Is The VIX Warning Us Of Another Calamity To Come
August is typically a lesser performing month for the S&P 500, only to be outdone by September. September is historically the worst performing month of the year for the stock market. August is also, historically the most volatile month of the year with September following suit to a lesser degree. For the aforementioned reasons, the dog days of summer that lead into the Autumn months find the market with lesser volume and suspect moves. But history is not always a proven guide.
With one full week remaining, the Dow Jones Industrial Average has gained 1.5% in August, the S&P 500 index is up 2.1%, and the Nasdaq Composite Index has advanced about 3.6 percent. Of all the months whereby the S&P 500 would achieve a new record high level, August and September were the unlikely months for such an achievement, nonetheless, here we are. Additionally, the S&P 500 finished the week above the previous record closing high. All in all, the S&P 500 is up some 6.6% YTD, recapturing all that it has lost since the February-March correction. It has been a long, hard-fought battle for the S&P 500, climbing a wall of worry that seemed ever growing with each President Trump tweet, threats of tariffs and the implementation of certain tariffs, fears of inflation, a flattening yield curve and more. Even so, the S&P 500 managed to do what it historically does, following the trajectory of corporate earnings. On the other hand we have heightened levels of volatility, which I'll get to a bit later.
Since the correction commenced back in February, there have been a host of market pundits, economists, analysts and fund managers making the case for a bear market. With every month that passes and every headwind put before the market/investors, would-be market forecasters offer a plethora of rationale for further market declines or at least a market that would be flat to down in 2018. The rhetoric hasn’t curtailed much since February, despite the trajectory of the S&P 500 since and as we close out the final trading week of August.
In a recent article by Finom Group (for whom I am employed), I offered up one of the infamous permabear perspectives that are consistently found with era. David Stockman has been warning about this bull market cycle that is the longest in history. He's been committed to his warnings since 2010 at the very least.
Within the article titled Political Headlines & Permabears vs. Record Setting Bull Market, I demonstrate David Stockman’s many headline-grabbing forecasts since 2010. All of his forecasting projected a bear market is upon investors and that they should reduce risk. But Stockman is just one of the many permabears outlining and forecasting doom for investors. In fact, there is an entire web-based publication called ZeroHedge that is dedicated to highlighting and headlining fear as its means of fostering a doom and gloom perspective for investors. One thing that most permabears have in common is a rooted conspiracy theory about the government and/or the market.
With that said, let’s look at one prominent chief investment officer. Scott Minerd of Guggenheim Partners warned investors heading into the month of August. As it has become customary, he pondered, via Twitter, whether the market’s optimism about stocks was misplaced.
At its current pace, stock benchmarks are poised to produce the best August return in four years. That puts Minerd’s forecast in steep jeopardy heading into the final week of the month. In earnest, however, anything can happen this coming week and especially with volumes being as light as they are presently. At present, S&P 500 volume is 18% below its 50-day moving average.
Is this unusual or alarming? It's not really unusual and in fact its par-for-the-course during the dog days of summer. Nonetheless, it is something to be aware of and possibly understand in hindsight, should something rattle markets near term and produce outsized moves.
As it pertains to the permabears and those generally found fearful of the market trade in 2018, I understand it’s not easy to block out all of the noise and focus on the key drivers of the market. Fears surrounding weakening economic performance abroad, midterm elections, trade negotiations between the U.S. and China, wage inflation and/or lack thereof, consumer and corporate debt levels and concerns that the differential between the rates of short-term and long-term Treasury debt, specifically the 2-year Treasury and the 10-year Treasury notes could forecast an economic slowdown have persisted throughout the year. But keep in mind, GDP recently had its best result in several years.
As I look back on what has been a very turbulent and truculent 2018, I’m forced to recognize that the greater portion of our work at Finom Group has centered on debunking headlines and quelling fears. As I’ve remained focused on driving fact-based economic and corporate earnings content, the media performs its own rendition of this exercise that is largely rooted in gaining viewership and ad revenue. Regardless, my forecast for the market never wavered under the pressure of both fearful media headlines as well as the greater market volatility. As the chief market strategist for Finom Group, I believe that a strong economy drives strong earnings, which in turn drives the market. To the extent that fear of “this and that” produces various degrees of market pullbacks, these pullbacks have been market-buying opportunities given the underlying fundamentals. In other words, value trumps fear and corporate earnings continue to validate such value in the absence of realized consequences the fear heralded in the first place. For example: There is a lot of fear surrounding trade wars, but to date, its weight on the economy has been inconsequential and as earnings have grown nearly 25% in the first half of 2018. And let’s not forget that some of those dip buyers are the corporations themselves which will be allocating some $1trn worth of buybacks in 2018. On to discussing volatility, after all, that is what I'm most "infamous" for.
Last week’s market performance, that ended the week with a strong Friday SPX trade didn’t find with it the usual market volatility/VIX decline. Don’t get me wrong, the VIX itself was down some 3.38% and dipped below 12 to end the week. More importantly, though, VIX futures didn’t move as much as one might think and as depicted in the daily table of futures contracts from the CBOE.
While it’s true that post VIX futures expiration, which also occurred last week Wednesday morning, there tends to be lighter futures volume and some rebalancing, these may be no lesser an excuse for the activity than… well any other excuse one throws at the little changed m1 and m2 contracts on Friday. Recall, the S&P 500 was up .62% on Friday and closed at an all-time high.
What’s funny about the consternation concerning Friday’s “lack of volatility” (in quotes because it didn’t lack enough for many volatility traders) is that it may prove to be nothing, nothing at all. While many would have expected the VIX to plunge further and VIX futures to express greater decay value, they didn’t. Truth is, this happens nearly every month and at least once a month and it’s bewildering activity lends itself to the same consternations every month that can be reviewed in social media tweets. But here’s the deal and why it means more to traders or investors today. It carries more weight today because of what happened in February of 2018, Volmageddon/Volpocolypse. Through January and into February, the VIX rose alongside the SPX, a rather unusual occurrence.
Moreover and beyond the general VIX-SPX correlated moves, as the VIX is dependent on the SPX options participation for metric performance readings, the SKEW has maintained a high level over the last 30 days. The grand takeaway here is that the SKEW remains high due to hedging activity. We can see the mounting hedging activity within the SKEW chart that shows progressively higher lows… well, since April. Additionally, the SKEW reached a record level earlier in August.
That’s the bottom line! As the S&P 500 has scratched and clawed its way back from the depths of 2018, it has done so climbing that wall of worry that I discussed earlier, and with hedging programs implemented along the way. In short, investors have been once bitten in 2018, and proven twice shy. This is also the case because of all the aforementioned reasons to be concerned about the market.
Even as the SKEW remains elevated and important to recognize, Volatility of Volatility (VVIX) has come down since mid-August and now is below 95. If VVIX were above 100 with SKEW where it is or even higher presently, I’d be a bit more concerned about the market near term. Nonetheless, the current levels for both VVIX and SKEW juxtaposed with the SPX and low reading on the VIX does give a short-VOL trader “cause for pause”. Additionally, given the aforementioned, this might be exactly why hedging is prolific at present. With the SPX at all-time highs and the VIX below 12, historically very low, fund managers are forcing themselves to hedge downside risk i.e. twice shy!
When I look to review CoT VIX Futures activity, here’s another interesting factoid.
As depicted in the chart from Hedgopia, net short interest in VIX futures has fallen week-to-week by some 22% and to a 4-week low. Currently, net short futures are 101.8k, down 29.6k. The good news is that another Volmageddon-type event is unlikely given the level of participation in VIX futures presently. The bad news is… well we don’t know...yet. And maybe there’s nothing to know other than these are the sets of data, facts or circumstances presently shaping the VIX and the SPX. While some are fearful that today's market breadth and sentiment are running hot, the fact is that sentiment is not nearly as hot as it was back in January, per the Investor Intelligence readings.
There is more noise than ever before in the markets and little of it is consequential. Over the long haul, the market is always prone to pullbacks and prolonged upswings, much like the VIX is prone to surges and prolonged complacency. For both the SPX and VIX, we’ve seen the latter occurrence more so than the former and as such, September might bring about some degree of mean reversion. The data presented is somewhat offsetting. Simply because VIX futures and VIX-ETPs didn't perform akin to its usual SPX movement correlation in a single day is not reason enough for fearful trading. More importantly is knowing the facts, the data and juxtapose what we know with our YTD performance and goals set for the year. Knowing the facts and data helps aid investors with respect to risk management. What is your YTD performance and given the data at hand, what are you willing to risk?
Nice article Seth... good timing