Why Stock Market Volatility Is Creeping Higher

This week, stocks slipped into the red for the year. Is a repeat of the sell-off from earlier this year coming?

Senior ETF Analyst
Reviewed by: Sumit Roy
Edited by: Sumit Roy
Volatility is creeping higher. After two months of steady upward moves, the stock market hit a bump in the road in May. After Thursday's slide, the S&P 500 was back in the red for 2016.

To be sure, the market isn't anywhere near where it was earlier this year, when fear and panic sent stocks plunging precipitously. At the time, certain measures of investor sentiment reached record lows, and the S&P 500 (SPDR S&P 500 ETF Trust (SPY | A-97) had its worst start to the year since the Great Depression.

In January, the S&P 500 was down as much as 11.3% on the year, and the CBOE Volatility Index was north of 32.

Currently, the stock index is only down fractionally year-to-date, while the VIX is around 17—nowhere near panic levels, but up notably from 12.5 a month ago.

Year-To-Date Change In S&P 500

The Worry: Fed Rate Hikes

It's clear to see that the market is struggling this month after the swift rebound in March and April. On the positive side, crude oil and junk bonds aren't the problems they were in January and February.

Likewise, China has been out of the headlines, as the country’s economic and currency issues remain dormant for now.

On the other hand, the Fed is back in focus. Minutes from the Fed's last meeting released this week indicated more willingness on the part of Janet Yellen and company to raise rates. In turn, the probability of a rate hike this year based on Fed funds futures spiked significantly.

Traders now see a 28% chance that the Fed will increase rates in June, up from nearly zero last week. Moreover, there's now almost a 50% chance the Fed hikes rates by the July meeting, according to the futures market.

No Earnings Growth

Perhaps it was just a coincidence, but the fact that the stock market plunged shortly after the first Fed rate hike back in December is surely raising some concerns among investors that a second hike may lead to more selling.

That's especially the case when investors don't have earnings growth to hang their hats on. Corporate profits have declined on a year-over-year basis for four-consecutive quarters. Even excluding the energy sector, earnings have stalled, with no growth seen in the first quarter.

Market Peak’s 1-Year Anniversary

The lack of earnings growth may be the main reason that, despite many ups and downs, the S&P 500 hasn't gone anywhere during the past year.

In fact, today marks the one-year anniversary of when the S&P 500 hit its all-time intraday peak around 2,135. There have been two major corrections and two big rebounds since then, but a look at the charts reveals a flat, range-bound market.

S&P 500 (2015 to present)

Worse, the small-cap Russell 2000 (iShares Russell 2000 ETF (IWM | A-91)) is in a downtrend. As can be seen from the chart below, the index has put in lower highs and lower lows since the peak of last year.

Russell 2000 (2015 to present)

Based on the latest close, the Russell 2000 is trading in the same place it was back in 2013.

Catalysts To Drive Market

It's anyone's guess if stocks are set for yet another leg lower or whether they'll finally break out of their funk and hit new highs.

Renewed earnings growth would be the most obvious catalyst for an upside push. That's not easy to come by, given the tight labor market and margin pressure corporations are facing, but it's a necessity for the bull market to continue.

As for the downside, it doesn't take much to spook investors, as we've seen since last August. A correction in the 10% range can be ignited by any number of headline-grabbing catalysts that spark a sudden shift in sentiment.

But a bigger, 20%-plus bear market in the S&P 500 would take a much larger scare or even a recession (the last 20% sell-off came in 2011 during the eurozone crisis).

Contact Sumit Roy at [email protected].

Sumit Roy is the senior ETF analyst for etf.com, where he has worked for 13 years. He creates a variety of content for the platform, including news articles, analysis pieces, videos and podcasts.

Before joining etf.com, Sumit was the managing editor and commodities analyst for Hard Assets Investor. In those roles, he was responsible for most of the operations of HAI, a website dedicated to education about commodities investing.

Though he still closely follows the commodities beat, Sumit covers a much broader assortment of topics for etf.com, with a particular focus on stock and bond exchange-traded funds.

He is the host of etf.com’s Talk ETFs, a popular video series that features weekly interviews with thought leaders in the ETF industry. Sumit is also co-host of Exchange Traded Fridays, etf.com’s weekly podcast series.

He lives in the San Francisco Bay Area, where he enjoys climbing the city’s steep hills, playing chess and snowboarding in Lake Tahoe.