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Market Risks – Will Volatility (VIX) Pick Up?

by Feb 6, 2019Bishop's Corner0 comments

Despite an upbeat SOTU address from the President last night, the market seems to be dismissing several red flags.

For example, Apple lowered its revenue projection mid-quarter, and Amazon’s guidance fell short of analysts expectations, while Eli Lilly warned that profits will be down.

But that’s not all, the government is just temporarily open…  uncertainty remains on whether the US and China can reach a trade agreement… a disconnect between the bond market and the stock market … mutual fund and exchange-traded fund outflows…

…yet the VIX (the market’s fear index) has dropped by more than 58% since Christmas Eve.

Sometimes the best strategy is to sit on your hands.

The stock market is off to its best start since 1987 (traders old enough to remember know how that turned out)…

But instead of betting on stocks to crash right now… I’m watching for tells in macroeconomic data, potential catalysts, shifts in volatility, and waiting for my money pattern to show up.

Here are the catalysts that you should be ready for…

Market risks telling us VIX could rise?

 

This is a tough time to be a trader, whether you’re a bull, bear, or just go with the flow. If you’re not already long stocks, it seems irrational to chase stocks since so many have reached overbought territory. My style isn’t in chasing momentum… I’ve seen rallies like this happen so many times, only for stocks to get crushed.

On the other hand, it’s hard to start buying put options or shorting stocks – if you’re bearish. Now, I’m also not trying to pick tops because I know where that could get me.

That said, there are still risks on the table… but I’m not trying to be early to the party, I want to be right on time. I’m going to be nimble, patient, and take what the market gives me.

For now, here’s a look at some potential market-moving catalysts on the table:

  • The volatility of the CBOE Volatility Index (VIX) hit a level that it hasn’t seen since 2017.
  • Corporate earnings
  • U.S. – China trade talks
  • Bank stress tests

The volatility of the VIX has been really low…

One indicator that I like to use to access the volatility regime is the CBOE VIX of VIX (VVIX).

Now, if you don’t already know, the CBOE Volatility Index measures the 30-day expected volatility of the S&P 500 Index using put and call options. Now, when the VIX is at the bottom-end of the range (usually when it’s in the low teens, or below), it means volatility is low. On the other hand, when it’s above the mid-20s, volatility is thought to be high.

That said, it’s good to be mindful of the location of the VIX. However, what’s more important is the volatility of volatility, or the VVIX.

Here’s a look at the daily chart of VVIX.

Now, the red horizontal line is often thought of as the line in the sand. When VVIX falls below 90 and breaks back above… chances are that volatility could pick up, so naturally… traders would look to buy volatility products like VXXB or VIX call options.

What’s VVIX doing now?

It’s well below 90…

Moreover, the CBOE Volatility Index (VIX) is 50% off of its recent highs.

Now, I’m not calling for a crash like we saw last year in February… but there could be a correction with all the potential catalysts on the table, which would benefit those who are long volatility products.

But why do I think this could happen?

There are a lot of risks on the table, and the market isn’t being too specific… they’re just in buy, buy, buy, mode. Usually, volatility picks up when market participants least expect it.

Corporate revenue and earnings forecast have been weak…

For example, large-cap companies like Amazon.com Inc. (AMZN), Apple Inc. (AAPL), Alphabet (GOOGL), Nvidia (NVDA), Electronic Arts (EA), and 3M (MMM) cut their guidance.

Now, what’s that mean when a company cuts its guidance?

They think the future is bleak and are expecting weak numbers. In other words, those large-cap companies are expecting lower revenues and, or earnings, in the next quarter or this year. That said, there are many companies expecting slower earnings growth, and could add another degree of risk on the table.

Moving on, there are some global risks on the table, which could move the U.S. markets.

U.S. – China trade war

The President of the U.S. (POTUS) noted in the State of the Union Address that trade talks with China must end unfair trade practices and reduce the trade deficit. The POTUS noted there will be a meeting with China’s leader this month.

In the State of the Union Address, he stated, “We are now making it clear to China that after years of targeting our industries and stealing our intellectual property, the theft of American jobs and wealth has come to an end.”

Now, we don’t know exactly what’s going to happen later this month… but this might be a buy the rumor, sell the news play.

This might be the right play now because traders have the risk-on mentality. In other words, they want to be long risky assets like stocks into the trade deal… but we may see some selling pressure once we find out the terms of the agreement.

Moving on, the Federal Reserve (Fed) gave some clues to its stress testing of large banks…

The Federal Reserve is being transparent with stress tests

The Federal Reserve is addressing many concerns with its 2019 stress tests for banks. One of the main tests is to see how banks will fair if the unemployment rate reaches 10% (currently the unemployment rate is around 4%). Not only that, the Fed will test for elevated stress scenarios in corporate loan and commercial real estate markets (a 25% drop in housing prices).

Now, the Federal Reserve’s stress tests will include 28 variables – such as market-moving economic indicators like gross domestic product (GDP), stock market prices, interest rates.

That said, the Federal Reserve seems like it’s getting ready for a potential recession since it’s moved to see how banks will perform in severely adverse scenarios.

But what’s the market think of all this risk-on sentiment?

When the stock market doesn’t give me any clues to where it may be headed… I like to look at the bond market, in addition to volatility (VVIX and VIX).

Bonds signaling potential risk?

Traders and investors like to look to the bond market to hedge their risk. Check out the hourly chart of the iShares 20+ Year Treasury Bond ETF (TLT) – an exchange-traded fund (ETF) that holds U.S. Treasury securities with maturity dates 20 or more years from now.

Late last year, when volatility was picking up and the market was selling off, traders and investors bid up the prices of TLT in an attempt to hedge their portfolios.

Compare that to the SPDR S&P 500 Index ETF (SPY).

Generally, the bond market doesn’t move with the stock market… this is due to the fact that when there is actual economic growth and increases in corporate profits, inflation tends to increase… in turn, it causes bond prices to fall.

If you look at the hourly chart on TLT and the way the market rallied… TLT should be at the low-end of its range… but it’s not. That said, there is a disconnect between these two markets – potentially signaling a pullback.

You see, TLT is thought to be a safe haven. In other words, if it’s risk-off sentiment… they’ll look to buy bonds. There’s one viable reason for this disconnect: smart money is protecting themselves with bonds.

What are investors thinking of all this?

Here are the facts…

In December 2018, the market saw record outflows from both mutual funds and ETFs. This was due to the fact investors were rushing for exits into the year-end. Although the S&P 500 Index had one of its best months since 1987, there were actually outflows in ETFs. Investors took out nearly $20B from U.S. equity ETFs in January – one of the worst monthly outflows in years.

But where did that money go?

We actually saw some rotation into defensive stocks (some big inflows into low-volatility ETFs). That said, it’s almost like the smart money is saying, “If I’m gonna be long the market… I’m going to pull my investments from risky stocks and get on the defensive and focus on stable stocks.”

That’s a pretty big disconnect.

Again, I’m not calling for a Black Monday-like crash… but I’m expecting a pullback at some point.

Do I know when that will be?

No. But, I will be positioned and let Weekly Money Multiplier members know about my next moves.  

To YOUR Success!

Jeff Bishop

P.S. I understand the learning curve with options takes time. That’s why I want to give you 3 free months of my service when you sign up for a year. However, this deal can’t be found anywhere online. Please call 833-265-1270 and someone from my staff will set you up on the spot.  

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