EC What Will Impact S&P 500 Trend In Early 2019

2018 could easily be characterized as the year that volatility came back into the market place due to Quantitative Tightening and geopolitical/macro concerns.  Asset prices reached record levels in 2017 and through much of 2018, but as the Fed ratcheted higher its rate hikes (4 rate hikes in FY18) the market became increasingly fearful that the FOMC would or had gone too far. When coupled with the lingering and looming affects of an ongoing trade feud between the United States and China, investors fled the equity markets in favor of perceived lower risk bonds and cash.

Volatility Comeback

Volatility (as gauged by the VIX) came back to the markets in a big way in 2018. ‪The VIX‪ was up 230% in 2018! That overstates the rally because when we consider the VIX for the full year, the mean VIX was up 42.7% on the year, from 11.09% in 2017 to 16.64% in 2018. (See table below)

This begs the question as to whether or not we have entered a longer-term volatility regime having a higher median, annual average. This doesn’t necessarily insist that 2019’s mean VIX reading will be greater than that of 2018, but greater than that of 2017 is highly probable.

In the first completed week of New Year trading (FY19), the market has already expressed a high degree of market volatility. “But volatility got crushed in the first week guys?” Yes, the VIX is down substantially from its peak of 36 just a couple of weeks ago and was down some 16% on Friday alone. Having said that, historic volatility (HV), otherwise known as realized market volatility, is much higher than the VIX is giving credit.

Whether we look at HV10, HV20 or HV30, all three historic volatility levels are higher than that of the VIX at present and going into the coming trading week ahead. This demonstrates how large and how violent the market moves have been in the last few trading weeks and just last week alone.

S&P 500 Outlook

The S&P 500 had two consecutive daily moves last week of greater than 2.4%, with Friday finding the S&P 500 closing out the week with a move of nearly 3.5 percent. While a move to the upside and for the whole of the trading week is a welcome sight for investors, the realized market volatility demonstrates the underlying ails of the market. What we have seen of late in the “rip your face off market rallies” is the exact defining characteristics of a bear market or at least an unhealthy market. What investors would rather experience are healthy daily moves of less than 1 percent. The VIX would have to retrench to 16 before such daily moves are found.

Last week’s S&P 500 weekly expected move was $84. We had extreme market moves on at least 2 trading days and in opposite directions, but we still managed to end the trading week within the weekly expected move and up roughly 1% year-to-date.

For this week's trading to come, and on the heels of a volatility crush last Friday, the S&P 500 weekly expected move has greatly declined from the $84 level last week to just $60.

As implied volatility moves lower or higher, the weekly expected moves generally perform in a synchronized fashion.

Given the reasons behind the technical breakdown of the market in 2018 and the belief it resulted as a disconnect from the fundamental economy, I believe there is a reasonable probability for the market to finish higher than where it ended for 2018. The highly misleading saying that "the stock market is not the economy" is true on a day-to-day or even month-to-month basis, but over time these two move together. When they diverge, it is normally a function of emotion, whether measured in valuation premiums/discounts or sentiment extremes.

Economic Data Remains Strong

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