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Investors looking for some action had to look beyond the stock market today, as conflicting pieces of economic data largely canceled one another out -- which of course is simply another way to say markets did absolutely nothing today. Seriously, nothing. At day's end, the Dow Jones Industrial Average (INDEX: ^DJI ) added a measly two points today, registering a microscopic gain of 0.02%.
Yawn.
In a more bearish note, both the S&P 500 and Nasdaq each ended lower, dropping 0.01% and 0.2%, respectively.
Two macroeconomic storylines dominated the day's news. First, in domestic news, a report from the U.S. Commerce Department showed that retail sales rose 0.8% in July, well ahead of economists' expectations. However, news from the other side of the Atlantic painted a far less favorable picture. While the German economy beat expectations, growing at a paltry but still positive 0.3% in the last quarter, and the French economy avoided recession, the overall EU economic output dipped 0.2% in Q2.
The continued sputtering of the European economy remains the single greatest threat to the fading global rebound, and stock performance remains relatively weak. Simply stated, people are scared and uncertain about the health of the eurozone. This is why valuations remain depressed despite relatively healthy corporate profits so far this year. Again today, the news spooked investors, driving the market's oft-cited "fear gauge," or the VIX (INDEX: ^VIX ) , sharply higher, to the tune of an 8.4% gain on the day. Sure, EU policymakers have made some progress, although much still needs to be done before investors see a light at the end of the tunnel.
Around the markets
Earnings announcements did generate some substantial swings in individual shares prices today. Shares of Home Depot (NYSE: HD ) rose 3.6% to lead the Dow after the company reported better-than-expected profits and raised its guidance for the remainder of the year. This kind of news also helps support the case for the beginning of a recovery in the housing market that many experts have suggested that, although weak, is already under way.
In other positive news, shares of Michael Kors Holdings (Nasdaq: KORS ) skyrocketed 16.5% after the company beat earnings and raised its full-year view. The company, which ranked as the best-performing major IPO last year, shows no signs of slowing down despite the relatively sluggish consumer environment. Not every report was as rosy, though. Daily-deal site Groupon (Nasdaq: GRPN ) tanked 26.8% as its quarterly earnings and guidance came in below analyst expectations. Its shares now sit a depressing 79% below their IPO level.
The markets right now are a complicated place. One on hand, stocks, especially blue-chip dividend-payers, offer extremely compelling risk/reward profiles. However, several major issues still loom large and threaten to crush investors again. In times like these, it's best to remember that winning over the long term at times requires a bit of a contrarian streak. That's why we highlighted three stocks on the Dow that are safe and cheap and should offer investors plenty of upside in years to come. To find out about the three best plays on the Dow, access the Fool's new research report detailing the three Dow stocks investors should love today.
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Report this Comment On August 21, 2012, at 11:10 PM, MHedgeFundTrader wrote:
Mr. Market sometimes speaks in mysterious tongues, and you really have to wonder what he is struggling to tell us by taking the Volatility Index (VIX) down to a subterranean $13 handle on Friday, a new five year low.
A number of advisors have been recommending that investors load up on the (VIX) in recent months to give them downside protection from an imminent market crash. Those who followed such advice were hammered, their clients no doubt striking them off invitation lists for summer barbeques.
In the past month, the (VIX) has cratered from $20 to $13. Just last October, it touched $49, when I urged readers to pile in on the short side. I came out in the mid-$30’s weeks later.
Those who traded the triple leveraged (TVIX) fared even worse, this blighted ETF plunging from $5 to $2.50 during the same period. The (TVIX) is doing the best impression of an ETF going to zero that I know of. A year ago it was trading at $110. This is why I plead with traders to avoid triple leveraged ETF’s like the plague. These things are designed for day trading by hedge funds only. Eventually, they all go to zero.
I am even seeing this in my own portfolio. A week ago, I sold short the September, 2012 (SPY) $147 calls at $0.38. A week later, the (SPY) has risen by 1.2% but the call options have done a swan dive to $0.34. This can only happen when they are crushing volatility.
I quit recommending (VIX) plays in March when I realized that there is some sort of arbitrage going on in the hedge fund community that is punishing (VIX) owners. I haven’t figured out the exact mathematical dynamics yet, but it has to involve selling short the cash stocks and shorting (VIX) contracts against them. Whatever they lose on the cash short is more than made up by the profits on their (VIX) short.
It’s easy to see how successful this would be. While August (VIX) traded at a lowly 13.40%, September volatility is still up at 18%, and January, 2013 is trading at a positively nosebleed 25%. That spread provides a lot of room to take in some serious money.
So what is the 13% really trying to tell us? Here are some thoughts:
*It is discounting multiple tranches of quantitative easing by central banks around the world that take all asset prices up for the rest of the year.
*It reflects the complete abandonment of the stock market by the individual investor, which is why trading volume has collapsed.
*It also indicates how exchange traded funds are taking over, sucking volume out of the stock market. The (VIX) doesn’t reflect activity in ETF’s.
*It could be discounting an Obama win in the presidential election. Stocks have delivered a 72% return since the Obama inauguration, the third best in history after Franklin Roosevelt and Bill Clinton. Mixed stock and bond portfolios have delivered the best returns on record, with both asset classes appreciating dramatically for 3 ½ years, something that never happens.
It could be that the (VIX) at this level has it all wrong, and that a stock market selloff is about to send it soaring. Those who have rigidly held on to that belief until now have been severely tested.
For those who have fortunately avoided the (VIX) trade so far, let me give you a quick primer. The CBOE Volatility Index (VIX) is a measure of the implied volatility of the S&P 500 stock index. You may know of this from the talking heads on TV, beginners, and newbies who call this the “Fear Index”.
For those of you who have a PhD in higher mathematics from MIT, the (VIX) is simply a weighted blend of prices for a range of options on the S&P 500 index. The formula uses a kernel-smoothed estimator that takes as inputs the current market prices for all out-of-the-money calls and puts for the front month and second month expirations.
The (VIX) is the square root of the par variance swap rate for a 30 day term initiated today. To get into the pricing of the individual options, please go look up your handy dandy and ever useful Black-Scholes equation. You will recall that this is the equation that derives from the Brownian motion of heat transference in metals. Got all that?
For the rest of you who do not possess a PhD in higher mathematics from MIT, and maybe scored a 450 on your math SAT test, or who don’t know what an SAT test is, this is what you need to know. When the market goes up, the (VIX) goes down. When the market goes down, the (VIX) goes up. End of story. Class dismissed.
The (VIX) is expressed in terms of the annualized movement in the S&P 500. So a (VIX) of $13 means that the market expects the index to move 3.8%, or 53 S&P 500 points up or down, over the next 30 days. You get this by calculating 13%/3.46 = 3.8%, where the square root of 12 months is 3.46. The volatility index doesn’t really care which way the stock index moves. If the S&P 500 moves more than the projected 3.8%, you make a profit on your long (VIX) positions.
Probability statistics suggest that there is a 68% chance (one standard deviation) that the next monthly market move will stay within the 3.8% range. I am going into this detail because I always get a million questions whenever I raise this subject with volatility deprived investors.
It gets better. Futures contracts began trading on the (VIX) in 2004, and options on the futures since 2006. Since then, these instruments have provided a vital means through which hedge funds control risk in their portfolios, thus providing the “hedge” in hedge fund.
But wait, there’s more. Now, erase the blackboard and start all over. Why should you care? If you buy the (VIX) here at $13, you are picking up a derivative at a nice oversold level. Only prolonged, “buy and hold” bull markets see volatility stay under $20 for any appreciable amount of time. If you don’t believe that we are in such a bull market now, you should be buying (VIX) on every dip.
A bet that euphoria doesn’t go on forever and that someday something bad will happen somewhere in the world seems like a good idea here. You would think that is a no brainer with a Fed disappointment on QE3, a fiscal cliff, and a 2013 recession on the horizon. But right now, the burden of proof is on the market as to exactly when is the right time to do that. And for the (VIX) to work well, bad things have to happen quickly, preferably by tomorrow.
The Mad Hedge Fund Trader
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