The Fed and Market Indigestion

In a move that would typically provoke double-digit responses, the S&P 500’s +3.3% jump in August barely registered for VIX ETPs that are the “raw material” for Alpha Seeker as it seeks out trends in these instruments. Surveying similar action on the year as a whole, 2018 is now beginning to recall memories of the turn in the last major VIX loop in 2007.

Much like this year, the early 2007 VIX low was followed by a shock in February which resulted in a new, higher floor for VIX even as the S&P 500 went on to make new highs in the fall. Then as now, the trendless but volatile VIX environment was a challenge for Alpha Seeker which recorded the only negative year in its backtest in 2007. Neatly fitting our Vol Loops thesis, this was then followed in 2008 by the simulation’s best year. It is also notable that the largest long VIX ETP (ticker VXX) is still positive on the year as of August for just the third time in the index’s 14-year history and second only to… August 2007.

In our experience this type of VIX action is an indication that the market is wrestling with big issues, and it is perhaps no coincidence that it is occurring three years into the first rate-hike cycle since 2004 – 2006. In a world economy saturated with record debt at all levels, it is reasonable to expect the credit cycle led by the Fed to continue to be the major factor for asset prices and volatility. Whatever course the market takes after its “indigestion” ends, we will continue to take our cues from the dashboard rather than any predictions.