Market Volatility Bulletin: Spot VIX Below 14 As S&P Once Again Approaches Resistance

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Includes: DIA, IWM, QQQ, SPY, SVXY
by: The Balance of Trade
Summary

Spot VIX is very much near its six-month lows as S&P gears up for another shot at hurdling 2800.

Technology is our friend, but we need to make sure that we as humans continue to use common sense.

SVXY still managed a strong since-inception return, despite last year's breakdown.  But the future may play out with simply mediocre returns due to a shift in roll decay.

Market Intro

CNBC: 1:07PM EST

US stocks (SPY, DIA, QQQ, IWM) are moving in a fairly tight range on Tuesday, after Monday's turn-around rally. Spot VIX is hanging below a 14-handle, though it nearly touched 18 in last week's commotion.

Thoughts on Volatility

I am pretty Trump neutral, and I'll have to side against the President on this particular topic. From my point of view, the more technology on my planes, the better. I think there is plenty of room for human error here, and unlike trading, lives are at stake in this sphere.

It does bring up an important point for investors though: While we should welcome technological innovation, we still need people (at least for now) to figure out how to use the advances, and where we may still want to keep people guiding the process.

Consider that less than fifty years ago, people still were with some regularity mailing in coupons to get their fixed income payments from the bond market. Clearly the system we have today is better.

But if the innovation is not properly understood, blow-outs are possible and even likely...

Take for instance the meaningful increase in passive ownership of equities and other investment strategies. In some sense this truly does represent an advance. I'm all for lower fees and I believe that index replication can be a positive advance to the way people approach the investment decision.

The other side of this argument is that more and more people may be simply dumping money into indexes, which in turn may be market-cap weighted in some form or other, without scrutinizing the decision set. There are at least two problems with this approach.

First, it increases the likelihood that the prices of these assets are not what they would be if more decision-makers were actively analyzing the opportunity set. Even those who believe firmly in the Efficient Market Hypotheses concede that at least some group has to be statistically compensated for doing the work to keep assets appropriately priced.

Second, if investors put their money in without much thought or commitment, they may also be quite swift to pull money out, because they will rightly come to understand that they never really knew what they were doing. This can promote environments where volatility gets overdone relative to news flow.

Markets may well be limiting the Fed's options for continuing to hike rates (if that indeed is the road that the monetary body wishes to pursue). I think it is safe to say that any hawkish surprises, particularly at an FOMC meeting, will not be handled gracefully by risk assets.

To be fair, the Jan '20 cut probability is still quite low, so it is not as though markets are demanding or even expecting a rate reduction. But more hikes appear for the time to be off the table.

Term Structure

The term structure certainly did poke higher (green) by quite a bit by the end of last week. The downturn over the last couple sessions (orange and purple) have been equally impressive.

Next Tuesday is the last full day of trade on the M1 VX contract. As such, one should expect to see the contract adhere more closely to action in spot VIX. The M2 has also moved around a good bit as well, and VVIX (VIX of VIX), while still low, is starting to perk up some.

SA - SVXY One-Year Chart

SVXY is up about 25% from its Christmas lows. With the 2/5/18 "Volmageddon" event now more than a year behind us, we can observe the product's behavior over the last twelve months.

The picture we are left with is a product that has swung both higher and lower, but ultimately neither gained nor lost much ground.

There are two factors at play that bear consideration. One is that ProShares, the fund issuer, cut the leverage in half shortly after the volatility blow-up to help prevent a similar disaster.

The other, and more instructive point, is that "contango" has simply not been as consistent a tail-wind to short-vol positions over the last year relative to how roll yield (the true source of gains) had contributed in the prior half-decade.

It is quite possible that we are close to the end of this bull market. We might expect that the VIX term structure will spend a larger proportion of its time above the M1 and M2 contracts than it did over the extended period of market gains, and more importantly, market calm.

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.

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.