Explaining the searing volatility in individual stocks and indexes and what it's signaling

Published Sat, Feb 5 20226:28 AM EST

"Volatility" is often invoked by investment professionals as a euphemism for a market in decline, the way "adversity" is used by coaches to describe a losing streak to the beat reporters. Yet in the past week, stocks were legitimately, empirically volatile — even as the broad S & P 500 index managed a 1.5% gain, with whippy moves around tight corners that left traders' nerves frayed and hair tousled. The S & P's daily trading range each day exceeded 1%, Meta Platforms shed more than $200 billion in market value Thursday and Amazon added almost as much the next day. Every one of the five largest Nasdaq stocks – Apple, Microsoft, Alphabet, Amazon and Meta – moved at least 10% after hours or intraday in response to its earnings release the past two weeks. Snap shares gained an almost comical 59% Friday after better-than-feared results, but that pop only recovered three weeks' worth of prior losses and still left the stock 53% off its peak from less than five months ago. Away from equities, bonds are repricing in a hurry for an expected brisk Federal Reserve tightening effort this year, with Friday's strong jobs report propelling the two-year Treasury yield as high as 1.32%, a level the 10-year yield brushed against just two months ago. The most heavily traded instruments in finance are unusually jumpy lately, too, a sign of stressed illiquidity conditions and trimmed risk limits among professional wielders of capital. Goldman Sachs derivatives research showed a week ago that the median change in the S & P 500 E-Mini futures contract over 15-minute intervals has climbed toward one-third of a percent, by far a post-Covid-crash high. All this agitated action reflects the swirling currents of cyclical, behavioral and mechanical influences, a matter of a macroeconomic transition and fast-money mood swings. It also suggests, it should be said, some structural fragilities. The mad rush of retail traders into options, often those that expire weekly — as well as the depletion of willing market-maker capital and the heavy presence of passive index funds — have helped contribute to the gappy, tail-wagging-dog behavior. Without seeming alarmist or charging that the markets are somehow "broken," these factors become acute in corrections and moments of macro confusion. Rocky Fishman, equity derivatives strategist at Goldman, wrote last week: "Our biggest technical concern is liquidity, with [S & P] futures' liquidity resembling March 2020. On-screen liquidity has become so poor that futures have been more than one tick wide over 20% of the time. Weak liquidity means flows matter more and leaves the potential for outsized market moves (in both directions)." Blame the Fed? But it's not all about the technical vulnerabilities. The economy's speedy progress toward full employment and stubbornly spiky inflation has carried the market toward a late-cycle phase, prompting the Fed to steer market expectations toward several 2022 rate hikes up from "maybe two" just a few months ago. At the same time, GDP and corporate-profit growth is decelerating from high rates, and corporate credit spreads have seen their firmest levels. The start of a tightening cycle tends not to be the bull market's matador, but plenty of chop and a less-generous return-to-risk equation are common. Jurrien Timmer, Fidelity's director of global macro, shows the S & P 500 over several recent Fed-tightening periods, overlaid at the index peak, with the current path in white. It shows the magnitude of the setback is perfectly normal, as would be more sloppiness in coming months. An economy with nominal GDP growth of 14% in the fourth quarter stepping down toward something closer to the long-run norm, with the Fed trying to calibrate the correct response on the fly, will inherently mean the range of potential outcomes is much wider than back in the 2010s, when inflation was muted and GDP growth hovered near stall speed in a narrow band. Markets, on some level, will allow for that broad set of possibilities. Earnings growth is becoming less robust and less inclusive, with margin erosion hitting some more than others and payback from pandemic-related demand acceleration showing up in some unexpected places. As a result, the market's response to the numbers is tracking as weak as they were in the troubled markets in 2011 and 2001-02, according to Bespoke Investment Group. Add in the copious amounts of accumulated paper profits over the prior two years in portfolios for which bonds are no longer providing an offset in equity sell-offs, and margin-loan balances retreating from a lofty place. Meta's collapse sends shockwaves The buckling of the very largest growth stocks in the market – the top five of which rose to 23% of the S & P 500 market value – means they've recently changed from a dampener of index volatility to a source of it. Meta's 23% collapse, from a starting place well above $800 billion in market cap, immediately ripples through the market in quite-tangible ways. Whether an investor is assessing risk through gut feeling or sophisticated models running stress scenarios, a mega-cap name gapping lower by that much encourages smaller positions and more hedges. Thus, the straight-down moves in Amazon and Snap ahead of their earnings Thursday during Meta's collapse. Whether this faltering of the Nasdaq giants relative to the overall market is a hiccup or just getting started is impossible to say. For sure, the Nasdaq-vs.-S & P 500 ratio chart looks like a plausible top here, as the growth leaders leak much of the valuation premium they claimed since early 2020. The inclusion of the year-2000 inverted-icicle peak in this relationship is not meant to say a rerun is underway, by any means. The run higher into the 2000 peak was ridiculously steep and that Nasdaq was full of less-mature companies. (In fact, Chris Verrone of Strategas has noted it is the ARK Innovation ETF whose recent trajectory most matches up with the Nasdaq's boom-bust cycle starting in the late-'90s.) The somewhat good news is, more of the growth-stock bellwethers delivered solid earnings and had their stocks stabilize than didn't in recent weeks. Only Netflix and Meta were outright flops. On some level, the market always feels – and is – more twitchy and emotional during corrections such as the one we've been in. Prices have moved quickly, making it easy to go back to a recent level even if it's far away in dollar terms. In the current case, there was a pretty decisive-seeming flush of liquidation and fear at the Jan. 24 low. The S & P has regained about half of all the ground lost from January high to January low and finished the past week in a somewhat indecisive spot – just above its 200-day average, still below the downtrend line from the peak. It's around its lowest valuation in two years, but with first-quarter profit forecasts slipping a bit. There seems plenty of room for investor sentiment and positioning to come back from anxiety and caution. Credit markets have softened up but not yet in a punitive way for corporate borrowers. The corporate stock-buyback window will open wider in coming weeks. All of this makes it plausible that the Jan. 24 low can hold up and stocks can work higher if in jagged fashion – even as it's tough to predict truly smooth sailing back to record highs is directly ahead, given imminent consumer-inflation data, seven "live" Fed meetings from March through December and the high-torque feedback loops activated by the year's mercurial start.

Traders on the floor of the NYSE, Feb. 4, 2022.

Source: NYSE

"Volatility" is often invoked by investment professionals as a euphemism for a market in decline, the way "adversity" is used by coaches to describe a losing streak to the beat reporters.