Point Hedges ETP Performance During Invasion of Ukraine

On Friday in Flight-to-Safety ETP Performance During Invasion of Ukraine, I reviewed the performance of some of the traditional flight-to-safety ETPs (Treasuries, gold, currencies and volatility) that are often used to hedge an equity-centric portfolio. 

Evaluating the performance of these ETPs since Russia invaded Ukraine a little over a month ago, I found some rather lackluster numbers.  As a group, these products have not even broken even since the invasion of Ukraine.

This time around, I have elected to look at the performance of some less traditional ETPs, including some much more targeted products that I have referred to in the past as “point hedges.”  Specifically, I looked at areas where exports from Russia and Ukraine are a significant portion of the global export market and whose disruption could have a significant impact on the global balance of supply and demand.  As it turns out, these commodities were easy to identify and the price dislocations have generally dwarfed the appreciation one might have been able to realize with more traditional hedges.

These products include: 
USO: West Texas Intermediate Crude Oil (solid red line)
UNG: Natural Gas (dark purple line)
DBB: Base Metals (light green line)
DBA: Agriculture (violet line)
WEAT: Wheat (light blue line
CORN: Corn (black line)
ITA: Aerospace & Defense (medium blue/green line)

[Note that nickel (JJN) should be on this list, but in part due to some chaos and mismanagement at the London Metal Exchange, JJN prices jumped have had multiple spikes of more than 100% and dwarf the performance of other ETPs in this graphic.  Additionally, for the international crude oil market, Brent crude oil (BNO) is typically a better measure than USO, but since the  Russian invasion of Ukraine, the two ETPs have only differed in performance by about 2%.]

It is easy to play Monday morning quarterback and say that with hindsight it is easy to pick the winners, but anyone who studied Ukraine’s biggest contributions to the global export market could have deduced that a supply shortage in wheat and corn was likely and for Russia, natural gas, crude oil and nickel were three areas of high risk in terms of their strategic value to the West, with wheat and corn also part of the equation.  I threw in aerospace & defense as a general military hedge.

Unlike the inconsistent and largely negative performance of more traditional flight-to-safety ETPs since the Russian invasion, the point hedges above have all seen gains of at least 3% during this period – and if you remove aerospace & defense from the mix, all the gains are at least 6.8% or higher. 

This is not to say that more narrow point hedges will usually outperform the broader traditional hedges during periods of geopolitical turmoil, but rather to remind readers that instead of a more generic hedge, a targeted hedge or speculative trade often has the potential to deliver substantially greater returns, such as the median 13% returns from the group of ETPs above.

This also means, of course, that should there be progress in the talks between Russia and Ukraine that each of these point hedges is exposed to the potential of a significant decline in price.

[source(s):  StockCharts.com]

Further Reading:
Flight-to-Safety ETP Performance During Invasion of Ukraine
Safe Haven Options Shrinking?
Chart of the Week: Flight-to-Safety ETPs
Revisiting the Flight-to-Safety Trade
Chart of the Week: The Flight-to-Safety Trade
Why Not Point Hedges?
Cheating with Partial Hedges
Forces Acting on the VIX
A Conceptual Framework for Volatility Events

While it has not been updated in a while, new readers may also enjoy older posts that have been tagged with the Hall of Fame label.

For those who may be interested, you can always follow me on Twitter at @VIXandMore

Disclosure(s): Net short VXX and long USO, DBB, DBA and ITA at time of writing

Flight-to-Safety ETP Performance During Invasion of Ukraine

Russia invaded Ukraine a little over a month ago, creating turmoil and panic in stocks and across a wide variety of asset classes and instruments. 

In the graphic below, I capture the performance of ETPs covering a variety of traditional flight-to-safety instruments that are used to de-risk or hedge an equity-centric portfolio.  These include: 
SHY: 1-3 Year Treasuries (solid red line)
GLD: Gold (dark purple line)
UUP: U.S. Dollar (light green line)
FXY: Japanese Yen (violet line)
FXF: Swiss Franc (light blue line)
VIXY: Short-Term VIX Futures (black line)

Note that normally I would use VXX, but the price distortions due to the suspension of new creation units makes VIXY a more accurate measure.

The graphic shows that none of the ETPs above turned in particularly strong performance.  Long volatility has been the best performer for the first two weeks, but is now down more than the S&P 500 Index, with a loss of over 12%.  The top performer for the entire period is gold, which has had a fairly steady if unremarkable return during this period.  The second-best performer is the dollar, which has seen a steady upside, but has consistently trailed gold.  Three ETPs have also generated losses, following a slight uptick the first few days.  The worst performer has been the Japanese yen and the other underperformers have been the Swiss Franc and 1-3 Year Treasuries.

All in all, these traditional or generic hedges have been a disappointment.  In my next post, I will look at some hedges that are better suited to the Russia-Ukraine situation and have delivered much better results.

[source(s):  StockCharts.com]

Further Reading:
Safe Haven Options Shrinking?
Chart of the Week: Flight-to-Safety ETPs
Revisiting the Flight-to-Safety Trade
Chart of the Week: The Flight-to-Safety Trade
Why Not Point Hedges?
Forces Acting on the VIX
A Conceptual Framework for Volatility Events

While it has not been updated in a while, new readers may also enjoy older posts that have been tagged with the Hall of Fame label.

For those who may be interested, you can always follow me on Twitter at @VIXandMore

Disclosure(s): Net short VXX and long GLD and SHY at time of writing

VIX Teasing Seven Down Days in a Row, with Interesting Performance Implications

The VIX has been down six days in a row and is currently up a few pennies.

Assuming the VIX closes down again today (a fascinating thought in an of itself given the increasing Fed hawkishness as well as concerns about a Russian escalation in Ukraine), what might the string of declines portend for stocks going forward?  I pose this question because I think the historical data is telling, with 30 such instances of 7-day declines in the 33 years of VIX data going back to 1990.

What typically happens to stocks when the VIX falls seven days in a row?  Not surprisingly, if the VIX is continuing to fall, then stocks are almost always continuing to rise, to the point they becomes overbought.  Going forward, stocks have a tendency to see a one-day decline and some slight underperformance during the course of the next few days and up to a week.  At some point, whatever had been the fundamental driver of the decline in the VIX begins to regain control of the price movements in stocks and stocks move up sharply, with a high likelihood of outperforming the long-term average moves in stocks.

In the graphic below, I show the movements in the S&P 500 Index following a 7-day decline in the VIX relative to the average moves in the SPX during the same period.  You can see that the relative underperformance lasts five days, at which point the overperformance kicks in, with the maxim outperformance coming after 100 trading days.

[source(s):  Yahoo, TD Ameritrade, VIX and More]

Further Reading:
Top VIX Crushes in History
VIX Narrowly Misses New Consecutive Day Decline Record
VIX Sets New Record with Nine Up Days in a Row
Streaking

While it has not been updated in a while, new readers may also enjoy older posts that have been tagged with the Hall of Fame label.

For those who may be interested, you can always follow me on Twitter at @VIXandMore

Disclosure(s): none

Barclays Suspends Creation Units for VXX

 Earlier today, Barclays announced the suspension of issuance of new creation units as well as sales from inventory for two of its ETNs: the iPath Series B S&P 500® VIX Short-Term Futures ETN (VXX); and the iPath Pure Beta Crude Oil ETN (OIL).  VXX is the premier VIX-based ETP and has been the most popular subject on this blog for the past 13 years.  It was the first VIX ETP to launch back on January 30, 2009 (along with VXZ) and remains the flagship product in the volatility space, averaging 70 million shares traded per day and regularly placing among the top five ETPs in terms of both share volume and options volume.

While the news from Barclays was a surprise, it was not unprecedented.  Credit Suisse suspended creation units in TVIX (a +2x version of VXX) twice: once in dramatic fashion in February 2012; and again in July 2020, when the product was delisted and moved to the pink sheets to trade under the TVIXF ticker.

The first time around, on February 21, 2012, there was not a VIX spike, per se, that triggered the event.  Instead, it was the general popularity of the product and the size of holdings in the TVIX note (ETNs are an unsecured debt note) that concerned the bank.  Credit Suisse acknowledged that the TVIX note violated the bank’s risk management rules related to the “internal limits on the size of the ETNs” and thus triggered the suspension of creation units.

The second time around, on July 12, 2020, the record volatility spike associated with the onset of the pandemic caused the size of the TVIX note to be roughly half of the size of the bank.  As a result, Credit Suisse concluded that the risk of continuing with this product was too high, so they decided to exit the ETN business, stop issuing new creation units and delist nine ETNs.

In both 2012 and 2020, the absence of new creation units led to a supply shortage and a large premium in the market price relative to the intraday indicative value (IV).  In 2012, new creation units were halted for a month and a day, with the price of TVIX rising to an 89% premium to TVIX.IV at one point.  When TVIX creation units were restored, TVIX fell 60% in three days and soon was trading within 1% of indicative value.  In 2020, the cessation of new creation units was final and irreversible, so TVIXF has now been trading on the pink sheets for 21 months without any new creation units.  Initially, there was almost no premium in TVIXF to TVIX.IV, but the Reddit r/wallstreetbets crowd eventually latched onto the potential for a short squeeze in TVIX in early February 2021 and spiked the price of TVIXF from parity to a 43% premium in two days.  Since the initial targeting by r/wallstreetbets, the premium in TVIXF to TVIX.IV has averaged about 72% and has been as high as 160% at one point.

An even more famous and noteworthy example of investors targeting a product with no creation unit capabilities for a short squeeze is the plight of the VelocityShares Daily 3x Inverse Natural Gas ETN (DGAZF), which spiked from 400 to 24,000 in a week in August 2020.  The VelocityShares Daily 3x Inverse Natural Gas ETN was traded under the ticker DGAZ when it delisted, with no new creation units along with TVIX on July 12, 2020.  The combination of longs targeting a short squeeze, limited liquidity in the OTC pink sheets, no new creation units and 3x leverage made for a historic spike of 12,000% in one week.  While such a scenario is unlikely to unfold in VXX, it is important to understand the history and the potential for outsized short squeezes when there are no creation units available to arbitrage away the difference between the heavily shorted underlying and its indicative value.

There are many other examples of ETPs that have had their creation units suspended, with resultant price anomalies.  Deutsche Bank did it with a variety of commodities ETNs in 2011 and 2012.  PowerShares also suspended creation units in the popular PowerShares DB Oil Fund (DBO) in 2015, with yet another large price spike.

While buyer beware is a good mantra to keep in mind when purchasing ETFs or particularly ETNs, it is even more important for short sellers to understand the risks of holding one or more of these products short when creation units are suspended and particularly when the products are delisted, with trading moving to the OTC pink sheets.

As for VXX, the reasons for the halt in creation units are not exactly clear.  Barclays says in their press release:

“This suspension is being imposed because Barclays does not currently have sufficient issuance capacity to support further sales from inventory and any further issuances of the ETNs. These actions are not the result of the crisis in Ukraine or any issue with the market dynamics in the underlying index components. Barclays expects to reopen sales and issuances of the ETNs as soon as it can accommodate additional capacity for future issuances.”

The underlying cause of the issuance capacity issue may be a number of factors, including the cost of hedging the position, exchange position limits or other factors.  Without knowing the underlying cause, it is difficult to predict when new creation units will be restored.  That said, as VXX appreciates in price, the size of the problem Barclays needs to tackle will continue to rise, which may further complicate the resolution process.

Of course, when new creation units are restored, one can expect that the price of VXX will almost immediately fall to that of VXX.IV.  Investors, therefore, need to understand the risks associated with long positions going forward and not find themselves in an air pocket like TVIX longs did back in March 2012.  For this reason, anyone who is insistent upon holding a long or short position in VXX should consider constructing a defined-risk position using options.  Alternatively, VIXY is an ETP issued by ProShares that holds a basket of VIX futures rather than an unsecured bank note with a promise to return the same performance as that basket of VIX futures.

It should go without saying that everything here I addressed relative to VXX is true for OIL as well and with all the turmoil in the oil markets related to events in Ukraine and Russia, there is already the potential for huge moves in the underlying.

I covered the TVIX creation units issue in considerable detail in 2012 and the links below probably provide the most comprehensive review of this matter anywhere on the internet.  I have also provided links to a number of tangential issues related to VIX ETPs and pricing anomalies.

In the graphic below, I show the divergence between VXX and VXX.IV during today’s regular trading hours (Pacific Time).  I find it interesting that it took more than three hours after the initial press release before VXX began to uncouple from VXX.IV and spike higher, ultimately reaching a 12% premium before the divergence began to narrow during the last half hour of trading.

Long-term, I still think VXX is likely to remain the premier VIX-based ETP, but Barclays has some work to do to get the creation units back and the product trading with a normal supply-demand balance.  Until then, keep a close eye on the varying premium of VXX and VXX.IV, while evaluating alternatives such as VIXY and UVXY.

[source(s):  Yahoo, TD Ameritrade, VIX and More]

Further Reading:

Attempt at TVIX Short Squeeze Fizzling Out
The Resurrection of TVIX
TVIX Premium to Indicative Value Creeping Back Up
TVIX Creation Units Return; What It Means for Investors
Is TVIX Now Just a More Docile UVXY?
Recent TVIX Volume and VIX Futures Volume
The Story of VIX ETPs Relative to their Intraday Indicative Values
The Ups and Downs of the New Premium in TVIX
Credit Suisse Suspends Creation Units in TVIX: What it Means
Four Key Drivers of the Price of TVIX
Will TVIX Go to Zero?
TVIX Topples VXX as Highest Volume VIX ETP
Who Is Trading TVIX?
Volatility Becomes Unhinged on Friday
TVIX Finally Getting Its Due As Day Trading Rocket Fuel
TVIX Trades One Million Shares for First Time
All About UVXY

For those who may be interested, you can always follow me on Twitter at @VIXandMore

Disclosure(s): long VXX at time of writing

Top VIX Crushes in History

Yesterday’s sharp downward move in the VIX gave me a reason to tweet that the volatility crush as seen in the SPX and VIX was among the top 25 in history.  Upward pressure on the VIX toward the end of the session dropped the VIX down to the 30^th largest VIX decline in history, but along the way the Twitterati raised a number of questions about volatility crushes and the VIX as a measurement tool of broad market volatility crushes.

Since I have never seen any data related to the VIX and volatility crushes before, I thought this might be an opportunity to present some of my data and talk about the findings.  In the chart below, I have captured the 25 largest one-day declines in the VIX since 1990 and have presented data showing the forward performance of the SPX in periods from one to 100 days and I have also added some brief commentary regarding the causes.  In some cases I link the volatility crush to a previous VIX spike and use some explanatory shorthand in the process.  For instance, the top crush day, May 10, 2010, followed 2 days after the 21^st largest VIX spike (“2d+ #21”).

[source(s):  CBOE, VIX and More]

Of course, most of these volatility crush days coincided with huge jumps in the SPX, but there are some interesting exceptions, not the least of which was the 0.04% decline in the SPX back on April 11, 1990.  That just happens to be the only day for which I cannot find any obvious explanatory catalyst – to the extent that a 0.04% in stocks can actually have a catalyst – but given the proximity to the upcoming Gulf War, my guess is that some sort of news related to Iraq played into this event.

Note also how many of these volatility crush instances follow other important market-moving high fear events one or two days later, in true mean reversion fashion.  Examples on this list range from the flash crash, Greece, Lehman Brothers and Bear Stearns to several VIX all-time highs, Russian political and economic crises, the Boston marathon bombing, etc.

Things get even more interesting if you compare the top 25 VIX crushes to the top 25 VIX spikes in history (for an identical table recapping the top 25 spikes refer to Last Two Days Are #5 and #6 One-Day VIX Spikes in History.)  For starters, the top 25 VIX spikes all move up at least 31%, while none of the top 25 VIX crushes managed to eclipse the 30% decline level.  Also note the differences in the mean reversion predictive value of spikes versus crushes.  In general, the performance of the SPX following VIX crushes is modestly lower than that of the SPX in general.  On the other hand, the performance of the SPX following VIX spikes is generally better than the SPX in general – much more so if the September 29, 2008 outlier is dropped from the data set.

Another point that I think is worth making speaks to the overall changes in the volatility space.  The critical data point is that 11/25 of the top 25 VIX crushes happened since the beginning 2010, while 14/25 of the top 25 VIX spikes have occurred during the same period.  This means that we have had as much in the way of big volatility moves in the list seven years as in the previous twenty years of VIX data.  In other words, the volatility landscape is changing and the rise of VIX futures and VIX ETPs are no doubt an important part of that change.

For those who may be interested, you can always follow me on Twitter at @VIXandMore

Related posts:

• Last Two Days Are #5 and #6 One-Day VIX Spikes in History
• VIX Sets New Record with Nine Up Days in a Row
• Volatility During Crises
• Forces Acting on the VIX
• A Conceptual Framework for Volatility Events

Disclosure(s): the CBOE is an advertiser on VIX and More

The Year in VIX and Volatility (2014)

This is the seventh year in a row I have offered a retrospective look at the year in VIX and Volatility, which is my attempt to cram some of the highlights of the year in volatility onto one eye chart graphic with a (somewhat) manageable number of annotations.

In aggregate, 2014 was a very quiet year for the VIX, with a mean close of just 14.19 for the year, which is the lowest the VIX has been since 2006 and third lowest since 1995. On the other hand, as I recently documented, VIX spikes were common last year, with 2014 registering the third highest number of 20% VIX spikes since the beginning of VIX data, in 1990. In short, the VIX was susceptible to large spikes, but these were typically followed by strong mean-reverting declines. For example, the peak VIX of 31.06 on October 15 was the highest VIX reading since 2011, yet just six weeks later the VIX was back in the 11s.

When asked in October what they perceived as the biggest threat to stocks, respondents to the VIX and More fear poll pointed to the end of quantitative easing and the removal of the Fed safety net as their top concern, with Ebola narrowly edging out the much more nebulous “market technical factors” for the second slot. As best as I am able to determine, it was the panic associated with fears of an Ebola epidemic that took an already elevated VIX and pushed it up into the 30s.

At various times during the year, Ukraine/Russia, crude oil, ISIS/ISIL, Israel/Gaza, the Fed and the European Central Bank all managed to increase anxiety and perceptions of risk among investors. Also, the narrow miss in the vote for Scottish independence created turmoil in the United Kingdom and across the euro zone, but managed to avoid morphing into another nationalist crisis. Early in the year, there was a currency crisis in emerging markets that was triggered by (unfounded, in retrospect) concerns about higher interest rates in the U.S. Throughout the year there were concerns about valuations and excesses momentum trading in the likes of biotechnology, social media, internet and solar stocks. To some extent, these concerns peaked in April (see The Correction as Seen in the ETP Landscape for additional details), only to return periodically throughout the balance of the year.

[source(s): StockCharts.com, VIX and More]

Last year at this time, the prevailing worries were focused on whether or not Fed Chair Janet Yellen was leaning toward a more hawkish stance, the inevitable march to higher interest rates in the U.S., the weakening of emerging markets currencies and the potential fallout from the Fed’s tapering of bond purchases. In retrospect, investors were largely worrying about the wrong things.

The first few weeks of 2015 have seen Greece, Saudi Arabia and Ukraine back in the spotlight, with the Swiss National Bank and European Central Bank dominating news on the central banking front. If the past is any guide, the big issue for 2015 has yet to rear its ugly head, whether it turns out to be a gray, charcoal or black swan.

Related posts:

• The Year in VIX and Volatility (2013)
• The Year in VIX and Volatility (2012)
• The Year in VIX and Volatility (2011)
• The Year in VIX and Volatility, 2010
• Chart of the Week: The VIX and Volatility in 2009
• The Year in Global Volatility (2008)
• 2014 Had Third Highest Number of 20% VIX Spikes
• The Correction as Seen in the ETP Landscape

Disclosure(s): none

Top Posts of 2014

Since I launched VIX and More some eight plus years ago, I have devoted one post to highlighting the top 25 most-read posts of each year. I do this in part for archival purposes: to see what is important to readers and how their interest in various issues changes over time. I also hope that these aggregations of most-read posts will serve as relatively easily accessible repositories of high-quality material for the benefit of new readers and long-term readers alike.

During 2014, the blog saw an extended hiatus for the first time in its history, largely due to events arising from the passing of my father. For this reason, I am limiting the number of top posts for the year to thirteen, largely because Song for My Father* ended the year in the #13 slot.

Looking ahead, volatility is back and so am I. I miss writing and I miss the interaction with readers. In the coming year I will significantly ramp up my activity on the blog and also in the comments section. I will also continue to write a weekly newsletter specializing in volatility (which just so happens to have a 14-day free trial), pen periodic guest columns for Barron’s and perhaps contribute to some other publications as well.  All this will be in addition to my primary role, which is that of an investment manager.

In 2014, some of the top stories were Ebola, Ukraine vs. Russia, crude oil, ISIS/ISIL, the Fed and the European Central Bank.  The posts below represent those that have been read by the highest number of unique readers during 2014. Farther down there are links to similar lists going back to 2008, along with several other “best of” type posts that I have flagged for archival purposes.

For the record, each year I also attach the hall of fame label to a handful of posts that I believe have particularly compelling and/or original content, regardless of readership. I was a tough grader last year, as I only added one new post to the HoF in 2014, but I already have an addition for 2015 and my goal is to continue to crank out Hall-of-Fame-worthy posts on a regular basis in 2015 – and even manage to do it without assistance provided by performance-enhancing drugs…

With an increase in posting on the blog, I also foresee a substantial uptick in my activity on Twitter, where @VIXandMore gives me a platform to contribute more in terms of time-sensitive news, short-term insights and other related subjects.

The thirteen most-read posts on VIX and More in 2014 were:

• Low Volatility: How to Profit From a Quiet VIX (Guest Columnist at Barron’s)
• The Correction as Seen in the ETP Landscape
• Largest Pullback of 2014 Hits 6.4%
• A Very Middling Pullback So Far
• Was the VIX Too Low in 2013? No…
• VXX and VXZ Now Five Years Old!
• VIX March Futures and Options Expiration on Tuesday, Not Wednesday
• Performance of VIX ETPs in 2013
• The Year in VIX and Volatility (2013)
• Fear Poll: Fed/QE, Ebola and Technicals Top Worry List
• How to Ride an Aging Bull (Guest Columnist at Barron’s)
• The Turnaround in Emerging Markets and VXEEM
• Song for My Father*

Related posts:

• Top Posts of 2013
• Top Posts of 2012
• Top Posts of 2011
• Top Posts of 2010
• Top Posts of 2009
• Top Posts of 2008
• One Year Blogiversary! (includes top 25 posts of 2007)
• The 1000^th Post
• Five Years of VIX and More
• The VIX and More Hall of Fame

Disclosure(s): none

Charting the Recent Decline of the BRIC Components

U.S. stocks are mostly green in today’s session, though there is a good deal of red in global stocks, notably in emerging markets, where the popular EEM emerging markets ETF is down close to 1% as I type this and the Brazil (EWZ) is down more than 2%.

In the chart below, I plot the recent decline of the four large BRIC emerging market country ETFs: Brazil (EWZ); Russia (RSX); India (EPI); China (FXI). While all four country ETFs have declined between 8% and 20% during the past six weeks, the various woes afflicting each country appear to be country-specific to a large extent, though obviously the issues affecting China’s manufacturing base and export market have a significant upstream impact on Brazil.

Emerging markets in general have been struggling as of late, but difficulties in Brazil, India and China have helped to fuel a global selloff.

Going forward, investors will be well-served to keep an eye on all four components of the BRIC block, as well as aggregated BRIC ETFs, such as the most popular issue in this space: the iShares MSCI BRIC Index (BKF).

For those who are interested in evaluating the risk and uncertainty in emerging markets in general, the recent VEXXM as a Measure of Emerging Markets Volatility and Risk is recommended reading for some background and information on VXEEM, the CBOE Emerging Markets ETF Volatility Index.

[source(s): StockCharts.com]

Related posts:

• The BRIC Bull
• Russia Leading the BRIC Rally
• BRIC Update: China a Leader or an Outlier?
• Time to Be Long China?
• Chart of the Week: China Through the Eyes of FXI
• When to Short China?
• VEXXM as a Measure of Emerging Markets Volatility and Risk
• VXEEM vs. VIX Indices and Futures in Today’s Selloff
• The Evolution of the Volatility Index Family Tree
• Chart of the Week: Emerging Markets
• The Emerging Markets Engine
• A Global Indicator to Watch

Disclosure(s): long EEM at time of writing

The BRIC Bull

The last time I wrote about the relative performance of the BRIC countries was a little over eight months ago, in Russia Leading the BRIC Rally. At that time, the bounce off of the March lows was barely a month old and Russia (RSX) was leading the way, followed closely by India (EPI), with Brazil (EWZ) and China (FXI) not rallying quite as sharply.

Fast forward eight months and Russia is still out in front, but starting to look a little tired. For all the talk of a Chinese bubble, FXI, the most popular Chinese ETF, is a distant fourth and falling farther behind the other BRIC ETFs with each passing week. Since the end of October, the top performers have been India and Brazil. In fact the top India ETF (EPI) is now 21% higher than it was the day before the Lehman Brothers bankruptcy, while the Brazil ETF is 29% higher than its was trading just before the Lehman debacle.

Looking ahead to 2010, I expect Russia will have considerable difficulty remaining the top performer. I would not be surprised to see Brazil eclipse the bunch, followed by India and a resurgent China. One thing is certain: if investors can predict the plight of the BRIC ETFs in 2010, quite a few of the other pieces of the investment puzzle will magically begin fall into place.

For more on related subjects, readers are encouraged to check out:

• Russia Leading the BRIC Rally
• BRIC Update: China a Leader or an Outlier
• Time to Be Long China?
• Chart of the Week: China Through the Eyes of FXI

[source: StockCharts]

Disclosure: none

Russia Leading the BRIC Rally

The last time I checked in with the BRIC countries, four months ago, the issue de jour was BRIC Update: China a Leader or an Outlier? At that time, China was starting to move impressively off of an October bottom and Russia was a notable laggard.

As the chart below shows, in the five weeks since the U.S. stock indices have bottomed, it is Russia (RSX, red line) that has been the strongest performer, followed by India (EPI, blue line), with Brazil (EWZ, gold line) and China (FXI, black line) bringing up the rear.

I watch these relationships closely for a number of reasons, not the least of which is to determine how well the group as a whole is performing, if any particular country is separating itself from the pack, whether commodity producers or consumers are in favor, etc.

Part of the reason Russia has bounced more than its BRIC counterparts is that Russia suffered disproportionately in the recent bear market. In the nine months from June 2008 to February 2009, the RSX Russian ETF lost more than 82% of its value. The last month, however, has seen some notable improvements. Russia’s credit default swaps, for instance, which reflect to the cost to insure the country’s debt, have improved from 694 to 412 in the last four weeks as the outlook for that country’s sovereign debt has improved dramatically.

Going forward, country-specific trends may continue to dominate, but I suspect the relative performance of Russia and Brazil will say more about improvements in the commodities market as a whole than about the plight of a particular national economy.

[source: BigCharts]

BRIC Update: China a Leader or Outlier?

I have commented on resurgent Chinese stocks several times in the past few weeks, most recently in China About to Break Out? Now that Chinese stocks (FXI, black line) appear to be on the rebound, an important question is whether this is an isolated phenomenon or one that will also affect other emerging markets economies.

As the chart below shows, the rally in Chinese stocks has significantly outdistanced the recent bounce in emerging market stocks (EEM, orange line). It is the other three members of the BRIC group, however, that are lagging China and the broad emerging markets group the most. Not surprisingly, commodity-rich Russia (RSX, blue line) is the biggest laggard among the BRIC countries, while India (EPI) and Brazil (EWZ) are trailing the broader emerging markets index, but performing better than Russia.

The question of whether growing domestic demand and a massive government stimulus package will result in a China-specific rebound or help pull other global economies along for the ride is not likely to be answered soon. In the meantime, China looks strong on a relative basis and other emerging economies should be watched closely for clues about the geographical breadth of the rally.

[source: BigCharts]

The U.S. VIX vs. a BRIC VIX

India has an India VIX, Germany has the VDAX, and some other countries (largely in Europe) have their own country volatility indices. Outside of North America and Europe, the volatility index pickings are slim, however, so when you want to get a sense of international volatility on a broader scale, you have to roll your own.

Which is exactly what I have done today.

In the chart below, the bottom half is a six month chart of implied volatility in the S&P 500 index. It is similar, but not identical to the VIX. Note the March high, a second peak in mid-July, and the recent uptrend in volatility.

On the top half of the chart is the implied volatility in the Claymore BHY BRIC (Brazil, Russia, India, and China) ETF (EEB), which attempts to replicate the performance of the Bank of New York BRIC Select ADR index. In contrast to the SPX, implied volatility in the BRIC ETF was relatively moderate in July, but has spiked dramatically over the course of the past two weeks. In short, fear and anxiety may be rising slowly in U.S. markets, but in the critical economies of Brazil, Russia, India, and China, signs of panic are much more widespread.

If emerging markets are the buffer whose continued growth is supposed to buttress developed markets in this economic slowdown, then emerging markets need to find their own firm ground and soothe anxious investors before they can be expected to lubricate the wheels of the global economy.

[source: International Securites Exchange]

The VIX and 3% SPX Drops

What happens to the VIX when the SPX drops 3% in one day? Does the VIX provide any advance warning of a selloff or merely serve as a contrary indicator after the fact?

Since 1990, there have been 25 instances in which the SPX has fallen 3% or more in one day. In analyzing those movements, it is important to remember that volatility has a strong tendency to cluster; as a result, a majority of the data points I looked at happened to fall within the same month and many were during the same week as another 3% drop. This should not be surprising, as almost all of the SPX plunges from the last decade have been triggered by the Asian financial crisis (including the spillover into Russia and Brazil) and the unwinding of the dot com bubble.

The following graphic depicts a composite view of changes in the closing price of the VIX on the 25 occasions from 1990 to the present in which the SPX has dropped 3%:


Note that the scales fixes the close on the day before the 3% drop at 100, so that percentage moves to and from that point are easier to calculate. It is worth highlighting that while the actual values of the VIX are not included here, only twice during this period did the SPX drop 3% with VIX values already below 20. In fact, the median value for the VIX prior to the SPX drop is 31.21, again partly reflecting the clustering of volatility that results in multiple sharp drops in the SPX.

On average, a drop in the SPX of 3% or more translates to a 14.3% spike in the VIX. More than half of the time, the day of the SPX 3% drop turned out to be the high in the VIX over this 11 day period. On average, half of that spike is retraced within two trading days and over 70% of that move is retraced in five days.

In future posts, I will discuss in greater detail the issue of the VIX providing advance warning of a selloff in the broader market. Suffice it to say that while the graph above shows that the VIX does jump approximately 10% in the four days before a 3% SPX move, there is not the obvious telltale movement in the day or two before the selloff that might get the attention of the casual observer.