June 2019 Commentary

RATE CUT HOPES ERASE MAY’S MARKET LOSSES

All three TCM strategies posted their best month of the year in June as markets were soothed by a dovish Fed meeting that cemented expectations of a rate cut as early as July. 

While headlines crowed about the market’s best June in decades, it was in fact just enough to offset May’s steep losses– much like this year’s strong numbers are only the mirror image of the drop from last September’s high.  This is the latest episode in the pattern that has emerged since 2018, where the market has gone nowhere in a wide sawtooth, ebbing and flowing with the direction of monetary policy while ignoring fundamentals such as slowing earnings growth, recessionary economic data and inverted yield curves worldwide. 

As this tug-of-war becomes increasingly volatile, it remains to be seen whether stocks are right in discounting a mid-cycle slowdown like 2016 or whether there will be some “catching down” to a recession that’s about to begin.  In other words: will this easing cycle be more like the “insurance cut” in 1995 when stocks were already at all-time highs, or a “behind the curve” one that did little to stop the rout in 2008?  With a new earnings season upon us in July, we may soon know more. 

INVESTING WITH GUARDRAILS 

In response to increasing interest and in light of the turbulence of the past 18 months, we would like to take a moment to highlight our US Equity Smart Index strategy.  As a reminder, Smart Index is designed to improve the risk profile of S&P 500 allocations by systematically reducing exposure during volatile periods as indicated by our proprietary VIX dashboard. 

Smart Index sample account, net of 1.95% fee.

As the chart on the right shows, over the very volatile period since Dec 2017 Smart Index has done just that, outperforming the S&P 500 with lower volatility and smaller drawdowns.  For more information, see the Strategies and Documents sections on our website, or contact us to schedule a webinar.

Finally, we are excited to announce a strategic partnership with Little Harbor Advisors (“LHA”) to pursue development of an Alpha Seeker ETF as well as several principal-protected notes based on TCM strategies.  With our VIX expertise and LHA’s structuring know-how, we look forward to bringing truly unique and accessible exposures that will help advisors navigate difficult markets.  For example, a principal-protected version of Alpha Seeker compares very favorably to variable annuities, for both the investor and the advisor.  We will have more information on these products as we get closer to launch. 

Alpha Seeker Review June 2019

Recent developments in the volatility landscape and their historical context for Alpha Seeker. Download the presentation here

May 2019 Commentary

VIX UNMOVED BY S&P’S WORST MAY SINCE 2010

May’s VIX high was reached well before the S&P 500 low

With the VIX sending few distress signals, Smart Index and Legacy Navigator saw index-like declines in May while Alpha Seeker’s lighter exposure kept losses in check relative to the equity markets. 

Reflecting an oddly disinterested options market, the VIX barely registered a pulse in May despite a series of overnight gaps that were responsible for substantially all of the S&P 500’s decline on the month.  Tepid moves and several strong reversals during regular trading hours kept a lid on any panic, with the VIX index only briefly breaking 20 around its peak on May 9th.  For now, distress signals appear to be coming mainly from the bond market, with collapsing Treasury yields leaving much of the curve inverted in a classic recession signal. 

All in all, the situation today bears resemblances to previous equity market tops as participants initially discount any warning signs only to over-react as the new reality becomes more widely accepted.  Rather than an event, this is a process that often takes months as it produces a signature of increasingly erratic and trendless equity markets.  Especially during this time, basing expectations on recent bull-market performance puts investors at substantial risk of disappointment.

This May Hurt A Bit

Grey shaded figures are hypothetical. Past performance is not indicative of future results.

From a business perspective, financial advisors have a lot in common with doctors.  Both use technology and experience to make decisions based on probabilities in the face of imperfect information.  Perhaps most importantly, outcomes in both fields are the result of a team effort: a doctor prescribes a therapy, but the patient must choose to see it through.  On paper, the choice is easy- until the physical and psychological discomfort of treatment stands in the way of the patient’s long-term health.  And so the search for a miracle cure or more cooperative doctor continues as the patient’s health deteriorates.   

Bringing the analogy closer to home, a “patient” looking for a repeat of Alpha Seeker’s 63% gross year in 2012 must be prepared to swallow the pill of a 14% drawdown and five months trailing the S&P 500 by an average of -5.5%.  Similarly, exposure to the strategy’s hypothetical 42% gross return during 2008’s bear market required enduring the discomfort of a loss in each month of Q1, an unremarkable +0.1% gross YTD return through June and 33 days of 2% or worse losses.  Figures for US Equity Smart Index tell a similar message (see table at right), as do the stats for just about every equity-like investment on the planet.

Every investor will eventually face discouragement.  After all, investing is a complex challenge involving ever-changing information and human emotion– there are no easy answers or foolproof rules.  As with medicine, responding successfully to the challenge is a team effort requiring a mix of experience, skill and at times, grit.  

April 2019 Commentary

AS STOCKS COMPLETE 7-MONTH ROUND TRIP, YIELDS CONTINUE TO CRUMBLE

Treasury yields have diverged from stock prices in 2019

Each of our strategies posted a solid month in April as another push higher returned the S&P 500 to where it stood seven months earlier before last Fall’s dramatic slide.  Whether via risk-managed indexing using Smart Index and Legacy Navigator or non-correlated VIX exposure with Alpha Seeker, our process has produced a significantly smoother ride during this consolidation, leaving our portfolios well-positioned to capture the market’s next trend.   

As to which direction that may be, there seem to be conflicting messages at present.  In particular, the strong bounce in stocks is at odds with Treasury yields that appear to be pricing in lackluster economic prospects.  Taken together with declining earnings estimates, this means that the rally this year is almost entirely a result of an expansion in the price to earnings ratio rather than any improvement in fundamentals.  In other words, the rally this year has set the bar high that either earnings will improve substantially or that rates will remain low enough to justify an elevated multiple.  Even if these expectations are eventually met, It’s difficult to imagine that squaring such a wide divergence will go smoothly.  After one of the best quarters in S&P 500 history, it may be time for investors to re-evaluate their risk management plan. 

March 2019 Commentary

VIX CURVE STILL HESITANT AS STOCKS APPROACH SEPTEMBER HIGHS

Mirroring the S&P 500, US Equity Smart Index capped off a strong quarter in March, while a hesitant VIX curve continued to be a drag on Alpha Seeker.  As we have often repeated, our basic strategy is to use the VIX futures curve as a portfolio exposure guide.   Having studied it since its inception 15 years ago, we believe the VIX curve to be the single best indicator of market risk aversion available.  From beating the market in the record low volatility in 2017 to profiting in the worst December since the Great Depression, we’ve successfully used this process to produce non-correlated return through many different market environments over the past seven and a half years.

Like any investment process, using the VIX curve in this way is not perfectly consistent over every time frame.  As we’ve seen more than once since 2011, the VIX futures curve (and hence, our portfolios) can be slow to normalize during sharp “V” bounces in equities like we’ve seen this quarter.  Of course, the VIX curve may simply be reflecting the fact that healthy markets typically don’t plummet and rally nearly 20% in the space of 6 months while the economic backdrop deteriorates.  Abandoning our process to chase an unhealthy market has never been in our playbook, and we don’t intend to start now.   In time, we expect this to pay dividends just as it has in similar circumstances over the past seven and a half years.  

ALPHA SEEKER AND THE VOLATILITY CYCLE

 Another common theme in our work is describing the behavior of volatility as a closed “loop” which constantly repeats.  This makes the VIX unlike most other financial prices that can move freely between zero and infinity, entirely unanchored to any particular level.  

Past performance is not indicative of future results

Since its underlying market (the VIX) behaves fundamentally different than other exposures in a portfolio, an investment in Alpha Seeker should also be evaluated differently.  As an example, going against common sense from experience with other markets, Alpha Seeker forward returns have historically been 3x higher than normal after periods of negative trailing returns (see chart at right).  This is the cyclicality of volatility at work in a very practical sense.   

For a specific example, this quarter has parallels to the first four months of 2014 which saw a sharp “V” in the S&P 500 and similar Alpha Seeker results, both absolute and relative the S&P.  Investors who stuck with the process during that period then went on to enjoy the best winning streak in the strategy’s history to that point, outpacing the S&P while gaining an average of 2% in 12 of the next 15 months through July 2015.  A few months later, the S&P give back nearly all of the year’s gains while Alpha Seeker finished the year +15.3% and just 1.7% off its all-time high.  History will never repeat exactly, but this is precisely the type of return profile that makes for durable portfolios over the long run.