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I Was Wrong About Shorting Volatility

I posited at the beginning of this correction that shorting volatility looked very enticing at current levels. That has turned out to be a terrible call as my belief that there would be a quick rebound in the equity markets was disproved. I’ll provide my outlook for the markets and shorting volatility going forward from here. Ever since the current market rout started, I’ve been salivating at the chance to get short volatility via the short term volatility ETF VXX (NYSEARCA: VXX ). This is a strategy I’ve used repeatedly over the past year or so to take advantage of buying the dip on a leveraged basis and it has worked very well. Unfortunately for me (and many others) this dip turned into a correction. My last post on the subject seems like ages ago at this point but if you’d like to see my rationale at the time, please take a look. Some time has passed and the landscape for shorting volatility has become a lot more complicated so in this article, I’ll update my views on shorting volatility and see what I think is next for markets and VXX. (click to enlarge) Obviously, I was too early. That comes from my steadfast belief in “buy the dip” that has developed over the past six years of this bull market. It has worked beautifully in the past but of course, this time it did not. This is why it is important to keep volatility-related positions small and why I always issue that warning in VXX pieces. I’ll issue it again here and offer that any position in VXX is, by its nature, speculative. Please keep positions small and understand that the potential for large rewards comes with the potential for sizable risks as well; the chart above shows this better than my words can convey. Now that we’ve established my original premise for shorting volatility this time around has proven to be unequivocally incorrect, let’s take a look at what may happen in the short to intermediate time frames with respect to the market and the VXX. The fact that the VIX is still elevated above 23 this many weeks into the correction is something I never thought would happen as it was beginning back in late August. I saw the spike down as just that and nothing more but obviously, we have something larger on our hands here. (click to enlarge) The VIX is showing tremendous ability to remain elevated and given the term structure at present, it appears traders think it will continue or even go higher. Credit: VIX Central We can see the spot VIX is near 24 while the front month is just over 22. But if we look further out, there is only a small drop in what the market is predicting volatility will look like several months into the future. While this isn’t unusual during a correction, there is real money on the line here so there are some traders with serious firepower betting on a sustainably higher VIX. The second mistake I made is in assuming contango would disappear quickly, as it had during so many quick down turns in the market in the last several years. As you can see, I made a pretty high probability bet that the spike in contango would be short-lived. Obviously, that is not the case. While contango has lessened significantly, it is still present. And as the down turn in 2011 showed us, it can stay that way for a long time. Given the way the VIX is behaving so many weeks into the spike, I have to think we are in for some more suffering before things get materially better. Now, these two conditions were the very reasons I originally put my short VXX trade so I’m not going against my system that has worked time and again; what I’m saying is that this time is different and requires a different approach. I found out this time was different the hard way – by losing money – but that doesn’t mean we can’t adapt and learn. First, I think the equity markets are in for some more selling before repairs can be made to the damage that we’ve seen in the past six weeks or so. We can see here that when the market (NYSEARCA: SPY ) broke down, it broke down hard and hasn’t looked back. (click to enlarge) The spike bottom has yet to be retested and the SPY formed a rising wedge pattern in the midst of a down trend, usually a bearish formation. We can see the formation was broken in the last week or so and stocks have moved down ever since. I think this wedge pattern coming to completion and the fact that there are no catalysts to buy mean a retest of ~187 on SPY is very likely and perhaps, even a move lower than that. The bottom line is my short to intermediate term outlook on the SPY is negative until we get a retest of the spike lows and until that happens VXX’s bias is up, not down. While the basic conditions of my short VXX trade are still in place (contango, elevated VIX) the one other major condition (a healthy stock market) has disappeared. That means VXX, VIX, and contango could stay elevated for extended periods of time and that means the short volatility trade is probably going to tread water or see another move lower in the coming weeks. I moved out of my short VXX position for a sizable loss because conditions changed and my reasoning for the trade in the first place evaporated. While taking losses is very painful, it is the right thing to do when you are proven wrong by the market. I will short VXX again at some point but I need to see a few things first. I need to see the SPY retest its lows successfully. That will mean a move down from current levels and some painful selling to set up a base that currently does not exist. Until that happens, shorting VXX is very dangerous. Second, I need to see the VIX sustain selling pressure. Until the market retests its lows the VIX is likely to stay elevated. That means shorting volatility in general isn’t going to work. Lastly, I think time is the final condition. This correction has taken a psychological toll on investors and that takes time to heal. Extremely volatile action like we’ve seen causes people to bail and until calm is restored, sustained buying pressure – and lower volatility – are going to be hard to come by. The time will come to short VXX again will come but for now, I’m out of this trade. I was proven wrong by the market so I’m licking my wounds until a better opportunity presents itself.

Fidelity Magellan Fund: Getting Better In A Good Market And Coasting On Past Successes

FMAGX is a storied name in the world of mutual funds. But the fund hasn’t been what it once was in a long time. It’s hardly a bad fund, and it may be turning itself around, but there may also be better options for you. The Fidelity Magellan Fund (MUTF: FMAGX ) has a hallowed place in the history of mutual funds. Former manager and mutual fund icon Peter Lynch is probably the name most associated with the fund. And while he led it to great success, he hasn’t been the manager for a long time… and performance has been less than inspiring for a long time, too. What’s it do? Fidelity Magellan’s objective is capital appreciation. It achieves this by investing in stocks. That may sound a bit simple, but that’s really what Fidelity puts out there. What this is basically explaining is that the fund owns stocks and doesn’t have specific style, region, or sector preferences. So it will own both growth and value names, invest in domestic and foreign stocks, and basically go where it thinks it can find opportunity. With an asset base of around $15 billion, however, you’ll want to keep in mind that it isn’t likely investing in too many small companies. So FMAGX is really a large cap style agnostic stock fund. Current manager Jeffrey Feingold is looking for companies with, “…accelerating earnings, improving fundamentals and a low valuation.” He believes these are the main drivers of performance, but admits that finding all three in one investment can be hard. So he works to find stocks with at least two of these factors going for them. Broadly speaking he also tries to diversify the holdings across aspects like type of company (fast growers, higher-quality growers, and cheap with improving fundamentals) and risk profile (for example, stocks with different leverage levels and earnings predictably). In the end, he explains, “…because of the way I manage the fund, security selection is typically going to be the primary driver of the fund’s performance relative to its benchmark.” How’s it done? Feingold has been at the helm of the fund since late 2011, putting his tenure at a little over three years. And in that span he’s proven pretty capable. For example, over the trailing three year period through August, the fund’s annualized total return was roughly 16.4%. The S&P 500’s annualized total return over that span was 14.3%. Assuming there was a bit of a transition period as he took over, that three period is probably a fair time frame over which to look at his performance. And its a big difference from longer periods. Despite the recent solid showing, the fund’s five-, 10-, and 15-year trailing returns all lag the index and similarly managed funds. Often by wide margins. So Feingold has been doing something right at a fund that’s been missing the mark for some time. However, there’s more to the story. The manager’s tenure has coincided with a mostly positive market. In fact, 2012 (the S&P advanced around 16%), 2013 (the S&P was up 32%), and 2014 (the S&P was up nearly 14%) were all fairly good for the market based on historical average returns. In other words, the manager has had a good backdrop in which to work. Looking to the future, however, it’s fair to say that he hasn’t been stress tested at this fund yet. So I wouldn’t get too excited by the recent performance. That said, so far this year, the fund has held up reasonably well. It’s lost less than the S&P and similarly managed funds. But I’d argue that this isn’t enough of a test to get a real feel for how the fund will handle a major market correction with Feingold at the helm. But it is at least encouraging. Not too expensive, lots of trading Looking a little closer at owning Fidelity Magellan, it’s got a reasonable expense ratio of 0.7%. Although you could argue that a fund with around $15 billion in assets could probably be run with a lower expense ratio, 70 basis points isn’t out of line with the broader fund industry. If you take the time to look at the fund’s annual report, though, you’ll notice that expenses have increased from around 0.5% in the last couple of fiscal years. But that’s really a statement to the improving performance. Magellan’s expense ratio is based on the cost of running the fund plus a performance adjustment. In other words, the expense ratio is going up because Magellan has been doing better. I think most would agree that this is reasonable. That said, Magellan’s 70% turnover looks fairly high to me based on the large cap names it’s pretty much forced into because of its large asset base. That number has been fairly constant over the manager’s tenure, as well, so this looks like a reasonable rate to expect year in and year out. There are a number of very good funds that manage to do well with turnovers in the 20% range, so the 70% figure is something I’d watch. For example, that level of trading in a falling market, as noted above, has yet to be tested at the fund. I make that comparison because a fund with a 20% turnover is clearly buying and holding companies it likes and knows well. Companies that it believes have solid long-term prospects. A fund that turns over 70% of its holdings in a year looks like it’s investing with a shorter time period in mind. You may be OK with that, but if you aren’t, then this may not be the right fund for you. If you’ve gone for the ride… Investors often buy funds and then forget they own them. If you have been in FMAGX for a long time it has probably served you reasonably well, overall. That said, you have also lived through some periods where management hasn’t lived up to the fund’s storied past. That appears to be turning a corner with a new manager running the show. However, the new manager has so far been running things in a good market. There are few solid clues as to what you might expect in a real downdraft. So improved performance is nice to see, but it’s too early to call an all clear-especially with the market turning so turbulent of late. In fact, Feingold might be on the verge of a true test of his abilities in a falling market. Only time will tell. In the end, if you own Magellan I wouldn’t be rushing for the exits. However, if complacency is what’s kept you in the fund I’d suggest looking around at other large cap funds. Magellan is hardly a stand out performer, despite the fund’s impressive history, and based on the management changes over time it may no longer be the fund you bought. So a little perspective on your options wouldn’t hurt, even if you decide to stick around.

Extended Duration ETFs Head To Head: EDV Vs. ZROZ

With the Fed still hesitating to hike the benchmark interest rates even almost after a decade, bond investing prevails. In any case, September was a chancy month for the lift-off. But a global market rout in August led by the Chinese market crash, slouching commodities and their shockwaves on other emerging economies held the Fed back from catapulting a lift-off. Not only this, the Fed slashed its projection for the benchmark interest rate for 2015, 2016 and 2017. The Fed’s funds rate for the longer run was cut to 3.0-4.0% from 3.3-4.3%, suggesting a slower rate hike trail. The expectation for 2015 real GDP growth has been upgraded to 1.9-2.5% from 1.7-2.3% projected in June while the same for 2016 was lowered to 2.1-2.8% from 2.3-3.0%. This economic backdrop pulled down the bond yields and drove up bond prices, especially the long-term ones. Yield on the benchmark 10-Year U.S. Treasury note plunged to 2.16% on September 23 from 2.54% recorded in the year-ago period. Yield on the 30-year U.S. Treasury note fell 50 bps to 2.75% on September 23. This, along with geopolitical uncertainty, global slowdown, stubbornly low oil prices and deflation fears are also driving demand for safe-haven bonds. Since long-term bonds offer up greater yield in this yield-starved economy, investors thronged to the long-dated Treasury bonds and the related ETFs. Investors should note that U.S. long-term Treasury bonds turned out compelling investments in 2014. Though the looming Fed lift-off is a negative for U.S. treasury ETFs, 10-year U.S. Treasuries outdid their Group of Seven counterparts in the August equities collapse, as per Bloomberg . In such a scenario, it would be intriguing to look at two top performing long-term U.S. Treasury bond ETFs and their key differences: Vanguard Extended Duration Treasury ETF (NYSEARCA: EDV ) For a long-term play on the bond market, investors have EDV, a fund that seeks to match the performance of the Barclays U.S. Treasury STRIPS 20-30 Year Equal Par Bond Index. This means that this benchmark zeroes in on fixed income securities that are sold at a discount to face value, and then the investor is paid the face value upon maturity. As such, these bonds are usually very sensitive to interest rate changes, and can be greatly impacted by shifting rates. This particular 73 bond basket has an average maturity of 25.2 years, and a yield to maturity of 3%. The effective duration of the ETF stands at 24.8 years suggesting high interest rate risks. The fund has amassed about $364 million in assets. Investors should also note that this is a cheap product, as it charges just 12 basis points a year, so it will be a very low cost way to get into long duration bonds. However, the real selling point as of late has been price appreciation as EDV gained about 3% post Fed meeting in September. However, the fund has lost about 6% in the year-to-date time frame on rising rate worries. In the last one year (as of September 23, 2015), the fund was up about 6.4%. This Zacks Rank #2 (Buy) ETF yields 2.99% annually. PIMCO 25+ Year Zero Coupon U.S. Treasury Index ETF (NYSEARCA: ZROZ ) This ETF follows the BofA Merrill Lynch Long US Treasury Principal STRIPS Index, which focuses on Treasury principal STRIPS that have 25 years or more remaining to final maturity. The product holds 20 securities in its basket. Both the effective maturity and effective duration of the fund is 27.22 years. This fund is often overlooked by investors as depicted by AUM of $182.74 million. The product charges 15 bps in annual fees and returned 3.8% in the last five trading sessions (as of September 23, 2015) reflecting a dovish Fed. The fund was up over 6% in the last one year while so far this year the product has shed about 6.7%. The fund yields 2.92% annually and has a Zacks ETF Rank #2. Since, ZROZ has a little higher duration and maturity, it can outperform when rates are downhill; but with the Fed preparing for a lift-off sometime in 2015 or as late as early 2016, ZROZ will likely lag EDV going forward. Link to the original post on Zacks.com