Fed Jawboning And Market Performance

Here's a reprint of something we discussed on the main site earlier this year.  It's as relevant now as it was in February... 


Mr. Bernanke is now scheduled to speak before Congress in the Semiannual Monetary Policy Report to the Congress.


We've discussed this event several times over the years, but it's worth touching on again, as we have seen some pretty consistent market action surrounding these speeches.

The day before the Fed Chair's testimony to Congress, the S&P 500 has been up nearly 70% of the time.  But the day of the prepared remarks, it was up 44% of the time, and the day after it was up only 28% of the time (7 out of 25 occurrences).


For some reason, these meetings have an uncanny tendency to occur very near market inflection points, with the market moving substantially in the other direction from the move preceding the testimony.  The chart below highlights these meetings (the gray vertical lines) superimposed on a chart of the S&P 500.

If the S&P 500 was negative over the month prior to the testimony, then the month following the meeting it was up 8 out of 10 times with an average return of a respectable +2.3%, though the risk/reward over the next month was about evenly distributed (-3.8% to +3.9%).

However, if the S&P was positive heading into the meeting, then the following month also showed a positive return only 13% of the time (2 out of 15 instances) and an average return of -2.8%.  The risk/reward was extremely skewed to the downside (-5.9% to +1.6%).  The last 12 occurrences, dating back to 1998, were all negative.

VIX Predicting The Future...And It's Cloudy

Options expert, and unofficial (though enthusiastic) Vix bikini spokesman Adam Warner noted today on Twitter that we may be in for an uptick in volatility based on where the VIX index is relative to historical volatility and also to VIX futures.

The chart below shows the premium or discount that the front-month VIX futures are trading to the cash index.  So if August VIX futures are at $30 and the VIX itself is at $28, then the blue line below would be at $2.

The futures traded at an exceptionally wide discount in the craziness last fall, and are now at the opposite end of the spectrum.  Since April, the spread between the two has traded in a pretty well-defined channel, and we can see from the little red (or green) arrows that when the VIX spread hit its upper (or lower) trendlines, then the S&P tended to decline (or rally).

We've now exceeded the upper trendline, so that's probably a bad thing if this relationship holds out.  I suppose since we went to a wild extreme last fall we could see the opposite of that now, but based on the past few months anyway this doesn't look real good for the S&P.

Battle Of The Fear Indexes

A couple of months ago, Credit Suisse rolled out a new indicator that was supposed to be a new and improved "fear index".

The de facto standard for such indicators is the VIX, with which nearly everyone is familiar.  The higher it goes, the more fear is supposed to be in the marketplace.

But the VIX is subject to movements not necessarily related to sentiment, and it can even move counter to how it should at times.  For example, if a big trader needed a slug of call options to bet on a market rally, then it's possible that could make the VIX rise.  As observers, when we saw the VIX rise, we'd assume there's more fear in the market, even though the underlying cause was a bullish bet.  Confusing, eh?

So CSFB created a new index that compares the premiums in calls versus puts, digging a layer deeper than the VIX does.  When the index was first unveiled, its movements didn't make a lot of sense when compared to the VIX, but recently an article on Bloomberg highlighted one potential use for it - identifying times when the VIX is masking underlying sentiment.

We're seeing that now:

There have been four other times during a bear market when we've seen a divergence like this, when the VIX is at a multi-month low, but the CSFB Fear Index is at a multi-month high.  Over the next three months following those four instances, the S&P averaged -9.2%, and with a risk that averaged more than 6 times greater than the average reward.

Source:
Biggest VIX Drop Hides Options Bets S&P 500 Will Fall
Bloomberg, July 6, 2009

Somebody Betting On A Bond Rally?

It's always interesting to watch position changes ahead of major known events.

An example is the latest surge in buying interest in the long bond fund at Rydex.  Assets in that fund surged by more than 200% yesterday...is someone betting on a change in the FOMC statement today?

The last surge in assets didn't result in any meaningful short-term move in bonds, and when these asset levels reach an extreme they tend to be more of a contrary indicator than anything.  But it'll be interesting to watch how these asset levels change over the next day or two, especially if they get their desired outcome.

Trading News Sentiment

One of the areas I've spent a fair amount of time on is news-related sentiment.  How stocks react to overtly positive or negative news, and what impact that tends to have on the broader market, is a consistent source of good information.

The new blog Sentiment News by the good folks at RavenPack (don't ask what it costs, it's not priced for individuals) highlights a study by Macquarie Research highlighting stock performance surrounding positive and negative news.


Some highlights:

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  Investors are more likely to react adversely to negative news sentiment than to react favorably to positive news sentiment.
  

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  Negative news sentiment is a stronger leading indicator of future underperformance than positive sentiment is for future outperformance.
  

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   Stocks tend to be underperforming prior to a negative news announcement.
  

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  Stocks tend to rebound after about five days {after negative news}.
  

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  There is no short-term reversal after positive news events.

All of these confirm what I've found as well, so they are useful rules of thumb if trading individual stocks or even sectors that are greatly impacted by bellwether stocks.

Source:
How Does The Market React To News?
News Sentiment, June 17, 2009