Kudos to Bespoke Investment Group for coming up with yet another interesting graphic, which I have reproduced below.
The graphic shows that the average daily volatility of the SPX was 0.72% in 2007, higher than the low volatility years of 2004-2006, but below the 80 year average of 0.75%.
For more information, try the original Volatility? What Volatility? post at Bespoke.
One indicator that I have yet to comment on in 2007 is the TRIN, also known as the Arms Index, after its inventor, Dick Arms.
The TRIN is calculated by first dividing the number of stocks that advanced in price by the number of stocks that declined in price to determine the Advance/Decline Ratio. Next, the volume of advancing stocks is divided by the volume of declining stocks to determine the Upside/Downside Ratio. Finally, the Advance/Decline Ratio is divided by the Upside/Downside Ratio. In mathematical terms, the TRIN looks like:
(Advancing Issues / Declining Issues)
────────────────────────────
(Advancing Volume / Declining Volume)
Like the VIX and put to call ratios, the TRIN is a contrarian sentiment indicator. Generally, a rising TRIN indicates increasing bearish sentiment and a falling TRIN reflects increasing bullish sentiment. I have included the traditional 1.2 and 0.8 thresholds as indicative of sentiment extremes. These are levels at which the probability of a market reversal increases.
Depending on their trading time frame, practitioners use different bars for the TRIN. In the chart below, I chose to use 60 minute bars over the course of a two month period to generate swing signals of the short to intermediate-term variety. For comparison purposes, day traders frequently use 5 or 10 minute bars. It is important to note that different length bars give very different signals and also usually require a rethinking of where one should place the threshold levels for market turns.
At the moment, the TRIN is generating a fairly bullish signal – certainly the most bullish signal since Thanksgiving, when the markets began a strong rally that surprised many who were not watching the TRIN closely.
I will have more on the TRIN in 2008.
On the heels of a strong fourth quarter, it looks as if Portfolio A1 will finish 2007 with at least a 20% advantage over the benchmark S&P 500 index since the portfolio’s February 16th inception. With one trading day left in the year, Portfolio A1 has a 23.4% gain, a full 21.8% better than the 1.6% gain in the SPX during this period.
I will publish some additional statistics once 2007 is in the books, but suffice it to say with the likes of MOS, DRYS, TEX, PBR, RIO and others in the portfolio over the past 10 ½ months, we have been fishing in very rich waters.
In addition to the usual equity curve and summary information, I have added a list of positions that were closed out during the year.
There no changes to the portfolio this week.
A snapshot of the portfolio is as follows:
A year ago, the VIX stood at 11.56. Last week it ended the week at 20.74, up 79%. Of course, in the absence of a VIX ETF (or ETN), it was almost impossible for volatility aficionados to capture that 79% gain.
For the moment, at least, things seem to be quiet on the volatility front. Last week the VIX gained 2.27 points (12.3%) to bring the index to a level just 0.17 below the 10 day simple moving average and 0.93 below the 20 day SMA. Partly because of this, the VWSI is back at zero and indicating no directional bias for the beginning of 2008.
As is my weekly custom, for a survey of the best in current thinking about the markets, Barry Ritholtz at The Big Picture sums up the week that was and the week that will be in his New Year’s Linkfest.
Finally, as volatility tends to run in 2-4 year cycles, it is appropriate to ask whether the 79% gain in the VIX in 2007 marks the beginning of a new volatility macro cycle. In spite of the historical precedent, I am on the record as saying that the most likely volatility scenario for 2008 is a VIX in the low to mid-20s.
(Note that in the above temperature gauge, the "bullish" and "bearish" labels apply to the VIX, not to the broader markets, which are usually negatively correlated with the VIX.)
Wine pairing: For a VWSI of zero, I began the year recommending some Rhone blends and later expanded the category to include any expensive blend. For 2007, I will close out the year with my two favorite inexpensive blends: the $8 Oakley Five Reds (the 2003 vintage is a blend of 41% syrah, 27% zinfandel, 22% petite sirah, 10% alicante bouschet, and 1% mourvedre from Cline Cellars); and the 2005 vintage of The Hermit Crab from D’Arenberg, a delicious $13 blend of 70% viognier and 30% marsanne.
I should note that while I have chosen to focus on technology and energy for the moment, the full sector rotation/business cycle theory spans all sectors. For those interested in further reading, the CXO Advisory Group has an excellent discussion of a comprehensive business cycle approach to sector rotation (they are skeptical about trading on the theory) and a variety of sources, including Fidelity and Optionetics, have good summary articles.
Getting back to energy and technology, I have included below a ratio chart of the AMEX Select SPDRs for the energy (XLE) and technology (XLK) sectors going back to their 1998 launch. The graph shows an almost perfect negative correlation between the ratio of energy to technology sector performance and the SPX from 1998 through the end of 2003. This time frame is reasonably representative as well, as it includes two bull periods of about 1 ½ years each, as well as a bear market of a little more than two years.
From the beginning of 2004 to the present, however, the correlation between the energy to technology ratio and the SPX flips from negative to positive, as energy starts to outperform technology at the same time the markets begin a long bull run. For the past four years, up to and including the current month, energy has generally had the upper hand or at least been the equal of the more ballyhooed technology sector.
I find it interesting that the last time the XLE:XLK ratio was this high was July 2006, when the markets were selling off over uncertainty about whether Bernanke would continue to raise the Fed discount rate. Now I won’t go as far as to say that the bull market is officially over if the XLE:XLK ratio gets over 3.0, but keep an eye on this ratio. As
In addition to dreaming about the great investment opportunities of 2008, the end of the year is a time when many investors think about rebalancing their portfolios, enhancing diversification, and lowering risk. It is also a good time to cut loose bad ideas and bad investments, while at the same time opening one’s mind to the possibility of new types of investments.
I can’t say where the best opportunities for 2008 lie, but I can tell you where to find them. Without a doubt, many the best investments for 2008 will found among the ETF universe. This should not come as a surprise, as the ETF universe has, by far, the broadest array of investment vehicles. So while some individual stocks may top next year’s list in terms of total return, the careful selection of a few ETFs in new asset classes will provide a better opportunity to enhance returns and lower overall portfolio risk at the same time.
While there are a number of places to research and screen ETFs, I am also a fan of those handy one page ETF ‘cheat sheets’ put out by Bespoke Investment Group: the US ETF Family Tree; and the Global ETF Family Tree, each of which are superbly organized. For my purposes, however, I can do one better with a four page PDF from ETF Guide: ETF Reference Guide 2007 Q4. Updated quarterly, this document gives me four important pieces of information that are not available from the Bespoke cheat sheets:
Armed with this information, now is as good a time as any to start thinking about how to take advantage of the changing mix of investment opportunities – and the ETFs that can expand the scope of your investment reach.
From the chart below, it certainly looks as if 2007 was the beginning of a new volatility macro cycle. It also looks as if the rate of change in volatility over the course of 2007 is unsustainable going forward – or at least inconsistent with the slope of volatility macro cycles during previous cycles. I am not going to make a specific long-term volatility forecast for 2008, but it would not surprise me if volatility flattened out in the low to mid-20s range in much the same manner that it did from late 1998 to early 2002.
While VIX macro cycles are somewhat dependent upon a subjective determination about the beginning and ending dates for each cycle, it should be noted that these cycles tend to last a minimum of two years, suggesting that the current rise in volatility should persist through all of 2008, even if the rate of rise in volatility begins to slow.
The evolution of the current macro cycle will undoubtedly be a big story to watch in 2008; VIX and More has a front row seat to watch the action and provide the play-by-play and color commentary as appropriate.
Portfolio A1 continued its strong performance last week, with cumulative gains of 18.9% since the portfolio’s February 16th inception – 16.9% better than the 2.0% return of the benchmark S&P 500 index during this period.
Notwithstanding the excellent recent run, this high turnover portfolio continues to seek out better opportunities and therefore dropped DryShips (DRYS) and Fresh Del Monte Produce (FDP), replacing them with Norwegian energy and aluminum giant Norsk Hydro (NHYDY), as well as The Pepsi Bottling Group (PBG), a Pepsi subsidiary. I find the Pepsi move a little surprising, especially since the portfolio had already experimented with PepsiAmericas (PAS) in November. How can a computer program have an affinity for a particular brand…?
There are no additional changes to the portfolio this week.
A snapshot of the portfolio is as follows:
During the week, I chronicled The Incredible Shrinking VIX, which addressed the issue of volatility falling in a market that was going mostly sideways to down. By the end of the week, the VIX was down 4.80 points or 20.6% from the previous week, to 18.47 – a level not seen since the beginning of November.
The interesting part of the week is that the SPX had a modest gain of 16.51 (1.1%), so that very little of the move in the VIX (perhaps 1.25 of those 4.80 points) can be attributed to a rise in the SPX. The rest? Some of it certainly comes from a seasonal pattern of historically low volatility around the holidays (see the CXO Advisory Group on U.S. Stock Returns Around the Year-End Holidays), but a considerable account is still unaccounted for. It looks like it may take the unfolding of events in 2008 to explain the shrinking VIX anomaly.
On the VWSI front, the shrinking VIX contributed to a new elevated VWSI reading of +6, suggesting that the VIX should be close to bottoming. Ironically, the VIX is up this morning, and so are the markets…
As is my weekly custom, for a survey of the best in current thinking about the markets, Barry Ritholtz at The Big Picture sums up the week that was and the week that will be in his Christmas Linkfest.
Finally, good news for those who are content to sit on the sidelines and wait for a more compelling market signal before committing to a specific direction, PowerShares is launching three new Buy-Write ETFs:
In the New World, semillon has gained a strong foothold in
It is harder to pick a particular US producer that has built a reputation for semillon, but one to keep an eye on is L'Ecole Nº 41, from the
For more information on semillon, StarChefs.com has a good discussion of the varietal, along with a handful of recommended producers in
CurrencyTrading.net, whose last blog list included VIX and More as one of their Top 100 Day Trading Blogs, is out with a new list of note: 50 Places to Discover News Before It Goes Mainstream, authored by Heather Johnson. It is a list well worth checking out, regardless of whether or not you follow the currency markets.
On the same subject, when you think of the information lifecycle in terms of the graphic below from Monitor110, consider how important it is for your news sources to include blogs that give you new ideas to think about, long before they find their way into the mainstream media. That is part of the reason why I have a “Blogs I Frequent” list on the right hand column of the blog. If you haven’t checked that list lately, now might be a good time to revisit it, as in the past month or two I have added several excellent blogs featuring cutting bleeding edge thinking.
I believe Rob Hanna of The Money Blogs was the first to comment on the unusual phenomenon of the VIX following the markets down. While Rob was cautious about the negative implications of this phenomenon on the broader markets, Brett Steenbarger at TraderFeed was more open about the likelihood of an impending period of ‘subnormal short-term returns’ indicated by his research in Stocks Down, Option Volatility (VIX) Down: What Happens Next.
Adam Warner of Daily Options Report has required a little more confirmation to believe that the drop in volatility is something more than the vagaries of the holiday trading calendar, but in Volatility Dippage, it seems he has finally come around to the point of view that the VIX drop is real and not a calendar-driven oasis.
I agree that the drop in the VIX is real, but not to the extent that the VIX suggests. Here is a perfect opportunity to use the VXV, which measures volaltility 93 days out instead of the VIX's 30 day window. Per the VIX-VXV ratio chart below, the expectations of volatility over the next 30 days (VIX) are dropping much faster than those over the next 93 days (VXV). Further, if you look at the VIX futures quotes, you can see that future volatility expectations are pretty much flatlined out through the November 2008 contract, with the VIX contract prices all currently hovering in the 23 range. The bottom line: fear may be slipping a little, but it is not in a free fall, as the VIX might lead some of us to believe.
I will close with a link to a post from May in which the title tells the story: High Positive Correlation Between VIX and SPX Often Signals Market Weakness.
For those who do not follow LDK, this is the Chinese solar company that was the subject of accounting fraud allegations by a former controller that helped to knock the stock down from the mid-70s to the mid-20s over the course of a month or so. On Monday, LDK reported that the Audit Committee of the Board of Directors had finished their review of the matter and concluded that there had been no wrongdoing. Things were looking up until LDK reported quarterly results after the close yesterday. The numbers were generally in line, but concerns about margins and the absence of raised guidance has put pressure on this stock this morning, which traded down as much as 27% earlier in the session.
While the story is interesting, the chart may raise even more eyebrows, as it is littered with gaps and the tombstones of overzealous traders. If you are thinking about playing solar roulette, consider that directional plays are extremely dangerous. One way to make to potentially make some money off of the faddish momentum and wild gyrations is to sell volatility below support and above resistance, so you can get paid while you watch the fun. Even if you don’t play this stock, the entertainment value alone makes it worth keeping an eye on.
On a related note, is it only me, or does anyone else who trades Chinese solar counterpart JA Solar Holdings (JASO) think of a hockey mask every time they look at the ticker? Given the volatility in that stock, somehow it seems an appropriate image…
Finally, anyone interested in rolling the dice in the solar sector, Chinese and otherwise, should start their research with the excellent solar stock comparison table at China Analyst.
The ISEE (below the long-term mean for the 30th day in a row) and the CBOE equity put to call ratio (spiking once again) both indicate that call buying relative to put buying is considerably below historical norms, which makes the VIX numbers even more surprising.
In times like this I turn to the VIX:SDS ratio. As shown below, my proxy for the fear premium component of the VIX is now showing a reading that is substantially below the 10 and 100 day simple moving averages. Is this merely a case of desensitization or is something else going on?
