The Bull Just Crashed - Dazed and Stumbling

The stock market this week resembled a drunken bull that just crashed into a concrete wall, got up and stumbled around in all sorts of wild directions. We've written on our blog before that we are not in Kansas anymore that this is uncharted waters and no one can tell you what will happen based upon historical data and we think that the markets just proved us right.

We saw a lot of strange things. First, the VIX (CBOE Volatility Index) generally has an almost 100% correlation the the S&P (and the markets in general) that when the VIX moves up (indicating market fear) the S&P will move down and visa versa. But on January 5th to the 29th the VIX was moving up and at the same time the SPY was moving up as well. That was signaling that the market was broken and something was wrong. The S&P went from 2,731 to 2,861 in that time period while the VIX was rising!

Next, event was the historical (never happened before from the data we have) jump in an acute period of time in the VIX. It went from 12.50 on February 1st to 46.34 in just three (3) trading days. This caused many institutional holders (of that bet on the VIX never spiking) to liquidate their assets in order to buy to cover their positions. The two hit the hardest were the XIV which is shutting down is my understanding and the SVXY. They had to buy to cover so much that it actually resulted in artificially inflating the VIX.

These funds (like SVXY) make adjustments after the market close and by 4:15 the February VIX future shot up 43% in 15 minutes. This caused a greater market sell off the next day and wiped out some prop firms heavy in XIV and SVXY. Some retail traders have taken a bath. Many of the top holders of XIV and SVXY are large wealth management groups that are not so wealthy.

When people get the monthly report showing a loss of 80% plus for the month there are sure to be lawsuits. We went in and looked at the change in NAV from February 2nd (a Friday) to the 5th for SAVY and it dropped over $1.9 billion.

The effects of this are still lingering as we see a deleveraging taking place. One person has commented that the size of the short-vol imbalance could be as much as $1.4 trillion. If that is the case the markets are in for more turbulence to say the least. We have one open alert on BAC that expires in about four weeks. Banks should do well with rising rates but we need the markets to stabilize.