I assume readers know that I am a pretty skeptical sort, and don’t expect a lasting stock market recovery until the fat lady sings (as Barry Ritholtz pointed out, in the dot-bomb bear market, the stock market did NOT anticipate economic recovery, but rallied after the economy had started to turn).
But as the Great Depression and the long 1970s bear market show, there can be very large rallies (and of course smaller ones too) before the final bottom is in (and that assumes the US is the model for our current mess, as opposed to, say, the Japanese stock market in the 1990s).
And despite newly bearish sentiment (a lot of blogs and commetators I read have changed their posture in the last week), you can always somewhere, somehow find a factoid that says the stock market will go up. Bloomberg gives us the latest, namely, declining expected volatility in the equity options market.
Options traders are betting stock swings in the Standard & Poor’s 500 Index will decrease at the fastest rate since the aftermath of the market crash in 1987, a sign that equities may keep rallying.
The difference between the benchmark index’s historic volatility and a gauge of so-called implied volatility based on expected swings rose to the highest in 21 years, according to data compiled by Credit Suisse Group AG and Bloomberg. The gap widened as investors paid less to insure against price declines, sending the Chicago Board Options Exchange’s Three-Month Volatility Index lower.
Historical volatility must fall 25 percent to bring the measures into accord. The last time the difference was this wide, stocks climbed for two quarters, according to data compiled by Bloomberg. Declining volatility is usually bullish for equities because it shows growing investor confidence…
Stock swings increased as the collapse of Lehman Brothers Holdings Inc. in September and government actions to bail out banks heightened concern losses would worsen. The S&P 500’s three-month historic volatility has more than quadrupled since June to 62.97. That’s 15.62 points higher than the CBOE’s Three- Month Volatility Index, a measure of expected swings in the S&P 500. They were as much as 29.7 points apart in the past month.
Stocks rallied the last time the difference was this large, just after the S&P 500 plunged 20 percent on Oct. 19, 1987. The index climbed 4.8 percent in the first quarter of 1988 and 12.4 percent that year. The VXO, a predecessor of today’s benchmark volatility index, decreased 31.7 percent in the first quarter and tumbled by 53 percent in 1988, its biggest annual drop.
“The volatility regime is going to shift significantly in the first quarter,” said Stu Rosenthal, who helps oversee $4 billion in volatility strategies at Volaris Volatility Management, a unit of Credit Suisse in New York. “The options market is predicting that the equity market will calm down.”