broken record
The latest in a series of sharp “V” bounces since the Corona Crisis of Q1 2020, US stocks surged back to all-time highs in October with the S&P 500 gaining +7% in its strongest month of 2021. After initially recovering with stocks, VIX futures were not as sanguine in the back half of the month (see chart below), perhaps viewing the equity rally with some skepticism in light of a potential “stagflation” scenario posed by rising prices combined with unprecedented supply chain disruptions just as the Fed appears poised to being tapering its support of the US Treasury market. Whatever the cause, by our estimation VIX futures are currently overvalued relative to stocks, implying either turbulence ahead for equities or lower prices for hedging positions.
Cumulative return comparison, 10/21 - 10/29
TCM strategies benefitted overall from the rally in markets, with Tactical Beta (+5.8% Oct) and Tactical Q (+6.7% Oct) capturing the bulk of market gains after some lingering hedge expense early in the month. Despite several quick market dips & recoveries which often create hedging expense for Tactical Beta and Tactical Q, “up capture” is running above historical averages in 2021, over 82% for both strategies on the year through October. Also benefitting from higher stocks, Hedged Yield (+3.0% Oct) posted the best month of its young track record while Alpha Seeker (-0.2% Oct) sat out the equity rally in response to the hesitation in VIX futures.
corrections aren’t a crisis
Corrections (declines of less than 5%) are a fact of life in equity markets. They are irrelevant to long term outcomes and very expensive to protect against, yet they still preoccupy investors and the financial industry that caters to them. In our experience, it also seems to be true that the longer markets rise, the more sensitive investors become to corrections. Despite this psychology, the mathematical fact remains that less frequent large declines are the true risk to compound returns, and it is these periods that our approach seeks to address.
The dots on the following chart represent every drawdown for the S&P 500 (i.e., every decline from the most recent peak) on a daily closing basis since the inception of the Tactical Beta strategy. The X-axis measures the S&P's worst drawdown over each episode. The Y-axis measures the Tactical Beta strategy's worst drawdown over the same period (blue dots) and for comparison, an unhedged exposure to the S&P 500 Index (orange dots).
Tactical Beta Strategy drawdown history, Nov 2016 - Oct 2021
During mild corrections (shaded area in chart below), Tactical Beta’s usual “hands off” approach tends to act more like the S&P 500 Index than the common perception of a hedged strategy might. For all S&P 500 drawdowns up to -5%, the cumulative hedging benefit of the Tactical Beta approach (the cumulative difference in Tactical Beta and SPX drawdowns) has amounted to +1.5% since Nov 2016. In short, the Tactical Beta strategy doesn't address the mild drawdowns that most investors are consumed with. Of course, if S&P drawdowns were always mild then hedging at all wouldn’t make much sense!
The difference starts to be seen in the “gateway to a crisis”, after the 5% drawdown mark (shaded in the chart below) where Tactical Beta strategy has historically provided the bulk of its positive spread over the S&P 500 Index. For example, in the three S&P drawdowns in excess of 10% since Nov 2016, the cumulative hedging benefit comes to 36.5% for the Tactical Beta strategy. The technical term for this is "convexity"- in other words, the benefits of the Tactical Beta approach haven’t come from a good batting average, but by being "right" when it counts. As the strategy’s results can attest, this might make all the difference for an investor’s compound return over time.
