What Does the Lack of Volatility Mean for Markets?

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Includes: DIA, FXI, PGJ, SPY
by: Macro Man

On the face of it, yesterday was a pretty quiet day. The Alcoa (NYSE:AA) "earnings" were largely shrugged off (no thanks to Bloomberg, which singularly failed to report operating earnings per share in any headline or story that Macro Man could find), as were the decline in jobless claims (as continuing claims rose quite sharply). Equities farted around in a range, and ended up largely where they opened. Yawn.

Oh, sure, there was news from the Bank of England, which surprisingly failed to extend its QE program. This caused a bit of a rupture in sterling and a somewhat larger one in Gilts, though such developments may well have flown over the heads of the average equity-based punter.

And yeah, whichever Chinese flunkey was left holding the bag at the G8 summit made the obligatory comment whingeing about the dollar's hegemonic reserve currency role in the global exchange rate system. Once again, Macro Man feels compelled to offer a bit of friendly advice to his friends in Beijing: if you don't want so many dollars, then quit buying them!

Anyhow, with volumes modest the underlying market flavour appears to be one of lethargy. Just look at the Bollinger band chart of the SPX below; the index is at its lower Bollinger band, which means it's a low-risk buy here for a bounce. Right? Right?

Perhaps....but then again, perhaps not. As you can see in the middle section of the chart, the Bollinger band width is unusually narrow, indicating a lack of volatility during the observation period. Maybe this means that we have returned to a low-vol, pre-Lehman, post-green shoots world. Or maybe it's indicative of complacency in the market, and that narrow bandwidth is a coiled spring, ready to explode and unleash its potential energy unto unsuspecting punters.

For some reason, Macro Man favours the latter explanation. In fact, if you look carefully, you can find instances where the spring is already beginning to uncoil. Take European equities, for example (where Macro Man's shorts are concentrated); the Eurostoxx has traded poorly for several weeks now, and as you can see the Bolly bands are beginning to widen.

EUR/USD, has also been stuck in a tearfully dire range; similar to the SPX, the Bollinger bands are at their narrowest width of the year.

So, too, were the bands in USD/JPY...at least until a few days ago when the pair magically fell off the end of a table, raising volatility and widening the bands. Not exactly an endorsement for "risk on", is it?

It sort of begs the question of how long the NZD can remain with its narrowest bands of the year. The well-flagged uridashi redemptions and Fonterra payout announcement looms large on the market radar, and perhaps everyone's already short...thus precluding a move lower.

But if we look at the chart of another illiquid, uber-speculative asset price, that of silver, we can see that when stuff finally starts to move, it can explode lower. The silver chart looks pretty dreadful, which doesn't bode particularly well for either the "risk-on" or the DGDF crowd.

Macro Man is sensitive, however, to charges of bias. He always attempts to be impartial in his analysis, because he finds that doing so yields superior investment conclusions. And so the news isn't all bad. Chinese trade data for June, leaked as Macro Man is writing this, revealed a better than expected y/y decline in imports. We have no granularity yet, so we don't know if this is "real" domestic demand or the final spurt of uneconomic commodity stockpiling.

Of course, exports were slightly worse than expected, and the overall trade surplus (y'know, the number that actually goes into the growth figures) missed by quite a large margin. But hey...we should look for good news where we can get it.

And so, to provide a balanced analysis on this fine Friday, Macro Man is happy to share with you the latest upbeat webcast from China bulls ne plus ultra, Goldman Sachs: