Market Volatility Bulletin: Stocks Drag, But VIX Doesn't Believe

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Includes: AGG, CVOL, DIA, IEF, IVOP, IWM, QQQ, SPY, SVXY, TLT, TVIX, TVIZ, UVXY, VIIX, VIIZ, VIXM, VIXY, VMAX, VMIN, VXX, VXZ, XIV, XVZ, XXV, ZIV
by: The Balance of Trade
Summary

Stocks traded lower, but VIX didn't respond too strongly to the news.

The relationship between the stock market and the economy is just not that strong, so positive data can only be viewed as so much of a lean.

VIX bounced once more off the bottom of its two-month range, but does not appear to be in a rush to run back higher.

Market Intro

US stocks (SPY, DIA, QQQ, IWM) struggled throughout the day beginning shortly before noon (excuse the time zone below being off due to our being in Bali at the moment).

Various measures of inflation arrived very much in line with estimates, which may have acted as a proximate cause for the falling Treasury Note yield (IEF, TLT, AGG) :

For the most part, economic data has been coming in at or better-than consensus. If Treasury vol remains under control, I assert that equities have a better chance of recovering.

Thoughts on Volatility

A lot of stock market bulls seem to be puzzled by the fact that the stock market is struggling just as the economy picks up. The visual above emphasizes that the relationship between the economy and stock market returns is pretty loose. This makes sense, as stocks are the price of a current claim on a perpetuity of cash flows… how much should one year’s GDP growth make in the grander scheme?

https://twitter.com/TimmerFidelity/status/991044713733066754

We had a long period with no 5% decline in stocks (more than 400 trading days). This creates a heightened sense of nerves when things don’t go “just so”. In the grand scheme of things however, the current drawdown is quite ho hum. Making large allocations based on the most recent tremors is probably unwise.

Eight out of eight times… well I guess that settles it! This is a small sample size, and so we just don’t have enough data to lean too heavily on such metrics. Still, this post makes the claim that the current environment is not intrinsically a sign of impending doom.

Term Structure

The run-down in stocks on Monday really left something for those both long vol (VXX, UVXY, TVIX) vs. short vol (SVXY). As Matt Thompson mentions in the Tweet below, spot has had a very difficult time trading below 15 for very long. Stocks’ decline for no particular reason on Monday highlights how mercurial realized volatility is today.

I like the first point made by Mr. Thompson: VIX represents the opportunity to take either side of an insurance trade. This vantage point can illustrate well why it does not make sense to be constantly on one side of vol, such as holding a position in SVXY. Even if it works out for long periods of time, longs don’t need to be right often to still create major problems for the shorts.

VVIX, the VIX of VIX, headed higher on Monday, though the metric still resides at the low end of its range, which indicates no major breakouts to spot VIX one way or the other. Range-bound VIX is the takeaway as far as VVIX is concerned.

Conclusion

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Thank you to David Lincoln on this comment from the most recent MVB. I’d be interested to hear from those who trade volatility from the short end how they have modified the mechanics of their trading over the last couple months.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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: I actively trade the futures and options markets, potentially taking multiple positions on any given day, both long and short. I also hold a more traditional portfolio of stocks and bonds that I do not "trade". I do believe the S&P 500 is priced for poor forward-looking returns over a long timeframe, and so my trading activity centers around a negative delta for hedging purposes.