MorningWord 8/16/13: It seemed just a month or 2 ago when the Fed floated the taper trial ballon that maybe just maybe the uptick in economic data and the hope for a pick up in second half corporate earnings would support the Fed’s intent to ease the easing. Yesterday’s price action in the stock and bond markets was the exact sort of action one would expect if the Fed were to be pulling back in the bond buying in a month, yields up (10 yr Treasury yield closed at new 2 yr high) and stocks down (worst day for SPX in nearly 2 months), similar to what we saw in June, but at that time the U.S. corporate earnings outlook for the second half of 2013 was a tad more optimistic.
There were two very obvious takeaways from yesterday’s nearly 1.5% decline in the SPX . First, a clear rotation out of some prior winners, BA, DIS, F, GOOG, HD & JNJ, all broke or very nearly broke important near term technical resistance (50 day moving avg). Second, and probably more important, was the fact that CSCO and WMT, two of the largest companies in the world, were down 7% and 2.6% respectively, as they both guided the 2nd half of the year below consensus and their prior guidance. Yesterday in this space I wrote about the curious case of retail earnings (U.S. Consumer Taking A Breather, Was iPad Miss the “Tell”? –here), so to many traders, WMT’s caution as it relates to the U.S. consumer at this stage of the earnings cycle should not be a huge surprise. But CSCO, who has for the last couple quarters spoken to a more stable enterprise and carrier spending environment, seemed to hint of a speed bump as the stock was making fresh multi-year highs. But again, this late in the Q2 earnings cycle, weak enterprise spending after disappointing outlooks from ACN, IBM & ORCL in the last 2 months should not have been a huge surprise to most investors.
SO I guess the point is, on yesterday’s close, If I knew nothing of earnings disappointments and weak guidance from 2 mega-caps, and I saw the 10 yr yield spiking and stocks getting drilled with the idea that the Fed was going to begin tapering its Bond purchases next month, I would have said that it makes perfect sense. But the recent commentary from the Federal Reserve has been more mixed with regards to the taper, so certainly no done deal on that yet.
But you get my point – the outlook for what the Fed will or will not do at their September meeting is as clear as mud, but one thing I am willing to bet on is that implied volatility has been and could remain far too low. We are keeping a close eye on our VIX Aug 15/20/25 Call Fly as it expires on Wednesday morning, but this trade could be very much in play with the VIX approaching 15 on yesterday’s close. Enis discussed in this morning’s Macro Wrap the nuance of pricing implied volatility based on this year’s price action. While it has not paid to own options for much of 2013, the risk/reward at current prices likely favors options buyers rather than sellers.