Stocks Calm Ending as Earnings Season Ushers in Volatility

Jul 09, 2014 6:05 pm ET

(Updates S&P 500, VIX move under ‘Global Growth’ subhead)

July 9 (Bloomberg) -- The selloff in technology stocks and small-caps is a warning sign that months of calm in the equity market are coming to an end.

“You’re getting investors who were once euphoric preparing for more volatility on the basis that the economy and market may not be as strong as they believed,” Matt McCormick, who helps oversee $11 billion as a fund manager at Cincinnati-based Bahl & Gaynor Inc., said in a phone interview. “It’s natural that people would want to be more cautious in an environment where there are more questions than answers.”

The Chicago Board Options Exchange Volatility Index has jumped 16 percent in two days, the most since April, as the Nasdaq Composite Index and Russell 2000 Index fell at least 2 percent. While the Standard & Poor’s 500 Index has still gone for 56 days without a 1 percent drop, the second-quarter earnings season may lead to bigger stock swings.

Speculation that U.S. stocks have risen too far, too fast fueled losses yesterday as Raymond James & Associates Inc. said equities are vulnerable to losses and Citigroup Inc.’s chief U.S. equity strategist cited concerns for a “severe” pullback. The S&P 500 ended last week at an all-time high and the Dow Jones Industrial Average topped 17,000 for the first time.

Global Growth

International Monetary Fund Managing Director Christine Lagarde this week signaled a cut in the institution’s global growth forecasts, saying investment is still weak and U.S. risks remain. In Europe, signs the economic recovery is losing momentum have sent stocks lower for the past three days. U.K. manufacturing unexpectedly slumped the most in 16 months in May and German exports contracted more than estimated.

More than 130 companies in the S&P 500 are scheduled to report quarterly results in the next two weeks, including Citigroup, JPMorgan Chase & Co., Goldman Sachs Group Inc. and Johnson & Johnson.

“With the big earnings season coming up, we expect a pickup in volatility,” Peter Tuz, who helps manage more than $450 million as president of Chase Investment Counsel Corp. in Charlottesville, Virginia, said in a phone interview. The VIX “was extremely low for quite a while, but that’s over,” he said.

Investors have seen diminished stock swings with the VIX reaching a more than seven-year low last week. The gauge, known as a “fear gauge” because it tracks the cost of S&P 500 options, is still down 13 percent for 2014. The S&P 500 climbed 0.5 percent to 1,972.83 at 4 p.m. in New York, while the VIX slipped 2.8 percent to 11.65.

Writing Off

To Frederic Dickson of D.A. Davidson & Co., the VIX’s jump isn’t a cause for concern. The volatility index is still 14 percent below its one-year average of 13.9 and has closed below that level for 49 days, the longest streak since 2007, data compiled by Bloomberg show.

“Going from 11 to 12, the market at this point is just writing it off as a technical correction,” Dickson, who helps oversee $44 billion at D.A. Davidson in Lake Oswego, Oregon, said by phone yesterday. “If the VIX goes up to 20, that would have caught my attention.”

Losses in the past two days have been concentrated in technology shares and small-caps with high valuations. Twitter Inc. and Pandora Media Inc., which trade at more than 150 times estimated earnings, plunged about more than 9 percent. Facebook Inc. and TripAdvisor Inc. sank at least 5.3 percent.

The S&P 500 is valued at 18 times reported earnings, the highest level since 2011. Analysts have lowered their forecasts for earnings since April and now predict profit growth of 5 percent in the second quarter, according to the average estimate from a Bloomberg survey.

More Cash

Jason Brady of Thornburg Investment Management Inc. said he’s been raising cash, selling riskier stocks and buying safer ones on concern the market is vulnerable to a selloff. The 100 best-performing stocks in the Russell 1000 Index during the May to July rally have fallen 4.5 percent this week, twice as much as the average stock in the index, according to a report from Bespoke Investment Group LLC.

“Prices are relatively high, not crazy, but definitely high,” Brady, who helps oversee $89 billion at Santa Fe, New Mexico-based Thornburg, said by phone. “High prices don’t necessarily mean you’ll have a big selloff, but the market is more vulnerable.”

--With assistance from Lu Wang in New York.