trick candle
June S&P 500 & May VIX futures hourly Apr 2024. Source: Barchart.com. Click for larger image
Like a trick candle refusing to blow out, stubborn inflation snapped a five month winning streak for stocks in April as rising interest rates dragged the S&P 500 back to February levels in a decline that saw VIX briefly approach the “Crisis Gateway” zone on Middle East war headlines overnight Apr 18th (chart) before ultimately retreating into month end as a lack of escalation and decent tech earnings calmed nerves. Perhaps suggesting a tax-related cause, selling during the month was focused mainly in the US (Russell 2000 -7.0%, Nasdaq 100 -4.5%, S&P 500 -4.1%) with international markets (MSCI EAFE -2.6%, MSCI Emg Mkts +0.3%) faring noticeably better.
Following signs of worry from hedging markets, TCM portfolio “airbags” began to deploy on Apr 15th with an initial 10% VIX exposure adding nearly 2% in TCM’s Risk Managed Indexing strategies at their peak overnight on Apr 18th before ultimately creating a modest expense as markets bounced into month end in the typical pre-crisis VIX pattern.
Far from a bug, this kind of hedging restraint in pre-crisis conditions is how TCM outperforms its peers during bull markets. For example, as the S&P 500 has gained 21% over the past 6 months, the expense of continuous hedging has reduced an investor’s return in strategies like JP Morgan Hedged Equity (JHEQX) by a hefty 11% versus just 3.2% with Tactical Beta’s tactical approach (chart). The path may be unfamiliar, but in a rising trend, a lighter touch is what produces higher portfolio values.
Cumulative return 11/1/23 - 4/30/24. Source: TCM, Barchart.com. Click for larger image
Similar outcomes can be found throughout Tactical Beta’s history because beyond just “hedging”, TCM’s focus is on risk management- whether from crisis declines or the risk presented by hedges themselves. While there are many strategies that focus on downside risk, very few effectively address the other “elephant in the room”- namely, that outside of a market crisis, the cost of hedging is often a bigger risk than market declines.
Factoring in the historical frequency of market crisis periods, hedging expense risk ultimately dwarfs the risk from market declines and is why insuring against every one leads to lower, not higher portfolio values over time. This is what TCM’s tactical approach seeks to fix and we are encouraged by the tremendous value it has produced in both its crisis avoidance and cost management forms over the past seven and a half years (chart).
Cumulative risk management effect as of Apr 2024. Source: TCM, Barchart.com. Click for larger image. “Hedged Equity Peers” is an equally-weighted composite of JP Morgan Hedged Equity (JHEQX), Swan Def Risk (SDRIX) and Gateway Fd A (GATEX), rebalanced monthly.
strangling the golden goose
In recent years, growth in the United States has been increasingly limited to government agencies and their allies in mega cap tech, using borrowed dollars. While deficit-fueled spending may flatter economic statistics for a time, it is ultimately a hollow victory since government grows only at the expense of the productive economy. By issuing debt and dollars without performing any productive work, the US government is increasingly plundering the wealth of its citizens in an attempt to spend its way to prosperity- a treacherous path that has often lead to disaster not just for markets but for ordinary people.
US Debt / GDP Ratio Jan 1966 - Oct 2023. Source: St Louis Federal Reserve
Based on Japan’s experience as the only high-debt country to so far avoid default, it is not unreasonable to expect “success” of this program to look something like a zombie market of nominal stock market gains without major volatility. Under these conditions, tactical VIX hedging has proven far superior to traditional hedging methods at capturing what growth is available. If instead the experiment is ended by market forces, we would expect a system reset of massive scope, likely led by the failure of sovereign bond and currency markets themselves. In this scenario, we anticipate the VIX would reach unprecedented levels in a tsunami of multiple major crises that clear the way for an entirely new structure.
Today, with banks and governments desperately in need of lower rates but stubborn inflation tying their hands, central banks find themselves in tough spot. Just weeks after the end of the Fed’s “BTFP” bank bailout program, stress in the system resurfaced in April with the failure of Republic First Bancorp (ticker FRBK), a regional bank with $4.4 billion in deposits. With 26 times more deposits and its shares -70% YTD, New York Community Bancorp (NYCB) could soon put further strain on an already severely underfunded FDIC with any shortfall sure to go on the taxpayer tab.
Markets today are surrounded by massive but slow-moving risks that tend to foster complacency. Throughout our 25 years in markets, we’ve watched investors injure themselves in the familiar performance-chasing cycle that encourages buying high and selling low, but the costs of that approach now could be extreme. More than ever, today’s choices are likely to be very impactful to an investor’s long term returns.