Learning To Love The VIX

Learning To Love The VIX

Nobody expected the world to float up forever. You don’t have to scare your clients but it’s time to review “alternative” allocations — statistics won’t dodge the storm clouds forever.

When the volatility gauges no longer reflect age-old market logic, two primary scenarios present themselves. Either the VIX has broken or investor assumptions about risk have changed so much that it amounts to the same thing.

Even the “flash crash” surrounding Jim Comey’s forced exit from the FBI and last Friday’s crumple on the FANG-heavy NASDAQ barely added up to a twitch in otherwise complacent markets.

Old hands are horrified. Yesterday’s headlines out of Washington were the darkest in years if not decades. While we debate how well the government is doing, everyone who has a take on the political climate has an extremely strong opinion.

By definition, that’s a divisive environment. In the market, strong differences of opinion used to translate into strong asset price swings, the classic rollercoaster as fear and greed fight for the right to arbitrate reality.

What we’ve gotten instead is a world where turnover slows to a seasonal crawl, most stocks grind within sight of 52-week if not record highs and the VIX goes nowhere but down.

And while we can’t see it in the indicators, that divergence from the age-old narrative makes a lot of people nervous. Maybe those people include your clients. Maybe it includes you.

I know that strategies I follow that incorporate any form of risk protection have, charitably speaking, thrown that allocation away in the last six months. The hedges have gotten a deep and unflattering haircut.

The world may have changed and we’ll continue the slow upward melt until we all retire.

But until then, we live in a world where interest rates are edging up here at home and even Europe is tiptoeing around a firmer policy posture. The mood in Washington is honestly more fragile — not worse, great things could be coming — than it’s been in decades. 

And with the possible exception of sectors that applaud every rate hike, U.S. stocks look a little stretched. Not a lot of people want to sell ahead of a big tax break, infrastructure package or other legislative bonanza. 

When and if they get it, the math doesn’t provide a lot of incentive to buy until earnings get a little more time to work. After the party comes the hangover.

When the hangover comes, your clients are going to want to know you took measures to protect their interests until the market recovers. Traditionally that means hedging their risk exposure through whatever uncorrelated vehicles you prefer: long/short, cash, quality, real assets, name your favorite “alternative” allocation.

In the meantime, simply having that position on the report shouldn’t really be an eyesore. If your clients feel the ominous pressure of a correction or some other dislocation on the horizon, you can point to the alternatives as something that can work for them when stocks stop working.

I like the notion that the best of these approaches generate at least a little income when other sources of income go nowhere. That means bond-like investment profiles, even vanilla annuities. 

While we’re waiting for the shock, they guarantee part of your clients’ basic lifestyle needs. They help pay the bills, support a basic piece of the all-important perception of wealth and the psychic fortitude it takes to roll with short-term risk.

People who feel that the downside is secure have the freedom to laugh a little in the storm. They can think clearly about long-term priorities and the opportunities to achieve them.

They can appreciate you more even when all the beta is floating up and alpha is dead in the water.

Even Bob Shiller says stocks are a buy until they aren’t. The VIX is a short until it isn’t. Complacency feeds on itself longer than the perma-bears can remain relevant. 

But the people I know who keep rolling a little cash into the VIX truly do sleep a little better when the bad headlines start multiplying.

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