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ETF Periscope: Low VIX Levels Should Be High On Your Hedge List
“Only two things are infinite, the universe and human stupidity, and I'm not sure about the former. “ -- Albert Einstein
In spite of the rather nice ride the stock market has had these last six weeks, it might be a mistake to assume it will last once September rolls around, when a series of domestic and macroeconomic factors come into play.
Still, while investors are probably wise to remain skeptical as to the ongoing robustness of the current, low-volume rally, there may be a big reason why Wall Street can continue to show gains well past Labor Day.
The Dow Jones Industrial Average (DJIA) has made an impressive 4% gain over the course of the last six weeks, though it is an important caveat to note that it has risen on anemic trading volume, well below last year’s summer levels. While it is common for trading levels to fall this time of year, with many of Wall Street’s major players kicking back in their summer homes and rejuvenating getaways, this year seems pretty extreme, with average trading volume falling off a staggering 40% compared to August 2011.
It seems as if there are relatively few sellers, amplifying the impact of the buyers. It might be due to investors standing pat until a clear direction can be ascertained, or to the relatively low-risk attraction of cash that seems in effect. In any event, all that can be expected to change when the summer officially ends following the Labor Day holiday, when volume historically returns to higher average levels, and with the renewed action, a likely rise in volatility levels.
What will be the most likely market movers come September?
Expect the market to react sharply to Ben Bernanke’s next pronouncements due at the upcoming September Fed meeting. There are a lot of investors who are anticipating that the Fed will take some action to help lower the stubbornly high rate of unemployment, particularly as inflation seems to be staying at sub-2% levels and GDP is expected to stay in slow-growth territory.
Of equal importance may be the next round of decisions, or indecision as the case may be, that will come from the Eurozone leadership. The European Central Bank (ECB) may use its September 6th meeting to provide actual details of how it plans to do, in the words of ECB president Mario Draghi, “whatever it takes” to prop up the sovereign debt crisis. The possibility remains that the ECB will actually provide particulars to address the debt crisis, such as a clear intention to purchase unlimited bonds as needed, to keep borrowing costs down for the PIIGS (Portugal, Ireland, Italy, Greece and Spain), particularly Italy and Spain.
Such an announcement, especially if seconded by Germany’s Angela Merkel, could move the equity markets on both sides of the Atlantic in a big way, perhaps even more than would a minimalistic gesture by Bernanke.
In any event, expect seriously escalated action on Wall Street within the next several weeks.
What the Periscope Sees
Market volatility is at a five-year low, as evidenced by the VIX sitting at 13.45, a level not seen since the start of 2007. That still places the VIX, known as the “fear gauge,” about 25% higher that it averaged between the start of 2005 and the end of 2006. However, the VIX has soared as high as 45 as recently as October of 2011.
The bottom line? Volatility is relatively cheap right now. For just about any portfolio, it can be considered as a good opportunity for buying insurance at a discount, especially with so many x-factors remaining in the current domestic and global economic picture. For those who want to help offset any potential corrections in the market, purchasing a VIX derivative, such as the ETF VXX, which tracks the S&P 500 VIX Short-Term Futures Index, is now, perhaps more than at any recent time, a smart way to go.
However, remember, the VXX, like the VIX, generally goes up as the equity market goes down, and vice versa.
Full disclosure: The author does not personally hold any of the ETFs mentioned in this week’s “What the Periscope Sees.”
Disclaimer: This newsletter is published solely for informational purposes and is not to be construed as advice or a recommendation to specific individuals. Individuals should take into account their personal financial circumstances in acting on any rankings or stock selections provided by Sabrient. Sabrient makes no representations that the techniques used in its rankings or selections will result in or guarantee profits in trading. Trading involves risk, including possible loss of principal and other losses, and past performance is no indication of future results.