The Smooth Correctionless Rally Continues
It has been like this for quite a while and soon some equity investors will forget how a correction really looks like (which is exactly when a real correction will happen I suppose). The group of major equity benchmarks reaching new all-time highs, multi-year highs, or other psychological milestones, has most recently been joined by the FTSE 100 (surpassing its 2007 high to close highest since September 2000) and Russell 2000 (hitting 1000 for the first time).
By the way, S&P500 at 1666 is exactly one thousand points from the March 2009 “devil” low of 666 (which is probably one of the useless pieces of market statistics that Team Macro Man are referring to in their latest post).
VIX near Lows, Sideways, and in a Very Narrow Range
The recent action (or rather the lack of it) in the VIX can be characterized by another piece of statistics with limited predictive power: The spot VIX has been in a narrow 1.27 point (12.26-13.53) range in the last 12 sessions (since 3 May). This has not happened since April 2006 (VIX was in the high 10′s and 11′s at that time). Furthermore, if we exclude the Friday dip to 12.26 (which could be attributed to the “weekend effect” to some extent), the range since 3 May would be only 1.04 points.
The VIX will certainly break out of that range and I would expect that to happen sooner rather than later, but the question remains which direction. There is some room and good reasons on either side. The prospects (especially potential size of the move) are better on the long VIX side, but that is also why being long VIX costs money over time. Before you go and buy VXX or UVXY because “VIX is low”, make sure you know which kinds of exposures these products represent. Which brings us to VIX futures and longer-term volatility expectations…
Longer-Term Volatility Shows a Different Picture
It is not all sideways here. The VXV index, which measures 3-month implied volatility of S&P500 options (compared to 30 days on the VIX), has been growing since its 6 May / 7 May lows. The magnitude of the move is not dramatic (about 1 point), but there is a remarkable difference between the stagnating volatility expectations for the short term (VIX) and the rising ones for the medium term (VXV).
The rising volatility expectations going further into the future are also obvious on the VIX futures curve, which has significantly steepened since 7 May. The long end added almost 1 point, while the spot VIX was sideways and the front month converged to the spot with approaching expiration (last trading day is today).
May VIX futures lost most of the premium over the spot as expiration approached:
June VIX futures, which will become the new front month this week, also lagged behind the longer term contracts, but managed to stay above the 7 May low. Keep an eye on this contract if you are trading VXX or UVXY now.
September VIX futures rose about 0.80 from the 7 May low. It looks similar on the other longer-term VIX expirations.
VIX Option Premiums Also Higher
Bottom line: There is much more going on in the SPX/VIX volatility universe besides what you can see on the headline spot VIX number. The recent days have provided a good example of that. The spot VIX might seem boring and complacent at the moment, but VIX futures and options have shown some moves.
Longer Term VIX from (an Even) Longer Term Perspective
Two noteworthy points when looking at the recent rise in VIX futures and VVIX:
- The 7 May low was really low, especially in the middle and on the long end of the VIX futures curve, which was perhaps too flat for the level of spot VIX (I covered that in the second half of the 8 May post). Maybe the recent surge in medium and longer term volatility has been merely a return to more normal conditions.
- The moves are very small, to the extent of being just noise, in the context of 2013, let alone longer history. See the two charts of constant maturity 3-month VIX futures prices below.
I’m sure you have seen enough “sell in May and go away” analyses and blog posts in the recent weeks, but looking at the impressive YTD performance of US equity indices I couldn’t resist and ran the numbers myself. I have looked at the full history of the Dow Jones Industrial Average (since 1897, because in 1896 the index started only in May).
Sell in May and Go Away vs. Buy and Hold
First let’s compare two simple strategies. Imagine your great-great-grandfather invested 100 dollars in the Dow at start of 1897.
Strategy 1: “Buy and Hold” – Don’t touch your investment for 100+ years (blue line).
Strategy 2: “Sell in May and Go Away” – Sell stocks every year by 20 May close or the close immediately before 20 May if that was a non-trading day (If you were doing this strategy, you would be selling at today close). Stay out for the rest of the year, and buy stocks back at close of the last day of the year. Repeat every year (green line).
You can see that Buy and Hold outperforms Sell in May and Go Away by wide margin. The performance does not include dividends. It does not include interest on idle funds (from May to year end). And it does not assume rebalancing costs (when index composition changes).
A few details:
- Balance at the end of 2012: USD 1,051 for Sell in May and Go Away vs. USD 32,396 for Buy and Hold
- Annualized performance: 2.0% vs. 5.1%
- % of winning years: 62.1% vs. 65.5%
- Standard deviation: 10.74% vs. 16.64%
- Maximum drawdown: 57.13% (in 1942) vs. 79.91% (in 1932)
- Longest time to new high: 35 years (ending 1965) vs. 26 years (ending 1954)
You can see that Sell in May and Go Away reduces the risk a little (lower standard deviation and maximum drawdown). This is even more significant when taking only the last cca 50 years into consideration: Since 1958 maximum drawdown of Sell in May and Go Away has been below 20% and since 1975 it was above 10% only once (10.40% in 2010). It would have saved most of your portfolio from the dot-com bubble burst as well as the post-subprime mess. The Buy and Hold drawdown was 27.45% in 2002 and 33.84% in 2008. Note that the drawdown numbers, as well as the standard deviation, only look at the end of year balance and don’t take intra-year volatility into consideration.
Nevertheless, in sum, the overall performance gap is too big to justify the reduced volatility with the Sell in May strategy. To most investors it’s not worth it, at least when looking at the whole history of the Dow.
The favourable risk statistics for the Sell in May strategy in the last decades made me look at how the two strategies compare over shorter periods, namely (trailing) 10 years and 20 years. See the charts:
You can see that there have been longer periods of time when the Sell in May strategy outperformed Buy and Hold. One of such periods is the 20-25 years ending now.
However, the differences in performance are relatively small in such cases, compared to the sometimes enormous differences in the other direction, including the 20-year periods ending in the 1950′s (and well into the 1970′s) and the 20-year periods ending around 2000, when Buy and Hold had outperformed Sell in May. Not surprisingly, the Buy and Hold strategy is beating the Sell in May by the widest margin during long bull markets (you don’t want to stay out during a bull market).
When YTD Performance in May Seems Too Good to Hold
What if the performance in the first 4-5 months is so good that it seems that a correction is inevitable? Like in 2013, when the Dow has increased 17% already. Should you sell this “overbought” market?
The table below shows top 25 years since 1897 with the best YTD performance by 20 May. 2013 is rank 8, but not far from rank 5 actually (Friday 17 May close for 2013; data for other years is as of 20 May close):
The most important observation is that exceptionally good performance until May does not imply poor performance during the rest of the year – quite the opposite. Among the top 24 years (2013 not included) there are 5 years with negative performance from May to year end, but:
- Two of them are years ranking 23 and 25.
- Three of them are still above -3%, which can be considered a red zero in the long-term perspective.
The only years with dramatic losses from May to year end after a great YTD performance in May have been 1899 and 1987 (the year of the Black Monday crash in October).
Furthermore, all these years stayed positive by the end of the year. The year with the best 20 May YTD performance that ended negative was 1930 (rank 38, 20 May YTD +7.49%, May to year end -38%, total -34%).
Average performance from 20 May to year end for the top 24 years by 20 May YTD was 7.73%, about double the average performance for the other 92 years (3.54%). In sum, good performance until May predicts good performance for the rest of the year (other things being equal, which they never are).
At the same time, a great performance until May is hard to beat (or even match) during the rest of the year. The last column in the table above shows how many % of that particular year’s (dollar) gains were made until 20 May. In all but 4 out of the 24 years more money was made until 20 May than during the rest of the year. Furthermore, in one of those 4 years (1996, rank 21) the percentage gain from May to year end was slightly lower than from year start to 20 May.
- In the long run, Buy and Hold outperforms Sell in May and Go Away by a wide margin.
- Sell in May has slightly lower volatility and lower drawdown, but the difference in long-term performance is too high a price to pay for that.
- Very good YTD performance in May predicts positive and above average performance during the rest of the year, although the growth is likely to be slower.
- This is true on average, based on the historical data. Actual performance this year will of course be driven by many different factors which are unique to this year and time.
- If you are a long term stock investor and you have no opinion on the near future of the fundamentals, your best bet is to stay long and ignore the Sell in May and Go Away.
- If you do have an opinion on the near future of the fundamentals, go with your opinion, because historical statistics like this is only one piece of an analysis and it should never be relied on blindly.
S&P500 and Dow Jones above Round Number Levels
After four bullish days in a row both S&P500 and the Dow have now closed above the round number levels of 1600 and 15000, respectively. The Dow was struggling a bit on Monday (15000 seems to be a bigger thing that 1600), but rallied above the level decisively yesterday. So now we have both the indices at all-time highs with the earnings season (strong on the bottom line and rather questionable on the top line) about to end. The macro calendar is much lighter this week compared to the previous one.
VIX Low, But Not That Low
The VIX has been between 12.50 and 13.20 during the last 3 trading days, after having fallen there from the 14′s last Thursday. It is now lowest since 12 April, but still well above its 2013 lows (11.30 on 14 and 15 March).
Some people may be surprised that the VIX is not making new lows when the equity indices are making new all-time highs. Keep in mind that while the VIX and S&P500 tend to move in opposite directions, it does not mean they are mirror images of one another. Although they are closely related, they in fact measure different things (stock prices vs. option prices). Moreover, while the equity indices are unlimited on the upside (S&P500 can theoretically rise to 2,000, 20,000, or even millions), the VIX is limited on the downside (theoretically by zero and historically somewhere around 9).
VXV near 2013 Lows
The VXV index, the 3-month version of VIX, is now in low 14′s. 14 has been the low on numerous occasions in the last months (ignore the dip on 28 March).
VIX futures curve moved downwards in line with the developments in stocks and spot VIX. The extent of the week-to-week change was almost the same along the whole curve, between 0.40 and 0.60 points.
Although the contango of course remains, the steepness of the curve is rather moderate, especially when you exclude the nearest expiration months. The difference between July (15.75) and November (17.60) is less than 2 points. This may be favourable for those willing to bet on longer term volatility using some of the exchange traded products tracking the S&P 500 VIX Mid-Term Futures Index (that includes the 4th through 7th month), such as VXZ or VIXM.
The front month, which expires in two weeks, has dropped below 14 for the first time since it started trading. It is now at about 1 point premium to the spot.
2-Month Low in VVIX
The VVIX index, which measures implied volatility of VIX options in the same way as the VIX measures implied volatility of S&P500 options, fell below 79, lowest since 12 March. It still remains well above its lows from January and February.
New All-Time High on S&P500
Equities ended April positively, closing at new all-time high on S&P500 and just 25 points short of all-time high on the Dow. Both indices are now just below (minor) psychological levels of 1,600 and 15,000. One third of 2013 is behind us and it was excellent for bulls, as all four months were positive and, more importantly, the deepest correction was only 3.25% (in the 5 trading days from 11 to 18 April; assuming closing S&P500 values only).
VIX in Narrow Range in the 13′s
In spite of the new highs in equities, the VIX is actually more than 2 points higher than its 2013 low (lowest 2013 VIX close was 11.30 on 14 and 15 March) and also higher than the low it made shortly after the previous S&P500 all-time high (VIX close 12.06 on 12 April).
In the last 6 trading days the VIX was moving in a very narrow range, with all 6 daily closing values between 13.48 and 13.71 and intraday range between low 13′s and low 14′s (except the spike to 14.85 on the first day due to the AP fake tweet).
Spot VIX below Realized Volatility
However high the current VIX level may seem when compared to previous VIX lows, it is actually lower than the realized volatility of S&P500 (14.41%) measured over the last 21 trading days (approximately the same length as the 30 calendar days period used on the VIX). Historically, a premium of implied volatility (and the VIX) over realized volatility has been much more common and we can now expect either a decline in realized volatility or an increase in the VIX.
VIX Futures Curve Flattened
Compared to the 12 April VIX low (the day after the previous S&P500 all-time high), the VIX futures curve is now flatter, with near term futures 0.10-0.30 higher, August about unchanged, and the long end lower by up to half point. For comparison I have also included the curve from 18 April (yellow), the day of the recent VIX high and S&P500 low.
VVIX in the 80′s
The VVIX index, which measures implied volatility of VIX options in the same way as the VIX measures implied volatility of S&P500 options, returned from the high values above 100 back to the 80′s. Like the VIX it is well above its 2013 lows.
Today we saw a small 2013 version of flash crash after AP (Associated Press) Twitter account (@AP) was hacked and displayed the following tweet:
“Breaking: Two Explosions in the White House and Barack Obama is Injured.”
The tweet appeared at 13:07 EDT and was on only for a few minutes. AP quickly stated that the message was fake and that “the President was fine”. You can see more about the (still developing) story on Bloomberg or CNBC.
Below you can find charts of selected markets to see in detail how they were reacting during the minutes after the fake tweet. All charts are 5-second bars, unless stated otherwise.
The Dow Jones Industrial Average lost 146 points (almost 1%) during the 2 minutes from 13:08 to 13:10. Then it quickly recovered:
VIX (updated every 15 seconds):
VIX May 2013 futures:
10-year treasury yield (30-second bars):
Gold June 2013 futures (30-second bars):
WTI crude oil (CL) June 2013 futures (30-second bars):
Twitter has become an important news monitoring tool for an increasing number of market participants (myself included), which apparently brings new challenges for regulators and for the integrity of markets.
The AP Twitter account was suspended after the event.