Mid-summer is supposed to be a boring time for markets. Maybe that will be the case during August, but first, the markets need to run a gauntlet of news this week. Between fiscal negotiations, a Fed meeting, key economic releases, and about 1/3 of the NASDAQ 100 (NDX) releasing earnings nearly simultaneously, investors will have a plethora of data to process. These events could provide catalysts for market volatility this week.
Today is likely to be the calmest of the bunch, as markets await Senate Republicans’ proposal for the next round of fiscal stimulus. Several weeks ago, the Democratic controlled House of Representatives passed a package of roughly $3 trillion, but the Republican controlled Senate has not been able to coordinate a response. The White House and Senate had differing priorities, which were said to be ironed out last week, but differing priorities among the Republican Senate caucus have delayed their bill from mid-last-week to late last-week to a promised late this afternoon. Equity markets are banking upon another round of fiscal stimulus to maintain the economic health of millions of Americans, along with businesses, states and municipalities that are major employers. The last round of fiscal stimulus largely expired this week, and with the two sides reported to be about $2 trillion apart, much will depend upon how the two sides can reconcile their differences. If the Senate proposal is released today (or not), its effects on markets could be felt on Tuesday.
The Federal Reserve begins a two-day meeting tomorrow, with its results to be released on Wednesday afternoon. Few expect a major change in Fed policy. It is hard to imagine them moving off their near zero Fed Funds target or making any comments that reduce their commitment to remaining vigilant – especially with fiscal stimulus on the horizon – but investors will turn to Chairman Powell’s press conference for clues about the central bank’s thinking on the nation’s economic outlook. Remember that the June 10th press conference was viewed as downbeat, followed by nearly 6% drop in the S&P 500 (SPX) on the subsequent day. Markets rallied after the press conference on April 29th, only to give back the gains and more in the subsequent two sessions. On Thursday, markets will likely be pricing in their reaction to the Fed press conference while reckoning with a pre-market release of second quarter GDP. Estimates are for a drop of 35% (no, that is not a typo). Many economic releases have exceeded dire consensus forecasts, and we will see if markets are quietly anticipating a similar beat.
Wednesday also brings us the political spectacle of a quartet of key tech executives from Apple (AAPL), Amazon (AMZN), Alphabet (GOOG, GOOGL) and Facebook (FB) testifying before the House Judiciary Committee and the Antitrust Subcommittee. The tone of the inquiry could be an important clue to the type of regulatory environment that these companies could face in the coming years. The questioning will be led by House Democrats, and it will be interesting to see whether they take a hostile tone. Since there is currently a likelihood that the Executive branch will change parties, and a possibility that the Senate could change as well, a rocky regulatory path could be facing these market leading companies in 2021 and beyond. In theory, their stock prices should be digesting a potential change in regulatory outlook. In practice, the market currently seems to view them as unassailable.
That same quartet of key companies will return to the news on Thursday afternoon, as all of them are now scheduled to report earnings after the close (FB moved its date to accommodate the hearing). Putting that afternoon into perspective, those stocks comprise about one-third of NDX and about 15% of SPX. I have stated publicly that companies that appear to be priced for perfection can easily disappoint investors after earnings. All these companies carry premium valuations. The valuation premium to the market is even more striking when we consider that their high weighting in SPX helps prop up the index’s valuation. The forward P/E’s of the companies, along with SPX for comparison, are:
We have recently seen similarly highly valued companies like Microsoft (MSFT), Netflix (NFLX) and Tesla (TSLA) plunge after releasing near or above consensus results, while Intel (INTC) was particularly punished for a disappointment. Anything less than stellar results from the quartet expected on Thursday afternoon could severely pressure NDX on Friday.
Taking all these events into consideration, it is not surprising that the CBOE Volatility Index (VIX) and the CBOE NDX Volatility Index (VXN) are trading at a premium to recent historical volatility, or that VXN exceeds VIX by over 20%. And while some might find it surprising that spot VIX is exceeded by its August futures, remember that VIX is a 30-day look-ahead. The market is telling us that they expect volatility to increase once the calendar turns to September and beyond. That said, volatility trades still have much to concern themselves with in July, even before the calendar turns to August.
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