 500 has fallen, not risen.

The stretch since February includes a period in which US stocks fell into a bear market – defined as a decline of at least 20% – before rebounding to new highs. Since February 24, the S&P 500 has gained around 13%.

“There are still a lot of scars from what happened earlier this year,” said Chris Murphy, co-head of derivatives strategy at Susquehanna.

Some analysts said the high VIX was driven by doubts about the recent rally in stocks, leading to demand for insurance-style contracts until the end of the year to protect recent large gains.

“There is so much uncertainty out there,” said Stuart Kaiser, head of equity derivatives research at UBS Group. AG

. “Nobody wants to be on the wrong side of this.”

Despite positive news about the vaccine recently, it is unclear when it will be distributed and how quickly the economy will rebound. Additionally, the coronavirus pandemic continues to plague the United States and there has been a surge of infections in the colder months. Traders also said they were monitoring the second round of January elections in Georgia, which will determine which political party controls the Senate.

The number of people hospitalized in the United States with Covid-19 has exceeded 90,000 for the first time. More than 110,000 new cases were reported in the country on Thursday, significantly lower than the totals in recent days. But infection levels are likely to rise again due to the gatherings for Thanksgiving celebrations.

And of course, it has been an eventful year. There have been more stock movements of at least 3% in a day for the Dow Jones Industrial Average, S&P 500 and Nasdaq Composite – up or down – than in any given day. what a year since 2008.

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There are signs that traders are positioning themselves for the gauge to slam its streak above 20 and drop as stocks continue to advance. Leverage funds like hedge funds have recently increased the bets that would pay off if the VIX goes down. Data from the Commodity Futures Trading Commission shows that these bets recently hit their highest level since at least early August. Bearish bets like these on the volatility gauge are akin to bullish bets on stocks.

Volatility controls funds added about $ 25 billion to their equity exposures during the first half of November, coinciding with the VIX decline, Deutsche Bank said in a report last week. These funds still remain around 15% below their total allocations to equities, the bank added. These funds typically make buy and sell decisions based on the level of market fluctuations, and calmer markets can fuel more buying.

Meanwhile, there has been a wave of bullish call option activity related to the iShares Russell 2000 exchange-traded fund, which tracks small company stocks. The Russell 2000 is up 21% this month, on track for its best month since its inception in 1984. Investors confident that the economy will continue to improve thanks to the vaccine have accumulated in the sector.

The Dow Jones Industrial Average has hit the 30,000 mark. Jason Bellini of the WSJ explains how we got there and what the 30,000 number tells us about the state of the stock market. Photographic illustration: Laura Kammermann

Write to Gunjan Banerji at [email protected] and Michael Wursthorn at [email protected]

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