This coming week will likely be a week of many crosscurrents. The Fed is holding an FOMC meeting, and its primary focus will be TO RAISE or NOT TO RAISE the base lending rate. If that were not enough, Friday is the expiration of options, futures, and options on futures. This is referred to as “triple witching expiration.”
Following the Fed meeting, it is often worth stepping back and letting the emotions of the moment get digested by the markets. Based on interest rate traders’ sentiment, the expectation is for NO increase in the base lending rate at this meeting. Nonetheless, shortly after those crosscurrents pass, we will be dealing with millions of offsetting trades on the options and futures markets going into Friday’s close.
Oh, but guess what? It does not really matter for most rules-based strategies. A well-designed strategy will have been stress tested to understand their volatility and return-vs- drawdown profiles. Therefore, the stress this week’s news events may put on many active strategies should be nothing new
A few more points to start the week:
The VIX volatility index closed near its low on Friday at 23.20. Larry McMillan, a contributor to Proactive Advisor Magazine and a world renowned authority on options and volatility, tells me the average VIX for the past 22 years is 19.984. Not a bad guess on my behalf last week when I said 20. The important point is that volatility is trending lower. A close below 22 is noteworthy. A close below 19 is important.
Counter-Trend Strategies: The S&P 500 (closed at 1961) is well below its 50-day moving average (approximately 2045), which is an important level watched by intermediate term investors and traders. Trend-following strategies see this as a down trend and are likely in cash or short. Counter-trend strategies see this move off the low as a great opportunity to capture a gain as the market “reverts to the mean.” Get the message here? Strategic diversification across investment strategies serves a purpose. Believe in it.
I almost forgot this important item…correlation among sectors and asset classes has gone up significantly in recent weeks as volatility has risen. This increased volatility has been happening for several weeks and that, along with momentum, are the primary drivers of change in strategy allocations of late.