stag party
YTD Return as of 4/29/22 Source: Yahoo Finance
Harsh lockdowns in China brought the “stagflation” boogeyman back with a vengeance in April as growth fears and spiking interest rates weighed heavily on stocks (S&P 500 -8.72% MTD) with particular focus on high-multiple tech names (Nasdaq 100 -13.37% MTD).
While stocks returned to the year’s low on April 29th, VIX futures (VIXY: ProShares VIX Futures ETF) remained below 2022 highs and 10% lower since the previous S&P 500 low on March 8th (see chart above), continuing to treat this episode as a 2018-style earnings multiple contraction rather than a 2020-style economic crisis.
Following this message, TCM hedging exposures were hesitant to deploy in April but ultimately produced marginal outperformance for Risk-Managed Indexing strategies, while the active trading and low correlation of Alpha Seeker (+1.3% Apr) continues to be a bright spot in 2022.
YTD returns as of 4/29/22. Alpha Seeker and Tactical Beta net of 1% management fee. Source: Yahoo Finance, TCM.
point break
Like every price control in history, the Fed’s attempt to set interest rates by committee has been riddled with failure, creating either shortages or surpluses in the flow of capital that give rise to the familiar boom and bust cycle in equity prices. Indeed, just the anticipation of recent rate hikes has flattened the 1-year trailing return of the S&P 500 to -0.50% as of Apr 29, recalling similar figures during the last rate-induced slowdown in 2018 (see chart below).
1 Year Returns as of 4/29/22. Source: Yahoo Finance
Along with enabling the misallocation of capital with excessively loose policy, the Fed has a history of raising rates until a market crisis forms (see chart below). In a globally interconnected system, any failure has the potential to propagate quickly and it is in this scenario where VIX prices become unhinged and provide powerful protection during periods like the Great Financial Crisis in 2008, the US Debt Downgrade Crisis in 2011 or the Corona Crisis in 2020. Especially in these periods, VIX protects like an airbag, not a seatbelt.
10 Year Treasury Yield and crisis periods, 1970-2022. Source: Bloomberg
In its previous attempt at tightening in 2018, the Fed reversed course only after the system started to seize up in December, prompting a violent equity selloff and an unusual Christmas Eve statement from Treasury Secretary Mnunchin reaffirming the capital positions in major US banks. Having treated the initial decline with much the same disinterest as we’ve seen this year, VIX futures finally exploded higher with clear crisis signals, providing a substantial cushion for the Tactical Beta strategy that month.
In the 1970s, stagflation (slowing growth with rising prices) was ultimately solved with aggressive rate hikes and a sharp recession. With inflation now well above the Fed’s stated 2% target, the same prescription may ultimately be called for. In a system now more leveraged and interconnected than ever, the monetary central planners certainly have their work cut out for them.