Has Volatility decoupled from the S&P 500?

VTS Community,

It's been a pretty fun ride for our three Tactical strategies since the beginning of November last year.  Defensive Rotation with QLD, Tactical Volatility with SVXY, and Strategic Tail Risk with SPY have all rocketed upward and it's been a great.

* Now when I say fun, I realize some people in the community are saying:  "When are we going to take some damn trades?"

I get it, people want a little bit more action.  But what are we going to do, exit this really strong trend just so we can get a few extra trades in?

Remember, our strategies are rules based, mining data from a wide variety of Volatility metrics to get the trade signals.  Quant based, no emotions or gut instincts attached, we just trade the math.  We don't exit anything until the Volatility market pushes into a new range.  Until that happens, we just sit on our hands, ride the trends for as long as they last,  and build profit. 

S&P 500  (SPY)  since our three tactical strategies entered this latest run up on November 1st, 2023  (71 trading days and counting)

* Volatility & the stock market are usually inversely correlated

As a super quick refresher course on correlation, it's a measure of what direction one security moves in relation to another security.  It does not imply any magnitude, it's just direction, but it tells us how two securities or strategies move in relation to each other.

Correlation can be shown on a scale from -100% to +100%

If we take the VIX index as an example, it is inversely correlated with the S&P 500 -70% of the time.  That is to say, when the stock market is going up, 70% of the time the VIX index will be going down, and vice versa when stocks are going down that typically means the VIX will be rising. 

VIX : SPY correlation since Jan 1, 1995

Has Volatility decoupled from the market?

If you've been paying attention to the Volatility Dashboard and our VTS Volatility Barometer, it has been doing something that may surprise a few people.  It's been trending HIGHER as the stock market is pushing higher as well.

* Click here for a Volatility Barometer refresher video

VTS Volatility Barometer in the past 1 year:

Even though the stock market has been rocketing higher the past 3 months, our Volatility Barometer is able to dig under the surface and potentially warn us ahead of time that the trend may be breaking.  This is very useful for our tactical strategies because of something we talk about often here at VTS, the dreaded giveback. 

The giveback is when you're riding a trend and making profit, but then the market reverses and some of those gains are given back before getting the signal to exit comes.  It can be very frustrating and the time that we would be most susceptible to giveback would be if Volatility were trending extremely low.  Our signals to exit trends come from the Volatility market, so the distance the market has to travel to flag that change matters a lot.

-  If Volatility has to travel 30 - 40% just to flag that exit, the giveback could potentially be higher as we're waiting for that signal.

-  If Volatility only has to travel about 10% before flagging an exit to safety, the probability is a little higher that we can hang on to most of the profit before the next market correction happens.

Longer term subscribers will remember some of those perfectly timed exits to safety from the past.  2015, a couple in 2018, the 2020 pandemic, several times we've seen our Volatility metrics rise and kick us out into safety just before a crash.  I'm certainly not saying that's happening now, just saying...

VTS Volatility Barometer is doing it's job

Right now is a clear example of when the Volatility Barometer is functioning as intended.  It has correctly analyzed the market and kept us in this latest trend for it's entirety without exiting a single time.  However, it's also picking up on the fact that it won't last forever, and we are within striking distance of getting kicked out into safety.

All three strategies are getting closer, but check out Strategic Tail Risk from yesterday's email:

We nearly got pushed out into safety after just a single down move in the S&P 500 of -1.3%.  Again, if our goal is stay in long term trends then we have succeeded, the last three months have been great. 

It's also our goal though to protect those gains and I'm pleased to see we're not that far off getting the signal to finally move to safety.  Markets don't go up forever, a reversal will come and there will be some giveback. 

The goal is to have metrics to know when to flip that switch and minimize it as much as possible.