Paratrade Systems Weekly Research News

12 Aug

Long only equity traders should leave now for labor day weekend.

If you devote your time to taking risk that correlates at all with the S&P 500 then you must always be asking – What are the risk/reward conditions in the S&P 500? If S&P conditions are poor, then it makes no difference if you have found a cheap spread or a superior market. You should at least consider a hedge and understand how your favorite position behaves when US stock indices decline.

Current Conditions

I study fear by using a synthetic version of the Vix index. This measure allows me to have an index that has somewhat more normal boundaries. Here’s how it looks:

Current Fear1

You can see that this measure ranges between 0 and 13. It is not normalized. Our problem today is not figuring out whether we should buy it when it gets above 3 or 7, it’s what to do when it falls down close to the zero level.

Current Fear2

You can see here that the current level of .23 is rather low. In fact it’s a little scary. Normally this is not enough to concern me since it also matters how long it’s been since we last had a decent spike up. The best returns come close to those spikes even when fear has subsided.
Let’s look at S&P returns filtered by eFear (“SynVix”) level:

  1. The first eFear range is below .5 and above .1
  2. The second eFear range is above .5 and less than 1

The first set of filtered returns will tell us how the S&P has performed in the past when the index is in this range while factoring out the very lowest levels. The second will show us returns when eFear is higher but still not attractive.

Current Fear3

The time frame shown here is important. The S&P had a very long smooth rally for almost two years, yet the returns when eFear was this low were nonexistent. The “low fear” case at least made some money over the sample period. The “very low fear” case lost 185 points over thirteen years while the S&P gained 1060 points
2013 was the best year for the very low conditions. and you can hardly see it. You can’t see a single period where returns were positive since July 2004!

To be bullish now requires one to find a new variable that will make this time – different. My normal choice would be interest rates and the case there must be based on level rather than rate of change. Bond prices are stagnant but perhaps the low yield level will force new money into equities regardless of fear levels.

I would rather wait for a better entry level.

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