Vix Vacation31 August 2016

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Vix Vacation

Scenario: Headline Risks

Vix Vacation

UPDATED

HiddenLevers

MARKET UPDATE

Market Update

sources: HiddenLevers, MarketWatch, NYTimes, LATimes, FT

Fed = Institutional Paralysis

Obamacare Chronically ill ?

- Now acknowledges USD rising on global flight to safety- Admits it doesn’t have tools for low inflation world- Multiple policy makers suggesting break with mandate- Knows 3D challenge but raising rates anyway

New S+P sectorReal Estate

HiddenLevers

WALL / MAIN ST DISCONNECT

Record VIX futures via ETFs, all time highs

Vulnerable to headlines + geopolitical blips

Record MF/ETF outflows Surrendering hedges, diving into equities

Valuation multiples down + earnings up

Disconnect: Most Pronounced in History

sources: HiddenLevers, Bloomberg,

$3.7 trillion restored to US equities since Feb lows +20%

US = one of few global bright spots

Record VIX shorts

Main Street Wall Street

Disconnect: Aug 2015 VIX Spike – didn’t stick

sources: HiddenLevers

Fed rhetoric = hawkish. Fed behavior = dovish. This has muted any VIX spike.

Shanghai Crash

Disconnect: Headlines Don’t Matter None.

sources: HiddenLevers, Economist, CNN, Marketwatch, UMD Global Terrorism Database (Boston Marathon, Charlie Hebdo, Westgate Shopping Mall, Ankara Train, Nice)

Major Terrorist Attacks

ZikaHurricane Sandy

Ebola Scare

Shanghai Crash

One-time events do not move the market. Events that affect growth of global economy move the market.

2nd Oil Crash/Growth Fears

Econ Growth Fears

HiddenLevers

VIX VACATION

VIX Vacation: VIX 101

sources: HiddenLevers, CBOE

What is VIX?Market volatility over next 30 days measured by options.

How is it calculated?VIX observes 100s of SPX puts and calls to measure "implied" volatility on options expiring in one month.

VIX + Portfolio VolatilityVIX is NOT the same as historical volatility, which is based on how the S&P actually performed.

VIX + Equities?VIX and equities move in opposite directions over 80% of the time.

VIX: Historical Perspective

sources: HiddenLevers

FEB ‘91-OCT ’97

VIX below 25

S&P +58%

APR ‘03 – AUG ‘07

VIX below 25

S&P +65%

DEC ‘11 AUG ‘15

VIX below

30

S&P +76%

Volatile VIXS&P -7%

Volatile VIXS&P -16%

Volatility clumps together. Bull Markets coincide with extended low VIX periods.

Volatility: Comparison to MDD + Stress Testing

source: HiddenLevers. *Using Fed Stress Test 2016 scenario

S&P500 5y Volatility 12.5%MDD -13%

S&P 500 – 5 Year

Stress Test Risk* -43%

S&P 500 – 10 Year

S&P500 10yVolatility 18.5%10y MDD -54.6%Stress Test Risk* -43%

Volatility changes with timeframe.Stress tests provide stable + realistic view of tail risk.

Volatility: Misleading for New Funds

sources: HiddenLevers. *Using Rising Interest Rates and Fed Stress Test 2016 scenarios

BOND Volatility 3%MDD -5.6%Stress Test Risk* -11.7%

MOAT Volatility 12%MDD -14%

Stress Test Risk* -38%

New funds lack sufficient data to rely on traditional risk stats. With no real downturn since 2011, stress testing can fill this gap.

HiddenLevers

SCENARIO: HEADLINE RISKSUPDATED

When do Headlines Matter?

sources: HiddenLevers

ImpactsEconomy

SurpriseBrexit

9/11

ImpactsPeople

OKC Bombing

HurricanesKatrina + Sandy

FOMCDecisions

Terror in France

Ebola

SARS Epidemic

CaitlynJenner

Impact on Economy+

Surprise Factor =

Market Impact

FX Rates

YAWN: Global Pandemic

source: HiddenLevers,

Little to no Impact on US markets from Zika

Market impact disappears with

virus

Impact likely regional to pandemic

Impacts travel industry

SHRUG: Terrorist Attack in USMarkets recovered from 9/11 crash by October

source: HiddenLevers, Barchart

ISIS attacks zero impact

11Sept MDD-11%

priced ingovt insurance for terrorism

BAD: Conflict in Korea

source: HiddenLevers,

North Korea = saber-rattling

S.Korea now #11 economy

Initial dropsKorean War -11%Gulf War -14%

Wars help US economy

1950-53 US-Korean War

S&P = +40%

Scenario: Headline Risks

Yawn:Pandemic

Shrug:US Terror

Attack

Bad:Conflict in

KoreaVIX

35S&P

-10%

VIX

30S&P

-9%

VIX

15

While the travel industry would feel the impact of a pandemic, it’s unlikely to cause meaningful market impact. SARS killed 750 in2003 but had no lasting market impact in Asia.

9/11 caused an S&P decline of 11% over one week, but markets recovered within one month of the attack.

The Korean war led to an 11% S&P drop in June 1950, followed by a quick recovery. Korea is a major economy today, so some impact could be felt without major US involvement.

S&P

FLAT

Vix Vacation – Take Aways

Main Street fears don’t impact markets

Low VIX lacks predictive value in bull markets

Headline Risks matter when unexpected + impact economy

Use stress testing + not volatility, to judge portfolio risk

10yS&P