Learning to Live With Increased Volatility
by: Sam Stovall, Chief Investment Strategist May 17, 2010

How quickly emotions swing from euphoria to despair. Year to date through April 23, its recent peak, the S&P 500 had risen 9.2%, the S&P MidCap 400 was higher by 16.9% and the S&P SmallCap 600 had jumped by 18.6%. Investors were on a high, breathing a sigh of relief that the U.S. economy was on the mend and that the concern over Greek debt that triggered the sell-off in January had been resolved. But as if to remind us that things were just too good to be true, the markets began to unravel as April came to a close.

Year to date through May 14, while all three U.S. benchmark indices were still up on the year, large caps gave back 7.4 percentage points since the April 23 high, while mid caps YTD return was cut in half and small caps had declined nearly 7 percentage points from the high. What’s more, the mood of the markets only seems to have turned sharply gloomier as volcanic eruptions, oil rig explosions, currency implosions, anti-government riots now seem to dominate the evening news.

This gloominess is also manifesting itself in the magnitude of moves within the broad U.S. equity benchmark, as well as in the sectors within the S&P 500. Specifically, the number of days in the past year that the S&P 500 fell by 2% or more in a single day has begun to pick up once again. Indeed, the last two down days of 2% or more came on May 4 and 6. In the past 12 months, we have witnessed 13 times that the “500” fell by 2% or more, versus an average of seven per year since 1970. Of course these readings are nowhere near the peak of 54 declines experienced in mid-2009 as a result of the mega-meltdown in equity prices. Also, past performance is no guarantee of future results.

Since the S&P 500 has fallen 6.7% since April 23rd peak of 1217.28, it should come as no surprise that all 10 sectors within the S&P Composite 1500 have also fallen. The Consumer Staples, Telecom Services and Utilities sectors each fell less than 2% since April 23, while the Energy, Financials and Materials groups all tumbled by more than 8%. In addition, 141 of the 145 sub-industries in the S&P 1500 declined during the same period. Gold mining companies were among the four notable exceptions, as they rose 8.6%.

It seems as if investors remember all too well the swiftness of price declines during 2008, and probably don’t want to get sucked into another swift downdraft. As a result, they have adopted the approach of selling first and asking questions later. Indeed, this is made clearer by comparing the average volume during up days and down days for the nine sector ETFs that make up the S&P 500. For instance, since December 31, 2009, there have been 58 days in which the S&P 500 ETF (SPY, $113, OW), advanced in price with an average 177 million shares trading hands. There have also been 34 declining days, with an average 278.4 million shares being traded. As a result, the daily average volume during down days was 61% higher than the average volume during up days. Year to date through May 14, this ETF posted a total return of -2.2%. Indeed, a similar story is told by the nine sector ETFs that replicate the sectors in the S&P 500. Seven of nine saw more up days than down days, but all nine experienced higher average volume during down days than up days. In addition, all sectors posted a ratio of down to up days from 52% for Consumer Staples to 62% for Financials.

Will volatility on the macro or micro levels subside any time soon? Probably not. Even though world equity markets have weathered financial crises of the past with only modest near-term price declines – such as following the Mexican Peso devaluation of December 1994, the Thai Baht implosion of July 1997 and the Russian Debt Crisis of August 1998 – today’s concerns appear to be deeper and more widespread. As a result, they won’t likely be resolved overnight. According to S&P Economics, five governments show 2009 net debt as a percent of GDP in excess of 100%, with Greece and Italy being notable members of this list. What’s more, many of the European Union members that are being called upon to bail out the wayward members of the E.U. are themselves in the top 20, based on net debt to GDP. Even more discouraging is the projected trend in debt, as 2012 debt–to-GDP levels for 14 of the top 20 countries are expected to rise in the coming three years.

While the volatility may remain elevated, however, we don’t believe the world will slip back into recession. Currently, S&P forecasts U.S. 2010 real GDP growth at 3.3%, while I.H.S. Global Insight sees global GDP growing by 3.7% in 2010. Therefore, we don’t think a double dip is in sight, but we do believe investors will remain hyper-sensitive as they would rather not be caught off guard (again).

Source: Learning to Live with Increased Volatility
Standard & Poor's
By: Sam Stovall

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