against all odds
US stocks recouped a third of the year’s losses in July with the S&P 500 (+9.2%) and Nasdaq 100 (+12.6%) turning in their best monthly performances for 2022 on renewed hopes for a Fed-engineered “soft landing” that would see growth slow just enough to contain inflation without tipping the economy into recession. After some hesitation around the mid-month Fed decision, VIX futures (VIXY: Proshares VIX Futures ETF) are now an astounding 4% lower on the year through July, producing a hedging drag for TCM strategies despite a 13% YTD loss for the S&P 500.
YTD Return as of 07/29/22. Source: Yahoo Finance
For now, it appears that the VIX / S&P relationship has begun to normalize by way of “scenario 1” outlined in our recent market update: an equity rally that has benefitted US equity exposures (Tactical Q, Tactical Beta, Hedged Yield) while foreign equities (EAFE and Emerging Markets Smart Indexes) continue to struggle with the dollar’s ongoing strength. Showing the flip side of non-correlation, July’s one-way equity move produced a loss for the “fade the rallies” approach that had benefitted Alpha Seeker so far in 2022, putting the strategy back near the flat line for the year.
eye of the beholder
Despite historically long odds, a “soft landing” scenario seems to have been the hedging market’s base case all year, resulting in VIX complacency that has precluded any hedging benefit thus far. July’s rally was a welcome reprieve that began to normalize the VIX / S&P relationship from the S&P side and now begs an important question: is the Fed really about to pull off a miracle, or is this just the eye of the storm?
“Everyone thinks the Fed can handle this, (but) that hurricane is right out there down the road coming our way we just don’t know if it’s a minor one or Superstorm Sandy or Andrew or something like that; you better brace yourself.”
The answer to this question leads in two very different allocation paths, “miracle”: offense, “eye”: defense. Looking backward, it’s clear that hedging markets have mostly been voting for a miracle. Looking forward, the “soft landing” will either come to pass and likely fuel a further equity rally, or it will fail and potentially spark a major “catch-up” move for the VIX.
TCM strategies were designed to take the guesswork off of advisors’ plates by moving in either direction based on a robust quantitative framework. With a challenging period having now led to this important crossroad, perhaps the most important question is: should one invest looking backwards or forwards? Looking at present conditions, we see substantial potential ahead.