Volatility Rules as Stocks Drop with Crude Oil

Volatility Rules as Stocks Drop with Crude Oil

Global stocks displayed a familiar habit of being led by the energy sector, which dropped nearly 1% as crude oil led metals and other commodities down and Deutsche Bank's woes affected bank stocks. 

Crude oil prices dropped to a one-month low on Friday, with West Texas Intermediate Crude Oil futures hitting a low of $43.35 and cash prices nearly falling below $43 a barrel, a level not seen since August 31. Energy sector stocks responded as expected, leading the S&P 500 to a 0.4 percent drop. For the week, the S&P and other US indices advanced modestly. 

Friday volume was up about 50 percent above average due to a quarterly event known as quadruple witching. Futures and options contracts expire on both indexes and individual stocks. As those contracts expire, many traders roll them over, exiting the expiring contract and taking a new position in a contract with more time left. 

Volatility tends to go up on witching days, as traders jockey for the best possible price on both their exits and new entries. Since there is volume in both buying and selling, markets often struggle to find any consensus direction. This Friday, crude oil appeared to influence that consensus by driving down energy stocks and pulling the market as a whole down with them. 

The financial sector also got jarred by a Department of Justice proposal to settle a civil claim against Deutsche Bank for $14 billion. The claim dates back to allegations of improper dealings in mortgage-backed securities leading up to the 2008 financial crisis. Deutsche Bank responded unequivocally that they will not pay the $14 billion. In a statement, the company said negotiations were "only just beginning" and that “Deutsche Bank has no intent to settle these potential civil claims anywhere near the number cited." 

Despite the show of bold defiance, Deutsche Bank AG's share price dropped the most since the Brexit vote and its riskiest bonds took a hit as well. Given the history of previous settlements by US banks, Deutsche Bank may be wise to play it cool. Goldman Sachs, for example, agreed to a $5.1 billion penalty and its subprime activity was more extensive. 

All of these events, not to mention the week's biggest economic news, from the Census Bureau, of a record increase in middle class income levels and large decreases in poverty across the US seem to be causing only minor shifts in the market's overall stance. Everyone appears to be waiting on the Fed, which will announce next week whether it will raise interest rates this month. 

The odds of a Fed hike, according to Bloomberg, are only 20 percent. That would make a December hike the more likely outcome. If that ends up happening, the market may see some dramatic movement in the coming weeks. Historically, elections tend to trigger rallies. And when Americans have more disposable income, as they do this year thanks to rising wages and decreased health insurance costs, the year-end Santa Claus rally tends to be magnified. 

There are no guarantees. Many analysts are predicting a crash or correction even as others are more sanguine. But few are predicting an end to the volatility which has become the new normal. Fewer still are expecting things to calm down in the next few weeks. 

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