Volatility Is the Only Constant

A spike in fear and a break of the S&P 500's 200-day moving average are met with strong dip-buying.
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The only sure thing in the stock market Wednesday was volatility.

The CBOE Market Volatility Index, or VIX, spiked to a four-year high intraday Wednesday at 26.21, and the

S&P 500

briefly traded below its 200-day moving average of 1449.79.

But the so-called fear index fell from its highs to end up 1% at 23.75. Major averages rebounded from steep intraday losses, as the bulls resumed their "buy-the-dip" mentality, particularly in the last hour of trading.

The S&P 500 bounced against its 200-day moving average, and ended the day up 0.75% to close at 1465.81. The

Dow Jones Industrial Average

closed up 150 points after being down as much as 79 intraday, finishing up 1.15% at 13,362.37. The

Nasdaq Composite

closed up 0.3% at 2553.87.

The early weakness followed news of troubles at another

Bear Stearns


hedge fund that's

suffered from bets in the mortgage market; there were also reports of margin calls from prime brokers causing some liquidation selling at other funds,

including Caxton Associates.

The credit market jitters prompted some to wonder how many Citadel Investment Groups are really out there able to come to the rescue and buy up much of this stressed, if not distressed, debt.

All the angst over the financials and mortgage markets was reflected in Market Vane's bullish consensus, which reached 54% for the week ended July 31, its second-lowest reading since 2003.

Stocks ended on a strong note, led by big-caps such as


(T) - Get Report


Exxon Mobil

(XOM) - Get Report



(MRK) - Get Report

. Perhaps traders were drawn to those most-liquid names as they search for a balance between the draining of liquidity amid a global repricing of risk, and a relatively resilient U.S. economy.

"There is uncertainty because of all the volatility, which makes people think some kind of financial event is more likely, and then there's the question of how much of it has to do with hedge funds," says Bill Nichols, a trader at Bear Stearns. "There are thousands of hedge funds ... it's the search for equilibrium."

In the credit markets, a modest rebound smoothed over a volatile session. The high-yield bond market rebounded in the last hour of trading along with the stock market, sending risk premiums lower by about 50 basis points, but there were signs of trouble midday, just after the giant volatility spike by the CBOE Volatility Index.

One high-yield bond fund manager reported that between the hours of 10 a.m. and 2 p.m., none of the brokerage firms were pushing out quotes for the high-yield derivative index, the CDX HY8. Typically he gets at least three per minute.

To this manager, the radio silence meant that Wall Street was under excessive risk-management control, perhaps as some rumor or fund sorted itself out. When quotes started to refill his inbox, there was no obvious price dislocation. It just started back up, he says, noting that quotes resumed after news came out about Caxton.

Embodying some of the day's confusion over what is liquidation selling and what is based on fundamentals was the sell-the-news reaction to a relatively strong earnings report out of


(MA) - Get Report

. The stock dropped more than 10% in early morning trading, and ended the day down 6.7% despite its strong quarter.

"Hedge fund liquidations would contribute to part of the declines in the stock market," says Justin Walters, co-founder of Bespoke Investment Group, when asked about outsized drops like MasterCard's or


(AAPL) - Get Report

prior to today's rebound. He had no specific knowledge of why MasterCard in particular dropped like a stone.

The sell-the-news phenomenon isn't new, says Walters. According to his research, the one-day price change of companies following their earnings report thus far this quarter reveals that "earnings beats" have not been rewarded. The companies that have been rewarded are typically smaller, with lower weightings in the S&P 500; Wednesday's examples include

Devon Energy

(DVP) - Get Report





"Sometimes you sell what you can and not what you should," says a hedge fund manager, speaking on the condition of anonymity.

Walters believes this is where the market may highlight some opportunities. "Stocks that are down, but reported great earnings with positive guidance ... those are the opportunity," he says.

Earnings thus far are weaker than in the first quarter, putting in 6.5% growth year over year with 366 companies in the S&P 500 reported, according to Thomson Financial. So far, 66% of companies have beat estimates, which is mostly on par with the past eight quarters in which an average of 68% of companies beat expectations. Thomson predicts earnings growth for the quarter winds up at 7%, down from 8% in the first quarter.

In keeping with TSC's editorial policy, Rappaport doesn't own or short individual stocks. She also doesn't invest in hedge funds or other private investment partnerships. She appreciates your feedback. Click


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