October 10, 2014 / 6:45 PM / 5 years ago

Wall St Week Ahead-Investors gird for scarier days in markets

NEW YORK, Oct 10 (Reuters) - Volatility has returned to U.S. stocks in sudden fashion, and for the first time all year it doesn’t appear that the weakness in equities is going to go away quietly in the span of a few days.

The S&P 500 is only down 4 percent from its record high reached in mid-September. But it posted back-to-back intraday moves of more than 40 points this week for the first time in three years, and Wall Street’s fear gauge, the CBOE Volatility Index, hit its highest level since December 2012.

No single issue has driven the selling. Catalysts include concern about the Federal Reserve’s eventual cuts to stimulus, as well as worries about weak growth worldwide and its potential effect on U.S. earnings. The slide in oil prices has also served as a harbinger for poor demand, and investors in general got caught betting heavily on further market gains at a time when this stew boiled over.

The volatility recalls the last major period of big market gyrations in the second half of 2011, when the first-ever credit downgrade of the United States and the threat of a debt default kept investors on their toes for several months. It’s unclear whether the current turmoil will last as long, but that it hasn’t been eclipsed by buying does show elevated concern.

“What is interesting about what is going on is that you have several themes all feeding into the same action, and that action is to mitigate risk,” said Peter Kenny, chief market strategist of Clearpool Group in New York.

The market’s recent performance, at least before Friday ended, is emblematic of this risk aversion: The only S&P 500 sectors to gain since the market’s September 18 high are defensive - utilities and consumer staples. This week also saw the biggest weekly inflow on record to U.S. taxable bond funds, while nearly $7 billion left stock funds.

One sign that investors anticipate more volatility has been in the options market, where volumes have increased sharply. October daily options volume has averaged 21 million contracts a day, above the 17 million daily average for 2014.

In addition, the CBOE Volatility Index is trading higher than monthly VIX futures contracts between now and May 2015, a sign of worry about near-term ups and downs in the market.

“Just look at options volume versus stocks volume over the past three to six months,” said Tim Biggam, lead option strategist at online brokerage TradingBlock.

“Options volume has been nothing but growing and stock volume has been sort of petering out. A lot of the big players are pre-positioning with options.”

They may be getting in front of potential disappointments out of earnings season, which picks up next week. Growing worry over Europe and other overseas economies has money managers concerned companies will forecast weakness. Should U.S. results prove strong, however, the season may stem the recent selling.

“The earnings reports from the U.S. should help put a bottom in the market and lead to some regained strength. We think we remain in good shape,” said Jim McDonald, chief investment strategist at Chicago-based Northern Trust Asset Management, which has about $924 billion in assets.

The next two weeks bring a slew of results, including from S&P 500 companies with some of the highest levels of sales abroad, like chipmaker Intel.

A profit warning from Microchip Technology late Thursday has already put a negative spin on that industry’s outlook. It dragged down the Philadelphia SE Semiconductor index by more than 5 percent on Friday, even as the semiconductor industry is forecast to see profit growth of 25 percent in the third quarter.

Tech stocks, including semiconductors, are showing weakness when looking at S&P sector rotation trends. In fact, the market’s growth sectors - financials, industrials, tech and until recently, consumer discretionary shares - are either weakening or lagging the market outright. Sectors like utilities and staples are leading, a sign of investors remaining cautious. (Reporting by Caroline Valetkevitch, additional reporting by Saqib Ahmed, Chuck Mikolajczak and Rodrigo Campos; Editing by David Gaffen and Nick Zieminski)

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