Market Swings Accelerate

11/16/2009


Stock-market volatility has picked up since mid-October, with daily price movements of 100 points or more for the Dow Industrials becoming more common. The Forecasts still sees a need for investors to play some defense, which is why we continue to recommend holding about 25% of equity portfolios in Vanguard Short-Term Investment-Grade ($10.61; VFSTX), a relatively low-risk bond fund.

100-point days the norm

After reasonably calm trading from late July through mid-October, volatility has increased in recent weeks. Evidence of this higher volatility is the increase in daily price movements of 100 points or more.

Indeed, six of the last seven trading days in October saw daily price changes of at least 100 points. And the volatility continued in early November, with price changes of 100 points or more in three of the first six trading days.

Granted, recent market volatility does not match the huge price swings recorded in the first quarter of this year. Still, an uptick in volatility bears watching for two reasons. First, higher volatility is often associated with transitional periods in the market. Second, higher volatility spawns a “trader’s mentality” that is not necessarily conducive to sustained market advances.

In addition to volatility, investors should watch two other developments that could affect the market’s action:

Intermediate potential risk near record highs. The current percentage of stocks on the New York Stock Exchange trading above their 200-day moving average is 89%, just off the all-time high of 95%. History shows that extreme readings in this indicator often foreshadow market pullbacks.

Transports’ failure to close above Oct. 20 high of 4,045.11. While the Dow Industrials have continued to move higher, the Dow Transports have failed to push past their Oct. 20 high despite the boost provided by Berkshire Hathaway’s ($3,385; BRKb) announcement that it plans to acquire railroad Burlington Northern ($98; BNI). The longer the Transports fail to move above the Oct. 20 high, the more likely a reversal of the upward market trend.

Conclusion

The Dow Industrials have been impressively resilient, and the flood of money going into virtually every asset class — money driven, in part, by extremely low interest rates — could fuel further increases in the near term. However, the market exhibits some red flags, such as increasing volatility. Thus, investors should continue to hedge equity portfolios with a 25% position in a short-term bond fund.


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