Like Picking up Nickels in Front of a Steamroller
More on the 'short vol' collapse... 'Like picking up nickels in front of a steamroller'... What is the 'VIX,' anyway?... Big news for Doc's Retirement Millionaire subscribers... In the mailbag: Readers react to this week's volatility...
Yesterday, we discussed the colossal bust in the 'short volatility' trade...
In short, over the past several years, stock market volatility – as measured by the CBOE Volatility Index (or "VIX") – has all but disappeared as stocks have moved higher.
As often happens in the markets, folks began to believe this was a one-way bet. They assumed that because volatility had been falling for years, it would continue to fall... And they piled into exchange-traded funds ("ETFs") and notes ("ETNs") designed to rise as the VIX moved lower.
They poured billions and billions of dollars into these "inverse VIX" vehicles, most notably the VelocityShares Daily Inverse VIX Short-Term ETN (XIV) and the ProShares Short VIX Short-Term Futures Fund (SVXY).
For a while, these folks looked brilliant...
After all, these vehicles rose nearly 800% over the past two years alone.
But regular Digest readers knew it was only a matter of time before this bubble found a "pin." Sooner or later, volatility would return. And when it did, these folks wouldn't just suffer losses... they could be wiped out.
Of course, that's exactly what happened this week...
Monday's big decline in stocks caused the VIX to soar by more than 115% – its biggest one-day jump in history. And the value of these vehicles plummeted during after-hours trading.
When the dust finally settled on Tuesday, these vehicles had fallen by as much as 90%. "Investors" had lost six years' worth of gains overnight.
But we weren't alone in sharing these risks...
Our colleague Dan Ferris began warning his Extreme Value subscribers about the dangers of the "short vol" trade more than a year ago. As he explained in the September 2016 issue (emphasis added)...
Investors are engaging in some strange behaviors that are flushing their market advantage down the drain. They're using the financial markets the way gambling addicts use casinos: as the most entertaining means of destroying their net worth...
Of all the bets investors are placing today, one stands out as particularly foolish: selling short the VIX...
This strategy is a lot like picking up nickels in front of a steamroller. You make a little bit of money... until you get crushed.
We don't bring this up simply to brag about Dan's call...
The September 2016 issue of Extreme Value also included the single best introduction to stock market volatility and the VIX we've seen anywhere.
If you're a novice investor, you may not even know what the VIX is. But even if you've been around the market for years, chances are you don't know what the VIX actually represents, or how it's calculated.
We don't have space to cover the all the details here, but Dan has graciously agreed to "unlock" a portion of this Extreme Value issue for any Digest readers who would like to learn more. You can access it for free by clicking here.
He also shared his latest thoughts on the short-volatility trade in a new video on the Extreme Value YouTube channel. You can find it right here.
Lost amid the recent market turmoil was some big news for one of Dr. David Eifrig's highest-conviction ideas...
Regular readers know that "Doc" believes we'll see a significant increase in military spending over the next several years.
With both troop levels and defense spending as a percentage of GDP at historic lows, Doc argues that our country's military readiness is as poor as it has been in decades. Meanwhile, national security threats have multiplied.
As he explained in a special report for his Retirement Millionaire subscribers last summer...
Until recently, the prospect of a full-scale ground war seemed far off. America maintained unquestioned power and glowing global trade turned enemies into business partners.
Now, Russia's shown aggression by invading the Ukraine and meddling in U.S. elections. China's repeatedly tested its boundaries in the South China Sea. North Korea's missile testing appears to be building to a crescendo. European alliances are dissolving. Turkey's at odds with various factions along its borders. And we haven't even discussed the Middle East yet, where a convoluted web of foreign and regional powers are waging proxy wars in Yemen and Syria.
We need to be prepared for a real war... that means heavy machinery like aircraft carriers, fleets of fighter jets, and troops ready to mobilize and fight.
Clearly, tensions have only risen since then...
And even the mainstream financial media have begun to warn of the rising risk of real global conflict. Take a look at this cover of the January 25 issue of The Economist...
According to the article...
In the past 25 years, war has claimed too many lives. Yet even as civil and religious strife have raged in Syria, central Africa, Afghanistan and Iraq, a devastating clash between the world's great powers has remained almost unimaginable.
No longer. Last week the Pentagon issued a new national defense strategy that put China and Russia above jihadism as the main threat to America. This week the chief of Britain's general staff warned of a Russian attack. Even now America and North Korea are perilously close to a conflict that risks dragging in China or escalating into nuclear catastrophe.
Hmm... Sound familiar?
Doc says defense spending must increase if the U.S. intends to maintain its status as a world superpower...
And last week, we learned that the White House agrees. As President Donald Trump noted during his State of the Union address last Tuesday...
Around the world, we face rogue regimes, terrorist groups, and rivals like China and Russia that challenge our interests, our economy, and our values. In confronting these horrible dangers, we know that weakness is the surest path to conflict, and unmatched power is the surest means of our true and great defense.
For this reason, I am asking the Congress to end the dangerous defense sequester and fully fund our great military.
Just this morning, we learned that Trump will likely get his wish...
According to reports, the U.S. Senate has now agreed on a "major" budget deal that includes a substantial increase in defense spending. As financial-news network CNBC reported...
The two-year deal, which would increase current spending caps by roughly $300 billion, would include a [$165 billion] boost for military spending, with slightly smaller increases for domestic programs. It would also authorize funds for disaster aid, community health centers, the Children's Health Insurance Program, and fighting the opioid crisis.
"This bill is a product of extensive negotiations among congressional leaders and the White House. No one would suggest it is perfect, but we worked hard to find common ground and stay focused on serving the American people," Senate Majority Leader Mitch McConnell said in announcing the agreement.
While acknowledging that both sides had to make "painful" concessions to strike the deal, Senate Minority Leader Chuck Schumer called it a "win for the American people" and a "genuine breakthrough."
Today's news is undeniably bullish for Doc's favorite defense companies...
But if you don't already have positions in these stocks, don't worry... Doc says it's not too late. He expects this trend to continue for another five to 10 years (or more)... and still rates each of these opportunities a strong "buy" today.
Doc recently prepared a short presentation with all the details – including how you can get instant access to these recommendations, absolutely risk-free. Click here to learn more.
New 52-week highs (as of 2/6/18): short position in Sprint (S).
In today's mailbag, several folks weigh in on the recent volatility. We'd love to hear how you're doing. Let us know at feedback@stansberryresearch.com.
"Porter & team, thank you for all your warnings to hedge if we're going to be long. Our first son was born on Friday, and his first day home was Monday. I was pleasantly surprised to see that our trading account was down less than 1.0% both days thanks to our hedges.
"It was a great feeling to be holding our son and helping my wife knowing that everything was going to be ok with our portfolio because we followed your advice to hedge our long positions. Meanwhile, everyone on TV and a few friends were in full panic mode both days (and that might have been us otherwise).
"You've given us the gift of peace and confidence trading in the markets; thank you! Just wanted you to know that your pleadings about properly allocating, position sizing, hedging, etc. don't always fall on deaf ears. You don't give yourself enough credit; you're a wonderful teacher!" – Paid-up Stansberry Alliance member Jesse Haro
"Using your recommendations for great stocks, I have repeatedly bought OTM puts 8-12 weeks out, then sold the ATM weekly puts every week. My returns have been outstanding.
"How did I do yesterday? I quickly exited all my short [puts] for a loss, then sat on my long puts and closed them when they reached 75-100% profit. At the end of the day yesterday, I had only 4 positions. Two more stops were hit today, to give me a total of 26% return in 2 days. I am now holding lots of cash and two small open positions. For a few days, I will watch on the sidelines before deciding how to play this market.
"Thank you for giving me such good and solid choices. Your guidance and insight is the best." – Paid-up subscriber Joanna M.
"Following Steve lets me sleep at night. I used to be a gambler, but now I am a speculator. Keep up the great work. It sure helps me. Maybe someday Porter will make me an investor!" – Paid-up Stansberry Alliance member Glenn S.
"Thanks Porter and team for the advance notice to sell many of The Total Portfolio positions in preparation for the new portfolio recommendations. I don't know if someone there has a crystal ball, but the timing was excellent. (More likely you guys just saw how overextended stocks were after the recent parabolic move.)
"Anyway, right after the reposition notice came through I started hitting the sell button on those positions and I'm glad I did. Most everything is way down and I'm sitting on cash. I've not yet purchased the new lots as I expect better buys will be coming in the days ahead. Thanks again for all the wonderful research you guys do. Keep it up, it makes my job a whole lot easier." – Paid-up Stansberry Alliance member Mike Brownson
"Talk about timing! As a very happy member of the Portfolio Solutions team and a 2017 Alliance member, I followed the specific sales recommendations last week following the 'get ready for the new Capital Portfolio' email being released on 2/1. Then I calmly placed limit orders for each of the new portfolio equities on Friday and Monday, fulfilling all but two of the components at prices 2-5% below the 1/31 entry price listed in the email, in the midst of the volatility. Having the position calculator based on the $ size of my portfolio made it a snap to execute the allocation sizing. The final two components were fulfilled on Tuesday morning at the volatile open below limit prices also, so I have fully 'legged in' over a few days.
"I cannot praise this portfolio approach enough. Now I will carefully observe TradeStops signals to manage the 2018 version of the portfolio. Let me also add that the NewsWire team really demonstrated its massive value in the past few days. Their spot-on analyses made it clear what was happening. Kudos to the entire team!!" – Paid-up Stansberry Alliance member Tom D.
"Greg, John, and Scott... Thank you for all the hard work and long hours all of you put into the Stansberry NewsWire. I felt like a kid in a candy shop the past couple days watching futures sinking like a rock, since I was hedged greatly to the down side after reading Greg's write up on the volatility starting around the [February 2] mark. Let's make sure Greg's espresso machine is firing on all cylinders. Amazing research. Keep up the great work. To the Three Amigos!" – Paid-up Stansberry Alliance member Martin O.
Brill comment: Thank you for the notes. We couldn't agree more.
Of course, we know many of our readers have neither the time nor interest to follow the daily gyrations of the market. That's OK. As longtime subscribers know, there's no surer way to make a fortune in the markets over the long term than buying great companies at good prices. Staying glued to your screens every day is not required.
But if you're a self-described market "junkie" like us... if you're also interested in shorter-term trading... or if you simply want to follow the markets more closely during volatile periods like we've seen this week, we think you'll love the work our Stansberry NewsWire team is doing. Best of all, you can access it for FREE on the Stansberry NewsWire mobile app. If you're an Apple user, you can download the app here. Android users can download from the Google Play Store here.
Regards,
Justin Brill
Baltimore, Maryland
February 7, 2018