Investors Ignore The Threat of More Volatility – Market Analysis by D’ron Forbes

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At the time of writing this entry the futures are in the green, but not holding onto enough gains to convince me that today will be any different. The Dow Jones futures ($DIA) are up about 42 points (+0.12%), which is not nearly enough to make up for the absolute smack down we’ve taken since the year begun. We put the bull to work overtime in 2021 chasing record highs, and now the bear seems prepared to collect the hefty tolls. 

Jerome Powell will appear in front of the Senate Banking committee today, on a mission to derail inflation at all costs. Although traders are well aware that they will be footing the bill, they are determined to bet that the second half of Monday’s session is indicative of a reversal in trend. Some are even convinced that Powell will hold off on raising short term interest rates, despite knowing that the CPI likely hit a 40-year high in December. 

Opportunities Grow but Risks Remain

After a down day in the market yesterday, value opportunities likely increased by around 53%. There was a record number of lows set for 2022, with 578 companies finding their way to new bottoms. The significant gap between the 20 and 200 day averages were little changed which shows a lot of downside risk still exists. 

The downside risk in the market is simply a symptom of increasing cost of capital. This will change the way companies operate and the way institutions view valuations. Premiums on future earnings will start to diminish over time as we consider that many companies will not be able to see the same level of funding, and as a prerequisite likely not be able to see the same level of growth. 

Along with the downside risks in the US market, several new Chinese property developers are at risk of default. If the market reacts similar to the Evergrande situation there could be added pressure to find safe haven in bonds. The 10-year treasury note is sporting a 1.73% yield which currently overshadows the lower 1.23% yield offered by the S&P 500 ($SPY).

Is The Threat of Volatility Gone?

Communications ($XLC), Technology ($XLK) and Real Estate ($XLRE) are currently the most oversold of all sectors, with Energy ($XLE), Finance ($XLF) and Consumer Staples ($XLP) going into today’s session with the most downside risk. The S&P 500 put to call ratio dropped by 12.3% yesterday, showing that investors do in fact believe they downside is done with for now. However, it may be a bit too soon to be making bullish bets on the entire market. It is likely best for investors to pick and choose which sectors may serve them best from one period to the next. 

What seems to be one of the main issues in some slower moving sectors is the high dependency on Exchange Traded Funds. The Russell 1000 ($IWD) for example, which represents the top 1,000 companies by market value, has in its top holdings a mixture of Finance, Energy, Consumer Staples, Healthcare ($XLV) and Communications. With the former 3 sectors currently already over bought and the remaining 2 looking for some upside there seems to be a need for the market to get in sync. 

This suggests that the upside in many sectors could be limited by the downside of others in weeks to come. This may limit the gains across the market for now, leaving us with lots of upside to carry into the second half of the year. 

With new value opportunities presenting themselves in the market, investors need to be diligent and take advantage. If the upside potential is to be limited as I presume, this will also present a rare opportunity to be patient at the same time. The volatility in the market came and went quickly in yesterday’s session. The vix at some point spiked 22% above it’s 20 day average but receded by the end of the session. The thought in every investor’s mind should be this. If a threat presents itself then disappears without finishing the job, is the threat really gone at all?