Brace yourself: Volatility in stocks expected to climb

It’s the consensus view of options analysts that day-to-day turbulence in the U.S. stock market will increase this year after falling since 2011. So far, nothing’s happened to prove them wrong.
Deutsche Bank AG became at least the third major bank telling equity derivatives clients to prepare for more frequent bouts of volatility as the bull market in the S&P 500 Index approaches its seventh year. Already, daily swings in the S&P 500 have widened more than 50% in the past month from last year’s average through Dec. 5, Bloomberg data show.
Stocks plunged Monday, with the S&P 500 dropping 1.8% to 2,020.58 and the Chicago Board Options Exchange Volatility Index increasing for the fifth time in six days. Declines spurred by tumbling oil and concerns Greece will exit the euro have sent American equities to the biggest decline to start a year since 2005, data compiled by Bloomberg show.
“This was a pretty ugly day and certainly not a good start,” Randy Frederick, managing director of trading and derivatives at Charles Schwab Corp., said. “The VIX spiked up quite a bit and that’s back to where we were in mid-December. There’s definitely some anxiety out there.”
Bank of America Corp. and JPMorgan Chase & Co. derivatives strategists predicted in December that daily volatility will increase for equities in 2015. Deutsche Bank made a similar prediction Monday, saying the end of Federal Reserve stimulus and intermittent panic about the rate of global growth will lead to more equity upheaval.
GLOBAL GROWTH
“Without Fed-induced liquidity, we’re not entirely sure how things will play out,” Pam Finelli, the New York-based head of equity derivatives and synthetic strategy at Deutsche Bank, said Monday. “While the U.S. economy is quite strong and data is quite good, we are reliant on global growth, and if it stalls this could contribute to higher volatility in the market.”
On Monday, the S&P 500 capped its first four-day stretch of losses in 13 months. The VIX, referred to as a fear gauge because it usually moves in the opposite direction of U.S. equities, surged 12% to 19.92, more than five points higher than its closing level Dec. 24.
A freefall in oil prices has exacerbated moves in U.S. stocks, as losses in energy companies have spread to the broader market. The S&P 500 has swung about 0.77% daily since Dec. 5, wider than the 0.51% fluctuations in 2014 up until that point. Crude has plunged 24% in that period.
OIL’S IMPACT
“This looks like a continuation of the worries about the impact of falling oil prices,” Bill Stone, chief investment strategist at PNC Wealth Management, said. He helps oversee $135 billion. “It’s a little bit of the global economic jitters. This is one of the things we thought we’d get more volatility from, the divergence between us and the rest of the globe.”
To Deutsche Bank strategists led by Ms. Finelli, VIX moves will widen as risk tolerance wanes among investors and the growing popularity in volatility-linked products intensifies swings.
The strategists expect moderately higher volatility on balance for 2015, with the VIX mostly remaining between 13 and 18 and readings above 30 possible at times. The VIX averaged 14.18 in 2014, down from 14.23 in 2013 and less than half the level in 2009, data compiled by Bloomberg show.
(More: Wall Street expecting bad year for bonds with Fed poised to raise interest rates)
The VIX at 30 “is a number we think we could see at some point this year,” Ms. Finelli said. “Do we stay at 30? Do we flirt with 30? We’re not sure, but the VIX spikes could be higher than what we’ve seen last year.”
The volatility gauge jumped above 20 in two episodes during the last three months of 2014, eclipsing 30 in intraday trading Oct. 15. In both cases, it erased more than half its gains within three days as stocks rallied toward fresh records.
These types of fluctuations in stocks, dubbed “storms in a teacup” by Bank of America strategists led by Benjamin Bowler, will continue into this year as market liquidity decreases under stress in equities, the team wrote in a Dec. 9 note. The same pattern of volatility shocks will continue as the Fed nears liftoff for increasing interest rates, according a Dec. 15 note from equity derivatives strategists at JPMorgan led by Marko Kolanovic.
While it may not be an easy ride, professional forecasters on Wall Street are unanimous in seeing U.S. equities gaining by the end of this year. None of the stocks strategists tracked by Bloomberg predicts a retreat in 2015, with the average estimate calling for an 8.5% advance.
They’re calling for a 174-point jump to 2,233 in the S&P 500 this year, according to the average estimate of 19 tracked by Bloomberg. It’s the first time strategists have been unanimously bullish since 2009, when stocks surged 23%.
NOT PANICKING
While the VIX has surged this year, it still isn’t at levels indicating market fear, according to Bruce Bittles at RW Baird & Co.
“I don’t think people are panicking,” Mr. Bittles, chief investment strategist at Milwaukee-based RW Baird, which oversees $110 billion, said. “Last year, we saw the VIX get above 30. I think it would take a lot more than a 20 reading to do that.”
Traders’ anticipation of more turbulence has sent a measure of demand for VIX options surging. The CBOE VVIX Index has jumped 32% since Dec. 26 to 121.87, 46% higher than its 12-month average. That gauge closed at 138.6 during the mid-December selloff, the highest in four years.
The two most-owned VIX contracts are expecting the volatility gauge to climb this month. Contracts expiring Jan. 21 betting on the VIX to increase to 20 have the highest ownership, followed by options wagering on a jump to 30 by that same day.
“I’m optimistic things will go well, but I think it’ll be a bumpy ride,” Randy Warren, who manages about $140 million at Exton, Pennsylvania-based Warren Financial Service & Associates Inc., said Monday. “People are going to be much more responsive to what’s going on in the environment, whether it’s economic numbers or the interest-rate situation or the Fed not doing QE any more.”