Never think that lack of variability is stability. Don't confuse lack of volatility with stability, ever.
--Nassim Nicholas Taleb
US stocks have been more volatile lately as Washington bickering causes nervousness about what will happen next in the markets. I see a lot of people on Twitter and in the media arguing that the moment a deal is made, markets will resume their uptrend. Perhaps this is true, especially given that emerging market strength is unquestionably gathering steam, which could hold global beta sentiment up. However, it is worth considering the possibility that US averages could still be under pressure, due more to earnings and renewed uncertainty over tapering.
Inflation expectations have notably diverged from equity prices in the US, which I have hammered all year
as a big theme many seem to be underappreciating. Growth estimates for next year have been cut by both the Fed and the IMF. On a rolling 52-week basis, small-caps (NYSEARCA:IWM) are overbought. Earnings growth does not appear to be strong enough to justify the extent of P/E expansion this year, and leverage in equities is at an elevated level. From a contrarian standpoint, there are more than enough reasons to be negative on US stocks.
What about from a volatility perspective? While the VIX
(INDEXCBOE:VIX) by itself is more reactive than predictive, the shape of the term structure of bets on future volatility can be indicative of a coming change in sentiment. Take a look below at the price ratio of the iPath S&P 500 VIX Short-Term Futures ETN
(NYSEARCA:VXX) relative to the iPath S&P 500 VIX Mid-Term Futures ETN
(NYSEARCA:VXZ). As a reminder, a rising price ratio means the numerator/VXX is outperforming (up more/down less) the denominator/VXZ.
When shorter-term VIX futures are outperforming longer-term ones, it indicates that money is betting that near-term volatility will increase relative to volatility in the future. When the ratio outperforms and that strength sticks, it means that money is aggressively preparing for a decline in equity prices. Note that the ratio appears to be in somewhat of a bottoming process, and the strength still appears to be early. The implication? If the trend holds past Washington negotiations, the pain may not be over yet for US stocks. My firm's ATAC (Accelerated Time and Capital) models used for managing our mutual fund and separate accounts, which are currently in emerging markets, are nearing a defensive rotation regardless.
October getting fun yet?
No positions in stocks mentioned.
This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.
The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.
Copyright 2011 Minyanville Media, Inc. All Rights Reserved.