Volatility Falls Most Since 1930s as Stock Funds Gain

Date: Wednesday, February 20, 2013
Author: Whitney Kisling, Bloomberg

Price swings in U.S. stocks are narrowing the most since the Great Depression, a signal of reviving investor confidence that’s fueling the bull market poised to enter its fifth year.

Average daily price moves for the Standard & Poor’s 500 Index have fallen to 0.43 percent in 2013 from an average 1.08 percent the past five years, the steepest decline for any corresponding period since the 1930s, according to data compiled by Bloomberg. The last time the annual average was this low was 1995, when the S&P 500 surged 34 percent and doubled in the next four years. Stocks gain an average 17 percent during years when the gyrations are so small, the data going back to 1928 show.

The combination of declining volatility and the best start to a year since 1997 is prompting bears to warn that investors are growing complacent as the rally ages. Bulls cite smaller fluctuations as another reason to buy, on top of rising earnings forecasts, below-average valuations and the biggest deposits in equity mutual funds in nine years.

“Switching from net outflows to net inflows has been a big part of volatility being dampened,” Michael Shaoul, the chairman and chief executive officer at Marketfield Asset Management, said in a Feb. 14 phone interview.

“There’s net buying, so it’s much, much easier for the market to stabilize,” said Shaoul, who oversees more than $5 billion in New York and has beaten 96 percent of peers in the past five years. “Then you have a feedback loop with the retail investor, who sees a more sedate market and that encourages people to give more allocations to funds.”

Best January

The S&P 500 climbed 0.1 percent to 1,519.79 last week for a seventh week of gains and the longest winning streak in two years. The benchmark U.S. equity gauge is up 7.3 percent in 2013 after the best January since 1997 and is about 2.2 percent below 1,565.15, the record reached in October 2007 before it retreated 57 percent through March 2009. The index rose 0.7 percent to 1,530.94 today.

The S&P 500 swung more than 1 percent on four days in 2013, down from an average of seven days a month during the past five years, Bloomberg data show. Volatility was that high for 122 days in 2008 as the housing market collapsed, Lehman Brothers Holdings Inc. filed for bankruptcy and investor confidence was shattered by the plunge in U.S. equities that wiped out $11 trillion of market value.

Price Swings

Price swings haven’t been so narrow since 1995, when the S&P 500 rose or fell about 0.38 percent per day. The benchmark gauge’s 34 percent advance that year, the biggest since 1958, set the stage for a five-year rally, the data show. Average daily volatility at 0.40 percent coincided with a 16 percent gain for the S&P 500 in 1972 and a 20 percent surge in 1967, according to the data.

Halliburton Co., FedEx Corp. and Textron Inc. are among the stocks that have seen their daily price changes narrow by at least 0.6 percentage point this year.

“The retail investor is swayed by the ups and downs of the market, especially after 2008,” Eric Teal, chief investment officer at First Citizens BancShares Inc., which manages $4.5 billion in Raleigh, North Carolina, said in a Feb. 14 phone interview. “We haven’t had a lot of external shocks to the market like we’ve had in the past years, so it’s a little more encouraging for them and I would expect to see them keep pulling money out of bond funds and into equity funds.”

Funds Pulled

Investors who pulled almost $300 billion out of stock funds since the market bottomed pumped $37 billion into equity funds in January, the most since 2004, estimates from the Washington- based Investment Company Institute show. Technology companies and financial institutions received the biggest inflows, according to data from Birinyi Associates Inc., the Westport, Connecticut-based investment adviser.

Smaller price fluctuations may be a sign that investors are becoming too complacent, according to USAA Investments.

The Federal Reserve has left its target interest rate for overnight loans between banks near zero since 2008 and promised not to increase it as long as the unemployment rate stays above 6.5 percent, forcing investors to search for higher returns in risker securities. Money-market funds yielded an average of 0.04 percent as of Feb. 14, according to Crane Data, while the S&P 500 has climbed 13 percent over the past 12 months.

Stock Run

“What we’re concerned about now is it may have run too far too fast,” John Toohey, vice president of equity investments at USAA, which manages more than $54 billion, said in a Feb. 12 phone interview from San Antonio, Texas. “Economic growth isn’t that strong at the moment. Any sort of crisis, we’re worried that volatility will spike up, and with equity markets recently being so strong, it’s likely to lead to a correction.” past week, rising two basis points to 2.02 percent today.

Investors are piling into stocks because the Fed’s bond purchases have depressed interest rates on Treasuries and created an artificial environment, according to Nassim Nicholas Taleb, professor at New York University and author of “The Black Swan” and “Antifragile: Things That Gain From Disorder.”

“I am forced to buy stocks myself because I’m afraid of bonds,” Taleb said in an interview on Bloomberg Television’s “Market Makers” with Erik Schatzker and Sara Eisen. “We have never lived in a world as artificial as today, as far away from the organic nature of how things should be. Any environment that cannot convert crisis to fuel is doomed.”

Profits Shrink

U.S. gross domestic product unexpectedly contracted in the fourth quarter and is forecast to expand 1.9 percent this year, according to the median of 94 economist estimates compiled by Bloomberg. The unemployment rate is at 7.9 percent, compared with the 5.8 percent average since 1948. Corporate profits may drop 1.5 percent this quarter, analyst estimates compiled by Bloomberg show.

Lower-than-average volatility preceded the last bear market, when daily swings fell to an average 0.54 percent during the two years before the S&P 500 peaked. The index tumbled 38 percent in 2008, the biggest drop since 1937.

Volatility at today’s levels has never led to losses on the S&P 500. In the nine instances that the index gained or fell 0.43 percent or less, the S&P 500 ended the year higher.

VIX Declines

The Chicago Board Options Exchange Volatility Index also has declined in 2013, dropping as much as 31 percent to a five- year low of 12.43. Declines in the VIX, which measures options contracts on the S&P 500, came before gains in the S&P 500 in 2009 and at the end of 2011.

Earnings at S&P 500 companies will expand 6.7 percent this year and 11.6 percent in 2014, according to more than 1,900 analyst estimates compiled by Bloomberg. Profits have grown for four straight years.

“We have finally reached the point where investors are more comfortable buying stocks again,” said Howard Ward, the chief investment officer at Rye, New York-based Gamco Investors Inc., which oversees $36.7 billion.

Investor concern about growth and corporate profits is keeping valuations attractive, according to Wayne Lin, a fund manager at Baltimore-based Legg Mason Inc., which oversees $654 billion.

The S&P 500 trades at a discount to its six-decade average. The price-earnings ratio climbed to 15 last week, 9.3 percent below the 16.4 average since the 1950s, data compiled by Bloomberg show.

‘Tail Risks’

“People aren’t fully convinced that the tail risks are gone,” Lin said in a Feb. 13 phone interview. “Once the market believes that tail risks are off the table completely, that will filter into higher valuations.”

Apple Inc., based in Cupertino, California, trades near a record low multiple and is poised to gain, according to Ward. Shares of the world’s largest company by market value are the cheapest in 12 years relative to the S&P 500 after falling 14 percent to $460.16 in 2013.

Halliburton swung between gains and losses of 1.3 percent so far in 2013, down from 1.9 percent the past three years. The biggest provider of services for hydraulic-fracturing, or fracking, to extract natural gas advanced 23 percent in 2013, compared with 6.6 percent for the S&P 500. The Houston-based company surpassed analyst profit projections by 4.1 percent last quarter.

FedEx, Textron

FedEx, the Memphis, Tennessee-based operator of the world’s largest cargo airline, is up 16 percent this year, as daily volatility fell to 0.7 percent, from 1.3 percent in the three previous years, data compiled by Bloomberg show. Shares of Textron, the Providence, Rhode Island-based maker of the Cessna Aircraft, are fluctuating 0.8 percent on average, compared with 1.9 percent since 2010.

Bridgewater Associates LP, the $140 billion hedge fund founded by Ray Dalio, is betting on stocks as economic confidence encourages investors to shift to riskier assets, Bob Prince, the co-chief investment officer, told clients on a Jan. 23 conference call.

“The point is not so much that we’re going to be in the gangbuster period of growth,” Prince said, according to a transcript of the call obtained by Bloomberg News. “It’s more that growth is likely to be better, particularly in the United States, than it has been. It’s more of a movement of capital. The money moving out the risk curve and into risk assets won’t take much growth to trigger that kind of shift.”