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Volatility Update: Tug of Earnings Stress is Only Beginning

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October 15, 2015
Volatility Update: Tug of Earnings Stress is Only Beginning

October isn’t yet living up to its reputation as a rocky month for Wall Street. In fact, the S&P 500 (SPX) has recovered year-to-date losses after a 4% rally that spanned only a few, recent sessions.

As might be expected with SPX gains, broad-market volatility measures have relaxed. But the pull of other markets—oil, for instance—should remain a must-watch for investors. What’s more, Q3 earnings offerings pick up their pace and could help dictate whether early-October gains are the start of a deeper advance or a head fake for a stock market that could continue to surprise investors into year-end.

Relaxed State?

The CBOE Volatility Index (VIX) dipped toward 18 in early October after remaining above 20 through most of September (figure 1). That’s an area that several market observers believed could potentially anchor a new range for VIX. The index, sometimes known as a “fear gauge” due to its tendency to spike during periods of market mayhem, is now a far cry from the panic levels north of 50 hit in late August. VIX tracks short-term SPX options.

VIX-stock-volatility

FIGURE 1: MARKET “FEAR” ILLUSTRATED.

The CBOE Volatility Index (VIX), charted on the new-look thinkorswim® platform, tracks short-term S&P 500 (SPX) options. Many observers watched for a “new normal” for this gauge closer to the 20 area after a late-summer volatility spikes. That means some analysts could be wondering if the recent VIX drop closer to 18 is sustainable. Data source:  CBOE. For illustrative purposes only. Past performance does not guarantee future results.

Risk perceptions and VIX are easing as the S&P 500 recoups losses. Yet not all market sectors are participating equally in the advance. As crude oil bubbles higher and tests the $50-a-barrel area, the energy sector has been pacing SPX’s 4% advance. The sector, which is the biggest loser year to date, rallied more than 12% in the first week of October. Economically sensitive basic materials and industrials are the next top performers. Health care, financials, and utilities are notable laggards (see the table).



First Week of OctoberYear to Date
Energy12.1%-13.3%
Materials10.1%-9.5%
Industrials6.0%-6.6%
Telecommunications4.3%-3.9%
S&P 5004.0%-3.0%
Consumer Staples3.8%1.1%
Technology3.6%-1.0%
Consumer Discretionary3.5%6.5%
Financials2.5%-6.1%
Health Care1.6%-1.6%
Utilities0.9%-7.5%


Could Be Ugly

The Q2 earnings reporting period offered few reasons for bulls to cheer as aggregate S&P 500 earnings were down 2.2% from a year earlier on 3.5% lower revenues, according to Zacks Investment Research. Energy was the main disappointment. Excluding that sector, earnings were up 5.1% on 2.1% higher revenues, these analysts said.

Q3 could be more of the same. Zacks analysts estimate broad-market profits will be down 5.6% on 5.5% lower revenues. Energy again could be the biggest drag, they guess. But even excluding that sector, overall earnings are anticipated to be up a historically slim 1.2% on slightly lower revenues from a year earlier.

Interestingly, sector performance in the first week of October suggests that market participants are anticipating a rebound in the economically sensitive energy, industrials, and basic materials sectors moving into the future. Of course, seven days does not a trend make. Concern about global growth challenges—particularly the economic slowdown in China and emerging markets—could pressure overall earnings in coming quarters.

The extent of China’s impact is hard to quantify until actual numbers hit the tape. Perhaps for that reason, Q3 earnings reports are likely to be a key driver for some time, at least until the October 28 Federal Reserve interest rate meeting—yes, them again.  

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