Fear No Evil - I'm Fading Volatility

| About: iPath S&P (VXX)
This article is now exclusive for PRO subscribers.

Summary

According to the post Fed market movements and some scared pundits and investors, there's much to fear today.

The level of doubt is as high as the level of complacency was this time last year.

I would fade fear here, as I see the market somewhat clear to climb the wall of worry toward new highs.

Fear is at a height now that is quite the contrast to the height of complacency I noted around this time last year. It may not be apparent in the value of the VIX; however, it is evident in Thursday's market scare and in the comments of market pundits. In August 2015, when I issued my warning to investors to prepare for the coming correction it seemed nobody could fathom its possibility. Currently, fear is too high in my view, so much so that investors are missing investible opportunities on fortuitous turn of events.

Fear around Deutsche Bank (NYSE:DB) and oil prices have factored in holding back a post-Fed meeting relief rally, but those fears appear to have been mitigated. Though, it does not seem like Wall Street wants to believe it. As the normalcy bias of investors comes to a better balance, volatility should fade. And as the quarter turns over and money managers bank their performance, capital flows can start fresh into favored investments. I expect that to drive stocks to climb the wall of worry toward higher highs for equity markets. As a result, volatility instruments like the iPath S&P VIX Short-Term Futures ETF (NYSE: VXX) can resume their normal pattern of attrition.

After much hoopla, and market volatility, the Federal Reserve met in September and decided to again pause from its plan to normalize monetary policy. The Fed held interest rates steady, despite a split decision. The Fed also lowered its expectations for the rate hike trajectory into 2017 and 2018, while still seeing economic growth. By the way, that is good news for security valuations in case you missed that point.

Heading into the meeting, hawkish language from the likes of Fed VP Stanley Fischer and Boston Fed President Eric Rosengren helped raise fear of a Fed action. That fear was heightened because of a series of economic data points that raised skepticism about the health of the economy. I have reason to believe the August data will prove to be anomalous, and welcome readers to see my follow up focused economic article covering that topic near-term. Anyway, as a result of all the concern, the S&P 500 Index (NYSE: SPY) dipped and volatility instruments surged, with the iPath S&P VIX Short-Term Futures ETF surpassing $40 in the process.

SPDR S&P 500 Trust ETF stock chart iPath S&P 500 VIX Short-Term Futures ETN stock chart

SPY & VXX Charts at Seeking Alpha

After the fact, the VXX dropped back down to what appears to be important technical support around the $33.33 level or so. Stocks have, however, met some resistance in their attempts to remark old highs on the relief run back upward. Tops among the obstacles have been the Deutsche Bank potential insolvency issue and oil prices under pressure, with the Wells Fargo (NYSE: WFC) and Mylan (NYSE: MYL) witch hunts, the presidential election, geopolitics and the terrorism incident in the Northeast playing secondary roles. But many of these bricks in the wall of worry have been mitigated or smoothed.

After the Department of Justice (DOJ) noted it could fine Deutsche Bank as much as $14 billion for the role it played in the financial crisis, concerns about its ties to the financial system rose to the forefront. The entire stock market reflected concerns at the start of the week, and the financial sector (NYSE: XLF) especially. I believe those concerns are well-founded, especially after German Chancellor Merkel said Germany would not bail out the important bank. But wiser heads prevailed over the course of the week, and the Justice Department made a gesture to the bank, indicating its fines could be less severe. Also, while a bailout has been ruled out for DB, some are speaking about other ways it could be defended against disruptive insolvency, including a bail-in, in which Germany takes a stake in the bank like the U.S. did in General Motors (NYSE: GM). Also, we know Deutsche could divest some assets and that other sources of capital could avail if need be to prevent any important systemic failure. If Deutsche Bank finds the brink of the abyss, I expect it will be rescued one way or another.

Concerns about oil were renewed I believe by the latest Oil Market Report from the IEA showing weakened demand. However, that issue appears to have been mitigated by OPEC's surprise decision on Wednesday to freeze production. While the details are suspect, especially if you listen to the guys on Wall Street who today are afraid of their own shadows versus last August when they were invincible, it appears the production action will support oil prices. With oil stabilized, other sectors of the economy and market are likewise stabilized. For instance, financials were impacted by both the Deutsche Bank and oil fears, and have since recovered significantly. Though, Thursday they were under pressure again and the fear index and relative securities were surging again.

Security Sector

09-29-16

2:00 PM ET

iPath S&P 500 VIX ST Futures

+8.2%

SPDR S&P 500

-1.0%

SPDR Dow Jones (NYSE: DIA)

-1.1%

PowerShares QQQ (NASDAQ: QQQ)

-0.8%

iShares Russell 2000 (NYSE: IWM)

-1.2%

ProShares VIX Short-Term Futures ETF (NYSE: VIXY)

+8.1%

VelocityShares VIX Short-Term ETN (NYSE: VIIX)

+7.7%

ProShares VIX Mid-Term Futures ETF (NYSE: VIXM)

+2.6%

VelocityShares VIX Medium-Term ETN (NYSE: VIIZ)

+1.0%

ProShares Ultra VIX Short-Term Futures ETF (NYSE: UVXY)

+14%

VelocityShares Daily 2X VIX Short-Term ETN (NYSE: TVIX)

+14%

VelocityShares Daily Inverse VIX Short-Term ETN (NYSE: XIV)

-7.0%

VelocityShares Daily Inverse VIX Medium-Term ETN (NYSE: ZIV)

-2.5%

REX VolMAXX Inverse VIX Weekly Futures Strategy (NYSE: VMIN)

-10%

Certainly, fear will never fully subside, and it will have its bouts and tantrums through the often volatile month of October. However, I also expect many institutional investors to begin to put capital to work as their fiscal years turn over. They'll look for value in the energy and financial sectors and industrial and other areas. My recent downgrade of the energy sector will need review now, given the change in circumstances. I'm also going to have to revise my forecast for oil prices.

But, too many on Wall Street are hanging onto fear when they should be embracing courage in the face of it. Look for equities to march to new highs now and for volatility instruments to get back onto their long-term paths of attrition. I'm looking to short the VXX on dips in the market and blips in the instrument like today's, especially as the new quarter takes hold. Stay tuned to my business column here at Seeking Alpha for my regular updates on the market and its factors.

Disclosure: I am/we are short VXX.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: My position is short short-term in nature through options and could be closed at any moment.