Do you feel lucky, punk? Do you? Ranked volatility is suggesting that now is the time to be buying, for long-term buyers. The setup has been right 72% of the time. The problem: Is it different this time?
One of David Varadi’s premium indicators ranks volatility. It looks back in time and compares current volatility to volatility in the past, and ranks the result on a scale of 0 to 1. Looking back over the past 252 trading days (one calendar year) , we see that ranked volatility is higher than it has been in over a year. Hat to Jeff Pietsch over at ETF Prophet for directing my attention to this.
So what happens when we buy such extreme volatility?
The Rules:
- Yesterday, Ranked Volatility = 1. Today, Ranked Volatility < 1. Buy SPY at the Close.
- Sell X Days Later (from 1-100 days).
- No commissions or slippage included
- All SPY history used.
The Results:
Obviously, buying when volatility is high, relative to the last 252 days, works. However, during a true Bear Market, buying volatility can lead to disaster. (See spreadsheet below, noting 2008 results). There is likely a method to mitigate the disaster, but I do not intend to write about that tonight.
What I’d like to highlight is how the results above suggest a change in the character of the market. These returns are generated by holding the trade for 100 trading days.
From 1994 to 2000, there were 6 trades that generated double-digit gains. (Yes, I’m aware there was huge Bull Market). From 2001 to 2007, there was only 1 trade generating double-digit gains. Despite a huge bull run of almost 100%, there have been no double-digit gains generated from 2008 to the present day.
I’m not sure what this all means. I just think it is significant. Perhaps the old adage about buying when there is blood in the streets has run its course. Maybe even Warren Buffett, who is famous for buying panic and disaster, has so thoroughly popularized the methodology as to render it impotent.
Are You Feeling Lucky?
Past history shows that we have arrived at a significant buying opportunity for long-term holders. More recent history suggests the edge is wearing thin.
The market always seeks to remove money from the naive, and the naive are much more likely to be swayed by emotion. Since high volatility is very likely to increase the influence of emotion and increase investor anxiety, I personally have difficulty believing that buying when there is blood in the streets is losing its edge.
Therefore, I’m Nibbling Tomorrow
Look, I’ve been saying for weeks, if not months, that we will be trading in a volatile range. A re-test of the current bottom is very likely. While swing-trading high volatility markets can be very, very profitable, short-term trading in these environments is best left to professionals. For everyone else, this is the time to deploy a small amount of cash in accounts that run long-term trades. Make sure the amount of cash deployed is small enough not to cause extreme angst should the market continue tanking but large enough to contribute to the long-term success of the account. In other words, don’t bet enough to cause you to sell at the bottom if the market trades much lower, but do bet enough to ensure you are rewarded for buying such a challenging (but potentially very rewarding) market.
BONUS!
Here is a graph of all the trades made based on the setup, over the last 7 years. Green arrows show the buys, and red arrows show the sells 100 days later. The lower pane displays the indicator. Finding the bottom looks easy with this indicator. Knowing when to sell, as always, is the hard part.
Good stuff .. As always! Although this time reminds me of 2008.
Re: 2008, me too!
I’m still holding 2 PDS picks. Will they ever get a sell signal?
Studies like these are always interesting and judging from past results does have merit too. The recent selling has shown that different studies work in different markets and nothing is guaranteed. All a trader can do is and to quote Dalton from the movie Roadhouse “know your opponent; expect the unexpected”. Trade for a bounce but also plan and allocate for selling.
Well said!
Sweet post!
It’s the “can lead to disaster” part that gets me. It seems too that redman59 has been through this before too. The only bright spot I see is Brent is still over $100. WTI is under $80 this AM. If the markets are telling us that we are rolling over into recession, rather than bumping along slow growth, we could go a lot lower for a lot longer. If this is 1987, then a few weeks of pain with lower volatility.
Oh, I almost forgot, great post Wood.
Thanks Yogi! Yes, we are definitely pricing in another recession or even a depression.
agreed.
I remember early 2009 I would run stock screens with these criteria:
down 75% from 52 week high
p/b under 0.5
forward p/e under ten
and it wouldn’t turn up 50 stocks, it’d turn up 2000. so you had to narrow to forward p/e under 5, p/b under 0.3 and so forth.
those kind of screens aren’t as dramatic today, but we are talking numerous stocks under p/b 0.5 and down 50% ytd and so forth.
The thing is, the volatility futures market is behaving very strangly. We are in steeeeeep backwardation, front month VIX futures are at 35. Second month VIX futures are at 31.4. This is relatively incredible, thats a very liquid market, probably trading billions of dollars a week/day, and they are pricing in a VIX over 30 7 WEEKS FROM NOW. VXX has 13% backwardation. This occurs about 2% of the time, including the post lehman brothers days, since vix futures started trading.
We are literally pricing in another financial crisis in the volatility markets. Yet none of the other indicators are anywhere close to 2008 levels. Check this out, 5 year TED spread chart:
http://www.bloomberg.com/apps/quote?ticker=.TEDSP:IND#chart
3 month libor:
http://www.bloomberg.com/apps/quote?ticker=.LOIS3:IND#chart
Last summer had signs of the mildest crisis, right now these indicators are flashing essentially nothing, I mean a 2 week chart looks dramatic, but WHEN THE S&P WAS MAKING ITS ALL TIME HIGH, in 2007, those things were off the charts. The recent rises aren’t even a pimple on a teenagers face by comparison. If we are heading into a true crisis, panic hasn’t even begun. But… gun to my head, if we were heading into a true crisis panic WOULD have actually begun…
What I’m getting at is this: we have a congress that is actually doing the right thing, despite all appearances and their deep desires to mess things up: deficit spending like crazy. The deficit is currently like 8-9% of GDP, which is what we NEED, a $3T US gov’t “deficit” (how can we really owe a debt when all we owe is the push of a button on a magic dollar machine) would have the economy booming like mad, saving the rest of the world along with it…
But I digress. Volatility futures are literally behaving mini 2008, stocks are still 100 points above last summers lows on the S&P. TED/libor is plainly calm. Its a relatively remarkable set of circumstances and as I said in my “bullshit blog” 6 months ago, the play is this:
buy deflationary panics just as governments announce meaningful interventions. How can we solve the crisis? Worldwide? It probably literally takes like 2 steps, the ECB just sets interest rates for all countries. You think the market would fight an announcement that was “the ECB shall loan to ireland, greece, PIIGS galore, at 3% for now, to no limit, fight us if you dare”? They would not. And the US, the worlds consumers, just run a massive infrastructure program. Clean up bridges, etc, clean up O’Hare, which is a blight on our society like no other. Can we afford this? We can afford whatever we wish. Throw in Japan finally listening to their own best economist and just running a rebuilding stimulus like none ever seen… Hopefully that would weaken the yen, strengthen the carry trade, stimulate the worlds economy…
Combine that with elimination of margin in oil futures and we have a solution.
Anyway, sell “inflationary mania” rallies, and buy deflationary dips right when governments take proper and prudent action, right when there is a “sea change” in mood. I would guess that “sea change” will only come from prudent government action.
Nothing going on is that serious, we have no debt crisis, Europe actually does have a debt crisis, but not one that can’t be solved.
But Europe wants a balanced budget ammendment everywhere? That will lead to disaster. Its Occam’s razor. Lets ay that for the hell of it there are exactly and only two schools of thought on economics:
1. MMT. This observes that the government is not revenue constrained, more advanced thinkers in it realize that government debt is essentially just voluntary interest payments on dollars created, it suggests that the essential function of taxation is inflation control, and more advanced thinkers in it realize that the total gov’t “debt” is literally teh sum savings of the world, in dollars. It suggests fiscal stimulus at a time like this to aid the populace in saving and paying down debt.
Essentially they note that spending dollars into a dollar based economy is likely to raise economic activity. They acknowledge that lower taxes accomplishes this probably more efficiently than gov’t spending.
2. Austrians. Their blogs are basically just anarchist political rantings (see mises.org) and while I can get angry and yell along with them, as I agree with much of what they say, emotionally, they advocate a deflationary depression. They have a theory that spending less money will lead to a better economy, and deflation is good, because it will “purify” things. They rant that the dollar has depreciated 93% (13x) since the inception of “the bernank” despite the fact that during this period of inflation the citizens of the US have benefitted from the greatest rise in standard of living in human history. THINK ABOUT how much better off we are than our grandparents and great grandparents were, my god. Who reading this blog DOESN’T have numerous flat screen TVs?
One school: spending dollars into the economy will raise economic activity
Other school: through the miracle of magicness, a deflationary depression will improve economic activity.
Really?
I don’t dispute the desire for less regulation, smaller gov’t, but the FACT is that the MMT kids are correct. We don’t need to “fund” the social security system, its promises are emminently managable. We don’t need to worry about hyperinflation, a dollar collapse hurts us less than it hurts everybody else, frankly.
I digress, I rant, I blather, but nothing, NOTHING, in our current situation isn’t manageable. But its action -vs- the general anger of tea partiers and the like. And anger is winning. Get on TV, give a big heartfelt speech about how government debt is the reason people are underwater on their mortgages, and people respond. Observe that the ENTIRE THING can be dealt with and hyper conservative bloggers call me names.
We are losing because of ig’nance. Because centuries of leanringa nd understanding are being thrown under the bus in favor of … anger.
Its the anger of the american populace that threatens the world more than any other force. What we, not me, but we as a whole are doing, screaming for fiscal responsibility, is no different than Saudi Arabia in a recession having its people screaming fo rless oil exports. Literally no different. I promise you they wouldn’t.
Only America, folks. Only America screams for its own pain to be delivered under glass, steaming, and topped with a fine Chaffron cream sauce.
But about markets, I think for the time being stocks beat shorting volatility, due to intense backwardation. I also think that if you have a “buy and hold” trading account, this is a GREAT time to short 5% of it in VXX. VXX ends in 2019, maybe, maybe they continue it, and it will fall 99% from here by then. Call it a free 5 or 10 percent, but I’m not sure you should expect results soon…
I just left a heinously long rant here.
Point was: rant, and also financial markets (see libor and TED spread) are showing nearly no signs of panic. But the fact is that our reality is deflationary without government intervention…
heinously long rant apparently didn’t show up. lol
Let me check behind the scenes. May have gotten held up as spam.
Yep, got caught in spam filter. Rant is now published.
thanks, or, maybe, depending on how rantish my rant was, no thanks. lol
woods, you are one of the webs best bloggers
Thanks Check. Busy at work here so I can’t respond at length, but your rant is well worth reading and considering.
Hi Wood, the Ranked Volatility from ETF Rewind is very simple, a 1-year rank of 100-day Historic Volatility. You may find that a helpful environmental filter. DV’s construction is pretty different, but also highly effective. Keep up the good work. My best, Jeff aka Mrkt_Rwnd
Thanks for the clarification Jeff!
If your study is any guide to the future, the next two weeks are going to be just as choppy as the last two.
You have a stronger stomach than me. I don’t think I be able to pull the trigger just yet.