Bank failures spark panic before emergency measures calm nerves
Mega-cap tech lifts S&P 500 to 2nd consecutive quarterly gain, Nasdaq to best quarter since 2020
Bank stocks and small caps still floundering
stress fractures
2-Year Treasury Yield, 3 day chg 1976-2023. Click for larger image
Stress fractures from higher rates began to show in March after mounting losses at Silicon Valley Bank created a deposit flight that culminated with the 2nd largest bank failure in US history on March 10th, sparking a panicked move in the 2-year Treasury note (see chart) and above-average reactivity of VIX futures (VIXY: ProShares VIX Futures ETF) to daily moves in the S&P 500 as fear intensified.
In a classic contagion, concern quickly spread to other banks, forcing the closure of Signature Bank of New York, a fire sale of European giant Credit Suisse and various emergency liquidity measures to stem the bleeding. Recalling the failure of Bear Stearns in March 2008, the Fed’s stop-gap measures then managed to spark a relief rally in large cap equity indexes but notably failed to resuscitate financials or small cap stocks (see chart).
MTD Return, March 2023. Source: Yahoo Finance. Click for larger image
Buoyed by mega-cap tech names that benefitted from sharply lower interest rates, the S&P 500 (+3.7% Mar) saw its second consecutive quarterly gain and in another blow for backward-looking “first order” analysis, the Nasdaq 100 index rose over 20% to record its best quarterly performance since 2020.
After the adjustment period in early 2022, more favorable conditions since the peak of inflation have produced gains for TCM Risk Managed Indexing and other strategies over the past 8-9 months, paying investors during this period as they wait for the next VIX crisis move which may now be around the corner.
While VIX exposures were lower as expected in a positive quarter for equities, their strong reaction during the bank crisis “warning shot” in early March was perhaps an indication of things to come and if history is any guide, the size and speed of last year’s interest rate spike points to a major “break” ahead (chart below).
enemy of my enemy
As the waiting game stretches on, it bears repeating that VIX returns are the opposite of most asset classes. Rather than the “stairs up, elevator down” profile of the stock market, VIX exposures historically have a positive skew, mostly grinding lower in between large crisis-period spikes. While Dashboard signals can help reduce exposure to the “grind”, this positive skew profile also extends to TCM VIX positions which are most often a small drag in between crisis periods.
Under this framework, a VIX futures decline during a period with no panic is hardly surprising and has no implications for their expected response to the next crisis. Of course, investors are not perfectly logical and tend to anchor to past conditions that are no longer relevant, resulting in the familiar and unprofitable “buy high, sell low” cycle seen in so many investment portfolios. As an example, an investor focused on the unremarkable volatility in the early stages of the last banking crisis in 2008 (chart below) would likely have missed one of the largest VIX moves in history as the crisis culminated later that year. Too often, investors are their own worst enemy.
S&P 500 and VIX Index with select 2008 bank failures. Sources: Yahoo Finance, thebalancemoney.com
Responding to the 2008 crisis, the Fed turned a real state bubble into an equity, real estate, and a government debt bubble that has been destabilized by sharply higher interest rates. Now caught between saving the banking system or letting inflation run wild, there are no easy solutions. Considering the current predicament (chart below), it is perhaps fitting irony that the name for a group of black swans is a “bank”.
With tactical strategies, every investment continually buys a new trade under new circumstances. Now, the conditions that produced last year’s low volatility decline are over and an investment in TCM strategies today means exposure to the VIX just as a potential crisis is brewing and the VIX is beginning to show signs of life. No doubt, many will stay fixated on the past and miss the present message. Others may recognize that a significant opportunity is at hand. The difference is only a matter of perspective.