Rebounding Stocks Remain Volatile

U.S. stocks surged back in an impressive rally today but have still left investors unnerved, as evidenced by elevated levels of volatility and the price of gold trading higher. While every stock in the Dow Jones Industrial Average closed higher today, so did the price of the SPDR Gold Shares (GLD), the ETF that tracks the price of gold, investors’ current favorite for hedging against falling stock prices.

One measure of stock market volatility used by professionals is the CBOE Volatility Index (VIX), which tracks changes in option prices on the S&P 500 index. The Volatility Index, and more particularly, the 30-day and 90-day forward-looking futures contracts tied to the VIX, will often show subtle changes in their price action that may precede important turning points in the market. 

Consider the two charts below. The first one shows how the VIX and the VIX futures indexes displayed subtle divergences right before prices peaked back in April and again most recently. It also shows that a certain kind of divergence occurs between the price and the VIX indicators. Because the VIX indicators should be inversely correlated with the S&P 500 (when stocks go up, they go down), then any time they move in sync it represents a divergence between what is happening and what investors expect should be happening.

The second chart shows that, the last time the market bottomed out, a clear pattern of lower highs in the VIX indexes was evident at the same time the market was making lower lows. The current environment has not yet established this pattern, suggesting that the market volatility may not be over yet.

Investors are showing a preference for hedging their portfolios by buying gold. Demand for the metal has been evident in its rising price since the summer began, and even a resurgent stock market could not dissuade buyers from driving prices to their highest close since 2013. 

Commodities are typically inflation sensitive, so a currency war between countries might be expected to affect commodity prices across the board. Yesterday, we pointed out that this is not how things are currently playing out. The price of gold, as tracked by GLD, has risen while the price of oil has tumbled. From this, we deduce that the price movement in gold is not a commodity-driven move, but a move inspired by the current fear of market participants. If stock market volatility continues, then prices may yet trend lower.

During the recent significant rumblings in the stock market, oil prices have declined rapidly, and stocks in oil-related industries have fared the worst. If volatility doesn’t go away and stocks continue to fall, energy stocks may have a hard time gaining ground.

For investors, it becomes useful to think in terms of what will benefit from a prolonged trend lower for oil prices. The answer is whatever starts to do well when the trend first manifests itself.

Consider this chart below, which compares the performance of several stocks since early April, when oil prices began their latest slide. Shares of Exxon Mobil Corporation (XOM) and FedEx Corporation (FDX) have seemed to follow oil lower. But three stocks that seemed to have lifted higher include United Parcel Service, Inc. (UPS), Delta Air Lines, Inc. (DAL), and Alaska Air Group, Inc. (ALK). It is notable that all three of these companies rely on the price of oil and oil energy to do their business. No surprise: if costs are down, profits are up. 

A rapid rebound for market averages may conceal the fact that investors, at least so far, are still nervous. Volatility is still high, and gold prices are trending higher. Investors looking to bargain shop might want to consider stocks that benefit from falling oil prices.

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