Fantastic question today from our buddy Sunil:
“I heard there is government shutdown drama coming up. Are we good with our current allocations?”
So yes for anybody who doesn’t closely follow the political news, and honestly I can’t blame you if you don’t, but there is an impending deadline. You may hear the media talking about how if they don’t figure out a way to resolve this, the federal government will run out of money on Friday (tomorrow)
Now that sounds a lot worse than it actually is. Basically they just have to agree on a few key points of where to allocate funds and everything goes forward. Government shutdowns do happen, the last one being in 2013 if you remember, but most of the time they do a little back and forth posturing before finally agreeing on stop gap measures to kick the can down the road.
So it might happen (it probably won’t) but I am not in the prediction game and Sunil is right, we should mostly be concerned with how it affects our current positions.
Let me bore you with a quick story. In the first few years of my investing career, in large part I was using traditional methods of technical analysis. Tracking moving averages, RSI, MACD, Bollinger Bands etc, as well as using fundamental analysis like dividend discount models, earnings power values, net net working capital etc. It was fine, I did ok, but the problem is a lot of that is backward looking. It usually requires the price to have already happened before it shows up fully in the analysis.
Around 2010 everything changed. I switched over to primarily using volatility metrics and it transformed my strategies. I was more consistent, had a higher win ratio, avoided some bad days that I otherwise would not have.
The reason for that is that it’s a lot more forward looking because we’re not only looking at what’s already happened (realized volatility) but we’re also taking into account what market participants are expecting to happen (implied volatility)
So the truth is we don’t actually have to make any decisions on whether we want to hold our positions through a binary event. All of the volatility metrics I track within each strategy will tell us everything we need to know. It doesn’t guarantee success and we do get caught in bad trades sometimes, but the win loss ratio is greatly improved by allowing volatility to be our guide. Let me show you a few examples:
June 2016. The famous Brexit vote.
S&P 500 in June 2016:
The S&P 500 was up 2% the week leading up to the Brexit vote and was 0.1% from an all time high the day before the vote. Anybody using traditional analysis would have had zero warning that anything was afoot.
VIX Index in June 2016:
The VIX Index however was steadily rising the whole month and was between 17 – 20 before the vote. Forward implied volatility told us everything we needed to know. DO NOT hold through that dangerous binary event.
As it turned out the vote went a surprising way, the VIX spiked, and the XIV suffered it’s largest single day loss ever of -26.79%. Traditional investors may not have seen that coming.
November 2016: US election night.
VIX Index from mid October – mid November 2016:
Again the VIX Index was screaming warning signs to move to safety positions. Now as it happened we saw a huge recovery the day after the election, but we can’t forget that the S&P 500 futures were “limit down” and negative over -5%. It could have easily been a bloodbath for anybody holding through that night.
Conclusion: Bottom line, heading into the potential for a government shutdown we will let the volatility market dictate our positions. It’s possible volatility will rise today and tomorrow and perhaps push us completely into our safety positions. Or we may end up mostly holding through it. For 7 years I’ve stopped making those personal market predictions and most of the time it has worked out extremely well. We’ll take the signals as they come, emotionless.
As of right now, only the VTS Tactical Volatility Strategy will be moving to cash. The VTS Aggressive and VTS Conservative will remain and we’ll check where we’re at tomorrow.
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