The SPY And VXX Go Hand-In-Hand – VXX Is In The Penalty Box
Uncertainty is the stock market’s worst enemy. Russia’s invasion of Ukraine has put the world on the verge of a World War with the US, Europe, and its allies on one side, and Russia, China, and their allies on the other. After dealing with the pandemic over the past two years, the Russian invasion left no room for the world to rest as it has gone from crisis to crisis.
The NYSEARCA:SPY is the ETF that moves higher and lower with the S&P 500, which reflects the US stock market. The BATS:VXX is an ETN that follows the VIX volatility index, reflecting the implied volatility of put and call options on the S&P 500 stocks. Since markets tend to take the stairs higher and an elevator to the downside, market participants flock to the options market to purchase price insurance when the stock market declines As of Wednesday, March 23, the APS was long the SPY ETF, and while it would be short the VXX ETN, we decided to put the ETN in the penalty box for now.
The S&P 500 had been trending lower since the January 4 high- Bear markets experience vicious rallies
The S&P 500 index is the most representative stock market indicator in the US equity market. On January 4, 2022, it reached a new record high of 4,818.62 and ran out of upside steam.
As the chart shows, the index has made lower highs and lower lows since early the second trading day of 2022. The index fell to 4,116.06 on February 24, the day Russia invaded Ukraine, a 14.6% decline from the peak.
On March 23, the S&P 500 closed at 4,456.24. The leading stock market index rallied in the wake of the March FOMC meeting. The index broke the first level in the pattern of lower highs as it exploded to the upside in a rip your face off rally after the central bank hiked the Fed Funds rate for the first time since December 2018 and told markets they expect to increase the short-term interest rate by 25 basis points seven times in 2022. Moreover, the FOMC indicated that it was prepared to begin reducing its swollen balance sheet, providing additional credit tightening. A hawkish Fed is not typically bullish for the stock market. However, bear markets often experience vicious rallies that give way to lower lows.
The chart of the S&P 500 SPDR (SPY) shows the decline from $479.98 on January 4 to a low of $410.64 on February 24, as the 14.4% drop nearly matched the S&P 500 index. The SPY bounced from the February 24 low, and moved to a level that was above the first obstacle in the pattern of lower highs and lower lows that had been in place since January 4.
The SPY is a highly liquid ETF product with over $409 billion in assets under management. The average daily volume is above 118 million shares, and SPY charges a 0.09% management fee.
The VXX had been trending higher since January 12
Many markets tend to take the stair higher during bullish trends and an elevator lower during corrections, causing the statistic measure of price variance to rise during bearish periods.
The stock market tends to experience this phenomenon, causing the demand for price insurance or put and call options to rise during corrective periods. The VIX index is a real-time indicator of the implied volatility of put and call options on S&P 500 stocks. The VIX typically rises during bearish periods.
The VIX reached the low for 2022 on January 4 at 16.34 when the S&P 500 peaked. Since then, it has moved in the opposite direction to the stock market index, making higher lows and higher highs as the bearish trend in stocks has increased the demand for options, which are price insurance.
The fund summary for the iPath Series B S&P 500 VIX Short-Term Futures ETN (VXX) states:
At the $25.49 level, the VXX product had $630.37 million in assets under management and trades an average of over 49 million shares each day. VXX charges a 0.89% management fee.
The VXX had made higher lows and higher highs since early January.
Markets reflect the economic and geopolitical landscapes
Markets reflect worldwide economics and political events. In March 2022, the dance card is full of issues pushing markets across all asset classes all over the map, causing volatility to rise. The most significant factors impacting markets are:
- The war in Ukraine is the first major conflict since World War II. Tensions between the world’s nuclear powers have risen and could reach a boiling point.
- The US, Europe, and allies worldwide have sanctioned Russia, causing supply-demand distortions in the raw material markets, shipping and logistical issues, and potential shortages of essential commodities.
- The US Fed began tightening monetary policy at the March FOMC meeting. The central bank hiked the Fed Funds Rate by 25 basis points and told markets they will likely move seven times in 2022, pushing the short-term rate to 1.75%. Moreover, balance sheet reductions are on the horizon, another form of tightening credit. Higher interest rates make bonds increasingly attractive and often cause capital to move from stocks to fixed income assets.
- Inflation continues to rage, with the February consumer price index rising to 7.9%, the highest level in over four decades. While the Fed tightening battles the economic conditions, the war in Ukraine and sanctions on Russia will push commodity prices higher, complicating the Fed’s job in managing inflation.
- China and Russia agreed on an alliance in early February with a $117 billion trade deal and a “no-limits” support understanding.
- Russia’s invasion of Ukraine could be a steppingstone for further expansion and Chinese plans for reunification with Taiwan.
- A new variant of the COVID-19 virus has caused lockdowns in China, impacting the global supply chain.
These issues are a toxic cocktail that could cause volatility to continue to grip markets across all asset classes, and the US stock market is no exception. However, markets move higher and lower with sentiment, and even though many signs point lower for the S&P 500 and higher for the VIX and VXX product, the sentiment has created the reverse trends.
The trend is always your best friend in markets
Price trends are a trader’s best friends as they are a real-time indicator of the collective wisdom of market participants. However, as trends develop, countertrend moves can obscure the larger picture. The stock market’s rally that followed the Fed meeting and liftoff from a zero percent US interest rate environment was a sign that selling has pushed prices to an oversold condition. In bear markets, oversold periods can lead to vicious rallies that confuse market participants. In a true bear market, the rip your face off rallies tend to be golden selling opportunities.
While many of the factors currently impacting markets could change the trends, they remain clear and present dangers to the stock market as of March 23. Meanwhile, stocks moved higher despite the geopolitical landscape.
The APS looks to take the meat out of trends- Short SPY, but we stopped trading the VXX for now
The Algorithmic Portfolio System follows trends. The APS contains a portfolio of highly liquid and optionable products.
As of March 23, 2022, the trend in SPY was higher and lower in VXX. The APS was long SPY shares as the trend is always your best friend in all markets. SPY is a component as it meets the strategy’s requirements.
VXX was a portfolio component, but on March 14, Barclays, the administrator of the VXX ETN product, suspended sales from inventory and further issuance of the VXX.
Barclays announced today that it has indefinitely suspended any further sales from inventory and any further issuances of the iPath Pure Beta Crude Oil ETNs (OIL) due April 18, 2041, and the iPath Series B S&P 500 VIX Short-Term Futures ETNs (VXX) due January 23, 2048, in each case effective as of the open of trading on March 14.
Barclays said in a statement that this suspension is being imposed “because Barclays does not currently have sufficient issuance capacity to support further sales from inventory and any further issuances of the ETNs. These actions are not the result of the crisis in Ukraine or any issue with the market dynamics in the underlying index components.”
“The ‘Issuance Capacity’ thing is a bit of a get out of jail free card, so we can interpret that as ‘we no longer feel comfortable managing the implied risk of this product,'” said Dave Nadig, CIO and director of research at ETF Trends and ETF Database.
“Remember, an ETN doesn’t ‘own’ anything – it’s just a promise to pay a pattern of returns from a bank,” Nadig continued. “In this case, with, say VXX, Barclays owes the ETN holders the pattern of returns of a daily-rebalancing front-second month VIX futures portfolio. It’s not complicated to run, but that doesn’t mean it’s riskless.
Barclays announcement caused us to remove VXX from the APS portfolio because of performance uncertainty. We constantly monitor and review the portfolio components and make adjustments or changes when conditions change.
Following trends via an algorithmic system requires strict adherence to rules. We do not attempt to pick bottoms or tops in any markets and are typically short at bottoms and long at tops. Taking the most significant percentage out of trends requires removing emotional impulses from trading and investing. We ignore fundamentals, news, and all of the daily noise. However, we never ignore changes to the components that could impact their performance.
Our signals are never intraday; they can only change at the end of a session. Our system does not get caught up in the daily frenetic trading activity. News and noise are at a frenzied level with the war in Ukraine.
The price of any asset is always the correct price because it is the level where buyers and sellers meet in a transparent environment, the marketplace. Crowd behavior that determines trends can be the optimal market approach across all asset classes. As of March 23, the crowd’s wisdom points to a bullish trend in SPY. When the trend changes, the APS will issue a sell signal for the ETF that follows the S&P 500 index. We have temporarily put the VXX in the penalty box. We will monitor the product’s performance and may replace it with another vehicle with significant liquidity and optionability.