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TRADING THE WEEK: Of Valuations and Volatility

Traders Magazine Online News, August 21, 2017

John D'Antona Jr.

The equities market is at an impasse – where high valuations and still-low volatility are both contributing to keep a lid on activity.

Traders who spoke with Traders Magazine have continually told of high stock prices, but at the same time a reluctance to sell given strong fundamentals. Those opinions got more support from one of bulge bracket research departments. In a note to its clients last week, Bank of America Merrill Lynch reported that the stock market is the most expensive it’s been since the “dot com” bubble.

“The S&P 500's forward price-earnings ratio just hit its highest level in 13˝ years,” the report began. “The forward P/E ratio expanded in July to 17.7 times, from 17.4 times.”

And that’s not all, the research team added this development came as the valuation backdrop remained the same, with U.S. equities trading above "nearly all metrics we track, but equities continue to look attractive relative to bonds." Across sectors, all but two — industrials and consumer staples — saw multiples expand in July.

And if super high prices weren’t enough to discourage fresh buying or selling, market volatility or the lack thereof hasn’t helped goose activity either. According to market consultancy Tabb Group, market volatility as measured by the VIX, has for the second month in a row hit an all-time low. Tabb reported  that in July 2017 the VIX average close was 10.3, decreasing even further from the all-time low in June 2017 of 10.5.

“Without volatility, there’s real desire to not trade the market,” said a floor trader in New York. “And despite all the political machinations and news items, the market really feels a bit tired here. No one wants to do anything until we get something big hitting the tape.”

One thing that won’t be hitting the tape any time soon is an announcement by the Federal Reserve that it will hiking short-term interest rates for the third time this year. The weak inflation numbers coupled with modest employment gains have pushed the chances for one more rate change lower to about 37% from 47% two weeks ago, according to Fed Futures traders.

This flies in the face of comments supporting a third interest rate hike last week when New York Federal Reserve President William Dudley told the Associated Press he supported another rate increase this year if the economy improves further.

"It depends on how the economic forecast evolves," Dudley told the AP. "If it evolves in line with my expectations ... I would be in favor of doing another rate hike later this year."

It has been almost a given that the FOMC would vote again to raise rates by December. But with inflation running around 1.5%, or below the 2% Fed target, traders and economists said that another hike becomes problematic and could halt the ongoing modest expansion.

Looking back at last week, trading volume was 5.92 billion shares, off slightly from the 6.38 billion shares reported the week prior, according to BATS Global Markets.

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