Volatility Takes a Sabbatical

The theme of the second quarter was low volatility, as stocks continued to grind higher.  As June ended, the S&P 500 had gone 51 consecutive trading sessions without moving 1% or more in either direction.  Not since April 16 has the index moved at least 1% in a given day.  This is a remarkable streak and quite a contrast with the volatility of recent years.  Naturally, when something like this happens, the inclination is to try to figure out what it means for the market going forward. 

The current streak is the longest since 1995, when the S&P went an incredible 95 straight sessions without a 1% move.  Of course, this preceded a tremendous run for stocks, and there are certainly similarities between today and the mid-1990s.  In both cases we had come out of a recession and financial crisis, though the early 1990s crisis was less severe.  In both cases the market gradually worked its way higher while many expressed skepticism about the rally.  That said, the overall record of stocks after long periods of low volatility is mixed, with returns not differing much from their normal averages. 

Focusing on today’s situation, the lack of volatility has driven the volatility index (VIX) down to its lowest level since 2007.  This has prompted some to assert that there is too much complacency among market participants and that stock prices are therefore headed lower.  This conclusion is understandable, but the VIX is an indicator that seems to work better at the other extreme.  In other words, when the VIX is elevated, one can generally take it to the bank that stocks are poised to rise, but when the VIX is depressed, it doesn’t necessarily mean stocks are poised to fall.  The low VIX fits with some of the sentiment surveys that are indicating a high level of bullishness, and that is worrisome, but there are other signs that the run in stocks could continue.  Even though we know there will be a correction sometime in the future, we think it’s a no-win strategy to try to guess when one might come. 

We would actually welcome greater volatility because it creates more opportunities for long-term investors like ourselves.  One of the reasons for the lack of activity in our clients’ accounts (our trading has been low, even by our standards) is the low volatility. 

Getting back to the quarter, just as the market is sending some contradictory signals so is the economy.  The abundance of economic data has been strong, including unemployment claims, housing activity, bank loans, wages, the Small Business Optimism Index, and the Purchasing Managers Index.  On the other hand, the broadest measure of economic activity, GDP, has been shockingly low, declining 2.9% in the first quarter.  There are some logical explanations for this however.  First, the unusually harsh winter affected economic activity in Q1.  Second, Easter was later than usual this year, which negatively affected the first quarter.  ISI points out that there was also a late Easter in 2011, with a similar effect on Q1 and a bounce-back in Q2.  Our view is that the economy is strengthening, though not yet at a fast pace.  Perhaps one positive side effect of this slow progress is that it has kept excesses (for example, aggressive corporate spending and reckless bank lending) from building.  Even though we are five years into an economic recovery, it feels more like two given corporate behavior. 

Another noteworthy development in the quarter was the surge in merger activity.  With growth hard to come by, stock prices up and borrowing rates low, this is to be expected.  Add to this the idea of corporate inversion, and you have a particularly fertile environment for deals.  A corporate inversion entails a company moving its headquarters to a low-tax nation without shifting its operations.  Recently, many US corporations have achieved this by acquiring foreign companies, which will allow them to pay a lower corporate tax rate and more easily access cash the acquiring company has stashed overseas.  The US is one of the few nations that taxes corporate income earned overseas, which has caused US companies to keep well in excess of one trillion dollars offshore.  Corporate inversions have been especially popular in the healthcare sector, and the US government has expressed its displeasure.  But rather than making our corporate tax rates more competitive, thereby reducing the incentive of US companies to “defect,” our legislators appear to be more interested in figuring out a way to prevent such mergers. 

Best regards,

Mark Oelschlager, CFA

Portfolio Manager

Oak Associates, ltd. 

The investments mentioned or listed in this article may or may not represent an investment currently recommended or owned by Oak Associates for itself, its associated persons or on behalf of clients in the firm’s strategies as of the date shown above.  The investments mentioned do not necessarily represent all the investments purchased, sold or recommended to advisory clients during the previous twelve month period.  Portfolios in other Oak Associates strategies may hold the same or different investments than those listed or mentioned.  This is generally due to varying investment strategies, client imposed restrictions, mandates, substitutions, liquidity requirements and/or legacy holdings, among other things. The particular investments mentioned were not selected for inclusion in this report on the basis of performance.  A reader should not assume that investment(s) identified have been or will be profitable in the future.

© Oak Associates 

Read more commentaries by Oak Associates