1Q2019 Review: Market Volatility ETF

Bucking the trend of the fourth quarter of 2018, the US stock market has had a solid first quarter in 2019 – the best performance since 1998.
Cumberland Advisors - Quarterly Review - Market Volatility ETF
Our quantitative strategy produced multiple entry signals between late October and Christmas Eve. An exit signal occurred near the end of February and the first entry group went to cash. As readers have learned in the past, our quantitative strategy utilizes a binary model that either fully invests each separate account or stays in an all-cash position. The cash position allows us to buy when the market dips. We can also adopt leverage as a choice for less-risk-averse investors.
Our bullish view of the equity market built from the end of the fourth quarter last year and expanded into the first quarter in 2019. We continued adding to our positions during the sell-off and held those  positions throughout the volatility of the past four months. Although our model decided to exit one entry group near the end of February, we want to clarify that we were not making a market top call. Each of our exit decisions is carefully calculated through our mathematical optimization process. Rather than calling the top, the model targets the optimal exit point, where we will not miss the next dip to re-enter.  This quarter marks the three-year anniversary of the strategy.
Our quantitative model currently remains neutral. We are waiting for the next buy signal to reinvest the cash position, or, exit signal for the remaining 2018 entry groups.



Market Volatility ETF Portfolio 3Q 2018 Review

The US equity market has had a strong third quarter this year. Our quantitative strategy benefited from the market rebound in July and August and took profits off the table at the end of last month. We have been sitting in all cash and waiting for the next entry signal since we exited near the market top.

 

Cumberland Advisors - Quarterly Review - Market Volatility ETF
 

The S&P 500 large-cap index is up about 9.69% YTD (ex-div) and hasn’t significantly deviated from where the market was at the same time last year. These numbers are certainly making investors happy, since the 10-year Treasury is yielding only about 3% nowadays. Although 2017 and 2018 show some similarities in the overall numbers, the detailed paths are quite different. We may still remember the ultra-low-volatility regime in 2017. But after a correction in February and some large spikes in volatility in the first quarter of 2018, we haven’t seen many short-volatility trades floating around this year. Needlessly to say, it was painful for the “short-vol” funds just half a year ago.
However, the third quarter proved to be another contrarian case. Market volatility continued its downward trend, falling to a 11-handle (Figure 1 below) and showing signs of relief after the spiral jump back up in February. While the 50.85% drop in VIX since April helps to explain the market comeback so far, it may be a misleading signal with regard to the underlying market. With the heated tariff war and midterm election coming up, we caution our readers not to interpret the VIX too literally. As we learned in the first quarter, VIX can spring up drastically in no time.

Chart 1. VIX since April 1, 2018. Chart source: Yahoo! Finance
The spread between the S&P 500 and VIX (Figure 2 below) continues in the third quarter: VIX is down over 20% while the market is up over 6%. This trend may be a sign of rising complacency in the market, as this type of widening does not typically happen during summer swoons. Nevertheless, as we always remind our readers, although we decided to go to cash with our quantitative strategy, that is not a short call from our model. Of course, “cash is king” has its merits. Our strategy is not to be afraid to hold cash and to be ready to enter when the time is right.

Chart 2. S&P 500 vs. VIX in 3Q 2018. Chart source: Yahoo! Finance
*Data updated on September 20th, 2018.
Leo Chen, Ph.D.
Portfolio Manager & Quantitative Strategist
Email | Bio

 


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Market Volatility ETF Portfolio 2Q 2018 Review

While the U.S. stock market had a long overdue correction in February of 2018, the first quarter ended merely flat eventually. Continuing from the rebound since February low, the stock market kept rising strongly in the second quarter.

Cumberland Advisors - Quarterly Review - Market Volatility ETF
 

Out of the three major indexes, the NASDAQ is leading the race by miles ahead. The technology-heavy index has closed at all-time highs for 20 times as of June 15 this year, piling upon last year’s record of 72 times. Although the Dow Jones Industrial Average had comparably 71 closing all-time highs in 2017, the Dow has only closed at all-time highs for 11 times this year, all of which were from January 2018. Moreover, the NASDAQ has also outperformed the Dow by roughly 10% including dividends during the first half of 2018. Standing in between the NASDAQ and the Dow, the popular benchmark S&P 500 has been relatively benign in 2018. Although this large-cap index has risen over 2% in both May and June so far, investors certainly have poured more interest into the small caps in the meantime, evidenced by the second quarter performance comparison below.


Chart 1. S&P 500 vs. Russell 2000 in 2Q2018. Chart source: Yahoo! Finance.

The second quarter has seen a lower volatility level compared to the first quarter. The VIX has calmed from above 20 down to 11 handle since April. Some major factors such as the alleviated concern over trade war and the improving U.S.-North Korea relations most likely contributed he significant downward shift in volatility. However, there are still some dark clouds in the near-blue sky. For example, the crude oil is still fighting to hold the $60-$70 per barrel ground. Not surprisingly, the oil volatility OVX has gone up in the second quarter.


Chart 2. S&P 500 Volatility VIX vs. Crude Oil Volatility OVX in 2Q2018. Chart source: Yahoo! Finance.

The recovery from the February correction has shown the resilience in the stock market. It is likely that the stock market can move higher in the next quarter if the volatility remains at or below the current level. However, as some sectors such as technology have demonstrated in the second quarter, not all sectors will be able to take advantage of the calming volatility equally this year. Perhaps, 2018 will be a year that favors active investors.

Leo Chen, Ph.D.
Portfolio Manager & Quantitative Strategist
Email | Bio


Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

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Cumberland Advisors Market Commentaries offer insights and analysis on upcoming, important economic issues that potentially impact global financial markets. Our team shares their thinking on global economic developments, market news and other factors that often influence investment opportunities and strategies.