Will Start Of Q2 Earnings Take Us To S&P 2000?

Market focus soon turns to earnings after two days of better-than- expected U.S. jobs numbers emboldened investors to propel the S&P 500 to record levels and the Dow Jones Industrial Average clear of 17,000 for the first time in its history. We know this latter milestone drives media interest more than professional investing interest, but it is noteworthy nonetheless.

In the process, the CBOE Volatility Index (VIX) set fresh seven-year lows of 10.28 ahead of the July 4 holiday weekend. Could we soon see a single-digit VIX? Because the index is sometimes viewed as a gauge of sentiment, contrary-minded investors may worry that the index has fallen too low, and a single-digit reading may just be the wake-up call some investors are hungry for. But even they may want to see how earnings season shakes out.

Earnings Kickoff
With little this week in the way of major economic reports (see the calendar below), earnings are the headliners. S&P 500 component Alcoa AA -1.54% (AA), a telling indicator of industrial demand, kicks off the next quarterly reporting wave on Tuesday. Wells Fargo WFC -0.94% (WFC), reporting Friday morning, and Citigroup C -0.54% (C), reporting a week from today, will offer a glimpse at earnings from the big financials. These are teaser reports before the floodgates on Q2 earnings results swing wide beginning next Tuesday.

Analysts seem relatively upbeat about the upcoming reporting season. According to Zacks, S&P 500 companies are expected to post 2.9% total earnings growth for Q2 over the same period a year ago. Although that is down from estimates of 5.5% a few months ago, 2.9% is more than double the pace of Q1’s performance.
New Math?

Optimism about an earnings rebound is one reason VIX is at seven-year lows to start Q3, but a sizable drop in actual volatility seems to be an important factor as well. VIX is unique in that it captures volatility perceptions; it is computed based on the implied volatility embedded into short-term S&P 500 Index options. But there are other ways to attempt to measure volatility, including Average True Range (ATR), which reflects changes in prices of a particular stock or index.

ATR considers closing prices plus the highs and lows of the day. The math is straightforward. The first step is to compute the true range for a trading day, which is the greatest of:

• The difference between the high and low
• The difference from the high to the previous day’s close
• The difference from the low to the previous day’s close

As the indicator name suggests, ATR is merely the average of the true ranges over a period of days. Figure 1 shows the 30-day ATR on the S&P 500. Although it’s climbing to new records, the S&P 500 is seeing relatively small swings and range-bound action. The true ranges are small, and ATR has plummeted to 52-week lows of 10.56%.

JJ 1 Kinahan-Weekly-Blog-7.7.14-Fig-1

Simply put, VIX in the single digits certainly seems plausible if actual volatility continues falling and the earnings reporting season unfolds quietly.

On Your Toes
In that respect, however, there are two wild cards to watch for in the week ahead: (1) Action in the energy markets amid ongoing conflict in Iraq and for Russia/Ukraine, and (2) the recent uptick in bond yields on strong jobs data last week and ahead of the release of Fed June meeting minutes due out Wednesday afternoon.

In other words, the prospect for higher energy prices and/or interest rates could certainly pose a risk to the falling volatility scenario into Q3.
Good trading, JJ @TDAJJKinahan

Figure 2: Weekly U.S. economic report calendar. Source: Briefing.com.

  • Love this market. Stocks are overly priced. Got to be realistic. Nice correction. Heaven for traders. Enjoy…!