Via ConvergEx's Nicholas Colas,
What is the weirdest thing about 2016?
“Trump wins US Election”? “UK Leaves EU”? “Cubs Win World Series”? How about this one: “The VIX Peaks in February”?
For the first time since the start of the modern VIX in 1990, the “Fear Gauge” peaked in that month. October (no surprise) is the most common month for a peak reading (5/26 years, or 19% of the time) followed by August (4/26 year, or 15%) and January (also 4/26 years). Troughs for the VIX come most often in December (7/26 past years) and July (6/26 years). And while it hasn’t done so just yet, the VIX seems set to repeat the typical seasonal pattern and trough this month. The lowest close of 2016 thus far has been 11.34 (August 19); today’s 11.7 close was the low tide mark for December. That tells us that the Santa Claus rally may still have some legs, and the VIX will decline as stocks rise. As for what sectors to play, we’d take a look at rate sensitive names (Utilities and Telecoms) for a trade into year end. They’re unloved at the moment, but Santa’s good cheer may change that.
It is almost time for all those “Year in review” shows on TV. Expect to see and hear a lot about how 2016 was a truly watershed year, with the June Brexit vote and the November Trump presidential victory leading the political headlines. And, for once, those shows will ring true. This really was a historic year, if only because conventional wisdom proved itself so spectacularly wrong.
The funny thing about those events is, however, that they were not the ones that roiled U.S. equity markets the most. For example, the peak reading at the close for the CBOE VIX Index “Fear Index” (and the low point on the S&P 500) was back on February 11, rather than right after the June Brexit vote or on the day everyone realized Donald Trump would soon go by the nickname “45”. A headline in the WSJ on the February 10th summarizes the concerns of the day: “Economists, CEOs: Recession Risk Rising”. Those concerns were far more vexing to markets than the UK or US votes.
Here are the comparisons between the February 11th close for the VIX and the S&P 500 relative to levels around Brexit and the U.S. election:
- February 11th low on U.S. macro concerns: S&P closes at 1829, VIX at 28.14. The low close for the year.
- June 27, post-Brexit bottom: S&P closes at 2000 (9% higher than the February levels), the VIX at 25.8 (one day prior).
- November 4, pre U.S. election jitters: S&P 500 closes at 2085 (14% higher than the February levels), the VIX at 22.51.
News headlines come and go, of course, but there is something unique about 2016 and the cadence of these measurements: the VIX has never before peaked in February.
Now, we aren’t talking about the longest time series here – the modern VIX dates to 1990. But still, in 26 years the VIX has established a reasonably predictable seasonality.
For example:
- Over the last 26 years, the VIX is most likely to peak in October (5 times), August (4 times) or January (4 times). Those total 13 of the 26 years in our sample, or half the total.
- Months with lower-than average VIX peaks include December (1 time, 1996), May (1 time, 2010), and March (1 time, 2004). Based on this history, we can say that it is a 50/50 shot that the VIX will bottom in one of these 3 months.
- Unless something goes seriously off the rails between now and the end of the year, the VIX will have peaked in February for the first time ever.
The VIX also exhibits seasonality on the downside as well. December is the most common month for an annual closing low (7/26 years), followed by July (6/26 years). Simply put, historical patterns point to a 50/50 shot that the VIX will trough in July or December of any given year.
So far in 2016, the VIX closing low was back on August 19th at 11.34; today’s close was 11.71. Now, the VIX has made its closing low in August twice over the last 26 years, so this isn’t as unusual as a February peak. But with U.S. equity markets still seemingly in rally mode, we would assume that the VIX will follow the more common precedent of bottoming in December. Or, put another way, U.S. stocks will continue to rally because a seasonally declining VIX will drag equities higher since the negative correlation between the direction for stocks and the VIX is consistent and strong.
So what should you buy if you are looking for one last puff on the 2016 post-election rally “Cigar”? Every month we look at the Implied Vols (essentially the “VIX of”) every sector of the S&P 500 as well as major asset classes like corporate bonds, precious metals, and emerging/developed economy equities. Here are a few ideas:
- Perhaps the most oversold asset class in the current move is fixed income, with 10-Year Treasury rates soaring from 1.8% on November 1st to 2.5% at the close today.
- Implied volatilities for sovereign and corporate bonds have already declined, anticipating that this asset class won’t be moving as much as in the recent past.
- The implied Volatilities for equity sectors that function as yield substitutes – notably Utilities and Telecomm – are still well off their lows. Their “VIX” readings should decline into year end, as those for fixed income assets already have, lifting these stocks higher.
Or, in more straightforward terms, Utility and Telecomm stocks are oversold. Their fortunes are substantially linked to long term bond yields, which have already borne the brunt of their post-election selloff. Until the new Trump administration comes out with a deficit-busting infrastructure/tax program or inflation really heats up, interest rates may well just trade around current levels. And that could be until well after Inauguration Day. Long enough, in other words, to let these rate-sensitive stocks recover some lost ground.
via http://ift.tt/2h2WeCu Tyler Durden