Rebalancing and Indexes

This rebalancing issue may explain why most active managers underperform: According to Hendrik Bessembinder, a finance professor at Arizona State University, the entire gain in the U.S. stock market since 1926 is attributable to the best-performing 4 percent of listed companies, and the cap-weighted indexes captured all of it because they don’t rebalance.



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Synthetic VXX 2006 to Present

Synthetic VXX prior to 2010

VXX hit a low in early 2007 at a synthetic price of 25k.  During the 2009 low it went to a synthetic high of 162.5k.  This was nearly 550% above the all time low and took nearly 4 years to recover.

https://flare9xblog.com/2017/12/02/vix-term-structure/

Assuming a short VXX position held through that bear market the following would not have led to a margin call.  

Turkey Contagion

It's unlikely that Turkey's debt crisis will have a meaningful effect on global markets.  The IMF will likely step in and bail out the nation.  Other central banks will make sure there is plenty of liquidity to prevent contagion as well.  Most of the time that liquidity finds its way into stock markets.

Wage inflation spiked on the previous NFP.  Data from the recent NFP shows wages growing at 2.7% yoy.  The past 3 recession were preceded by annual wage growth of more than 4%.

U.S. Tariff Policy and potential Trade War

The Trade War that President Trump's Administration is implementing has put a lid on equity market performance since February.  However, as we approach midterm elections, it looks less likely that the current U.S. Administration will be able to follow through with their tariff policy by September's deadline. 

Given the investigations around Trump and likelihood of a negative impact from the Mueller investigation, it's likely there will be elevated volatility and risk in the market. 

However, if Republicans maintain control of both the House and Senate and nothing significant comes from the Mueller investigation, it is likely that a trade war will offset any earnings growth potential discounted by the market.

More than likely, a negative impact from the investigation leading to volatility will occur and the trade war rhetoric will die down.  This will likely cause 1.5 - 2 months of volatility eventually leading to a rebound in sentiment and new highs in the S&P to close out the year.

Wage Growth Vs Inflation

Historically, it takes average hourly earnings of production and nonsupervisory workers growing at about 3% year over year to get inflation to the Fed’s 2% target. Wages rose 2.8% year over year in May, a modest and welcome upside surprise from expectations of 2.7% and still ahead of inflation, but not yet at that 3% threshold. Nevertheless, this was still the fastest pace of wage growth since June 2009, when wages were still early in their post-recession decline (they would bottom in October 2012 at 1.2%). It’s also the fourth consecutive month of year-over-year wage growth accelerating, a streak we haven’t seen since 2013. Given the Fed’s emphasis that its inflation target is symmetrical, indicating comfort with letting inflation run a little hot, we would not consider wages an immediate threat.

VXX Short Strategy

I made a spreadsheet where I plot daily VXX returns assuming a 25% core short position.  Then you push more shares into the core for every 20% drop in VXX.  The blue line is the return from initial principle.  The orange line is the maintenance equity for holding that short position.  From the model, it looks like if VXX were to rise about 180% from the avg price entry you would get a margin call assuming a 25% required maintenance margin.  

Stock Buyback Blackout Months.

January, April, July and October have lower repurchase rates because for the 1 month before an EPS report companies are not allowed to repurchase their stock.  This reduced demand can potentially exacerbate volatility in those stocks.