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Small caps go for a ride on the Fed's Tilt-a-Whirl

Small caps go for a ride on the Fed's Tilt-a-Whirl

By: Mat Lystra, Sr. Research Analyst

Summer in the US means fairs and amusement parks and with them come the ubiquitous "Tilt-a-Whirl" ride. The "Tilt-a-Whirl" spins its riders around on a wave shaped platform, an experience that can turn from exhilarating to nauseating, and back again, in a matter of seconds. Small caps have been on a similar ride in 2016 and the Fed has a hand on the start-stop lever.

The Fed began what was described as a process of "normalization" by raising the target Federal Funds Rate (FFR) at the December 2015 Federal Open Market Committee meeting. However, in the first quarter of 2016 the Fed twice passed on further increases to the FFR. In December the Fed used the term "balanced" to describe the risk outlook for the US economy but has since dropped this language, leading some to speculate about rising downside risk.[1]

Fed committee member Eric Rosengren voted in favor of maintaining the FFR at the March 2016 meeting before proceeding to make a speech warning that ultra-low unemployment rates, brought on by persistently low interest rates, could cause outsized inflation.[2] However, Fed Chairman Yellen's remarks[3] have indicated that she seems willing to risk such a scenario in order to promote wage growth and reduce involuntary part-time employment. 

The vacillating guidance from the Fed has contributed to the directional uncertainty in the market. From the third quarter of 2015 volatility has returned to the market with an intensity not seen since the financial crisis. Perhaps the steadfastly accommodative Fed policy regime during the recovery period lulled the market to sleep. And now the market has suddenly been awakened.

The illustration below uses the Russell 2000 Index which measures the US small cap market to demonstrate just how much more volatile the small cap market has become in recent quarters. During the period January 2012 through June 2015 (14 quarters), the Russell 2000 Index had a greater average daily return with a lower standard deviation than during the three most recent quarters from July 2015 to March 2016. We can also see that the difference between the average daily up market and the average daily down market was 36% greater in the latter three quarters than in the prior period. 

Average Daily Moves of the Russell 2000

Source: FTSE Russell as of March 31, 2016.  Past performance is no guarantee of future results. Please see the disclaimer for important legal disclosures.

The same trend can be seen if we look at the graph below that illustrates the CBOE's Russell 2000 Volatility Index (RVX) of implied volatility. Using the same two time periods, January 2012 through June 2015 and July 2015 through March 2016, we can see a meaningful uptick in volatility. The average value of the RVX in the recent period is higher and within a larger band of values than that of the prior period.

Average Daily Values of the Russell 2000 Volatility Index (RVX)[4]

Source: CBOE through March 31, 2016.  Past performance is no guarantee of future results. Please see the disclaimer for important legal disclosures.

The Fed's indecisiveness has created an uncertain outlook which is manifested in higher volatility. Small caps are viewed by some commentators as a particularly sensitive barometer of the health of the US economy. When small caps begin to behave like the "Tilt-a-Whirl" ride – up and down, round and round – it is best to buckle your safety belts because higher volatility may be the defining market condition of 2016.

For more on this topic, please refer to the quarterly FTSE Russell Small Caps Perspective Paper.


[1] Source:

[2] Robb, G. (2016). Fed’s Rosengren sees risk that unemployment rate could fall too far, too fast.  MarketWatch, accessed on April 18, 2016 at:

[3] Source:  Janet Yellen speech 3/29/2016

[4] For more information on the RVX please visit:

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