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Volatility Update: Correlations Drop and Markets Meander

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June 9, 2016
CBOE Volatility Index (VIX) remains low as market correlations drop.

Many measures of market volatility are near lows for the year despite recent rounds of murky economic data, uncertainty on the interest rate front, and other unknowns, like the U.S. Presidential election. One reason for the low volatility might be due to the fact that, while the S&P 500 has bounced around in recent months, it’s at roughly the same level as it was six months ago and even a year ago. The lack of movement is not because individual stocks or sectors aren’t moving higher and lower—they are! But the overall market can see periods of mixed trading and falling correlations.  

Bad Data Didn’t Budge VIX

CBOE Volatility Index (VIX) didn’t move higher late last week, as you might have expected. Recall that on Friday, the Labor Department reported the U.S. economy added only 38,000 jobs for May, which was well below estimates of 155,000 jobs. Although this was bad news for the economy, the poor showing seemed to drastically diminish the prospects of an interest rate hike by the Fed at next week’s meeting. Moreover, the dollar dropped, bonds rallied, and the stock market faced a bit of selling pressure. Yet, when the dust settled, VIX remained below 14 and, as you can see in figure 1, near the lower end of its three-month range.

CBOE Volatility Index

FIGURE 1: VIX SUB-14 DESPITE WEAK JOBS NUMBERS.

The VIX saw a muted reaction to Friday’s jobs report. Data source: CBOE. Chart source: the TD Ameritrade thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.

Sectors Sending Mixed Messages

Since VIX tracks the expected or implied volatility priced into a strip of S&P 500 Index options, it often ticks lower when the overall market moves quietly from one day to the next. In that respect, mixed trading across various sectors can result in lower readings from the VIX. For example, if energy, basic materials, and industrials are moving lower, but financials, health care, and utilities are moving higher, the gains in the winning groups serve to offset the losses in the losing groups. In short, the S&P can remain flat when this sector rotation is ongoing.

The table below shows the performance of 10 broad sectors that make up the S&P 500. It includes the percentage change over the past year (since June 30, 2015) and year-to-date. Notice that while the S&P 500 is up 1.5% since June last year, some sectors like technology, consumer staples, and utilities have achieved bigger gains. Others, like energy, financials, and health care have not fared as well.


Past 12 MonthsYear-to-Date
Financials-3.9%-1.6%
Technology5.8%2.3%
Energy-11.8%9.9%
Materials-2.0%9.2%
Consumer Staples12.2%5.8%
Consumer Discretionary3.4%1.2%
Health Care-2.9%0.2%
Utilities20.7%15.9%
Industrials3.3%5.4%
Telecom5.1%2.5%
S&P 5001.5%2.5%
Data through 06/03/2016. For illustrative purposes only. Past performance does not guarantee future results.

Another way to see that market action has turned mixed is by using one of the correlation indexes from the Chicago Board Options Exchange. Figure 2 shows one such index, listed under the ticker symbol JCJ. During times of higher correlations, when sector and individual stocks are moving higher or lower together, JCJ moves higher. Notice the spike in mid-January when, incidentally, VIX was also moving northward.

However, since that time, like VIX, the correlations index has been grinding lower and is near the low for the year. Falling correlations suggest that stocks are not really moving in tandem like they were earlier this year. In other words, trading is mixed.

CBOE correlation index

FIGURE 2: CBOE CORRELATION INDEX.

JCJ suggests that the pattern of mixed trading has set in. Data source: CBOE. Chart source: the TD Ameritrade thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.

In conclusion, headlines about a softening jobs market, fear over interest rate hikes, or other economic worries might be stirring up a bit of anxiety among investors, but there hasn’t been a significant impact on volatility. In fact, while VIX is at the low end of the 2016 range, trading is mixed and falling correlations are now part of a multi-month trend.

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