Volatility Returns, Weekly Wrap 2/4-10/2018

Macro and Markets

By now I expect everyone has read about the demise of $XIV. My $UVXY calls were put on with those exact considerations in mind. In fact, I was using a technical indicator on $XIV as the main timing signal. But I got out way too early and have been kicking myself every day of this week. I got only a double as opposed to the potential 10+X in profits. The trade was indicative of the last two weeks: I was far too complacent, expecting only a 3% pull back as conditioned by calmness of 2017. In retrospect, the parabolic rise should have given reason to be wary. The intra day volatility was breathtaking this week and may be signaling a new volatility regime. It doesn’t necessarily imply an equity bear market however; as the post 1995 experience shows (see exhibit 1).

After a week like this it behooves us to take stock of where we’re over a multi year time frame. The recent rise out of the ascending channel looks particularly glaring on this scale. The last two weeks simply took us back into the middle of the channel. Friday’s low poked below the 200 MA. Both Tuesday and Friday, the two up-days this week, had higher volume. I’m leaning towards having putting in a bottom — sentiment and breadth indicators more than confirming, but after this week I don’t know anyone who’s willing to go out on a limb and make that assertion.

Here’s a summary of longer term views on the stock market from analysts that I highly respect compared with my own:

  • Gary Savage is calling for a V-shaped recovery and a parabolic top in April-May. However, if that doesn’t materialize, he’s willing to default to Chris Ciovacco’s view.
  • Chris Ciovacco has been very consistent on us being in a 15-20 year bull market.
  • Jeremy Grantham’s melt-up missive gave examples of tops in mid to end 2018 in illustration, although in the text he also acknowledged the possibility of topping in 2019.
  • In contrast I have placed the top in 2019 since before March 2017. Nonetheless, I also see potential pull-backs in May-June and October of this year.

The common denominator is to expect new highs this year, which was why last week I called the current correction the last low-risk buying opportunity. Even though I completely underestimated the ferocity of selling, coming into this week I had planned to buy on further declines, and buy I did. On both Monday and Friday I added considerably to $DIA calls. I would be lying to say I felt no fear at the Friday lows, nevertheless I’m glad about sticking to the plan.

It’s obvious that the trauma in the short $VIX products would lead to margin calls, as was the effect of higher stock and bond volatility on risk parity funds and their brethren (source). One disadvantage of the systematic funds is their future transactions can be common knowledge and front-run. I’m not good enough to figure out when the selling will subside, but I also felt it must be directionally correct to take the other side of a forced liquidation as long as I could withstand further drops.

So what if I’m wrong and we’re at the start of a new bear market? While the possibility is always there, that is a “meta” part of the game and letting it enter day-to-day decision making leads to “paralysis by analysis”. For now I have a clear bullish stance and positioned consistently; if and only if my views change based on facts, will I make adjustments.

Precious Metals

Gold was reasonably steady, silver took a dump and miners were absolutely slaughtered this week. I’m not sure how much is due to selling by risk parity funds. They hardly benefited from the snap back in equities on Friday (which will fuel rumors about the PPT I’m sure). We’re still in the bottoming process into what I believe will be the yearly low. COT started turning but not yet enough. I take a long view here so unconcerned with the day to day or even week to week.

Portfolio

There’s no other word than UGLY to describe this week. MTD the active account is down -15.4% and the total portfolio -11.06%, vs. -7.24% for SPY and -4.75% for 60/40. YTD the active account is down -1.54% and the total portfolio -1.28%, vs. -2.01% for SPY and -1.96% for 60/40.

Current portfolio composition is as follows: PMs 11.9%; equities 54.1%; FI, 25.7%; cash equivalent, 3.8%; and other, 4.5%. The “other” category is composed of 3X ETFs, 0.3% and options, 4.2%. Effective exposure from options is equal to 98% of total portfolio value for a leverage ratio of 23.3X. The portfolio is 152% long equities (not beta-adjusted). There was a pretty drastic decrease in options market value. But the effective exposure was stable due to additional $DIA calls.

My options are providing additional equity exposure equal to the value of the entire portfolio and I’m done with taking on additional positions for now. If stocks bounce back to new highs, I’ll be more aggressive with profit taking and hedging. The speed and depth of the current correction should have reduced the probability of a top in May but I’m not trying to catch the exact peak either.

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None of the above is investment advice, the standard disclaimer applies.