Signal Flares
Continuing its dance around the 10% “correction” level first reached four weeks ago (1/24), the S&P 500 shed 3% in February while creating alternating signals of panic and calm in the VIX marketplace that benefitted the nimble Alpha Seeker strategy (+0.3% Feb) while continuing to keep hedge profits elusive for other TCM strategies which fell mostly in line with their underlying indexes.
Amazingly, the market’s indecision persisted even through news of war, with an enormous intraday reversal that saw stocks end higher and the VIX lower after headlines of Russia’s invasion of Ukraine on Feb 24. Even at their peak that day, VIX futures (VXX: iPath VIX Futures ETN) remained below the year’s high set on Jan 24, providing an underwhelming hedge for stocks which declined nearly 3% over the same period (see chart below).
VXX (iPath VIX Futures ETN) daily price ranges, YTD 2022. Click for larger image
VIX prices reflect the anticipated variability of equity prices. In contrast to an exponential rise during the uncertainty of a crisis like Q1 2020 (see charts below), the VIX plateau after TCM hedges began in mid-January suggests expectations of volatile but rangebound equities. While this estimate has remained roughly accurate, VIX prices and hedging results have remained similarly rangebound.
S&P 500 and VXX (iPath VIX Futures ETN) YTD return comparisons. Click for larger image
After years of Fed-enabled denial, inflation is finally forcing investors to confront the realities of a hyper-leveraged financial system. VIX and equity markets are so far treating this as a chronic issue that will be addressed slowly and smoothly over time, but markets rarely move in smooth lines. As we saw with the last “rate scare” in late 2018 and early 2019, the situation can change quickly with even the slightest word from our leaders. With foreign policy now thrust into the mix, the stakes have been raised further.
No two markets are exactly alike, and there will be many twists and turns in the road ahead. We won’t navigate them perfectly, but will trust the collective wisdom of the VIX marketplace to continue guiding us to long-term success.