ETF Periscope: Riding the D.C.-to-Wall Street Volatility Express

You should sit in meditation for twenty minutes every day – unless you’re too busy;   - then you should sit for an hour.”--Old Zen adage

Batten down the hatches. The Congress critters are at it again.

Last week was certainly a wild one on Wall Street, with both fear and greed making an extended appearance. The Dow Jones Industrial Average (DJIA) swung close to 500 points over the course of the five trading sessions, though it did manage to end the week in the positive.

The Dow ended the week gaining 1.1%, and the S&P 500 Index added 0.8% to its bottom line. Meanwhile, the Nasdaq Index (COMP) dropped slightly, landing in the negative by 0.4%. For the Nasdaq, it was the first down week in almost six weeks.

However, with both parties in Congress apparently digging in their heels before the debt-limit deadline hits in a few days, coupled with a big wave of Q3 earnings reports on tap over the next five days, the potential for an even more volatile week looms just around the corner.

There remains the matter of the current government shutdown of course, now hitting hard against a two-week milestone, though that issue seems to have morphed into one giant debt ceiling problem.

Amongst numerous other resultant problems, it has virtually halted the flow of government economic data from reaching investors. The data vacuum has increased emphasis on the third quarter corporate earnings reports, which so far haven’t been very pretty. For those S&P 500 companies that have already reported, expectations are below the historical average by about 8%.

One perceived positive by investors last week was Ben Bernanke’s new heir, Janet Yellen, which proved to be the choice that Wall Street wanted to see, at least judging by market response.

It was primarily the revelation that she was assuming the Chair of the Federal Reserve, coupled with indications that Republicans and Democrats were actually sitting down to a serious discussion on how to conclude the current budgetary impasse, that brought the equity market back into the black after the week’s initial dive into fear with its resultant red ink.

However, with all the other uncertainties swirling about investors’ heads like dark clouds, the removal of this one variable, although a major one for the markets, will hardly be enough to stem a strong downturn should Congress fail to step up and strike a coherent budget deal.

If watching the major indices dip and rise in rapid response to each round of breaking news out of Washington this week isn’t obvious enough for investors, another way to keep track of the underlying sentiment of Wall Street’s major players can be found in the Chicago Board Options Exchange Market Volatility Index (VIX). 

The VIX was to be found near 12 back in early August, which was the low point of the year, and mimicked the level found during the run-up just prior to the 2008 crash.

So what did the VIX do last week as the market bounced around between the news cycles?

It started the week close to 17, hit a high of just over 21 when political negotiations seemed to stalemate, and ended the week close to 16, as reconciliation between the parties seemed to be occurring. Worth noting is that the VIX generally goes up as the market goes down, and vice-versa.

So where can the VIX be expected to land if the debt ceiling is successfully raised, even for another 6-8 weeks, perhaps the most likely compromise?

Probably not close to the August levels, since so many variables remain, such as the unreported economic data, Q3 earnings still to come, and clarification about the date and extent of the stimulus tapering.

And if the fools on the Hill actually shoot themselves in the foot and manage to create a default situation?

Off the charts VIX, or certainly doubling its current number. Fear will be the emotion de jour, and investors will shift their capital to a safe haven, wherever that happens to be deemed.

Let’s hope the VIX veers back towards the low side. Just in case, a little volatility insurance in the form of one or another of the many VIX derivatives might not be a bad insurance bet to place.

To that end, one can utilize VXX (S&P 500 VIX Short-Term Futures ETN), which tracks the S&P 500 VIX Short-Term Futures Index Total Return, for that purpose.

While it remains a flawed vehicle in terms of accurately reflecting the VIX, for this sort of purpose, that being a broad volatility hedge, it may be regarded as adequate.

What The Periscope Sees

Every week, the Sabrient SectorCast ETF Rankings rate each of the ten U.S. industrial sector iShares (ETFs) by Sabrient’s proprietary Outlook Score. The rankings are revised on a weekly basis.

Once again, the latest rankings featured the seemingly unstoppable Technology Sector at the top, with a near-perfect score of 98. Next best performer was the Energy Sector, which came in a distant second at 80. Lastly, in third place but not by much was the Financial Sector, which ended with a score of 77.

Here is the current list of some of the top-performing Technology Sector ETFs year-to-date, as of the middle of the second week of October:

FDN -- First Trust Dow Jones Internet Index Fund, +36.26%

SOXX -- iShares PHLX SOX Semiconductor Sector Index Fund, +29.63%

FXL -- First Trust Technology AlphaDEX Fund, +26.52%

QTEC -- First Trust NASDAQ-100 Technology Sector Index Fund, +26.38%

SMH -- Market Vectors Semiconductor ETF, +25.24%

IGV -- iShares S&P GSTI Software Index Fund, +20.26%

ETF Periscope

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. 

ETF Periscope