If it is true that bullish markets are less volatile than bearish or sideways markets, then it is worth considering whether the unusually low volatility in the market indexes over the past week is a forecast of a continued upward trend in U.S stock markets. If so, then the fact that this low volatility has occurred as the S&P 500 index (SPX) reached new historic highs is not coincidental.
The chart below reviews a weekly look at State Street's SPDR S&P 500 Index tracking ETF (SPY). Shown below the price chart is a study that tracks a 10-week average true range. This version of the study is measured as a percentage of the current price of SPY. The study shows that the difference between the high and the low prices in the past week was unusually narrow, so much so that only a handful of weeks in the past two years traded in such a tight range.
In 2017, this range was actually fairly common, though still on the lower half of trading ranges. That was the last significantly bullish year for the index. Coming now one week after the market broke into new high territory, it may be that this is an indication of a low-volatility upward trend. This kind of trend is similar to earlier years in this decade, and if such a trend were beginning to take shape right now, investors would be wise to consider whether it could last into 2020.
Trading Range on the 10-Year Treasury Note Is Troubling
One interesting indication that could actually help to push stock market indexes higher might simply be a flight out of bond funds fueled by rising interest rates. Interest rates (or yields) are inversely correlated with bond prices. So if interest rates are going to rise, the bond prices are going to fall. This is bad news for those who have their money in fixed-income funds that track bond prices such as iShares 20+ Year Treasury Bond ETF (TLT).
On the other hand, it is good news for the stock market in general, since money coming out of bond funds will look for a place to go. Typically, investors moving their money out of bonds are likely to move their money to stocks as an alternative. Such a dynamic taking place through the end of the year could fuel another stock market rally.
The chart below shows why this dynamic could play out. The level of volatility in interest rate changes over the past three months, as tracked by the average true range on the 10-year Treasury Note (TNX), is consistent with times in the past several years where interest rates have risen for the following year.
Auto Parts Manufacturers Should Be Wary
A small company in the auto parts manufacturers industry group reported disappointing earnings today as its stock dropped by over 40%. Shares of Modine Manufacturing Company (MOD) fell as the company announced its sales for HVAC-related products were disappointing and would likely influence company results for the next quarter.
Perhaps this is an isolated event in this industry; however, the chart below depicts the fact that price action for Modine shares were highly correlated to the movements of a portfolio of the top five stocks in this industry group. These stocks include Johnson Controls International plc (JCI), BorgWarner Inc. (BWA), LKQ Corporation (LKQ), Aptiv PLC (APTV), and Lear Corporation (LEA). The important question for these companies, not to mention their investors, to consider is whether today's results are an indication of a larger trend at play among consumers.
The Bottom Line
Stocks closed the week with a very tight range, so tight that it is in the lowest 5% of such results for the past two years. The lower volatility may be a bullish indication. Volatility patterns on TNX may also corroborate this idea, as it forecasts reduced bond prices, which could drive investors out of bonds and into stocks. Meanwhile, increased volatility among one of the smaller companies in the auto parts industry could signal trouble ahead for the rest of the group.
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