Will ECB Determine the Market's Next Move?

Will Draghi take investors to Wally World -- or on an endless roundabout past Big Ben and Parliament?

Jan 21, 2015 at 9:18 AM
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Well, we never quite got "officially" overbought on this particular VIX-go-round. CBOE Volatility Index (VIX) peak-closed at 22.39 (so far) on Jan. 15, about 14% above its 10-day simple moving average (SMA). And then on Friday, VIX grudgingly declined late in the day in the face of a sizable market rally and a long weekend ahead.

What's interesting about that action is that even with the decline, VIX clearly had some weekend worries on its mind … or rather, traders that buy and sell actual S&P 500 Index (SPX) options had some worries. A 1% pop in stocks coupled with a long weekend could send options tanking … but not when oil continues to crash, the Swiss franc soars, and general instability rules.

On a normal long weekend, traders and investors fear paying extra for weekend decay. But now, traders and investors fear extra time between regular sessions means extra time for another bad story to hit from somewhere. As well they should, as we've had three months of that. We could make a strong case that we've had a full calendar year's worth of "bad" stories, albeit with long stretches where the market ignores (or discounts) the news.

That's a long-winded way of explaining Tuesday's seemingly odd volatility action. Stocks were volatile and mostly down, while VIX acted heavy. Normally, volatility has an appearance of strength on a Monday, and especially on a Tuesday following a long weekend. But when you go into a weekend with fear of news, there's a built-in "relief" when nothing disastrous came out. It seems like "down 0.5%" is the new "up."

I really doubt volatility goes down much at all over the next couple days, at least until the ECB speaks:

"WHEN the European Central Bank's (ECB) governing council meets on January 22nd, it will take a historic decision. Among the main central banks, the ECB alone has abstained from a big programme of quantitative easing involving the creation of money to buy sovereign bonds with the aim of spurring growth and inflation. The economic case for QE in the euro area is overwhelming: the feeble economic recovery that has followed Europe's double-dip recession is faltering; headline inflation has turned negative and longer-term inflation expectations have also declined to a worrying extent. Mario Draghi, the ECB's president, seems determined to adopt QE in some form, but he will have to compromise on the way that the risks are shared among the euro-zone national central banks in order to get the policy through."

What could possibly go wrong? No way the market gets disappointed that QE-Europe is a weak sequel to our own QE-America! The same way "European Vacation" paled next to "Vacation". Bernanke got us to the Wally World of economic recoveries; can Draghi do the same?

And yes, I have a degree in economics and that's the best analogy I can come up with.

But seriously, if this volatility cycle ends -- or at least cools -- it's not likely because of anything the ECB might say. Likewise, if we start tanking, I won't blame them either. There's little doubt we have a backdrop set for either a short squeeze or a bigger shakeout. And if it happens this week, we'll either blame or credit the ECB. But it feels more likely it's something that might happen very soon anyway.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.


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