Skip to main content
 The Bond Market is Giving us a Warning Sign.

I'm sorry to bring this to your attention, but as a close watcher of the VIX for the past 20 years I felt it was my duty bring to light some ominous notes, unfortunately, and see attached of 2 charts comparing TLT (etf that tracks long term treasuries) and the VIX (Cboe Volatility Index).



Over the last 6 months or so, there has been a real correlation between treasury prices and fear or volatility.  So, what does this mean for market sentiment?

Historically, or at least over the last few years, these two prices move opposite to one another because the stock market becomes more fearful and volatile when liquidity is leaving the system and interest rates are rising.  Meaning, as interest rates rise and bond prices fall in value, the stock market typically becomes a bit more volatile and VIX rises as the liquidity for investing becomes a bit harder.

Lately, however, the VIX has gone up and down with bond prices, not opposite.  I think the market is really starting to worry about a recession and how the 2020 election will play out for the economy.  Long term treasuries rallying and interest rates falling have been a sign of a flight to quality and conservative investment strategies.  The fact that a lower interest rate environment is causing more volatility in stocks is a bit concerning like we have seen to start 2020.  Since the start of the year, the tide of coronavirus and Election 2020 has risen all boats.  Bonds have rallied, stocks turned themselves around and rallied up over 2% for the year in the S&P 500, and VIX (volatility and fear) has risen.  This is not normal, at all.  The reason I believe this is happening is that strong earnings and jobs numbers are forcing stocks higher, yet I believe bond traders and VIX traders are starting to be concerned about valuations and the sustained growth we have experienced coming to an end.

So, when was another time we saw this occur? Bond price up, stocks up, VIX up? Uh oh, the end of 2007.  Yes, throughout the one year time frame from August 2007 to August 2008, bond prices moved lock step in correlation to VIX. 


And guess what happened to trigger this strange correlation in both time frames? An inverted 2/10 year yield curve. We all know the data on a “yield curve inversion” issue and it being a predictor of a recession 12 months or so down the road. With the fear of a pending recession always looming over investors’ heads, VIX and fear rise anytime people see long term interest rates fall as market participants anticipate the end is near and fly into government debt. 

Growth stocks have been the real story over the last year, and with the amount of volatility on the rise, I think it is prudent to diversify some of that exposure into value, volatility, short term bonds. I’m not saying get out and the end is near, but I am saying a rebalance or underweight growth is prudent because with higher volatility also comes faster moves to the upside so you can still get portfolio appreciation from the FAANG or growth ETFs like VUG but you will get it that much faster, thus a lower allocation is worth it in order to reduce risk.

Comments

Popular posts from this blog

Is the KCJ Foreshadowing a 2008 Repeat?

The CBOE Correlation Index (KCJ) is close to the lowest level we have seen since it was first listed in 2007. The KCJ measures the implied movement of the S&P 500 components options, compared to the implied movement of the S&P 500 index options. Simply put, the higher the number, the more likely all stocks are going to move together. Conversely, a low number will be characterized by sector rotation, and flat markets; one sector moves higher, another moves lower.  (Source: Access Hollywood) Correlation, for lack of a better term, is correlated with volatility. Not surprisingly, 30-day S&P 500 historical volatility is near the low level of 6.5%. Currently at 33.5, KCJ is sitting close to rock bottom, lower than where it was in 2007, (but not lower than where Lindsay Lohan was in 2007).  So far this year, the market has been able to grind higher, characterized by leadership in FANG(Facebook Apple/Amazon, Netflix, Google) and sector rotation. A...

Morning Update

ECB officials said last night that ECB President Mario Draghi will likely wait to hear Germany’s Constitutional Court’s ruling on the EFSM before publicly unveiling his plans. Many were hoping Draghi would unveil his plan after the ECB’s September 6th meeting, but this is becoming increasingly unlikely. Today Reuters is reporting that Germany is the latest European nation to begin studying the possible impact of a Greek exit from the Euro. This comes ahead of Chancellor Merkel’s meeting with Greece’s Prime Minister today. Merkel has repeatedly said that she would like Greece to remain in the common currency, though clearly someone in Germany believes a Greek exit is possible outcome worth preparing for. This morning US new durable goods orders numbers we released for July, coming in at a gain of 4.2% M/M. Though this was strong than expected, it was primarily driven by strong aircraft sales. Non-defense orders excluding aircraft were down a sharp 3.4% M/M versus a 0.2% decline expecte...

Morning Update

This morning stocks, gold, and crude oil are all higher with VIX futures lower. This risk appetite is being driven by a report in the Financial Times that EU authorities are in “fresh talks” with the Spanish government to iron out details of a bailout before it is formally requested. This has helped the Euro regain the 1.3 level after selling off hard yesterday. Prior to Oracle’s earnings report yesterday after the close, one trader bought 20,307 Oct. 32 puts for $0.79 and sold the same number of the Jan. 34 calls for $0.98. This spread, known as a collar, was put on for a net credit of $0.19 and was likely used to protect the downside risk of holding a long stock position through the earnings announcement. Spreads like these are useful when you are long stock and bullish over the long term but believe the stock could dip in the near-term. By buying the Oct. 32 puts the trade is able to eliminate risk below that level. However, by financing the puts by selling the Jan. 34 call the tra...