Savvy Traders Laud the Return of Market Volatility

Savvy Traders Laud the Return of Market Volatility

Savvy Traders Laud the Return of Market Volatility

$VXX, $DIA

After last week’s action, some market participants await a return to the calm, but that may not be in their longer-term interest to revert to the very unusual market conditions that we had before.

What they should be looking for new is a market that respects asset-price volatility, correlations and certain asset class valuations, together with less extreme investor-base Fed conditioning.

For that past several sessions, the VIX rose from less than 14 at the end of January to more than 37 just 5 days later, then to 50+.

The major stock indexes corrected by 10% right after.

That after 400 sessions+ when the S&P 500 had not experienced 3-5% pull back from its highs. And while a daily move of 100 pts in the DJIA had become unusual, 1,000-pt intra-day occurrences were seen regularly.

Adding to that, was a side by side decliner in the price for fixed-income exposure, which dented the risk-mitigation effectiveness of well-diversified portfolios.

All of that happened within technical-driven market moves in contrasted with the generally improving economic and corporate fundamentals.

The impact of this market volatility highlighted the fragility of some recent investment approaches and instruments.

The sudden price collapse of very popular short-volatility strategies was accompanied by the demise of a handful of related products and some asset-class contagion.

Then, retail investor exited stocks and other risk-on assets.

It comes as no surprise that many investors long for a return to the comforting calm of Y 2017 and January of this year.

But, when we look at market history, those things were very unusual and strange. The tranquility during the run-up to the recent market correction, also contained elements of the end of low volatility.

Stock prices flowed along nicely, until the end of January.

During that frame the DJIA posted 70+ record highs in Y 2017 alone. Almost all asset classes were increasing in price, regardless of their historical relationships.

Volatility was quiet, and almost nonexistent

The VIX marked 6 of its 7 all-time lows in Y 2017.  During that frame product providers and users capitalized on the acceptance of ETFs (exchange-traded funds).

And some ventured into more arcane areas where the implicit/explicit promise of the product, instantaneous liquidity at reasonable bid-offer spreads would not happen if/when the segments reverted to their usual condition of very limited liquidity.

 “All of this was underpinned by excessive investor confidence in the ability of “non-commercial” market participants, central banks or liability-driven corporate investors, to continuously and always repress volatility. With that came conditioning to buy the dip at ever-higher prices, regardless of the cause of the price pullback. Consequently, dips became less frequent, smaller in magnitude and shorter in duration — all of which reinforced the abnormal price and market conditions,” said a savvy market observer.

So, rather than long for a return to such conditions, investors should want a transition to a new and orderly market structure that can now show the following aspects:

  • Volatility trading at higher levels than in Y 2017, and in a relatively range-bound fashion or 18-25
  • The yield on the 10-year T-Bonds trading mostly in a 2.75 – 3.10% range for now
  • The yield differential between 10-year US and Bund bonds trading mostly in a 195 to 225 basis points range.
  • The correlation between risk-on assets and risk-off assets regaining their historical, or negative relationship.
  • Currency markets taking on more of the role of a 2-way shock absorbent.

With that market participants would gain greater respect and better pricing for liquidity and volatility, which would also bring discipline to an excessive market phenomenon of over-promising liquidity in inherently less liquid asset classes.

These conditions are not as calm and rewarding as those before the February correction. But they do give us a healthier market long term, especially when the  fundamentals continue to improve and provide a solid foundation for market valuations.

We here at HeffX-LTN like the return to volatility, savvy traders like the volatility and good money is made in volatile markets.

Stay tuned.

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Paul Ebeling

Paul A. Ebeling, polymath, excels in diverse fields of knowledge. Pattern Recognition Analyst in Equities, Commodities and Foreign Exchange and author of “The Red Roadmaster’s Technical Report” on the US Major Market Indices™, a highly regarded, weekly financial market letter, he is also a philosopher, issuing insights on a wide range of subjects to a following of over 250,000 cohorts. An international audience of opinion makers, business leaders, and global organizations recognizes Ebeling as an expert.

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