Market Volatility Bulletin: All's Well That Ends Well

by: The Balance of Trade

Stocks are frolicking in the glow of a possibility of diminished prospects for a government shutdown.

The US has indeed enjoyed a great 2019 thus far, but look at some of the other countries' markets!

SPX VX term structure sits at multi-week lows, and it's getting confirmation from other indexes; skew measures may be perking up.

Market Intro


The Dow (DIA) is leading the charge on a meaningfully positive day for US stocks (SPY, QQQ, IWM). Hopes of a deal to quell another government shutdown is a likely cause of the rally.

With the exception of the real estate sector (XLRE), all sector SPDRs are flashing green for the day. Financials (XLF) and Basic Materials (XLB) are up near 2%.

The CPI print is due out tomorrow.


At least to the extent that one attributes these gains to the news about the averted shut-down, the celebration may prove short-lived. All the same, spot VIX is sporting a 15-handle, near three-month lows with what appears more room to descend.

Thoughts on Volatility

It is possible that the 5y5y swap has some 'uncertainty premium' built in that rises and falls, which distorts this measure as a pure indicator of inflation expectations (just a theory).

Still, the drop is significant. The ECB bond buying went into overdrive in 2016, and at the times a wide swath of sovereign European bonds were trading with negative yields.

Will the ECB continue to purchase assets if the mission of embedding inflation expectations is not accomplished? I'd say there is a great chance that the answer becomes 'yes', especially given the high indebtedness of Italy.

It sure can feel that way sometimes, Contrarian. It is worthwhile to keep in mind, however, that the Fed itself may become constrained if economic variables begin to really heat up. Tomorrow we get the CPI print.

If inflation never becomes a problem, then it is difficult to criticize the Fed on the basis that the Fed Funds rate is wrong. The monetary base is a different matter.

In contrast to the previous Tweet, it is worth remembering that the US recovery so far this year is actually quite pedestrian in comparison to many international equities (GXG, TUR, FXI).

While the US had a tough slog in Q4 2018, the last calendar year was beset by challenges for international stocks (ACWX) almost without ceasing.

For those looking to continue playing upside, then, foreign markets may be a better way to go. Think of 2016-2017 as the playbook, where EEM enjoyed even more accentuated upside.

Term Structure

The pinkish curve is the current VX term structure, as compared against the end-of-day term structures for the last five Tuesdays.

Today is the last full day of trade for the Feb. contract, and so I would not overthink the steep M1-M2 contango, which will be gone tomorrow. The emphasis, rather, belongs on the fact that the curve has passed through a flattening period and now looks to be working a contango narrative as the base case.

We'll need stocks to calm down (small-magnitude moves) over the next week or so, but the recovery is becoming more credible as the base case story.

Mind you, that is not necessarily the story that 'should' prevail. There are plenty of potholes in the 'all's-well' storyline that stocks are hanging onto.

But if dips are manageable and swiftly reversed, then it is difficult for realized vol to get the sustainable boost required to feed a higher VX term structure.

The thaw is not just a large-cap story either. Russell 2K VIX is now at the lowest readings going back to late September. There is no overlap between the names trading in the S&P and the Russell's basket of stocks.

This gives the long-vol argument (VXXB, UVXY) another obstacle at the moment, as we are seeing sympathy between the two indexes.

MarketChameleon: SVXY Skew

There is a modest warning signal emanating from the short-vol product SVXY. Namely, put skew is becoming somewhat more pronounced than it has been going back to late November. We're getting back to levels that have corresponded to more chop out in the market.

Recall that this ETF was deleveraged at the end of Feb '18, and so it is natural to see the drop from year-ago highs.

Recall that in March-June of 2018, there was an overall pattern of healing in the S&P, but with some nasty spills and pullbacks along the way. We saw a gradual lift in the SVXY skew prints. It looks to be the case that the current pattern is trying to mirror that of the previous recovery.

I don't personally read this as highly problematic for stocks. Indeed, I see it as indicative of a market with a sustainable shot at a rebound, but with less-than-smooth sailing on the way up.

Wrap Up

If this is your first time reading Market Volatility Bulletin, thanks for giving it a try. If you're a regular, I thank you for your ongoing contributions in the comments section.

I appreciate this post from jz30. Congrats on taking that day to do some buying: Dec 26th turned out to be a massive rally that has had some impressive legs on it to say the least.

Dec 24 was a frightful Christmas Eve. Given how powerful and immediate the shift was, I wonder if we're in for more 'fleecings' in the near future if the sanguine spirits of traders prove capricious.

Thank you for reading.

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.