November 2020 Commentary

typical vix in an atypical year

From a VIX perspective, the election surprised by not being very surprising. Following the typical pattern around a known deadline, hedges which had propped up the VIX ahead of the election were abandoned with the passing of the “known unknowns” of the event itself, causing a quick repricing lower in the VIX and higher in stocks immediately following the election.

In response to this message from the VIX, TCM strategies moved from defense to offense during the first week of November, with Alpha Seeker in place to profit from the slow decompression in volatility in the balance of the month while Smart Index strategies benefitted from their strategic index exposure during a strong month for equities. When it was all said and done, the S&P 500 and Nasdaq finished nearly 11% higher with the VIX receding from near-panic levels at the start of the month, though still stubbornly above normal (see chart below).

VIX futures curves, 2020 vs 2016. Source: vixcentral.com

process over opinion

When it comes to investing through extreme uncertainty, the election is another example of the value of process over opinion. Our process is simple: when crisis conditions are present, defend against crisis-sized losses. Not just a psychological benefit, avoiding major losses is more beneficial to portfolios than maximizing gains. This is clearly demonstrated by the substantial outperformance of Smart Index vs the S&P 500 in 2020 despite trailing the index in each up month this year- the same profile it has produced for our clients over the past four years. Even with its outstanding March return set to 0%, Smart Index would be nearly double the S&P 500 on the year through November! (see chart below).

YTD 2020 return comparison. Smart Index net of 1% fee. Orange line = hypothetical results setting Smart Index March 2020 return to 0% and using actual returns otherwise.

This is the power of compounding- a concept that humans don’t easily internalize. Since investment returns compound on each other, the path of returns is as important to a portfolio’s end result as the magnitude of any one period. A risk-managed approach may not fully participate in relief rallies like we saw in November, but as this year’s results have shown, smart risk control can make all the difference for portfolios over time.

October 2020 Commentary

stocks dip, vix rips

As stocks fell for the second consecutive month and the VIX pushed higher in front of the US Presidential Election, Alpha Seeker recorded its 4th consecutive monthly gain while Smart Index strategies finished nearly 2% ahead of their benchmarks for October.

Known Unknowns

At current levels, VIX contracts already reflect the “known unknowns” surrounding the election. If these uncertainties are cleanly resolved, the VIX will likely find a new lower level as it moves on to the next set of issues. If instead, a new uncertainty such as a contested election were to enter the picture, it is possible to see VIX products move substantially higher over the coming weeks. If 2020 has taught us anything, it is the value of preparation.

LHA Market State Tactical Beta ETF (MSTB) Launched Sep 29, 2020

We are pleased to announce the launch of the LHA Market State® Tactical Beta ETF (MSTB).  Below are links to the Press Release and the ETF’s Prospectus. Please visit www.lhafunds.com or contact Little Harbor Advisors, LLC at (781) 639-3000 (ext. 147) with questions, comments or requests for more information. 

Investing involves risk. Principal loss is possible.

The LHA Market State Tactical Beta ETF is distributed by Quasar Distributors, LLC.

September 2020 Commentary

SPECULATIVE UNWIND KEEPS VIX upside-down

View fullsize

Sept 2020 return comparison. Click for larger image

Continuing the streak of positive correlation that began in mid-August, the VIX and stocks fell together in September, creating a drag from hedging positions that were added early in the month in Smart Index, Smart Tech and Legacy Navigator. Benefitting from its focus on long and short S&P positions, Alpha Seeker notched its 3rd consecutive positive month and has now doubled the S&P 500 on the year with just 0.29 daily correlation.

POSITIVELY INCLINED

Normally, the demand for insurance exceeds the demand for lottery tickets. In finance this shows up in the “skew” of option prices towards put options that normally make them dominant factor in determining the level of the VIX. When demand for options is skewed toward protection (puts), the VIX Index (the demand for put options) rises as the market falls, and vice versa.

Mirroring the persistent skew toward puts after the market crash in 1987, the daily correlation of the VIX Index with the S&P 500 since 1990 is -0.70, a strong but not perfectly inverse relationship. Positive VIX/S&P correlation can occur when option demand shifts strongly toward calls, typically around speculative peaks like the massive one we’ve seen in recent weeks (see chart below).

View fullsize

Small Trader Option Premium vs S&P 500. Source: @SentimentTrader. Click for larger image.

During these periods, the VIX Index can be “upside-down”, driven by the demand for calls (lottery tickets) rather than puts (insurance). As the speculation peaks and demand shifts back towards put options, the VIX/S&P relationship then normalizes. For more information, see Matt’s appearance on a recent podcast as well as his contribution to this Bloomberg article.

Like so many things in markets, this is a naturally cyclical process driven by human emotion. As this cycle plays out, we will continue to be guided by the “Holy Grail” of investing:

August 2020 Commentary

VIX STILL fighting the equity mania

View fullsize

5 Day Correlation: VIX Index and S&P 500 Index. Click for larger image

Riding on the back of continued gains in equity indexes, TCM strategies were all substantially higher in August. The mania in tech names in particular has become reminiscent of the late 90s, boosting our Smart Tech strategy by nearly 30% since May and over 10% in August alone. Curiously, late in the month the VIX index began rising alongside equity markets, bucking the normal inverse relationship and suggesting discomfort with the market’s torrid pace or perhaps growing apprehension over the coming US Presidential Election.

Money Games

While those fortunate enough to own assets celebrate their nominal gains, we are reminded of a college party where guests played games to earn play “dollars” that could be used to bid on such coveted prizes as a gift certificate to the local Chili’s. While the preoccupation among starving students was with competition in the game room, in reality the real action was in the money room.

When vying for resources with ring-toss and dart skills proved tedious, new money began to find its way into the hands of the organizers near the vault upstairs- slowly at first, then growing increasingly bold as the night wore on. While obscene sums began to be exchanged for increasingly questionable “games” upstairs, activity in the downstairs economy dwindled as hours of game earnings now barely registered on the bid sheet. With the best prizes impossibly out of reach, participants focused on buying the items they could as their prices also steadily rose, all the while marveling at the vast resources of the organizers upstairs, never understanding the real game.

While stock prices soar as the Fed prints and funnels trillions to mega-cap tech companies through its bond purchases, it is important to keep in mind that every new dollar is also a new claim on society’s resources. Similar to a stock split, manipulating the value of the dollar is an accounting maneuver that creates an illusion of wealth, with real costs for everyone and true benefits for only a select few. If the market ever comes to this realization, the adjustment could be dramatic; investors today would be wise to have a plan.