Volatility returned in the first quarter with vengeance after almost 18 months of straight up market. I have been very busy at work so I am doing one update for the first quarter. During this period, we had the largest correction since early 2016 and the stunning collapse of the short VIX ETFs, SVXY and XIV, the latter has been my favorite trading tool for the past 7 years.
Our portfolio lost 1.7% in the first quarter comparing to the 1.2% loss of the S&P 500 index. Along with the overall financial markets, our portfolio experienced significant drawdown in January and Match. After a very nice gain in early January, we had a 13% drawdown in late January and early February while the S&P 500 index lost 10% in the same period. This is not surprising as we had about 1.3X leverage. The most stunning of all is the complete collapse of the short VIX ETFs, SVXY and XIV on February 5th. These ETFs tracks the inverse of 30 day VIX futures. During a 15 minute period, from 4:00pm to 4:15pm on February 5th, the 30 day VIX future went up 80% and brought the full day increase to more than 100%, essentially wiped out XIV and SVXY. XIV was subsequently liquidated. SVXY survived but lost more than 90% of its value. We had XIV position in January but sold our position one week prior to the collapse when our preset sell signal was triggered. I had anticipated that the collapse could happen under extreme conditions, e.g. a bad terrorist attack or a significant natural disaster. It is baffling the collapse was triggered by a moderate correction of the financial markets. The most reasonable explanation is that the short VIX trade had become too popular and crowded. There were huge short VIX future positions. When things went bad and everyone was rushing for the exit, XIV and SVXY were forced to cover their short VIX future positions causing a huge short squeeze. We will continue using SVXY as a trading tool and will maintain its weight in our portfolio at no more than 10%. Proshares has announced that the leverage level for SVXY will be reduced to 0.5X. This is good news and will help reduce it's risk.
Going forward, fed tightening cycle and the possibility of a trade war between the US and China are the largest risk. The fed tightening cycle is a longer term but more important risk. In the short to mid term, the market will focus more on the prospect of a trader war. The danger of some sort of trade conflict is a high probability event and the market will likely continue to be volatile for the next a few months. Longer term, despite all the headlines, I don't anticipate it will materially impact the US economy. A compromise will eventually be made but it may require some pain on both sides, i.e. the recently announced tariffs on both sides may actually have to be enacted to cool some heads for a meaningful comprise. Nevertheless, we will stay our course and focus on where the trends will lead us.