VXX And The Risk Outlook - The Fed Trigger

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Markos Kaminis
13.18K Followers

Summary

  • Investor angst about this week's Federal Open Market Committee monetary policy meeting is behind market volatility, in my view.
  • As a result, the iPath S&P 500 VIX Short-Term Futures ETN has had an upside bias.
  • The move could reverse sharply Wednesday, if a dovish taper message is delivered and digested well.
  • Gains in volatility could accelerate if the FOMC delivers a hawkish surprise.

Volatility Ahead
Altayb/iStock via Getty Images

The risk outlook for this week is especially interesting due to one key factor event. The U.S. Federal Reserve will hold its September monetary policy meeting with its decision and statement set for 2:00 PM EDT release Wednesday, and with the Chairman's press conference to follow at 2:30 PM. As a result, option premiums have fattened fast this week in the iPath S&P 500 VIX Short-Term Futures ETN (BATS:VXX). The VXX itself should display an upward bias into Wednesday. What happens to markets and to the VXX after the Fed event will depend greatly on how markets behaved heading into the event and on the information that comes out of the event itself.

Despite the Fed's best efforts to temper investor angst about its expected near-term tapering of extraordinary quantitative easing measures, the market will remain concerned about a possible Fed miscalculation. I believe this was one of two key reasons why volatility picked up last week (the other being the threat of tax increases), and why markets began to show weakness. It is entirely possible that we could see a significant upward move in the VXX this week (+50%); one like the spike we saw in May. An even greater spike is possible if a market correction is catalyzed.

Chart
Data by YCharts

A long-term chart of the VXX security clearly illustrates that this is not a security to be bought and held long-term. Rather, it is probably best employed as a short-term hedge to broad portfolio risk when deemed appropriate by sophisticated portfolio managers. Aggressive investors or "risk lovers" may find speculative appeal in these securities at moments of market misbehavior.

Chart
Data by YCharts

Last week's charts of the VXX security and the SPDR S&P 500 Trust (SPY) reveal that something was up. Volatility gained investor attention and stocks lost some favor. I believe that last week gave us a taste of what we are seeing in full display this week.

The Fed Trigger

The catalyst is clear with regard to what is driving investor angst. We have a Fed policy meeting this week. In his Kansas City Fed Symposium address, normally held in, and known as, the Jackson Hole meeting, Federal Reserve Chairman Powell did his best to quell investor concern about the forthcoming "tapering" of the Fed's extraordinary policy measures. Specifically, the Fed Chairman wanted to alter market perception, I believe from the point of view that tapering is just the first step, to be followed by hikes of the Fed funds rate. The Chairman conveyed that any future consideration to raise rates would be based on a more critical standard. He basically implied that the idea of rate hikes was not anywhere near the decision table just yet.

That said, the market is a savvy character and knows very well that the Fed is simply doing its best to not cause a stock market correction. Normalizing monetary policy and the Fed funds rate would be prudent as the economy normalizes. If the economy starts to overheat coming out of the pandemic, the Fed could need to abruptly raise rates.

Nonetheless, rising rates presents the risk or likelihood of higher discount rates against which the forward forecast cash flows of corporations will be measured. Greater discount rates, in isolation and absolution, translate to lower business and stock values. Nothing should be only considered in isolation, but the simplification of problems is common to human nature. And then there is the risk of Fed policy error. If the Fed is acting prematurely, it could catalyze a recession.

So, market angst is justified, and the sharp rise in volatility instruments like the VXX, understandable. Long or long hedge positions (against market risk exposure) in the VXX security should prove profitable at least into Wednesday, but they could reverse sharply as early as Wednesday. However, if the Fed statement justifies or raises market angst, say with the start of tapering, which is unexpected for this meeting, then a full-fledged market correction could ensue. In that case, the VXX could mark over a 100% gain, in my view, and stocks could drop 10% to 20%.

This is a short-term perspective. I generally view market corrections as buying opportunities and would look to short volatility and VXX post these instances, depending on specific circumstances. If this week's FOMC policy meeting provides another dovish taper message, and stocks enjoy a relief rally, thereafter, look for volatility to be revisited in early November and/or mid-December around those Fed meetings, depending on developments. I will update my followers of my view for the markets and volatility as events demand.

This article was written by

Markos Kaminis profile picture
13.18K Followers
Markos N. Kaminis generated a 23% average annual return on "Strong Buy" stock selections over 5 years while working as a Senior Equity Analyst on Wall Street. As an internal whistle-blower, I sacrificed absolutely everything to do the right thing. And despite being an eyewitness and victim of terrorism on 9-11, I am currently volunteering at a busy border crossing helping Middle Eastern & North African refugees, most displaced by war or other horrors, to land safely in Europe. Despite my life experiences, I still have hope, and believe that we must persevere with patience (forgiveness), tolerance and love. I have determined to struggle for the better good of my brethren rather than for myself, and you'll see that play out over the course of the rest of my life. But I worked far too long and hard to become an excellent stock-picker to not incorporate this work into the fold. Markos N. Kaminis generated a 23% average annual return on "Strong Buy" stock selections over 5 years and ranked 2nd among a group of 60 analysts in-house as a Senior Equity Analyst over a seven-year period at Standard & Poor's. After proving his value in-house, he was promoted into a special role as an idea generator, supporting the portfolios of institutional clients as well as driving performance within S&P's recommended lists and portfolios. At times, Markos was responsible for up to 10% of the firm's entire "Strong Buy" list and is due a great deal of credit for the group's outstanding performance during his tenure. Markos followed a group of 30-40 Small and Mid-Cap firms, and was charged with finding new buy and sell candidates across industry sectors. He generated a 23% average annual return over five years on his "Strong Buy" recommendations, and 26% over three years ended 2004. He was ranked 1st of 60 analysts in-house for his "Strong Buy" performance over 4 years (2nd over 5). Markos also authored IPO research and wrote for high-level newsletters, The Outlook, Equity Insights and Emerging Opportunities, as well as for BusinessWeek Online. He represented his firm as an analytical expert commentator for major media, including television, Internet and through quotes and interviews in reputable publications. Besides predicting the stock market correction of 2015 through a series of prescient reports here in August. (see proof here: http://seekingalpha.com/article/3482226-investor-who-predicted-the-stock-market-correction-offers-an-update ), Markos also advised investors to buy stocks at the bottom of the market in mid-February 2016 and again post-Brexit at the trough, and to buy gold in January 2016 before the commodity started its move higher. More recently, he called the pickup in the economy for 2018, the upward move for stocks in 2018, and the breakout in oil, starting in June of 2017. See: June 15, 2017 – Buy Oil Back Now; August 1, 2017 – Why Oil Prices Will Break Out – The Demand Driver; September 30, 2017 – Why Oil Prices Can Break Out Part II: Vulnerable Supply; and January 26, 2018 – Up 44% Since Our June Bullish Turn – Oil Still Supported Here. While not perfect, over the years, Markos has made countless correct market and security calls for his followers, including forecasting the demise of J.C. Penney on the heralded CEO hire's disruptive plans, the bankruptcies of Washington Mutual and Pilgrim's Pride in the $30 and $20s, respectively, as well as the purchase of Facebook in the mid-$20s when it was considered a pariah post its IPO (today it is a market darling). Markos also warned of the real estate market collapse and the financial crisis in the early days of his blogging. What I personally want you to know about my plans: After witnessing the worst of Wall Street firsthand and having the ideal vision of my childhood career choice corrupted by reality, I almost switched to full-time charity work at age 40 and still have plans for several non-profit endeavors. The future is somewhat unknown, and I am open to employment offers for portfolio management or other ideas. While continuing to publish regularly, I expect to begin work on several book ideas that I believe are important for business, for our nation and for society. I may put  my stock selection skills, earned through blood, sweat and tears, to better use, and to make my own way. I would like to give investors something rare, a dignified partner who can manage money with integrity and a clear conscience about the degree of due diligence behind investment decisions... someone who cares more about your money than your wife. I hope readers will become followers of my column here & at my blog, so that when our numbers are substantial, we might start an investment fund or two. Prior to his Wall Street career, Mr. Kaminis spent time in the back-office, as a mutual fund accountant, where he managed for a time the work of two men. Before this, from age 11 to age 25, he worked as a carpenter's apprentice and carpenter with his father, in both commercial and residential projects. Mr. Kaminis has an intimate knowledge of the real estate (undergraduate degree in Real Estate and Finance) and construction market, as well as the restaurant industry. However, as a generalist stock analyst, he showed the ability to learn any and the most complicated of industries in short time - and he gamed every challenge presented to him. Mr. Kaminis earned his MBA at the Katz Graduate School of Business at the University of Pittsburgh, and his BA at Temple University in Philadelphia. However, Markos has been studying the stock market since age 13, when he determined his career path. He made his first investment at age 16, and funded much of his undergraduate education with the proceeds of his investing success. Mr. Kaminis continues to keep busy forecasting the economic path and securities market activity. Markos is considering the eventual start-up a long/short capital appreciation hedge fund. Such a fund would limit risk through beta reduction, using a diversification strategy targeting sector & industry and long & short position inclusion. At the same time, Markos' theoretical fund would seek maximum capital appreciation through the exploitation of Mr. Kaminis' inherent economic & market discernment gift and proven stock selection skills. Mr. Kaminis also has a team of a select few analysts, technicians, strategists and economists that he has been impressed by over the years, which he expects to tap for the project when the time is right. Mr. Kaminis welcomes your interest in such a potential forward effort, and looks forward to discussing his plans with those appropriate and within legal constraints. Markos toys with very early stage entrepreneurial efforts in the testing of certain business models, all of which he intends to tie to a planned non-profit project serving the most helpless among us. The tie will be that the businesses will give employment opportunity to individuals who would otherwise have difficulty finding gainful employment. It will house and heal the homeless, ex-convicts, those completing rehabilitation efforts for drug and other addictions, and others in need of help. Markos is currently Directing the widely syndicated blog he founded, "Wall Street Greek," and is writing for other well-known publications besides advancing several big ideas. Markos' column is syndicated across sites like the Boston Globe, Kiplinger Magazine, UPI and other reputable newspaper and TV websites, as well as private networks, Amazon Kindle, iPhone and more. In the past, he has written for RealMoney.com, Motley Fool and others. Requests to research specific companies are welcome, as we serve our readers. You may contact us via this blog's contact info. Mr. Kaminis welcomes you to follow him here at Seeking Alpha, where he is proud to be a long-time contributor to this strong team of writers. He considers the Seeking Alpha team and management close friends, and for you, people worth knowing and following. Visit his site: Wall Street Greek (http://www.wallstreetgreek.blogspot.com/)

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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: Volatility Instruments are a Special Breed of Security Worthy of Special Disclaimer

This article is not investment advice. This article is meant for regular and experienced traders of volatility instruments and market enthusiasts, as a guide to my macro market expectations and how those might influence these securities. Also, trading in options is highly risky and is not advised for the great majority of traders and investors. Speculative option bets can result in the fast loss of your total investment, or much more. It certainly is not advisable for inexperienced investors, risk averse investors, investors dependent on income from holdings, or long-term investors. Also, everyone should consult a personal financial advisor, who will learn the intimate details of the investor’s goals, needs and requirements before providing tailored investment advice to that individual investor.

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