ETF Periscope: Volatility Gains as Congress Showboats

It’s more fun to talk with someone who doesn’t use long difficult words but rather short easy words like What about lunch?” -- Winnie the Pooh

Washington is back doing what it seems to be best at these days, which is ramping up the national angst while it plays a Congressional game of “chicken.”

As we head into the first week of October, it would seem that the possibility of a government shutdown increases as the clock ticks down towards a Monday-at-midnight deadline, when its fiscal year ends. So unless Congress cuts a deal to continue the funding of the government, the first shutdown in 17 years will occur.

Now, we have all seen this political power game play out before. Who can forget all the Sturm und Drang over the “fiscal cliff” battle, way back at the end of 2012?

Somehow, to the surprise of absolutely no one, that crisis was more or less averted, though not without the drama of a down-to-the-wire deal being cut.

As before, there’s at least a fair chance that another last-minute deal shall be struck, even if it is only in the form of a stopgap measure that allows for another few weeks of bad political theater before Congress finally approves a new budget.

But there always remains the chance that things get out of hand during the political process and a shutdown actually does occur.

It’s happened before, and though it usually gets resolved in a week or two, Wall Street gets understandably nervous during the whole process.

And even if the shutdown is avoided, investors can look forward to more of the same uncertainty with the looming debt ceiling issue arising in mid-October.

One problem with this sort of Washington-style cockfighting is that there’s always the possibility of things getting out of hand, especially as the shutdown fray occurs against a backdrop of the present fragile economy.

Investors are understandably easily spooked, and with many of them sitting on profits from this year’s strong market numbers, it wouldn’t take a lot of uncertainty on the political front to cause a retreat from equities into cash.

This sort of capital movement obviously has the potential for creating a domino effect, where the market corrects, the economy tightens, and consumers join investors on the sidelines.

As we’ve seen throughout the year, investors generally have been a resilient lot, and with the market having performed so admirably for the bulk of the year, there’s a good chance that any market dips caused by bad Washington theater are likely to be regarded as buying opportunities.

But in the meantime, expect volatility in the market to rise and to remain at higher levels at least until mid-October.

Keeping track of volatility can adequately be accomplished by following the performance of the Chicago Board Options Exchange Market Volatility Index (VIX), which is rarely mentioned in the financial press without it being noted that the VIX is commonly referred to as the “fear gauge.”

It’s not an inaccurate term, as it does serve to reflect investor perception regarding the level of market uncertainty.

The VIX has spent a fair amount of time this year down around the pre-crash levels seen during the first half of 2007. With the equity market hitting all-time highs, this would be expected, as the VIX tends to move down as the market goes up, and vice-versa.

Lately, the VIX has remained relatively low, though a 10-15% upward move can easily occur within a day or two if sour economic or political news predominates.

So, should the shutdown occur, it would be an obvious thing to expect a sharp rise in the VIX over the next few days.

But in terms of insurance against an even sharper market drop, even the resultant elevated prices that would be evident in VIX derivatives might be worth the cost.

That is, if you feel there is still more tomfoolery yet to unfold from Congress in the near future.

For those considering incorporating volatility insurance into their portfolio, the simplest way is to use a VIX derivative-based ETF, as the VIX can’t be directly traded. Currently, the most popular such vehicle for the purpose is VXX (S&P 500 VIX Short-Term Futures ETN), which tracks the S&P 500 VIX Short-Term Futures Index Total Return.

What the Periscope Sees

Each week, the Sabrient SectorCast ETF Rankings rate each of the ten U.S. industrial sector iShares (ETFs) by Sabrient’s proprietary Outlook Score. The rankings are revised on a weekly basis.

The Technology Sector, which has headed up the list for the majority of the last several months, inched up even higher this past week, nabbing an impressive score of 98. The Energy Sector came in at the number two spot, while the Financial Sector fell off slightly from the previous week, while still retaining the third spot in the Sabrient SectorCast ETF Rankings.

Here is the current list of some of the top-performing Technology Sector ETFs year-to-date, as of the end of the fourth week in September:

FDN -- First Trust Dow Jones Internet Index Fund, +38.65%

SOXX -- iShares PHLX SOX Semiconductor Sector Index Fund, +27.94%

FXL -- First Trust Technology AlphaDEX Fund, +25.92%

QTEC -- First Trust NASDAQ-100 Technology Sector Index Fund, +25.80%

SMH -- Market Vectors Semiconductor ETF, +23.48%

IGV -- iShares S&P GSTI Software Index Fund, +21.66%

ETF Periscope

Full disclosure:  The author does not personally hold any of the ETFs mentioned in this week’s “What the Periscope Sees.”

Disclaimer: This newsletter is published solely for informational purposes and is not to be construed as advice or a recommendation to specific individuals. Individuals should take into account their personal financial circumstances in acting on any rankings or stock selections provided by Sabrient. Sabrient makes no representations that the techniques used in its rankings or selections will result in or guarantee profits in trading. Trading involves risk, including possible loss of principal and other losses, and past performance is no indication of future results. 

ETF Periscope
daniel / Tag: VIX, VXX, FDN, SOXX, FXL, QTEC, SMH, IGV /