Chaos Lurks Beneath the Stock Market’s Deceptive Calm
The calm facade of the stock market is beginning to crumble, as volatility and uncertainty rear their heads.
There’s chaos beneath the stock market’s calm—a calm that could be ready to break.
On the surface, everything looks copacetic. The S&P 500 index has risen 1.1% for the week as of Friday morning and is on pace for its first close above 5000. It’s also on pace to close higher for the 14th week out of the last 15, something that last occurred in 1972. The Dow Jones Industrial Average was little changed, while the Nasdaq Composite has advanced 1.9%.
That would seem to reflect the current narrative, with some minor tweaks—that inflation continues to moderate, the Federal Reserve will lower interest rates even if it doesn’t in March, while the economy continues to grow. It’s a great backdrop for corporate profits, one that seems confirmed by the latest earnings releases, which have come in 6.8% above expectations, above the 5.7% average for the previous four quarters, and suggest 9% earnings growth during the fourth quarter.
More Volatility in Earnings Reports
The calm, however, is only surface deep. Nowhere is that more true than in shares of companies that have reported their fourth-quarter results. Yes, we know that earnings are supposed to cause stocks to have big moves. But the recent responses have been larger than normal: As of Thursday, the median S&P 500 stock has moved 3.6% after reporting, according to Dow Jones market data, nearly a point higher than the 2.7% median over the past 10 years.
These large swings are happening because the outlook for companies is far less certain than what it appears to be for the overall market. It also reflects the uncertainty many investors feel as they watch an expensive market—the S&P 500 trades at 20.4 times 12-month forward earnings—make its way higher while seeming to ignore the possibility that economic growth could decelerate, disinflation could peter out short of the Fed’s target, or that rates could remain right where they are.
Investors on Edge: Companies Face the Consequences
“You’ve got investors on edge, so they’re reacting somewhat more intensely to these results,” says Sevens Report’s Tom Essaye.
That manifests itself in an ugly way for companies that disappoint the market on earnings releases. FMC dropped 11.5% after offering below-consensus guidance that was blamed, in part, on the weather in Brazil. Yet the companies that are giving the market encouraging news are seeing their stocks fly high. Palantir Technologies jumped 31% after reporting better-than-expected earnings on Monday, boosted by strong demand from its commercial customers.
Volatility Index Remains Deceptively Low
For now, that volatility isn’t reflected in the Cboe Volatility Index, or VIX, which sits near 12.8, well below its 20-year average of 17.7 and down from 21.7 on Oct. 20, a level that seems too low given the S&P 500’s 21% gain since bottoming in October—and given the risks that are lurking. Those risks include high valuations, sticky inflation, a cautious Fed, and even a mild recession, according to Evercore ISI strategist Julian Emanuel, who thinks the next big move in the S&P 500 could be 10% to the downside. “Volatility is the baseline, not the outlier,” he writes.
Brace for Impact: Investors Need to Prepare
And something investors should start preparing for now.
Analyst comment
Negative news. The market is experiencing a deceptive calm while the underlying chaos and volatility are starting to emerge. Earnings reports are causing larger than usual swings in stock prices due to uncertainty and investors reacting more intensely. The volatility index remains low, but experts warn of potential correction and advise investors to take necessary precautions. Market outlook is uncertain, and investors need to be prepared for potential downside moves.
