Digesting a Market Drop
After 15 consecutive months of positive returns in the S&P, the past 5 sessions have given pause to investors. The length and euphoria of the current bull market has advanced with so little volatility that a shakeup is not only an important reminder that risk is present, but is also healthy in the long term. The post-election market has not registered a 2 day drawdown of over 1.5% in 15 months and has also seen an increase of price-to-earnings ratios well above and beyond the market average of 15 times earnings. So, while returns have exceeded an impressive 38% through January, the rubber band has continued to extend offering almost no time to evaluate gains and recover energy. That doesn’t mean the S&P can’t continue higher, but a 5% pullback or two is advantageous as it allows breathing room for investors to reassess true value. This “shake off” goes a long way toward preventing a more drastic move in the future.
The Volatility Fallout
Perhaps the most intriguing storyline over the past few days has been the fallout in the volatility trade. A trade centered on the VIX (volatility index or fear index) is predicated on taking advantage of historically low volatility and has been hugely successful over the past two years. By taking a short position in the VIX you are betting that volatility will continue to contract which typically happens when the market rises as it has for 15 the past months. Millions in profits were generated utilizing this strategy rocketing one associated index (Ticker: XIV) to $2 billion in market cap and a price of $115 at its close Friday. At Blackpier Capital we liken the inherent risk in this strategy to picking up nickels in front of a train. This stance was validated during Monday’s trading session when XIV lost over 95% of its value thus bringing the short VIX strategy to a screeching halt. It is now trading almost inconceivably at $6 leaving many traders, firms, and individuals holding the bag.
Shorting the VIX is like slowly adding pressure to a spring, i.e., small profit, small profit, then pop, it breaks in much more dramatic fashion than the pressure was added. Monday’s market drop and volatility spike opened the floodgates for the massive short bets on volatility to not only suffer, but incur amplified losses as investors ran for the doors. Ultimately this created a flash crash in a small oversaturated portion of the market which reduced the $8 billion derivative market on the VIX to fractions. Overall this is of little concern to long term investors or Blackpier Capital, but it does serve an almost forgotten warning shot that risk does exist in the capital markets.
Outlook Moving Forward
While an excessive spike in volatility is hardly indicative of market fundamentals, it likely had an effect on the depth of the 5% fall Monday that rebounded from intraday lows ending down 4.1%. The events of the past week are reminiscent of the 2010 “Flash Crash” in velocity or the 2015 selloff which resulted in over an 18% correction before pushing higher in a strong 2016 and 2017. The type of volatility that we welcome and thrive in. It also serves as an important reminder of how quickly corrections can happen without a directly attributable event.
Volatility, or fear, has been re-introduced to the stock market and can not simply be shoved back into the closet. The residual effect of this will be more turbulence than we have grown accustomed to throughout the second longest bull market in history. For Blackpier Capital, the initial downward velocity will not be favorable, but natural fluctuations should prove profitable in coming weeks and months. The overarching question is now, “Is this short-term, or is fear here to stay?”
This is the kind of week that separates repeatable and comprehensive strategies from more near-sighted approaches. We have experienced similar market scenarios and have tested the breadth of our portfolio to reflect that. Opportunely, this is the time when Blackpier returns to the fundamentals of sound investment strategy, process, and sticks to the plan. Due to the risk profile from our multiple strategy portfolio approach, we are optimistic of what the impending future holds and Blackpier is poised to take advantage as the market adjusts to the reintroduction of volatility. Again, long term investors should stay the course. We, at Blackpier, always emphasize the importance of understanding risk and properly diversifying a portfolio to increase stability over time.
Past results are not indicative of future results. No representation is made that results similar to those shown can be achieved. Certain market and economic events having a positive impact on performance may not repeat themselves. The actual performance results experienced by an investor may vary significantly from the results shown for a number of reasons, including, without limitation, different investment periods, portfolio changes and different economic and market conditions. There can be no assurances that the principals will be able to navigate future market dislocations.
The returns presented within this document are prepared by Blackpier Capital LLC and have not been independently verified. This document is being provided to you on a confidential basis solely to assist you in deciding whether or not to proceed with a further investigation of the strategy. Accordingly, this document may not be reproduced in whole or in part, and may not be delivered to any person without the prior written consent of Blackpier Capital LLC. Certain information contained herein constitutes “forward-looking statements” which can be identified by the use of forward-looking terminology such as “may,” “will,” “should,” “expect,” “anticipate,” “target,” “intent,” “continue,” or “believe,” or the negatives thereof or other variations thereon or comparable terminology. Due to various risks and uncertainties, actual events or results or the actual performance of the strategy.