Market Drivers: Volatility, Possible Inflation, Housing Slowdown

English: The Dettifoss in Iceland on 31 Jul 19...

English: The Dettifoss in Iceland on 31 Jul 1972. Picture taken and uploaded by Roger McLassus. (Photo credit: Wikipedia)

After spiking to new highs earlier in this holiday shortened week, it appears that “the rally of 2013” may be slowing down. For the time being, fear over the health of the financial recovery, as well as concern surrounding next week’s sequester cuts have kept the DJIA from reaching a new all-time high. Here are three drivers that have moved the market this week:

Volatility

Or should we say lack of volatility? The CBOE Volatility Index (VIX) is a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices. It is also known as the “fear gauge” of the market.  In general the VIX is inversely correlated to market performance. In plain  English, when the market goes up, the VIX goes down, and vice versa. How does this apply to current conditions? Currently markets are running to long-term highs while the VIX (until Wednesday) had been in the 12-13 range, well below the measure’s long term average of 20.1.  In fact, it has not closed above 13 yet in 2013. Looking at the numbers, it appears that traders and investors are shrugging off the prospect of sequestration (more about the sequester here) looming in a few weeks and planning on a continued bull market for the near term. It is worth keeping in mind, that the VIX is a short term indicator with a one month horizon. However, following Wednesday’s FOMC minutes the VIX spiked to 14.68, an indication that we may be headed back to “normal” volatility levels.

FOMC Minutes

On Wednesday, markets sold off following the release of the minutes from the Federal Open Market Committee January 29-30 meeting. The debate surrounding the policy of quantitative easing within the Fed is heating up. Many are concerned that about the cost/benefit of additional bond purchases, and possible complications that additional purchases could cause for the eventual withdrawal of policy accommodation (such as inflationary risks). The prospect of decreasing liquidity in the financial markets caused an immediate downturn as the DJIA dropped over 100 pts. by the end of the session. The selling spread overseas as well as there is a hint of fear that the 2013 rally is coming to a halt.

Housing Market

On Wednesday, the Commerce Department reported U.S. housing starts fell 8.5% in January to 890,000, significantly missing the expected 3.1% drop.  Also on Tuesday,  the National Association of Home Builders said U.S. homebuilder confidence declined slightly in February to 46 from 47.  While the numbers are softer than expected, David Crowe, chief economist of the National Association of Home Builders, points out that,  “given the strength [home builder confidence] showed during all of 2012,  I think this is it just simply taking a breath.” He also says “many of the uncertainties we’re beginning to see in the fiscal field and federal government have given people the chance to say "perhaps lets hold on for a month of two and see how all of that works out’ before they all move forward with their plans." Also, housing starts during the winter months can be swayed by weather patterns (a winter storm for example could disrupt construction) so it is better to look at a several month average versus making a snap judgment on one month’s numbers.

Talk about “renewable energy.” Krafla, Iceland is home to the world’s largest geothermal power station. However the plant has a rather unique issue, it actually produces a surplus of energy. The facility is now faced with the challenge of what to do with it. A potential solution would be to run a giant “extension cord” to connect the plant to a large customer base in the European Union. This would also serve as a conduit to import energy in the event of a crisis. As with all projects though, there are critics. Local resident Ms. Einarsdottir said, Iceland should use its energy sources to “supply ourselves and coming generations” and not gamble with Iceland’s unique heritage by “building more and more plants so that we can provide electricity to towns in Scotland.”