Conclusion: Looking to recent history, VIX ~15 has been an explicit signal to get hedged; thus, we are doing so in our Virtual Portfolio.
Position: Long the iPath S&P 500 VIX Short-term Futures ETN (VXX)
In this morning’s Early Look, Keith used a very appropriate quote from Daniel Kahneman that we feel describes the appropriate state of our industry:
“The illusion of skill is not only an aberration, it is deeply ingrained in the culture of the industry. Facts that challenge such basic assumptions – and thereby threaten people’s livelihood and self-esteem – are simply not absorbed.” (Kahneman, page 217)
Regarding the first part of the quote, perhaps the reason the VIX has a coincident relationship with the S&P 500 instead of a leading one is that it’s simply human nature to not want to buy downside protection when the market feels like it wants to trend higher. Everyone’s best ideas are working on the long side and both sell-side consensus and legacy financial media sources cheer on gains instead of focusing on the catalysts which could bring about mean reversion. While it’s not always an appropriate time to position for mean reversion, we’ve been consistently making calls to hedge for meaningful downside risk in U.S. equities when the VIX is trading with a 15-handle on it – just as it is today.
That brings us the second point Kahneman makes, which is that “facts that challenge such basic assumptions” (like combining top-down fundamentals with a quant overlay to make an explicit call not to chase “Dow 15,000”) and are threatening to the “livelihood and self-esteem” of market operators “are simply not absorbed”. Often times, they are, in fact, refuted with great vigor as we have seen in our inboxes from making similar calls in years past.
That said, however, our number #1 goal as an outsourced Macro Team remains to help our clients preserve and grow capital across economic cycles and all types of market environments; thus, making contrarian calls is not something we shy away from.
Today, that call is to get hedged, no matter how counterintuitive it feels at current prices. Our quantitative levels on the VIX are included in the chart below.