Market Intro
CNBC: Thursday Close
Well, the good news is that stocks (SPY, DIA, QQQ, IWM) did not seem overly concerned about Mr. Powell’s follow-up appearance on Thursday.
After delivering prepared remarks, said: "We don't see any strong evidence yet of a decisive move up in wages. We see wages, by a couple measures, trending up a little bit, but most of them continuing to grow at about two and a half percent. Nothing in that suggests to me that wage inflation is at a point of acceleration."
The Dow, S&P 500 and Nasdaq all hit session highs on the back of that comment before retreating. Earlier this week, he testified before the House Financial Services Committee, where he indicated market volatility won't stop the central bank from raising rates. - Fred Imbert, CNBC
Treasury yields (IEF, TLT, AGG) fell, as traders and investors preferred to park assets in a less volatile instrument:
At the peak of the Congressional Testimony on Tuesday, the TNX had reached 2.95; it is down fully 15 basis points. Treasury volatility appears to be settling into a range.
Thoughts on Volatility
DJ makes an interesting point. I’m not sure the bull market is over. To my mind, there are several factors that could keep the bull alive, sustained earnings growth foremost among them (especially if it is revenue growth).
Where I am increasingly coming into agreement with DJ is that the low-vol, “easy bull” market very well could be putting in its death throws. The price action we’ve experienced in SPX has no place in the world of 2017. Even January 2018 had a couple pullbacks, but they were bought with both hands. Bearishness was simply not to be tolerated.
Now, however, volatility markets are taking a more flexible, two-sided approach to making projections about price action. Not only spot VIX, but also VVIX is getting pretty jumpy.
Put simply, at least in the short term, Bears no how to strike back, and do so with power. The Feb 11, 2016 through Jan 28, 2018 period was more or less a period where Bulls hegemonically determined price behavior in stocks. Now it is a dialogue.
What this means for those who trade volatility-related instruments is that the old playbook has to go. VX futures now follow a spot index that needs to carefully consider a far wider range of appropriate trading levels, as realized volatility simply will not sit comatose.
This was always a risk, and even 2016-2017 saw many mini crises. What to my mind was different was that “Buy the Dip” was an established, proven mantra that always seemed to work and therefore became self-fulfilling. No dips were available to be bought because most everyone knew just what to do with them.
But a new world, one where losses can and do follow losses, is at hand. Bulls are not out for the count, but have simply forgotten how to fight. Thursday’s price action was clear indication of that - SPX 2730 reversing down to 2660?
To take back the tape, Bulls need to embrace true earnings and cash flow growth over a macro backdrop that was dominated by central bank alarmism. It’s a doable task, but it may take rewiring and an increased comfort level with higher volatility and a far more flexible term structure.
Term Structure
For all the drama of the last few sessions, the VX term structure far more closely resembles the term structure of mid Feb than either the lows of January or the highs of early Feb. Spot VIX is more jumpy, both to the upside and the downside, and VX futures are taking notice.
The flattish shape to my mind signals a flexible view, that is open to a push higher, but also to a return to gentler levels. As well it should. Yesterday was a great example: Powell’s reassuring words regarding wage inflation temporarily assuaged markets. But the relief couldn’t stick.
A couple days ago, before the first Powell meeting, I had this to say:
I would expect the vol slide to be pretty steep if we head lower. This is to say that for trading vol from the short side (SVXY), I think the downside risk is higher than the upside gain from a standpoint of sensitivity. What this means is that if SPY marches higher, then I think the term structure will fall, but not by all that much. On the other hand, if SPY revisits the 50-day moving average for instance, then near-dated futures will perk up quickly.
I bring this up because I really believe the VX futures are doing an admirable job pricing out these threats and opportunities. Like we saw over the period of Feb 14-26, the term structure is more than willing to move back into contango, just so long as it reserves the right to rip into backwardation on a moment’s notice and with far more of an upside sensitivity.
This means that products that are long vol like VXX have much more opportunity to thrive, as the threat of negative roll contribution is far less severe or sustained.
Conclusion
If this is your first time reading Market Volatility Bulletin, thanks for giving it a try. If you're a regular, we thank you for your ongoing contributions in the comments section.
The article we released recently about ProShares decision to curtail the magnitude of exposures to the S&P VIX Short-Term Futures Index can be read here. The piece has generated a lot of productive discussion.
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