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Market Notes: Is "Sell In May" Turning Into A June Swoon? -- June 5

Jun. 05, 2013 6:20 PM ETF, UVXY, XIV
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It wasn't apparent until today how the "Sell in May" scenario was going to play out. The major averages sliced through recent support levels with the market-leading Dow Transports (DTX) making an easy pass through the 620 level. For the bulls to return to power, the next support areas will be critical: SPX 1600, DTX 600, DJIA 14440, Nasdaq 3370, RUT (Russell 2000) 955-960. Note that 1600 corresponds to the 50 day moving average (dma) which has been a source of support for the SPX since the beginning of the year (see chart). A break below this would spell double-trouble for the bulls.

Mirroring today's market move was the volatility index (VIX), but in the opposite direction. Big upward moves in the VIX reflect fears of market instability. How long these fears last depends on what is causing them. If you believe the financial media, the cause of fear is that the Fed may end its quantitative easing policies sooner rather than later. But if that's really the case, then today's worse than expected economic numbers showing a decrease in both private employment and factory orders should have boosted the market rather than prompting a sell-off. What this really means is that investors are either worried about something else that isn't apparent (at least not to me) or that investors are simply taking some money off the table, especially in those areas where valuations have grown rich. If these next critical support levels don't hold, then we'll know that the problem is more likely to be a structural one.

A note on levered VIX funds
During volatile times, many home-gamers turn to gambling on VIX products hoping to cash in on a big increase or decrease in the underlying instrument. (FYI: The VIX is comprised of various near-term options on the SPX.) I just want to take a moment to remind folks that holding some of these derivative products, especially the levered ones, can lead to substantial losses if not monitored closely.

For example, the double levered VIX funds, the UVXY and the TVIX, have done nothing but steadily lose value since their inception dates (12/2010 for TVIX and 10/2011 for UVXY). Since 10/2011, both funds lost nearly 100% of their values (99.7% to be exact) while the VIX fluctuated from a high of 47 to a low of 11. Even during volatile periods, these funds--which are designed to return twice as much as the VIX on any given day--can't even do that. Look at today. The VIX gained over 7.5% while UVXY gained not much more at 8.4%. TVIX actually under-performed the VIX returning less than 7.4%!

The moral of this story is that if you feel you must play any of these VIX products including the unlevered ones, please do so only on a daily basis. Holding them for more than one or even two days can be hazardous to your portfolio's health. (The only one worth holding for any length of time is the XIV, an inverse VIX fund, but I still don't recommend doing it.) If you're looking for portfolio protection during times of rising volatility, buying index puts or put spreads is a much better way to go.

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