A New Risk Indicator To Sidestep Market Downturns: Is It Better Than VIX?
By Chris Georgopoulos, originally published on 11/14/11
Without question the most popular model to predict market crashes is the VIX, commonly referred to as the “Fear Gauge,” a market index that measures the implied volatility of the S&P 500 index options. Its concept is quite simple, when the uncertainty and fear among investors rises, they commonly run to the S&P 500 options to either hedge or speculate. The increased interest in the options usually leads to higher premiums and as the premiums increase so does the VIX. However, predicting the future isn’t 100% accurate, most of the time it’s not even close. Every forecasting model has its flaws and the VIX is not an exception. There are many problems skeptics have found with the VIX such as; its population study is limited to only the 500 stocks of the S&P 500 and” {the} model is similar to that of plain-vanilla measures, such as simple past volatility” (Wikipedia). A blog post on sensibleinvestments.com summarized the VIX as “simply an indicator of actual volatility in the market but one that is very sensitive to changes in actual volatility particularly if it is on the downside.” Is there a better way?
An elementary statistics theory states that the larger the population size, the greater the likelihood that the sample will be represented. If markets are graded by the performance of popular indexes such as the S&P 500, why limit a forecasting model’s population to only 500 stocks? The economy has become global; interactions from every corner of the world’s businesses affect every other business. If there is a model that forecasts market direction, should it limit itself to just the largest companies? As for only using a month or two of short term option premiums to garner a prediction, as the VIX does, it seems to limit itself to only a single variable. Instead of short term options premiums and limited samples what if we could measure real-time individual stock trend alerts on thousands of domestic and foreign stocks and ETFs? Or simply what if we analyzed the micro components (every stock) to develop a macro forecast of the market based off trends and risk?
By studying the history of risk alerts from SmartStops.net, an intelligent risk management service, two proven alternatives to the VIX were found. SmartStops.net has developed their own proprietary risk model that monitors the trends and risks to over 4,000 of the most popular stocks and ETFs. If the risks grow on any individual investment SmartStops.net alert their subscribers with both long and short term exit triggers. However not only do these alerts help individual and institutional investors manage specific investment risk, the reviews of the alerts themselves have predictive capabilities. By back-testing every alert that SmartStops.net has issued from their inception versus the S&P 500 performance, there is proof of this and the results speak for themselves.
There have only been 7 days for which the amount of Long-Term Exit Triggers (stop alerts) as a percentage of every stock and ETF covered by SmartStops.net has been over 20%. The subsequent market action of the S&P 500 has averaged a negative return for the time periods of 1 week, 1 month, 3 months, 6 months and a year. The 6 month average return is over -7% and when examined from the absolute lows of the S&P 500, the returns average over -19%. If you remove the knee-jerk market reactions caused by “Flash Crash” on 5-6-2010, the returns are even lower. 
Another metric offered by SmartStops.net is their SRBI(tm) (SmartStops Risk Barometer Index); this index measures the current percentage of stocks and ETFs that are in “Above Normal Risk” state (ANR) divided by the 100 day average above normal risk percent. By definition, a stock that is listed ANR experienced a risk alert as its last SmartStop alert identifying a downtrend. Conversely, a stock that is listed in a “Normal Risk State” experienced a reentry alert as its last SmartStop alert indicating trading strength and an upward trend. Back-testing historical SRBI data since inception shows that the repercussions to the market when the percentage of downtrends increases to over 40% of all stocks and ETFs covered are profound. Below you will see that there have been only five occasions where this has happened. In each case the S&P returns for the following year were all negative. 
Is this a better way?
Before a concrete conclusion can be determined, the predictive capabilities of the VIX must also be analyzed. Read More…
ETFs And Allocations To Protect Portfolios In The Current Financial Storm
excerpt from article at Seeking Alpha:
This is a followup to a previous postings suggesting how investors can take refuge in the oncoming financial storm. If you’ve not done so already, be sure to read my previous post Say It Ain’t So for a description of our dismal macroeconomic picture.
The purpose of this article today is to explore any safe havens for your investments to shelter them from this worldwide slump. What are we protecting against? Problem is, we don’t yet know. And we won’t until the elections play out next year, and events in Europe unfold.
The market may not wait for the politicians. Technical indicators suggest a very large correction in the market can be expected, and fundamental macroeconoomic trends unfortunately offer no consolation.
How severe will the downturn be?
In my view, that will depend in part on what fiscal and monetary policies we pursue, and how international political relations progress. There my crystal ball is a little cloudy.
Scenario one sees a continuation of monetary easing, as pursued by both the Bush and Obama administrations, and largely aped by European governments to a lesser degree.
In this scenario, the policy response will be pure Keynes, with large bouts of government spending to build out our country’s infrastructure and hopefully create jobs. The Fed will assist with gobs of money dished out to offset rapidly deleveraging private expenditures and to support our wobbling real estate market.
for rest of article, click here
The New Oil Dynamics
originally posted by Tony Daltorio at http://wallstreetmess.blogspot.com/
The oil market changed back in 2009, but most Americans did not notice.
That was the year, for the first time, China temporarily surpassed the United States as Saudi Arabia’s biggest and most important customer.
At the time, Saudi oil minister Ali Naimi said “Ten years ago, China imported relatively little crude oil from us. Now, it is one of our top three markets, and is the fastest growing market for us globally.” He added that this showed the increasing “depth of Saudi-Chinese relations”.
Today, when oil tankers leave Saudi ports with their load of crude oil, they increasingly travel eastward to the rapidly growing economies of Asia rather than to the established markets of western nations.
When looked at historically, this new trend is significant. Remember that the most of the oil industries in the Middle East were originally set up by western companies with the sole aim of providing oil for western economies.
The day when Saudi oil exports to China permanently overtake those to the U.S. has not arrived yet. But it will soon. Read More…
Valuations in Free-Fall: S&P 500 Cheapest Since 1957!
originally published at Kapitall, who go on to identify potential stocks to play.
The Standard and Poor’s 500 index valuation has hit 25% below the average from the last nine recessions, even as price estimates continue to fall, according to Bloomberg‘s data. These estimates provide a statistically significant outlook on analyst expectations for future growth and the degree to which stocks might be considered undervalued.
Historically, market contractions have not reached these lows since 1957 when the gauge for American equities traded at 13.7 times forecast earnings. Today’s equities trade at 10.2 times 2012 forecast earnings and earnings estimates continue to fall to their lowest level since April.
“What you’re seeing is a growth scare,” Wayne Lin, a money manager at Baltimore-based Legg Mason Inc. “The question is, how much of that is priced in. I’d say that if we don’t have a double-dip recession, if earnings just stay flat, these valuations are reasonable. The market already expects those downgrades.” (via Bloomberg)
Unlike previous market crashes or recessions, this one has been relatively slow-going. In the previous nine quarters, companies prepared for further economic volatility and managed to exceed income forecasts after cutting costs and lowering debt. With lowered analyst estimates for 2012 companies will have an easier time hitting their mark.
Whether or not lowered earnings estimates makes today’s stock prices a bargain is an ongoing debate between bears and bulls. According to Rob Arnorr, founder of Research Affiliates LLC, “the measures by which stocks are cheap today rely on continued recovery and a continued surge in already peak earnings. It relies on a very shaky foundation.”
for stock picks, go to Kapitall.
Know when to Hold ‘em, Know when to Fold ‘em
SmartStops comment: Its why this service was brought to fruition. Follow SmartStops and you can be protected before you lose it all.
Unprecedented Monthly Volume Sell-Off Suggests Now’s the Time to Take Shelter - published at Minyanville by Kevin A. Tuttle
Do not concern yourself if the market goes up today, tomorrow, or a month from now. The risk of entering is not worth the reward.
Over the weekend I had the pleasure of speaking with a very prominent European money manager – overseeing hundreds of billions – about the “across-the-pond” financial crisis unwind and looming hazard of a potential domino-effect coming to fruition. Without rehashing the entire conversation, the consensus is not “if,” it’s “when” will the developing pressure finally blow. He actually went so far as to say it could truly begin unraveling within the next few weeks considering the catalysts currently in play.
The intent of providing the conversation synopsis is not for sake of fear, but understanding the potential ramifications. About three years ago, in one of my firm’s quarterly reports, we opined on a unique situation in regard to the GDP measurements of Global Nations. It stated the unprecedented growth statistics from the 56 nations tracked. “History is currently being made in the sense that all the globally tracked economic growth nations (56), every one… 100%…, are showing expansion.” This lead to my next comment… “If the economic cycle pendulum swings in both directions what would happen if the inverse occurred?” Are 2011/2012 the years we are about to find out? Maybe that’s somewhat extreme, but yet… is it possible?
We at my firm do not pretend to be intelligent enough to figure out all the nuances, catalysts, causes and reasons why the markets could fall apart; we’ll leave it to the team of economists and officials to attempt to sort that out. What we do instead is try to determine when the storm is coming and how to take shelter, which brings me to my point: Now is the time. Take shelter! Do not concern yourself if the market goes up today, tomorrow or a month from now. Clarity is key! Would you sail your boat into rocky waters with a potential hurricane looming because of your love of sailing? Is the risk worth the reward? For some, maybe; but for most, probably not.
S&P 500 Index
Since the “2011 Channel of Indecision” broke on August 4, the seas have picked up dramatically and have begun swallowing ships. The markets have never seen this type of monthly volume sell-off – 47% above average (unprecedented), as seen in the monthly chart above. As Kenny Rogers put it so eloquently… “Know when to hold em’ and know when to fold em’, know when to walk away, know when to run!”
Do leveraged ETFs move the market? SEC investigating..
SmartStops comment: Interesting to see that the SEC is now investigating whether leveraged ETFs are a cause of increased market volatility. When will the public realize that the basic underlying structures fueling our stock markets around the world have changed in our 21st century. There are so many more instruments and derivatives that create the need for a more dynamic intelligent risk management approach. Asset allocation and diversification, the tenets of modern portfolio theory are not enough in this day and age. This is exactly why the SmartStops service was created.
originally published at ETF Trends.
Leveraged exchange traded funds are being blamed for the wild volatility in stocks last month, but data and empirical evidence show the concerns are way overblown.
“With equity volatility doubling recently, some of the same topics that came up two years ago during the credit crisis have resurfaced as people look for possible culprits,” Credit Suisse said in a recent report. “ETFs have received some blame for the increasing volatility, although we believe it’s a case of confusing correlation with causation.”
The Wall Street Journal reports the Securities and Exchange Commission is looking into whether leveraged ETFs magnified the market’s wide swings in August. [SEC Reportedly Probing Whether ETFs Added to Market Volatility]
Many leveraged ETFs are geared to provide 200% or 300% of the daily moves in stocks. “Inverse” leveraged ETFs rise when stocks fall. These high-octane funds need to rebalance every day to provide the desired performance.
“Our findings show that the leveraged ETF rebalancing trades are unlikely to be the most influential factor in driving intraday swings into the close,” Credit Suisse said in its report. “Less liquid spaces like small caps and specific sectors may be more likely to be affected on rare days with extreme moves, but liquidity needs are often quickly met in the same way as for typical index rebalances that occur throughout the year.”
Are ETFs Responsible for Rising Market Correlations?
SmartStops commentary: Diversification alone is not going to be enough to manage risk in our 21st century markets. Smartstops offers a superior dynamic intelligent risk management service. Ask yourself, who is watching your back?
originally published at ETFTrends
S&P 500 stocks are moving as a herd and the increased presence of exchange traded funds in financial markets may be partly responsible for the spike in correlations, according to a report Monday.
Stocks in the S&P 500 over the past month have a correlation of 80%, higher than the peak reached during the financial crisis in late 2008, The Wall Street Journal reported.
“One potential reason is the popularity of exchange traded funds. ETFs account for more than 30% of volume in U.S. stock markets, compared with just 2% in 2000,” the newspaper said. “It’s reasonable to expect ETF trading to drive correlation higher because many of the vehicles are tied to stock indexes.”
The three-month stock correlation in the S&P 500 is the highest in at least the past 20 years, while sector correlation is also elevated, according to a recent note from Goldman Sachs analysts.
A higher correlation means prices are moving together, rather than going their separate ways. [Sector ETF Correlations at Two-Year High: Strategist]
Correlations have spiked recently amid the so-called risk-on and risk-off trades. High correlations are not indicative of a healthy or normal market, analysts say. [Rising Correlations]
“Elevated correlation is generally considered a poor environment for long-only fundamental investors,” Goldman Sachs said.
401k holders – made out worse
SmartStops comment: Its disappointing to see that Fidelity puts out these kinds of stories, because god forbid, people would actually sidestep periods of great risk in markets. Sure – if you pick the time period from Oct.2008-March 31,2009, you’ll show a bad record vs. buy & hold. But why does the mutual fund industry insist on hiding the other part of that data that has been published – about how missing the worst days of the market can increase your returns by an amazing amount? And it means you don’t even have to be that good at timing when to get back in. Fidelity – have you seen these studies? In Defense of Market Timing
We wish SmartStops could have been ready by Oct. 2007 for the public to use, given that’s when our risk alerts started and you could have been out of the market well before the Oct. 2008 drop. In fact, you could have been bottom fishing all you wanted during 2008 (keeping your losses to a minimum with smartstops) to earn a much better return than the 2% Fidelity says people who held from Oct. 08-March ’09 earned. Yes, buy & hold can show the better performance numbers overall for any given time slice period, but what was the opportunity cost to you? If you could have been out of the market 50% of the time earning money with that investment vs. losing money, why would you think buy&hold was the better way to go? Think about that opportunity cost when you are looking at our performance comparison tool.
401(k) holders who bailed on stocks in 2008 made out worse: Fidelity
Remember that this is standard rhetoric from the mutual fund industry. They want your money just sitting there.
