US stocks (SPY, DIA, QQQ, IWM) had a strong finish on what turned out to be a roller coaster of a week: down 1.23% on Monday, up 1.51% Tuesday, down 2.93% Wednesday, up .25% Thursday, and a 1.44% gain in the SPX Friday for a 1.03% loss for the week. Cyclical sectors (XLF, XLY, XLI) performed poorly, while defensives (XLP, XLU) fared pretty well as rates dumped.
Spot VIX closed on Friday at 18.47 vol points.
Thoughts on Volatility
Why all the volatility? Well, I think part of the fuel that's revving the beast is that there are headlines from a variety of different sources. The Star Spangled Banner blasting in Hong Kong is strange to hear.
To be sure, traders have to be willing to respond to news, which all too often is a missing ingredient; the N. Korean test missile firing over the Japanese region of Hokkaido in after-hours trade receiving nothing more than a momentary shrug in September of 2017 springs to mind. For the time being, market participants appear to have itchy trigger fingers.
Of course, falling bond yields was a large source of concern over the past two weeks. And to be sure, they really have fallen with some speed. The 30YR UST (TLT) hit an all-time low, breaching the 2% threshold. I don't know if you recall September of 2011 when the 10YR (IEF) first pushed through 2%, and that itself caused markets to rattle... 7 years further into an economic expansion, and we're seeing it for the 30Yr tenor: remarkable.
Bloomberg reports that the US Treasury is getting feelers out to see if demand would be sufficient for issuance of longer-maturity instruments, given how low the current rates are for Treasury instruments. This is a sensible play: make hay while the sun is shining. I do think that at some point, investors will really question how it made sense to sign up for 2% pre-tax nominal returns, all while US indebtedness levels climb higher and higher. For the time being, however, USTs are very strong performers this year - especially at the long end (about 25% year over year).
There's going to be plenty of Type I (didn't do what I shoulda done) as well as Type II (did what I shouldn't o' done) error in trading, especially as it concerns instruments with plenty of volatility. Accepting this early, and focusing more on the targets and triggers, as well as taking this into account when sizing position, are the two productive activities in which one can engage. I appreciate getting these kinds of comments from readers.
So often traders go around beating their chest and telling people about how awesome they are. It's refreshing to hear people share battle scars and frustrations, as it's far more authentic and relatable.
There have been plenty of times in the history of writing the MVB where the VX term structure barely moves, sometimes seemingly for weeks. That was not so much the case this week.
For those who trade VX-futures linked products (VXX, UVXY, SVXY, ZIV), movement in the actual futures and not just the index is what drives returns. We certainly saw plenty of movement - between backwardation and contango at that - for these ETPs.
The front-month will switch from the August ("Q") contract to September ("U") on Wednesday morning, with Tuesday being the last full day of trade. Compare the movement in the M2 as opposed to the M1 over the past week. Once the M1 expires, VX futures spreads will likely calm down some, as the U contract will have several weeks before its cash settle date.
Quick observation: once you get to around M3, the futures curve is reasonably flat.
Spot VIX closed near the bottom of its five-day range, having dipped below 18 only a day before the SPX had its worst day of the calendar year. That should be a warning on two counts:
- Falling VIX is by no means some guarantee of calmer waters ahead for equities.
- Though it's certainly lower than what we've seen over the past 12 months, 18 vol points is still 18 vol points. We shouldn't expect markets to behave the way they do when VIX is hanging down around 12.
For the last two weeks, spot VIX has ranged between approximately 17 and 24; it will be interesting to see this week if the index can break through the lower end of that range.
MarketChameleon.com - SPHB (teal) vs. SPY (red) implied vols
Finding opportunities in choppy markets can be fun and/or important, especially if there are factors that you don't have much of a view on. Above I am comparing implied vol on the High Beta S&P ETF (SPHB) vs. the standard SPY. Do keep in mind that while trading volume on SPHB itself is pretty strong, options volumes are not.
Looking at the market from several vantage points - different indexes, sectors, betas - can create different spreads and exposures rather than sticking to one product.
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.
Hats off to a group of commenters in the last MVB, with spirited points made on a variety of issues including causes of bad loans before the GFC, monetary policy, and the nature of deflation. I very much enjoy when people can disagree on interesting and potentially contentious topics without getting rude.
Thanks 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 time frame, and so my trading activity centers around a negative delta for hedging purposes.