2016 has been fraught with volatility. As we stated in a report sent out on January 3, we anticipate 2016 to be a year of elevated volatility which is a great benefit to the VIX Volatility Model (VVM). Indeed, its quick +15% or better gains in typically two days or less has been the motivation behind adding on a rule which automatically cashes in on such quick profits. With this rule in place, and with no operator override as I discussed here: https://www.virtueofselfishinvesting.com/reports/view/market-lab-report-how-experience-can-work-against-you the VVM is up +44.1% so far in 2016. Of course, its current signal being up almost +20% helps. But then that's the rhythm of the model- a few large gains swallow up the many tiny losses, and explains how the model has in backtests managed to well outperform the major averages in every single year.
Tidal Waves, Tsunamis, and Shock Waves
Market volatility and instability since October 2014 have been prevalent. The trendless yet choppy 2015 was by some media accounts the most challenging market year in 78 years. Looking back over the last couple of years, it is evident that sharp drops in the stock market are due to fears of a slowing global economy. These fears come by way of recessionary reports out of economic juggernauts such as the US, China, and Germany. Indeed, Oct '14, Dec '14, Aug '15, Sep '15, Jan '16, and Feb '16 all had short-lived but sharp corrections. The markets then quickly found their floors and bounced just as sharply as various central banks pledged to keep rates low. In the case of the US Federal Reserve, they reduced the number of anticipated hikes in 2016. In the case of the ECB and Bank of Japan, they both pushed rates negative. And Fed Chair Yellen has not ruled out the possibility of negative rates.
As more central banks jump on the negative interest rate bandwagon, the GDP of respective countries will have to increase. This is a Catch-22 since negative rates have not, in theory or in reality, ever been shown to boost economic growth but rather can have crippling effects on banks, pensions, insurance companies, and savers.
So should global growth fail to occur as the months wear on, central banks will be unable to reflate/normalize rates. Meanwhile, QE-generated capital has to go somewhere, and that somewhere tends to be into stock markets and hard assets such as real estate which keeps the top 1% safe who tend to be invested heavily in such areas.
But this may come at too high a price should the respective middle classes, a measure of health and stability in any economy, continue to erode adding to the growing social unrest seen around the planet. 70% of Americans live one month away from financial disaster, and one in five American families is food-challenged. And this is happening under the hood of the world's largest economy which begs the question of how less advantaged economies are faring.
The prevailing issue is global GDP. Should it fail to rise, the sagging global economy will start to win the tug-o-war against the easy money policies of central banks. This may at first lead to accelerating prices in stocks and hard assets as QE becomes an inevitability, but the final outcome of such practices is never pretty. Current global debt-to-GDP stands at around 3:1. History has shown that when debt reaches these extremes, governments mired in such deep levels of debt have never been able to pay back this debt. This is an important tipping point as regimes may start to topple taking down their respective fiat currencies. Indeed, fiat has a long-term historical lifetime average of just 27 years, so the day of reckoning could be upon us within the next couple of years or less.
But the end of an era makes way for a new dawn. And while the end may not be pretty, enhanced volatility will offer ample opportunities to profit. So while the VIX Volatility Model has performed handsomely in every year in the backtests, it achieved stellar performance during the years of elevated volatility which include 2000-2002, 2008, and 2011-2012. These were also some of the best years for the Market Direction Model. Indeed, the built-in fail-safes keep losses in check while the addition of profit taking rules in the VIX Volatility Model further enhance profits. So VVM can help you stay in sync with elevated levels of volatility when such shockwaves hit while also allowing you to ride trends as shown by profits made so far from the current signal. Of course, always keep in mind past performance is no guarantee of future results so the size of your positions should always be aligned with your risk tolerance levels.