July 2019 Commentary

STEEPEST VIX CURVE OF 2019 LIFTS ALPHA SEEKER PAST S&P IN JULY

Led by Alpha Seeker, all three TCM strategies posted strong returns in July as markets seemed to be on autopilot ahead of a widely-expected rate cut at the 7/31 Fed meeting.

2nd VIX future daily settlement / 1st VIX future daily settlement, 20 day average. Source TCM

One of the most important metrics in our Vol Dashboard, the steepness of the VIX futures curve (the difference between the prices of the first and second VIX futures) is an excellent indication of the strength and magnitude of the recent trend in the VIX.  In contrast to its stubborn flatness in Q1 while recovering from 2018’s end-of-year shock, since late March the VIX curve has returned to its more typical upward slope– the signature of a solid trend lower in VIX and a constructive environment for Alpha Seeker.  While risk assets in general also tend to do well during such periods, Alpha Seeker is set apart by its ability to profit in much the same from a steeply inverted VIX curve during stressed markets when risk assets are often declining.  This feature is easy to overlook while markets are rising.  On the day when there are no rising assets left to chase, its benefit will be invaluable.

FINDING YOUR BALANCE

Conceptually, an investment’s return is simply the result of its capture of the “ups” and “downs” of the market over a given period.  Over time, a portfolio is optimized by finding the mix of “up-capture” and “down-capture” appropriate for an investor’s risk tolerance while considering the full range of likely outcomes over a market cycle. 

Many investors assume that beating the market requires maximizing up-capture while stomaching the resulting volatility (down-capture). Recently, others have taken the opposite approach, advocating low volatility (reduced up- and down-capture) as the next “holy grail”.  As usual, the actual solution is more complicated than a single factor and does not lend itself well to the short attention spans of today’s typical investor.

Hypothetical growth of $1000 using historical capture ratios applied monthly to S&P 500. Source: TCM

Rather than a “bad day preventer”, the system at Thompson Cap was designed with entire market cycles in mind, seeking to produce a mix of up- and down-capture that leads to better outcomes over time.  While the ratios produced by Alpha Seeker and Smart Index have led to superior results in the few years since inception, the potential becomes even more compelling as the time frame is extended.  Applying historical capture ratios to past monthly returns of the S&P 500, the chart above compares theoretical outcomes of Alpha Seeker and Smart Index with the S&P 500 Low Volatility Index and an “aggressive” (1.2 Beta) equity portfolio over the two market cycles since 2000.  No strategy will be perfectly consistent, but the potential of even a slight improvement in risk management is obvious if only investors would choose not to surrender it.     

Alpha Seeker Roster Update

We’ve recently added two new tickers to the menu of available “long VIX” positions in Alpha Seeker: SH (ProShares Short S&P 500) and SDS (ProShares UltraShort S&P 500).   

Similar to the addition of UPRO and SPXL on the “short VIX” side, SH and SDS have very high correlation to long VIX exposures and will allow Alpha Seeker to better address the occasional lags between S&P and VIX performance.  As always, the ultimate goal is to improve outcomes. 

Please feel free to contact us with any questions.

Alpha Seeker Roster, Aug 2019

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.