Negative Momentum Accelerates as Volatility Continues to Climb

Volatility has returned to the capital markets, and with easy central bank policy likely to gain traction, markets will continue to face a bumpy ride. The economic backdrop outside of the United States reflects slow growth and declining prices, which has garnered the attention of numerous central banks.

Recall that last month the ECB embarked on a 60 billion Euro per month quantitative easing plan, while the Bank of Canada announce a surprise interest rate cut. On tap on Tuesday is the Reserve Bank of Australia which could announce a surprise rate cut.

The VIX volatility index is trading near the high end of its recent range reflecting a 20% implied movement in the S&P 500 index. Implied volatility is the markets estimate of how much a security will move over the course of a year. Implied volatility is the main component use to price options. Elevated levels of implied volatility reflect fear by traders, as they are bidding up the price of protection. Although current levels are nowhere near the 5-year highs of 48%, current readings are up nearly 45% from their recent lows.

The seasonals represent a reflection of how stock have performed during a specific month. Historically February has been a relative robust month for stocks. Over the last 10-years, the S&P 500 index has been higher 70% of the time notching up and average gain of 0.5%.

Momentum on the large cap index has turned negative and does not bode well for future price action. The MACD (moving average convergence divergence) index has recently generated a sell signal, pointing to accelerating negative momentum. This occurs as the spread (the 12-day moving average minus the 26-day moving average) crosses below the 9-day moving average of the spread. The index moved from positive to negative territory confirming the sell signal.