VIX Rising And Fear Is Surmounting For Major Averages

For a second day in a row, U.S. equity futures are pointing to a lower open ahead of yet another busy trading day. While the media headlines certainly centered on the 10-year Treasury yield rising above 2.70% yesterday, the tone and discussion may shift today and in the direction of the State of the Union Address. With U.S. equity indexes finishing lower yesterday and the S&P 500 lower by nearly .6%, the action may bring out the heavy hitters with cautionary statements and tones. Yesterday’s broad market decline marked the largest sell-off in nearly 5 months for the indexes.

Bloomberg news published a narrative yesterday that surmised Goldman Sach’s near-term outlook for the markets.

“Strategists at the U.S. bank say signals are flashing for a drop of 10 to 20 percent in equity prices in the coming months. Goldman’s risk appetite gauge is hovering near a record high, indicating a sharp rise in investor optimism, while traders seem complacent about political risks like Italy’s national elections, they say. Still, the risk of a full-blown bear market is viewed as low, as strong and synchronized global growth provides a reason to stay bullish.

While Goldman Sachs believes a pullback is on the horizon, the firm also denotes its belief that the pullback will not turn into a bear market. Additionally, the firm offered such a pullback in markets as a buying opportunity.

Also late yesterday, Todd Gordon, founder of TradingAnalysis.com, recited his concerns for the Nasdaq 100 as we head into a heavy week of tech earnings with Facebook, Apple, AMD, Qualcomm, Amazon and Google all reporting results. Gordon offers his technical analysis on the Nasdaq 100 in the following chart:

According to the trader, since 2009 the market has “respected the top end of this channel, which is your ceiling or resistance,” and it has also “respected the bottom side which is support, or the floor.

The good news, thus far is that the Nasdaq is currently trading below the 7,100 level, the bad news is that the index has fallen in 3 out of the last 4 trading sessions. There is a lot to glean from the technical analysis and combined with Goldman’s near-term outlook, the sentiment is ominous for equities. It remains to be seen if corporate earnings can still drive markets higher in the coming weeks. Nucor, AMD, Pfizer and a host of other corporate earnings will hit the tape today. But tomorrow, Facebook and Qualcomm will headline the tech sector earnings with both companies reporting after the closing bell.

McDonald’s Corp. reported fourth-quarter net income of $698.7 million, or 87 cents per share on Tuesday, down from $1.20 billion, or $1.44 per share, for the same period last year. Diluted EPS fell due to tax costs associated with the Tax Cuts and Jobs Act of 2017. Adjusted EPS was $1.71, well ahead of the $1.59 FactSet consensus. Revenue of $5.34 billion, fell from $6.03 billion last year, but exceeded the FactSet consensus of $5.23 billion. Global same-store sales rose 5.5%, ahead of the 4.9% FactSet consensus. U.S. same-store sales increased 4.5% due to the McPick 2 platform, beverage value items, and “strong consumer response” to Buttermilk Crispy Tenders and delivery. McDonald’s plans to open 1,000 new McDonald’s restaurants, three-quarters of which will be funded by an expanding network of affiliates and licensees, said Chief Financial Officer Kevin Ozan.

Aetna beat top and bottom line estimates when it reported this morning.  On an adjusted basis, the company earned $411 million, or $1.25 per share, down from $578 million, or $1.63 per share.  Analysts polled by Thomson Reuters were expecting adjusted earnings per share of $1.20.  Revenue fell 5.6% to $14.85 billion, but that figure came in slightly above analysts’ predictions. Revenue from health-care premiums and other premiums both fell. Total benefits and expenses declined 7.3%.  Aetna also said Tuesday it expects a lower corporate tax rate to boost gross adjusted earnings by $800 million for the year. It also noted that earnings will be reduced by between $30 million and $50 million from lower premiums because the health-insurer fee was suspended for 2019.

In Europe, the Stoxx 600 index has fallen 0.47% to 3997.85 points, the lowest since Jan. 25, 2018. In Britain, the FTSE 100 slumped 0.51% amid reports that data compiled by the government as part of its Brexit analysis shows the economy would lose 5% of its value over the next 15 years even under the best-case scenario the U.K. could arrange as it leaves the European Union. In Asia, stocks were also noticeably lower following Wall Street’s sharp decline, with the MSCI Asia ex-Japan index falling 1.28% to 605.80 points and the Nikkei 225 benchmark in Tokyo retreating 0.7% to close at 23,455.98 points.

With markets a bit unnerved and pointing to a lower open yet again today, the VIX has been steaming higher, finding it’s highest levels since the Fall of 2017. The VIX popped roughly 20% in yesterday’s trade and finished the day above 13. Ahead of what will prove to be another long day in the volatility complex, the VIX is breaching 14. VIX Futures are also higher this morning, possibly forecasting backwardation along the Futures curve in the near term.

Some traders are willing to let the VIX go from current levels as some 80,000 February 15 VIX Futures calls were sold yesterday at $.77. Having said that, holes in open interest be it for VIX Futures or SPX options have been quickly filled as of late.

The movement in the VIX complex has been the source of much scrutiny and consternation in the New Year. Many had expected the complacency that surrounded markets, resulting in a subdued VIX reading to persist as the major indexes rose substantially higher in the first month of 2018. But that simply hasn’t been the case as hedging strategies have come into play with markets at all-time highs. The reality is that with each passing year of the bull market cycle, the VIX has painted a different picture for which traders experience in many different ways.

I concluded 2017 believing that the VIX might find itself a healthy mean reversion to take advantage of with ample liquidity and cash holdings. Moreover, I was of the belief that 2018 would not mirror the action in the VIX from that of 2017. Last year I had been sampling and modeling for what I defined or coined as Long Against the Box-VOL participation. Every year I offer to clients of the Golden Capital Portfolio my monthly newsletter communication and it usually ends the year with a go forward strategy. Based on 2017’s abnormally low volatility levels, I believe there would be an opportunity to participate in the VIX complex from both sides of the spectrum. The screenshot below offers my verbiage to clients on December 31, 2017 in which I outline the Long Against the Box-VOL participation.

The trade-off in the Long Against the Box-VOL strategy is a rather simple context in that executing such a strategy is very much aligned with timing. Entering a VOL trade from the long side requires precision timing on both the entry and the exit or assigning appropriate strikes. Having said that, the strategy does also benefit from the greater short positioning should the trade fail from the long side and as it proves easier to participate in the VOL trade as the VIX decays. In no way shape or form does Finom Group or Seth Golden recommend this strategy to others as it is littered with difficult implementation. Having said that, it is proving a prudent participation thus far in 2018.

The markets are set up for a difficult day for long-only asset managers and ahead of key earnings reports, Fed speak and of course the State of the Union Address tonight. Stay tuned to Finom Group daily reporting and join in the conversation with our traders!