Archives

All posts by Simon Maughan

“Because as any coup-launcher or Fed-fighter or volatility-embracer knows, if you’re wrong on timing … you’re just wrong” – Ben Hunt, Epsilon Theory July 26, 2016

The number of short bets on sterling through the futures market is at a multi-year high ahead of next week’s expected cut in interest rates in the UK. While these may be the speculations of the same hedge funds that lost money on the UK referendum, there is a strong consensus that the pound is headed lower. As recent events have shown, this is putting UK companies in the shop window, but can OTAS provide a way of figuring out who is next to be taken over?

There have been strong suspicions and some academic research suggesting option market activity pre-empts M&A announcements. What the research cannot determine is whether trading was due to inside information or informed opinion. Typically it is out-of-the-money call option activity that is more informative than at-the-money or put options.

Before we look at the evidence from OTAS, will the Bank of England cut rates next week? This is a different discussion to whether it should. Jeremy Warner argues in the Telegraph that the sledgehammer-to-crack-a-nut response to a knee jerk, post Brexit survey of disappointed corporate Remainers is not the right way to run an economy. He points out that the acquisition of ARM Holdings funds the current account deficit for three months. Speculators may not be “fighting the Fed”, but they are battling investment flows.

The post referendum narrative is that the economically disadvantaged swung the result and new Prime Minister Theresa May has aimed her pitch squarely at where she believes this constituency lies. Politicians still fail to appreciate that many of those who feel left behind are middle class savers whose retirement plans are decimated by central bank group-think. Unfortunately, the prospects for this small-c conservative demographic are very poor, as explained by Ben Hunt in his latest Epsilon Theory.

If Ben is right and that nothing will stop the central banks from flooding markets with cash, as Brexit, data dependence and such-like are just excuses for more of the only thing the authorities want to do, then stocks should rise and the pound fall. Typically bull markets take place over longer periods than bear markets, and are associated with lower implied volatility as the direction of travel becomes more certain.

UK Large Cap Implied Volatility

UK Large Cap Implied Volatility

Implied volatility for UK large cap stocks is back in the average range of the past two years, but five points above the stable state of the first half of 2015 that saw UK stocks rising steadily. The two recent peaks reflect Brexit worries immediately before and after the referendum. The one before, which was a bigger shock regardless of what the media may tell you, was the global recession fears of February, now long forgotten in large part thanks to desperate/determined[1] action by the ECB.

The US market appears to be leading the UK, which is worth bearing in mind as the Brexit furore subsides and the Trump-panic-hype really takes off.

US Large Cap Implied Volatility

US Large Cap Implied Volatility

M&A activity may mean stock specific rises in implied volatility. OTAS shows that among UK large caps only BHP Billiton has seen such a rise over a month, while Anglo American and GlaxoSmithKline have risen over a week. This is based on at-the-money options, but OTAS users with desktop access may dig deeper to see at what level recent trading has taken place. The bulk of the activity for Anglo American, for example, has been out-of-the-money puts (no take-over expected here).

AAL 1-Week Exchange Traded Option Activity

AAL 1-Week Exchange Traded Option Activity

The chart for ARM Holdings shows that the take-over by Softbank was a surprise. The subsequent sharp fall in implied volatility reflects a done deal at a fixed price, while any continuing option activity is by arbitrage specialists using leverage to magnify small price movements.

ARM Holdings Implied Volatility

ARM Holdings Implied Volatility

There is much more to the option market than M&A. Specialist take-over investors will have lists of potential acquirers and targets and stay on top of many more factors than market signals. For the part-time speculator it is worth creating your own list of sectors and stocks that you believe could be vulnerable to approach were the pound to fall further. Putting these in a portfolio in OTAS will allow easy filtering for unusual activity, whether that is in the options market, dealings by directors, or idiosyncratic price performance.

For those interested in potential acquirers, checking the CDS of the companies may be a means of investigating which managements are planning leveraged take-overs. There are, however, other reasons why credit costs can jump, such as a shortage of cash from operations. For this reason, while OTAS provides an initial view on the world of potential M&A that goes further than press speculation, it is only suggesting stocks on which the user will need to do additional research.

Right now there is little unusual option market activity among UK large cap stocks. This may be because, as the quote at the top of the blog indicates, timing is everything. Or it may be because so few people seem to have been able to contemplate that the UK would have a corporate future outside the EU, any M&A activity comes as a complete surprise.

[1] Delete as per your preferred narrative

As UK stocks refuse to collapse, some Remain supporters highlight the drop in bank shares as evidence of the self-inflicted wounds of the referendum. A quick look at OTAS shows that the reality is different.

RBS

RBS Share Price and 12 Months’ Forward EPS Estimate

Earnings expectations for RBS, in blue above, have fallen 7% in the past week, but have also reduced steadily since November 2014. The rate of decline accelerated from November 2015 and the recent drop is not the steepest downgrade of the past year. What did happen, however, was that the stock price diverged from trend earnings from early May and it is the reversal of this move causing the recent, sharp fall in the share price.

There was no reason based on the likely result of the referendum for the RBS share price to rally while its earnings fell. At the very best the status quo was on offer, which suggests that there was a degree of irrational exuberance ahead of the vote. Equally, if the share price was to fall far below the trend of earnings, this would imply that the EU was a source of strong growth for RBS, which we have not heard even the heartiest Remainer claim.

The situation is very similar for Barclays, although the negative EPS Momentum and share price moves are not as marked. To put the referendum reaction in context, the long-term chart of Barclays’ share price and 12 months’ forward earnings expectations is shown below. NAD refers to New Annual Data and marks the date of publication of the annual accounts.

Barclays Share Price & 12 Months' Forward EPS Estimate

Barclays Share Price & 12 Months’ Forward EPS Estimate

Earnings expectations for Barclays have fallen sharply from the beginning of the year and it is hard to discern any meaningful Brexit impact. Over the long-term the share price tracks earnings momentum rather well. (If you want to know the discount for government ownership of a bank, check out the same chart for RBS using OTAS.)

Uncertainty is the bug-bear of market participants and implied volatility for UK banks has jumped to exceptional levels, on a two-year view. The uncertainty is a result of the referendum vote, but one read of the Bank of England’s Financial Stability Report is that Brexit has exposed significant fault lines through the UK economy that were already there. Further interest rate cuts and monetary measures to suppress volatility are the only game in town as far as the Bank is concerned, but this will continue to damage commercial banks’ earnings prospects as has been the case for many months.

One unknown for UK banking is whether non-EU banks will retain passport rights to operate on the mainland. If not, then some very senior US bankers will be looking for a new home on the continent, which is not a prospect that particularly appeals. Expect passporting to be the post referendum hot topic, much to the bemusement of the majority of voters.

Goldman Sachs has an important passport bank that is currently based in the UK. This, however, is not the primary determinant of the group’s earnings outlook. The chart below shows that exuberance for Goldman Sachs shares occurred about a month before the rally in UK banks, but that share price and EPS estimates were converging from early May. Once again, earnings momentum is the best indicator of long-term share price.

Goldman Sachs Share Price & 12 Months' Forward EPS Estimates

Goldman Sachs Share Price & 12 Months’ Forward EPS Estimate

Brexit is a great excuse for managements who need to impart bad news about earnings. Banks in particular sense rare media support for their plight, even though earnings have been falling for months and share prices were out-of-kilter with forecasts before the referendum. Whether Brexit, or over-leverage and a clampdown on tax inversion has slain the M&A golden goose, the best game in town for investment banks has ended. Throw into the mix that senior bankers may be leaving London and you have a number of upset people.

We are not singling out Goldman Sachs, other than in our title, which will most likely be one of the industry winners whatever the outcome. For all passport banks there is talk that Paris is not a likely destination because of the Establishment’s dim view of banking, Frankfurt a little dull and Dublin lacking infrastructure. All of a sudden Madrid emerges as one of the most liveable EU cities for jet-set financiers. There remain only the minor issues of where to buy a latte prior to market open and getting an answer for the East Coast before tomorrow.

The rapid rebound in stock markets since the UK’s vote for Brexit is witness to two things. The option market, which is easily and effectively tracked using OTAS, expected little disruption through the vote and this is what has happened. Equally, investors anticipate another injection of liquidity from central banks to prop up asset prices, as the likely reaction to further shocks and as we discussed in April.

The debate about the efficacy of further central bank support was well underway before the UK referendum, as the protagonists knew the result was unlikely to change their opinions. A summary of the arguments is provided here, courtesy of Evergreen Gavekal’s weekly newsletter. At a time when the machinations of party politics are dominating the UK headlines and there is great gnashing of teeth at the absence of leadership, it is well to remember that central banks and not politicians have determined economic outcomes for many years, and it is their policies on which we must focus.

The optimistic case is put by Niall Ferguson, distinguished economic historian, who argues that the world’s central banks have coordinated their actions to stymie the rise in the dollar and end the currency wars that some believe will be the trigger for the next global downturn. If so, then the Bank of England Governor Mark Carney may have helped trigger a final competitive devaluation for the pound through his otherwise unseemly haste to declare his Brexit warnings as fact.  Sterling could be argued to have been held up by fumes, Brexit or no Brexit, given the UK’s gaping trade deficit and short-term financing requirements and the economy may benefit from the recent depreciation.

The pessimistic case, put by successful fund manager John Burbank, does not doubt that central banks desire to pour more fuel on the fire of monetary easing, but sees the policy as self-defeating. Where optimists cite Reinhart and Rogoff’s study of recoveries and the average eight years from financial peak to eventual recovery, the pessimists assume that the dollar will resume its rise and draw liquidity from much of the rest of the world in the process. Time will tell, but both camps appear sanguine short-term, which brings us to the three month predictions of the option market as deciphered through OTAS.

UK IV

UK large stock implied volatility, a measure of risk or uncertainty, is at the top of its normal two year range. The post Brexit peak was lower than previous highs, including when Brexit first headed the polls and well below the February level, when global economic slowdown was the issue. While it is tempting to conclude that Brexit is no big economic deal, it is just as likely that investors expect evermore intervention by central banks. Thus the correct investment strategy remains to buy-the-dips, as it has been throughout the post-crisis years.

It is worth noting the frequency with which volatility tops out close to the two standard deviation level, marked by the upper solid blue line on the chart. While risk is not a normal distribution, the two standard deviation level remains highly instructive and statistical analysis provides a superior guide to upcoming investor behaviour than market commentary. The turning point normally comes when the noise level advising otherwise is at its zenith.

UK Stoxx IV

The recent disruption to the blanket volatility suppression undertaken by central banks does have a British flavour.  A week before the referendum, the relative volatility in the UK compared with the STOXX 600 matched the February peak and, again, was at a two standard deviation level measured over the previous two years. The post plebiscite peak did not reach this high, as it becomes increasingly apparent that uncertainty remains greater in Italy and Spain than in the UK (OTAS will show you this). Overall, UK large caps are barely more risky than Europe’s largest stocks and current relative risk is only a couple of percentage points above the average level.

STOXX IV

Turning to Europe and a longer timeframe, implied volatility in the STOXX 600 remains safely mid-range over the past ten years, a result of continuing central bank activity and the insignificance of the likely long-term economic effects of Brexit on the UK or Europe. There is uncertainty, as many are determined to repeat, but the range of expected outcomes appears to be narrow. Note from the chart above how over this time period the one standard deviation levels, marked by the dotted lines, prove to be the normal resistance and hold in all but the most extreme trading environments.

STOXX S&P IV

The final chart compares current volatility in Europe to that in the US. Risk reduction is a global policy, but the biggest Brexit shock, which came before the vote, was enough to cause a spike in this measure from which markets have not fully recovered. By keeping a careful eye on the relative positioning of option investors in different markets around the world, OTAS users have a ready-made guide to what is most likely to unfold in equity markets. This should be of use as the news flow shifts to the potential for political uncertainty in the US later in the year.

With little over a day to go before the UK referendum, we present a last look at the state of play across equity markets using the multi-asset analysis within OTAS.

The pattern for the valuation of the STOXX 600 is established. At above 16.5x 12 months forward earnings the market is stretched beyond its normal range and has reverted in fairly short order. Much below 15x and the index attracts buyers, especially around 14x.

STOXX Jun 2016

This narrow range of values has persisted for many months and means that the Brexit vote in the UK is having little impact on investors’ views on the prospects for European equities. Rather investors should focus on 12 month EPS Momentum and the stocks being upgraded. A two-step filter within OTAS reveals nine shares in the STOXX 600 where upgrades were at least 5% in the last month and 10% in the past three months. Eight of these nine companies have EPS Momentum in the top decile across their respective sectors. Contact us for details.

STOXX CDS Jun 2016

The average cost of credit for European companies has been rising since March of last year, most likely to be when economic growth momentum was at its best. This is in spite of the ECB announcing and now launching purchases of corporate debt. Unless the cost of credit falls there is unlikely to be any change in productive investment across the continent’s listed sector, although recycling new debt into buybacks is one probable consequence of ECB action.

STOXX IV Jun 2016

Risk, as measured by three month implied volatility in the shares of Europe’s largest companies, has been rising gradually since September 2014. Even if we allow that the most recent spike to over 30 was Brexit related, the peak was no higher than the August 2015 move that took far longer to dissipate, and was well below the February 2016 period. At this time investors were focused on the risks of a global slowdown, so for all the publicity surrounding the potential damage Brexit could do to growth across Europe, equity option investors are dismissive of the risks.

The prevailing trends in European equities are a declining valuation, punctuated by central bank induced temporary recovery, mirrored by rising risk recorded in both credit default swap and equity option markets. This speaks to a gathering economic slowdown as a far more important trend than anything Brexit could cook up for European shares.

This is of course what the calm voices have been saying throughout the fractious UK debate, but calm voices don’t sell in the media and hence are easily drowned out by the ranting and raving of those using economic and market predictions for other ends.

‘I think you know,’ said Miss Marple. ‘You are a very well educated woman. Nemesis is long delayed sometimes, but it comes in the end.” ― Agatha Christie, Nemesis

I am indebted to the work of Jared Dillian who, as well as being a highly entertaining writer, shares a similar world view about how investing works to that deployed at OTAS. Jared likes to focus on anti-consensus ideas, picking on trends that appear to have run out of road, in a similar fashion to OTAS flagging extreme moves from the norm across the multiple factors that influence equity prices.

A typical Dillian argument will throw out an investment thesis, while recognising that the timing may not yet be perfect for the trade. These ideas can be of use to active managers who require a portfolio of ideas at different stages of the investment cycle, so that as one great investment comes to an end, there are already several others lined up to take its place. Jared’s latest bête noir is the low volatility trade, which has seen big, safe, high yielding stocks outperform, and the evidence from OTAS entirely supports his claims.

DVY June 2016

The chart shows the performance of the iShares Select Dividend (DVY) ETF against our index of the top 500 shares in the US. As the shares in this fund deliver a higher percentage of total return in the form of dividends, the returns are more stable and predictable than for other stocks, and hence the shares exhibit low relative volatility. Lower risk should equate to lower return, but as the chart shows this is patently not the case this year.

Similar outperformance can be seen in the Consumer Staples Select Sector SPDR Fund (XLP). As with DVY, the break above the normal trading range came around the turn of the year and the subsequent outperformance has lifted the fund to an extreme level.

XLP June 2016

We have written before about the desire of the world’s central banks to suppress volatility and the success with which this has been achieved. Interest rates are the return received for uncertainty about the future and by pushing multiple rates negative, central banks have created situations where the future appears more certain than the present. This is the logic-defying macro environment that our guardians have created for us and Jared, for one, is calling them out.

There are reasons to conclude that it is central bank action, rather than real macro trends, which is creating today’s investment extremes. Much has been made about German ten-year rates going negative this week, but inflation-adjusted bonds in Germany have not followed suit. This clearly suggests that it is the actions of the ECB and not imminent deflation that is determining bond prices.

OTAS shows that the cost of credit for the average German company has risen this month and is safely ensconced in the normal range over the past four years. A situation where the debt costs for companies stays stable, while risk-free rates fall, drives up the relative cost of investment for the private sector and creates a slow growth economy with falling productivity.

German CDS June 2016

The outperformance of low volatility ETFs illustrates that the equity markets are now captured by the cult of the central banker in the way that other asset classes have been for some while. The question is for how long this can continue, or how much more money can back these trend following strategies. Political events may shake the faith in the establishment and there are a number of upcoming events that may do just that between now and the year end. Or, like many other bubble trades, there may simply come a day when fewer new buyers show up in the morning and commentators are left scrabbling for ex post reasons to explain a major price reversal.

As Jared Dillian says, “Up on an escalator, down on an elevator.”

Every day OTAS flags extreme positioning in stocks across markets, in a neutral, unbiased fashion that brings your attention to trends and possible turning points and assists in your decision making process. The analysis may be tailored to your personal portfolio and thereby reduce the risk that your next crowded trade is to the downside.

One of the funny things about the stock market is that every time one person buys, another sells, and both think they are astute – William Feather

The media is alive with lurid stories of volatility back at seven year highs. This refers to foreign exchange volatility and it is hardly surprising, as central banks have done their level best to dampen volatility for seven years, but everyone knew that this would last only as long as market participants chose to believe. If Brexit is indeed the reason why currency markets are aquiver, then this should be no surprise as the campaign for the UK to leave the EU has risen in defiance of central bank warnings, along with those of the rest of the establishment.

Back in April we published a post arguing that there was no evidence of Brexit related volatility in equity markets. OTAS implied volatility (risk) analysis centres on three-month single stock options and so April was already discounting expectations for the post referendum period. The prevailing consensus, however, may well have been that there was no way that the UK would vote to leave, and it is this consensus that is being shaken with reports of nine out of ten recent bets placed with bookmakers anticipating Brexit.

UK Shares Average Implied Volatility - Short Term

UK volatility, whereby options investors expect a +/- 16% move in share prices in three months, is at the top end of its two year range. This is +/- 1.5% more uncertainty than in April. Today’s level, however, remains below the peak in February, when it is worth remembering that the prevailing panic was about global growth, not politics. Last night US bond spreads were at nine year lows, which is a recession warning, and it would be a stretch to blame Brexit for concerns over domestic US economic growth.

UK Shares Average Implied Volaility - Long Term

It is also worth viewing UK equity volatility in a longer historical context. Compared with previous peaks in 2011 and 2008, the recent increase in uncertainty barely registers and remains well within normal bounds. Even during February’s market fall, when the prevailing wisdom was that there would be a recession this year and not one triggered by UK voters, uncertainty did not rise beyond the normal range. Investors should keep an eye on this measure over the next eight days to judge how far the Brexit hysteria spreads.

UK Company Aveage P/E - Short Term

UK average P/E valuation has fallen back into the normal two-year range, having reached a peak in mid-April. The valuation has moved, swung would be too aggressive a description, between 14x and 17x over the last two years and could fall another 8% before reaching that lower valuation. The drop since mid-April has been 10%.

A look at earnings also suggests that there is little to be overly concerned about in the world of equities. Analysts have been downgrading UK shares more often than upgrading for the last six months, but the ratio of downgrades to upgrades has fallen recently.

 Average UK Share

Upgrades over 1%

Downgrades more than 1%

Last 6 months

33%

59%

Last 3 months

30%

39%

Last 1 month

13%

18%

Source: OTAS

While it would be convenient to blame economic uncertainty caused by potential Brexit for the downgrades to earnings expectations, if this were the main reason for changes, then the downgrades would surely intensify as a leave vote became more probable. The opposite is true. We do well to remember that analysts almost always start a year more positively than they finish it, as reality bites into bonus-period optimism. Analysts are also notorious for not changing their estimates until guided to do so, thus there is a reasonable chance that company executives would use the cover of a leave vote to downgrade their outlook, whatever the underlying reason for caution.

With even Mark Carney admitting that the Chinese debt mountain is a greater concern than Brexit, there are plenty of excuses for corporate chieftains to cut themselves a little slack. Keep an eye on the OTAS measure of implied volatility for an early steer as to when this becomes a cliff edge issue, rather than the gentle undulation that it is at present.

Debt markets have responded enthusiastically to the recovery in commodity markets, which began with the ECB’s last major monetary intervention. The average cost of credit for European materials companies has fallen from 160 to 115 bps in the four months since the mid February peak. This brings the cost to the lower reaches of the average range over the past four years, as shown in the chart below.

Eur Mat CDS Jun 2016

The fall in the relative cost of credit for material companies compared with the wider market has been just as marked. The next chart shows that while the sector is consistently more risky in credit terms than the broader market; it is a heavily leveraged industry after all; the relative cost is at the benign end of the spectrum measured over the past four years.

Mat vs Mkt CDS Jun 2016

The improved outlook for the sector on the back of higher commodity prices is hardly a surprise and thus a reduction in implied volatility (risk) since mid-February is to be expected. Equity investors, however, remain distrustful of the sector and the risk remains at the upper end of the normal range over the past four years.

Eur Mat IV Jun 2016

This means that on a relative basis, there has been hardly any improvement in the risk profile of the materials sector compared to the rest of the equity market. The relative risk is 20% greater than it was at the low point in early September 2015 and 15% higher than the interim low in mid-January this year.

Mat vs Mkt IV Jun 2016

The reduction in relative risk in the materials sector that credit investors have clearly identified, might be expected to spill over into reduced risk for the equity, which would typically mean higher share prices.

White Rabbit: Don’t just do something, stand there                                                – Walt Disney, “Alice in Wonderland” 1951

Kudos to Ben Hunt for this excellent piece on the role of narrative in markets, and for using better quotes than me. Anyone who can base insightful equity analysis around a quote from the Godfather deserves special mention.

Ben takes us all the way from his overarching explanation of what is behind market moves, right down to the nitty gritty, which in this instance means Salesforce.com. The image below shows the inexorable rise of analysts’ forecasts for the company’s earnings, even though Ben notes that he is “pretty sure that Salesforce.com has never had a single penny of GAAP earnings in its existence”. The chart also shows the large wobble that the shares had earlier in the year, although the doubters have since seen the error of their ways.

Salesforce.com Share Price and Estimates

In a simple but telling piece of analysis, Ben shows that in the last five years, owning Salesforce.com on only the 21 days after its earnings releases and the 43 days that the Fed made an announcement, returned 167%. Owning Salesforce.com on the other 1,208 trading days would have lost 8%. For a stock up 138% in that time, you could have been standing around doing nothing an awful lot and avoided losing money.

Ben also notes that CEO Marc Benioff, whose ebullient narrative drives the stock’s upward trajectory when the Fed Chairman is not doing this for him, uses 10b5-1 programs to sell shares in his company every day. These programs are predetermined sales and thus do not flag on the OTAS Insiders stamp, but you can see them by unticking the Priority Transactions box in your Core Summary app.

Daily Selling by Salesforce.com Insiders

In many ways Salesforce.com is typical of the handful of software companies that truly make it. Over time the company’s success returns cash flow and eventually earnings and the rating slowly normalises. While Salesforce.com is still 3.8x the average sector multiple, the steady de-rating appears to be well underway.

Salesforce.com Eroding Valuation

Reflecting on Ben’s analysis that you make money in short bursts and could spend most of your time doing nothing, I was struck by the similarity of this to the OTAS trading mantra, which may be expressed as SLOW DOWN AND DO NOTHING. Most of the time when trading you may leave your orders in an algo and do something else. Only in exceptional circumstances do you need to intervene to adjust an order and OTAS will fire an alert to tell you when that happens.

The results are in for the first quarter earnings season in the US and do not make for pretty reading. For the sixth consecutive season, operating earnings of the largest companies have declined. A little over one fifth of companies issued earnings guidance and, of those, 71% advised analysts to lower their expectations. The gradual erosion of the earnings base of the country’s largest companies has taken its toll on the valuation of the stock market.

US May 16

The valuation of the market peaked in May 2015, just over a year ago. There was a first quarter rally on the back of more monetary easing in Europe, but the impact on US companies is likely to be short lived. When the ECB announced that it would be buying European corporate debt, this boosted the value of debt and pushed down the yield that borrowers have to pay. Large US companies can take advantage of this to raise debt in Europe and use the proceeds to buy back shares to temporarily support stock prices.

The decline in earnings also has a short term impact on valuation, by raising the market multiple, but as the chart shows, the more powerful force is the growing momentum out of US equities in response to declining profitability.

There is some good news, however. OTAS makes it easy to filter a market or portfolio of stocks to find those where the trend in earnings is bucking the general malaise. There are 33 companies with falling share prices and rising EPS estimates, where this contrast is sufficiently significant to stand out from the rest of the market. Ten of these shares are in the energy and materials sectors, which are whipsawed by the anticipated moves in currency and commodity markets, but the remaining 23 shares are trading at a 22% discount to the average valuation of the broader market.

The US stocks bucking the earnings malaise

By applying one filter for stocks with significant divergence between falling price and rising EPS estimates, and a second excluding energy and materials shares, in just a handful of clicks we are left with a chart showing only the outliers across the whole market. Hovering over each yellow disc reveals the name and recent performance of the company. Frontier Communications is highlighted below.

Another look at the stocks bucking the negative trendDouble clicking the name takes you to the EPS Momentum page for Frontier Communications and to a chart that shows the relationship between the share price and estimates of upcoming earnings. In the case of Frontier, investors were faster than analysts to realise the downgrades that plagued the last nine months of 2015, but both analysts and investors have been in step since the beginning of this year. Then the share price weakness over the past month contrasts sharply with the average 8% upgrade to forward earnings posted by the analyst community.

Frontier Communications' Loss Estimates Fall

Obviously it is up to investors to decide whether the recent share price weakness heralds another false dawn for the company, but OTAS provides layers of analysis to help make this judgement. For example, Frontier’s estimates have risen for the years to December 2016 and 2018, but fallen for 2017, so it may be that investors are most focused on next year. Frontier’s borrowing costs over seven times that of its industry peers and the shares may thus have reacted to the renewed prospects for a summer rate hike. Frontier will also pay a dividend in 20 days times and has a forward yield of 8.6%, but while free cash flow covers the pay-out, earnings do not.

All of these factors influence the decision to buy or sell Frontier, or indeed any stock. OTAS provides a one-stop shop for all the market intelligence that you need to make sure that you are as fully informed in your trading or investment decision as you can be. OTAS also draws out the priority issues that are impacting share prices, to help fundamental investors frame the most pertinent and timely questions when they interrogate a company’s performance, its financials and its management.

Short VIX positions are at an all-time high, while net shorts are at an eight month high. For those not versed in financial speak, this means that investors are expecting a low level of volatility, or uncertainty, and that share prices are not expected to change much in the short to medium term.

Low levels of uncertainty are traditionally associated with gradually rising stock prices, because investors pay more when they are confident about the future. Central banks have attempted to crush volatility precisely to boost investor confidence, in the hope that this would spread to the broader economy. Whether this has happened is fiercely debated, but a leading investment bank tells us that more than 60% of US large companies are buying back shares, a similar level to the 2007 peak. This certainly helps offset any weakness in share prices when earnings disappoint.

US large co. implied volatilityThe chart above shows that option traders expect US stocks to rise or fall by 12% over the next three months. There is no bias towards rising or falling in this analysis, but the chart clearly shows that implied volatility is at the low end of the average range over the past eight years. This is down by a third since February, when economic woes and earnings concerns were at their recent peak.

The February top had briefly exceeded the June 2012 high, just before Mario Draghi’s (in)famous “whatever it takes” speech. Since then, markets have been calmed once more, chiefly due to Draghi promising to buy up any piece of debt that investors in Europe can produce for him. The impact on volatility in Germany has been much the same as in the US.

German large company Implied Volatility

Investors expect German stocks to rise or fall by 13% over three months, which is in lock step with US shares. This level of volatility is also at the low end of the long-run average range and has fallen by a little under a third since February. The February peak level also exceeded, briefly, the early summer 2012 jump in volatility that did much to trigger ECB action back then (the US having already acted long before to crush the extraordinary volatility of the financial crisis).

The chart tells us that volatility can fall further, in both the US and Europe and still be within the average long term range. At implied volatility of between 19 and 20 (+/- 10% three month share price moves) the US chart would be back at levels that were sustained from March to July last year. This was a period of high and stable values for the US stock market, but critically indices did not break through to new highs.

Once again, under the captive eye of the investment world, central banks have poured oil on troubled water and may succeed in coaxing markets back towards record levels. If so, this will have been achieved by creating copious amounts of money and having it buy back stock. The accumulation of debt for this type of investment, which has no obvious productive purpose, will do nothing for earnings growth other than create a dependency on even more buybacks next year if companies are to beat their earnings.

Once again, an extended period of low volatility is likely to be interrupted by a panic about economic growth and sustainability of earnings, and the investment world will turn to the central banks and demand another shot in the arm. By using OTAS to follow EPS Momentum changes and movements in implied volatility, traders and investors can expect to gain advance warning of impending moves.