Monday, February 22, 2016

Why is the Stock Market so Volatile in the First Two Months of 2016?

Time to get real about what is going on with the stock market this year.  All this talk about a possible recession, the concern about more Fed tightening, the economic slowdown in China, etc. are just a lot of talking points for the folks in the mainstream media (MSM). 

Rule #1 about the stock market - stock prices go down because there are more sellers than buyers.  Therefore, someone is selling.

Who is this selling in the US markets?  

1.  If you take the 50 day moving average of the volume on the S&P 500 index since January 4 (first trading day of the year) there have only been 3 trading days out of 33 or 9.1% (through Feb. 19) that have been below the 50-day moving average.  A similar analysis using the NASDAQ indicates that only 7 out of 33 trading days (21.2%) were below the 50-day moving average.  Let's face it in any random 33 day period one would expect about half of the days to be above and half of the days to be below the 50-day moving average for volume.  Based on this very simple analysis it appears someone is selling.  By the way, I did the same count of the S&P 500 for 2015 (Jan. 5 through Feb. 19, 2015) and found 16 of the 32 trading days were below the 50-day moving average or exactly 50%.

2.  Could this be panic selling?  For this I looked at the VIX, a measure of volatility for the S&P 500.  The market drop in late August gives an indication of what high volatility looks like when the market is in "panic" selling mode.  Since January 4, the levels of volatility are higher than a year ago, but nowhere near the levels seen in August.  This indicates that the selling seen since the first of the year is orderly.  Don't believe me.  Go to and plot the VIX yourself (symbol $VIX).

3.  Even the casual observer of the market will notice a correlation (not causation) between the price of oil and S&P 500 since the first of the year.  A simple correlation analysis between the price of crude oil and the S&P 500 index indicates a correlation of about 85% since the first of the year.  The same analysis for the last 35 trading days of 2015 shows a correlation between the price of crude and S&P 500 of 68%.  Considerably less.  Does the market know something about the relationship between the price of oil and stock market that the rest of us retail investors do not?  Probably.

So what does all this mean?  

1.  The S&P 500 is down and the volume is up.
2.  Volatility is up, but not in panic mode.
3.  The S&P 500 is closely correlated with the price of oil so far this year.

Enter the Sovereign Wealth Fund (SWF).  What is a SWF?  A SWF is basically a savings account for countries, especially those that have a lot of excess cash like the oil exporting countries.  A good definition can be found at the SWF Institute or SWFI website (SWF#1). Investopedia also has a good definition SWF#2.

These Funds are usually quite large and are just not restricted to oil-exporting countries.  For example China, Singapore, and South Korea have SWFs.  Only about 60% of SWF assets are energy related.  Some of the largest SWFs are the oil-exporting countries like (estimated size in billions of dollars):

Norway                 $825 B
UAE                       773
Saudi Arabia           623
Kuwait                    592
Qatar                      256

In total the world's SWFs have about $7 Trillion in assets and the largest ones had about $3.04 Trillion in stocks world wide at the end of 2015.  According to Bloomberg if the price of oil stays between $30 and $40 this year the some of the oil-exporting SWFs will sell about $404 billion of equities worldwide (Bloomberg #1) to cover government budget shortfalls caused by lower oil prices.  The SWFI estimates that the SWFs sold about $213 billion in listed US equities in 2015 (SWFI #1), which continued into the first two months of this year.

I looks like the sellers are the SWFs.

If you are an investor what does that mean to you?  Several things:

1.  Assume the market this year will have periods of high volatility as SWFs enter the market to liquidate some of their equity positions.

2.  If you use technical analysis to guide you through your investing assume their will be periods when the signals do not work well.  Large-scale selling will trump most market signals.

3.  However you choose to handle the market, get ready for a tough year in the markets.

Good luck!

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