Mega cap tech offsets small cap and regional bank weakness
First Republic becomes 4th bank failure of 2023
TCM strategies remain defensive as most VIX contracts continue to signal worry

narrow escape

Even as regional bank stocks and the economically-sensitive Russell 2000 index continued to sink, a mega-cap tech kept the Nasdaq 100 and S&P 500 indexes afloat in April after earnings reports from Microsoft and Amazon offset news of the the FDIC’s seizure of First Republic late in the month marking the 4th bank failure of 2023. This mixed message was reflected by VIX futures which saw near-term contracts trade lower on the narrow rally while contracts covering the balance of the year held at levels consistent with lingering worry about the larger picture.

*VIX futures term structure, 4/3/23 and 4/28/23. Source: vixcentral.com*

In the context of banking issues, elevated VIX prices and with a repetitive ‘dip and recover’ rally pattern in stocks more indicative of mechanical trading than new fundamental demand, TCM strategies continue to be moderately defensive with Alpha Seeker (-1.0% Apr) carrying a short S&P 500 exposure while TCM Risk-Managed Indexing strategies continue to manage the expense of VIX exposures as they stalk the next VIX outlier (see charts below and discussion in next section).

At present, consensus expects the rate hike cycle to be replaced by rate cuts this fall after a brief summer pause, presumably prompting a new bull market for equities as inflation recedes and the economy returns to growth. History, however, suggests that the end of a tightening cycle does not necessarily mean the end of the bear, as demonstrated by the 2006 Fed “pause” that ultimately led to the Great Financial Crisis of 2007/2008. Of course, such differences of opinion are what makes a market and the current width of the market is offering some potentially large opportunities.

INSIDE OUT: a TCM USER MANUAL

VIX exposures are used for managing risk because of their ability to produce large positive return during market crisis periods, a positive skew return profile that mirrors the negative skew of stock markets which tend to see extreme returns mainly on the downside. By combining strategic equity with tactical VIX exposures, TCM strategies have created an extremely rare profile that is both long equity markets and positively skewed.

*Beta vs Monthly Return Skew, Nov 2016 - Apr 2023. *Alpha Seeker period Oct 2011 - Apr 2023. Source: TCM. Click for larger image*

This combination creates unique tools that offer compelling results to those with an understanding of the tradeoffs involved and the patience to let them develop. Applied to positively-skewed exposures like Alpha Seeker or Tactical Beta, the typical momentum approach of assuming recent performance to be indicative of future results is like using the handle of a hammer to pound a nail- it might be possible, but it’s not likely to produce the desired outcome.

Since insurance is not free, all hedged strategies can be expected to trail a rising market and for TCM’s tactical risk management approach, this outcome indicates that conditions have recently been conducive for a VIX outlier. With perhaps the most positive skew of any financial instrument (see VIXY on chart above), VIX outliers are expected to be rare and VIX exposures are expected to mostly produce an expense for a portfolio. Turning this logic around, tail events in VIX exposures can therefore be expected to cover many months or even years of their interim expense and in excess of that expense when it is managed well. This is the TCM philosophy in a nutshell.

Since its inception in November 2016, TCM’s Tactical Beta strategy has been turning conventional wisdom on its head with a strategy that pursues rare positive outliers in the VIX with an emphasis on hedging cost control (not elimination) in the interim. Having outperformed the S&P 500 by transforming 6 years of VIX hedging exposure from a sure loser into a net benefit, the results of this strategy have been compelling to say the least.

*Cumulative performance differential with S&P 500 TR, Nov 2016 - Apr 2023. Source: Yahoo Finance, TCM. Click for larger image*

To be sure, this approach relies on periodic crisis moves in the VIX, ideally in a series of daily or weekly waves. As long as this remains a possibility in an investor’s mind, the best approach with TCM exposures is to be “inside out”, willing to swim against the momentum tide. This is easier said than done, but like it has for TCM strategies dealing with the VIX, it can help advisors produce better results for their clients.

*Top 10 worst S&P days Mar 2023 - Apr 2023. Source: Yahoo Finance, TCM. Click for larger image*

"Inside out” to popular opinion, the VIX is not dead. Last year’s uncommon outcome was the measured action of stocks- the VIX simply reflected that reality. Those conditions are now ending with the rate hike cycle and crucially, have no bearing on the likely VIX response to different conditions in the future. Regardless of the existence of new solutions like 0 DTE options, 30-day protection will almost certainly be in demand as dominoes fall during the next crisis, as seen on several days since the regional bank crisis began flaring in March (see table).

For TCM strategies, there are always two ways up. The fastest (and rarest) is generally with a VIX crisis move, while the slower (and more common) route is with a rising stock market. There is no way to make the process resolve any faster, but based on decades of history, both outcomes are only a matter of time.

For almost a year now, most TCM strategies have been profitable even as they have been defensive and trailing their benchmarks. As described above, this is an indication that crisis conditions are becoming more frequent and from the appropriate “inside out” perspective, suggests an outstanding opportunity ahead for TCM’s positively skewed strategies.