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Stock Market Volatility Is Shrinking (Implications + Game Plan) – Mike Swanson (06/14/2021)

Sometimes, we need to step back and look at the big picture, because if we don’t and only focus on daily gyrations, which is what the apps and shows make us look at as they want to tell us about what is happening on that day or hour as that is “news,” it’s easy to get fooled by market action.

At the same time, making money in the markets isn’t so much about predicting the future as it is understanding the current trends and their implication.

Right now stock market volatility is actually shrinking and has been doing so for about three months. And this isn’t just happening with stocks, but also with bonds and precious metals.

This isn’t a shock, because last year we saw record volatility when the stock market crashed with the S&P 500 falling over 30% last Spring and then rallying back up to new highs, in a move that was one of the biggest percentage gaining moves ever in such a short amount of time.

Record volatility like that is most likely to lead to months if not even a year of shrinking volatility, which will eventually lead to a new volatility expansion. But right now volatility is shrinking.

When last year came to an end on December 30, I did a post saying that this was likely to be a defining feature of this year when I wrote, “I expect we’ll see the market continue to trade the way it has in the past few weeks with falling volatility while investors take on greater risks, when it comes to buying more on margin, buying more call options, and buying riskier stocks and then at some point next year, probably in the second half, things will blow up on them again.”

So, far this type of thing has played out in the crypto market – where investors went wild and got trapped buying crypto collectible coins when Bitcoin went above $50,000. So, the blow-up has happened there for now – and in some of the fad stocks that were big winners last year, but I don’t see a sign of a major top when it comes to the S&P 500 and the broad market.

Now, volatility is measured by two things the 200-day Bollinger Bands and the VIX.

The Bollinger Bands measure real price volatility and expand when volatility increases and shrink when it decreases. The 200-day bands show this on a real long-term basis and so does the 200-day BB width indicator on the bottom of this chart for the S&P 500.

The last time the S&P 500 went through a period of shrinking volatility like this was in 2019 from March to October of that year. I believe we are now going through a similar trend now that is likely to last until at least the end of July and perhaps a little beyond Labor Day.

In that scenario don’t expect the S&P 500 to do much.

This means there is limited downside for now in the market, but not huge upside either.

What would change my mind on that is if the market started to have a fast surge rally with an accelerated price advance that took the RSI above 80 on the S&P 500. That would lead to an extreme overbought condition in the market that means some sort of peak or correction is coming. If that type of overbought reading were to occur in the coming weeks or months I would sell some positions and put on some hedges, by shorting stocks lagging the S&P 500, and/or buying puts and going long some short ETF’s.

Personally, I’m pretty maxed out on the exposure I want being long in the market (having done most of my buys last year) so am pretty much content to simply hold what I already own. I have no need to really buy more or do much at the moment.

On the bottom of the above chart is the VIX, which measures not real price volatility, but the perception investors have of where volatility is going. The VIX is the premium that traders are paying for in the options market for volatility. They tend to go into a panic, which generates elevated VIX readings above 30, when you get near the end of a major market correction, which makes for a good buying point.

The VIX got elevated for months last year after the stock market collapsed and entered a range with $20 as the low as we ended 2020. Now the VIX is below 20 and likely to settle into the $12-15 range in the coming weeks and months as volatility continues to shrink.

While market volatility in the US stock market is shrinking this year the bond market went into a bear market after making a secular low in Treasury bonds last year. However, bonds (and currencies) tend to move in slow motion, and now we are getting a bounce/rally in the bond market within what is a larger bear trend. That rally in bonds is likely to help provide a bullish underpinning for stocks as long as it continues.

The TLT ETF, for instance looks like it could continue to bounce a little more as we can put a target of the RSI for it getting above 80 by the end of July.

Such a bounce would simply be a rally into its long-term 200 and 150-day moving averages. Corporate bonds would likely rally a little more and things like the JNK ETF are likely to make new 52-week highs.

Gold also is simply drifting around the $1900 area and may not do much one way or the other for the next several weeks. Gold got overbought a few weeks ago when its RSI touched 80. It is working off that condition this month by simply going sideways with support around $1850 and resistance in the $1910-1925 area.

The top gold stocks, though, can continue to breakout again and run and silver out of everything at this moment is in a position where it could possibly breakout and start a big rally.

I wrote about that last Friday in a post you can read here.

-Mike

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