Market Volatility Bulletin: All's Well That Ends Well

Sep. 05, 2019 12:17 PM ETAGG, DIA, IEF, IWM, QQQ, SPY, SVXY, TLT, XLRE, XLU, ZIV11 Comments

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Summary

US stocks are pacing hard with SPX nearing 3000 again, while VIX retreats below 16.
Haven't we seen this hope and optimism before though?
Familiar VX futures pattern reasserts itself, and it's worthwhile to take a look at sectors based on your belief about how sustainable this recovery is.

Market Intro

CNBC 10:58AM EST

Between Wednesday and Thursday morning, spot VIX has taken a thrashing. The latest is that the trade talks are making positive progress, and hopes are high for a productive October on that front.

Bond yields (IEF, TLT, AGG) are up, as are the major US indexes (SPY, DIA, QQQ, IWM).

Thoughts on Volatility

As a matter of fact, Stock Cats, I do vaguely recall this cycle occurring across very similar lines over the last two years. What's more, maybe this will not even be the final rotation.

It's been an ongoing source of volatility. I'll contend that it's slowed the overall ascending pattern of equities. Sure we've managed new highs. But there is no comparison between the risk-return profile of 2018-2019 with that of mid-2016 through 2017. Vol is down today and may remain so for some time. But trade will probably rear its ugly head again over the next few weeks as a "newfound" source of panic.

The data is spotty. There's really just no way around this. We get a spat of good readings, and then a dollop of poor readings. At this point a lot centers on what the Fed chooses to do. With pretty much the entire UST yield curve trading below Fed Funds, I really don't see how they could avoid loosening for a quarter or two.

Thanks Eric. It's a reasonable concern, and even gets addressed in CFA material as it relates to criticisms against the Efficient Markets Hypothesis - if nobody is paying attention (i.e. passive investing), then how can markets properly price risk?

The theoretical is that at least some players will actively manage their holdings, and they will arbitrage the gains from research, leaving the markets efficiently priced in the wake of their decision making.

That seems a little hokey to me. I think passive investing today probably has a lot more in common with momentum theories than with true research. I also think this may be part of the reason that vol at times gets almost preternaturally low.

Term Structure

It certainly looks as though the very familiar pattern of VX contango and roll yield benefitting short players (SVXY, ZIV) is about to assert itself once more.

Given how cyclical this relief-panic drama has become regarding trade, I think one might want to roll back any short exposure fairly quickly to the back side of the curve. Not quickly as in hours, but as within gradually over a few days.

The exception here is if you believe that the way has been paved for a real drop in volatility. That may sound silly, but you don't have to look much further back than mid-June of this year, let alone early January through April of 2019. So if you're short, I think you give some thought to how much relief we get from the aforementioned cycle.

By way of example, today's term structure in gold is pretty much in the middle of the pack of term structures for a sample going back to mid-July. So much of the future direction here is dependent upon your view to sustainability of the current sentiment.

E-Trade

On that same note, you'll want to give a look to how the various sectors are trading. If you believe, for instance, that the marked rise in yields is part of a larger story, then you might want to trade some options in the rate-sensitive sectors of the market (XLU, XLRE).

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.

SA published a piece I did regarding September as a "scary" month for stocks. Click here for the read.

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This article was written by

The Balance of Trade

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Adam Zingg, CFA offers both practical and theoretical perspectives that will benefit readers who wish to learn more about how to execute on views or strategies that interest them. Whatever your overarching philosophy or expertise, I believe there is value in understanding how trading works. This is perhaps especially true for investors, who often take a more philosophical, less mechanical view when it comes to their processes. It is not my goal to:1) convince you which side of the market to be on2) establish your trading time frames3) have you directly follow any specific trade ideasInstead, I aim to demonstrate how complicated sounding ideas can be simplified and accessible. My hope is to grow your tool kit of resources, and give you healthy confidence to execute your own personalized strategy. Trading and investment are fascinating, applicable across a wide variety of fields and disciplines. Greater focus on targeting, execution, and exit strategies build transferable life skills. In reading my work, it is my goal that you will consistently glean useful insights and build skills that enhance your ability to trade and make important decisions.

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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.