A shift in focus
S&P 500 E-Mini Future, 5m bars intraday 10/13/2022. Source: TD Ameritrade. Click for larger image
After weighing on stocks in the weeks ahead of its release, higher-than-expected CPI data on Oct 13th ironically marked the month’s lows with a massive intraday reversal (left) sparking a broader rally that took the S&P 500 +8.1% higher for October while the pressure from interest rates led to a relatively muted +4.0% gain for the growth-oriented Nasdaq 100 index.
Per usual, VIX prices mirrored the action in equities with initial strength eventually giving way as stocks rallied, producing moderate trading profits for Alpha Seeker and typical up-capture ratios for Risk-Managed Indexing strategies as the VIX Index returned to the low end of the “wedge” between crisis and bull market zones (below) that has contained VIX exposures throughout the year.
VIX Index, Oct 2019 - Oct 2022. Source: Yahoo Finance
Since VIX levels are set mainly by demand for S&P 500 put options, this wedge implies elevated activity but a lack of “tail risk” hedging in the options market. Should the odds of a crisis scenario increase, any spike in the value of S&P 500 “crash” puts will be similarly reflected in the VIX.
Taken together, this year’s price messages seem to be acknowledging elevated risk while also anticipating a market-friendly central bank “downshift” (slower pace of rate hikes) and eventually a “pivot” (rate cuts) as inflation recedes. In October, a surprise downshift from the Bank of Canada (50bps hike vs 75bps expected) and an article from the Fed’s informal mouthpiece at the Wall St Journal contemplating the same in the US did little to dissuade that notion. In the context of a rough year for stocks and heading into seasonally bullish holiday period with midterm elections approaching, hope may be all that’s needed for another rally before markets are faced with whatever consequences result from this year’s sharp adjustment in rates.
Portfolios are judged with the precision of the past but must be managed with the ambiguity of the future. This conundrum creates tension for investors and very often, a restlessness that only compounds the issue. While easier said than done, we believe this issue is best addressed through consistent alignment with favorable probabilities, even through periods when outcomes aren’t favorable.