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July 14, 2014

Summer love: US markets enjoy the weather so far
VIX, S&P 500 and Barclays High Yield Indexes: Jun 2009 – Jul 9, 2014

chart

Source: Bloomberg, as of 7/10/14. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

The Bottom Line:

  • It's been sunny skies for equity investors in recent months; overall volatility is at five year lows, with the VIX index at 12.59 (Jul 10); stock prices have hit new highs, with the S&P 500 trading above 1900 since late May. 
  • The mood has also been apparent in the high-yield (HY) bond market.  Low yields and tight spreads there are indicators of optimism about current economic conditions, reflecting the willingness of investors to lend to lower quality companies at low absolute rates – at terms that are tight relative to high quality Treasuries.
  • In other words, high-yield investors appear not to be very worried about companies' ability to meet their debt payments and to return investors' principal when the bonds mature.
  • Still this past week is a useful, if disconcerting reminder that downs (as well as ups) are part of a normal market.  The dip in stock prices, rise in bond yields and uptick in volatility was widely attributed to concern about the Federal Reserve raising interest rates sooner than previously expected, based in part on stronger US employment numbers released over the past two weeks.
  • Yet it's this type of pattern—pullbacks amid a general bullish trend, or short, sharp movements—that could be advantageous to active managers seeking to exploit pricing variations relative to their views on underlying value of specific securities.  

The Chart:

  • The chart shows the level of The Chicago Board Options Exchange (CBOE) Volatility Index (VIX), commonly called the VIX, the price level of the S&P 500 stock index and yield to worst of the Barclays US Corporate High Yield Bond Index from June 2009 – July 10, 2014.
  • A general rule of thumb implies that VIX values below 20 are typically reflective of a more complacent market, while levels above 30 indicate a relatively large amount of investor anxiety—for the first six months of 2014 the VIX averaged 14.
  • Note that since September 2011—the last time the VIX spiked notably—the S&P 500 has increased significantly with little in the way of notable pullbacks.
  • Over the last five years, below investment grade bond yields have declined from levels above 12% to a level below 5% for most of June 2014.

Context & Perspective:

  • The VIX reached a 2014 low of 10.32 on July 3, 2014 but jumped to 12.59 on July 10, 2014 as jitters about the Fed raising rates sooner than expected entered the market. From the end of the recession in June 2009 through the VIX price spike of September 2011, the VIX averaged 24; its average since that spike has been 17, but for the first six months of 2014 that average has only reached 14.
  • The S&P 500 set a new all-time closing high of 1985.44 on July 3, 2014 but declined to 1963.71 on July 8, 2014, again on jitters about interest rates.  The S&P 500 experienced two notable pullbacks: a 19.6% correction between 4/29/2011 and 10/3/2011 and a 9.8% pullback between 10/28/2011 and 11/25/2011. But since the end of November 2011, the S&P 500 hasn't experienced a decline in excess of 6%.
  • The yield to worst of the Barclays High Yield Index declined significantly, from 12.28% on 6/30/2009 to 4.83% on 6/20/2014; it had risen slightly to 5.06% by July 10th. But that decline was marked by some notable breaks. Between mid-May 2011 and early October 2011—roughly the same time that the stock market declined over 19%—the yield to worst of the Barclays High Yield Index increased by 354 basis points (bps). Two other notable but smaller corrections happened during the spring/summers of 2012 and 2013, when yields backed up by 119bps and 149bps, respectively.
  • At 5.06%, the current yield to worst of the Barclays High Yield Index is well below the average of 9.57% and median of 8.7% since 1/31/1994, the earliest data available. In addition, at the current option adjusted spread of 336bps is below the average of 585bps and median of 551bps since 1/31/1994. However, it's still above the tightest level of 233bps seen in 2007.
  • According to Standard & Poor's, the S&P 500 operating P/E was 17.7x at the end of June 2014 compared with 11.95x at the end of September 2011 – when volatility had spiked above 42 and the S&P 500 had retreated nearly 20%. The average quarterly operating P/E since December 1988 is 18.7x.
  • The most recent job figures generating the recent market lurch: The June US jobs report came in stronger than expected showing net new job creation of 288,000 for the month; the unemployment rate fell to 6.1%, which was the Fed's forecast for late in the year, rather than mid-year. With the minutes of the most recent Fed meeting stating that its bond-buying may likely end in October, market observers are taking the prospect of rates returning to more normal levels more seriously than before.

Definitions:

The price-to-earnings (P/E) ratio is a stock's price divided by its earnings per share

The Federal Reserve Board ("Fed") is responsible for the formulation of U.S. policies designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.

The CBOE Market Volatility Index was introduced in 1993 by the Chicago Board Options Exchange (CBOE) to measure the implied volatility of the U.S. equity market.  The index is calculated in real time using the Standard and Poor's 100 Index (OEX) options.  The index is calculated by taking a weighted average of the implied volatilities of eight OEX calls and puts having an average time to maturity of 30 days. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges.

The S&P 500 Index is an unmanaged index of common stock performance.

The Barclays High Yield Index covers the universe of fixed rate, non-investment grade debt, including corporate and non-corporate sectors. Pay-in-kind (PIK) bonds, Eurobonds, and debt issues from countries designated as emerging markets are excluded, but Canadian and global bonds (SEC registered) of issuers in non-emerging market countries are included. Original issue zero coupon bonds, step-up coupon structures, and 144-As are also included.

Yield to worst (YTW) is the lowest potential yield that can be received on a bond without the issuer actually defaulting.

A basis point (bps) is one one-hundredth of one percent (1/100% or 0.01%).

Option-Adjusted Spread (OAS) is a measure of risk that shows credit spreads with adjustments made to neutralize the impact of embedded options. A credit spread is the difference in yield between two different types of fixed income securities with similar maturities.


The opinions and views expressed herein, as well as references to individual companies or securities, are not intended to be relied upon as a prediction or forecast of actual future events or performance, or a guarantee of future results, or recommendations to buy, hold or sell, or investment advice.

Past performance is not a guarantee of future results.

All investments involve risk, including possible loss of principal.

Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges.

Common stocks generally provide an opportunity for more capital appreciation than fixed-income investments but are subject to greater market fluctuations.

Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls.

High yield bonds are subject to increased risk of default and greater volatility due to the lower credit quality of the issues.

Active Management does not ensure gains or protect against market declines.

Yields represent past performance and there is no guarantee they will continue to be paid.

Unless otherwise noted the "$" (dollar sign) represents U.S. dollars.

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