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27/2/2017 TheVolatilityClueYouMayHaveMissedSchaeffer'sInvestmentResearch

THE VOLATILITY CLUE YOU MAY HAVE MISSED

The risk of a volatility pop is real -- but with stocks at new highs, don't ght the tape

Stocks quoted in this article: XIV | VIX | SPX

2/27/2017 8:36 AM

"... [XIV] comes into the week between 65 and 70 -- an area that could prove pivotal... when the CBOE Volatility Index (VIX - 11.49) moves lower,
this ETN will advance, and vice versa. And last week, XIV burst above the 66 level -- double its November low -- but pulled back fairly rapidly from
Wednesday's peak just shy of 70. In September and October, XIV peaked in the 40 area, which is double the June 2016 closing low. The September
and October XIV peaks in the 40 area were also 50% above the 2015 close. The XIV's peak close at 69.81 last week is 50% above its 2016 close of
46.75, which makes the action in this ETN much like that when it peaked in September and October last year."
-- Monday Morning Outlook, February 21, 2017

ToddSalamone Follow
@toddsalamone

AsdiscussedinthiscommentaryonMonday,$XIVfailureatkey
6570areahintsatvolpop
schaeffersresearch.com/content/analys$VIX$SPX
1:17PM23Feb2017

The CBOE Volatility Index (VIX - 11.47) was at last week and -- since early January -- has traded sideways with lows mostly in the 11.25 area,
which represents half its pre-election closing peak at 22.50. But the VelocityShares Daily Inverse VIX Short-Term ETN (XIV - 64.52), which we
discussed a week ago in this space, pulled back from an area that we observed could act as resistance -- speci cally, double its November low
and 50% above its 2015 close, as you can see in the chart below.

As we head into this week's trading, note that XIV touched its 30-day moving average on Friday morning -- a trendline that it has not closed
below since the November bottom. Volatility expectations rose and stocks sold o mildly after Treasury Secretary Steven Mnuchin indicated
on Thursday that the economic growth impact from new policies will not be felt until 2018. But this action was short-lived, as both stocks and
the XIV rose from their Friday morning lows. Unlike late November and late December, though, the XIV's 20-day moving average did not
support the XIV pullback -- which could be a clue that volatility expectations are set to move higher.

Nothing has changed with respect to the risk of a volatility pop, with large speculators -- who have been wrong at major turning points in
volatility -- still in an extreme short position on VIX futures, per the weekly Commitments of Traders (CoT) report. Additionally, Schae er's
founder and chairman, Bernie Schae er, detailed mounting evidence for a volatility spike in an article entitled, "Is This An Inection Point
For Equity Volatility?"

The good news is that while the XIV declined from resistance, stocks carved out new highs into Thursday. Last week's action in the XIV and S&P
500 Index (SPX - 2,367.34) is fascinating in that one could have made money on an XIV short used to hedge a long portfolio, as the XIV declined
coincident with stocks rising.

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With all eyes on the White House's forthcoming proposal for tax reform, the prospect of potential hints as to what's coming when President
Donald Trump addresses Congress on Tuesday, a Fed meeting in March, Brexit back on the radar, and French elections in April, equity
volatility still has more upside than downside potential.

ToddSalamone Follow
@toddsalamone

bloomberg.com/news/articles/$SPXhasreached'17
strategists'targetsalready
10:27AM22Feb2017

S&P500IsAlreadyTradingatWallStreet's
2017isbasicallyover,atleastfortheS&P500.
bloomberg.com

1 2

Last week, I reminded you that that one noteworthy historical pattern of the SPX is that it tends to respect half-century mark levels, such as
2,250 and 2,350. For example, after an early December move above 2,250, the SPX did not stray too far above this level, trading sideways in
the nal three weeks of the month and retesting 2,250 a few times into mid-January.

Another level that came on my radar this past week, thanks to the Bloomberg report linked in the tweet above, is that the SPX reached Wall
Street strategists' average target for 2017 when it rallied to 2,364. There is nothing magical about 2,364, other than it represents an average of
forecasts. Note, therefore, that not a single strategist necessarily has a target of 2,364. But with this number likely on the radar of some
market participants and xed less than 1% above the 2,350 mark, an SPX hesitation in the 2,350 zone could resemble the mid-December
through mid-January action around 2,250.

"A tailwind for this rally has been the bearish positioning of investors, with fund managers persistently shunning equities in exchange for holding
cash... That's no longer the case. Fund managers became bullish again in December, and remain so now. Optimism towards the economy has
surged to a 2-year high. Cash remains in favor (a positive) but global equity allocations are back above neutral for the rst time since late 2015.
Another push higher and excessive bullish sentiment will become a headwind. The US is the most overweighted equity market on a relative basis."
-- The Fat Pitch blog, February 15, 2017

The obvious is that there are myriad possibilities, and this is exactly how you should approach the current environment. One could argue that
the SPX moves sideways in the 2,350-2,365 zone, much like the action in mid-December through mid-January.

I have mentioned the risk of a volatility pop as pre-election pessimism continues to give way to optimism. There has been massive short
covering, and once-skeptical fund managers have changed their tune toward a more positive outlook. Now, the SPX trades 67 points, or 3%,
above the round 2,300 century mark -- site of its 30-day moving average. This trendline could play "catch up" if it stalls again in the coming
weeks, or contain a pullback similar to that which occurred at the end of December into January.

But momentum tends to beget momentum, and there were a couple of times last week when sellers emerged, but buyers quickly
overwhelmed them. While you should be aware of the risks discussed above, you should not be " ghting the tape," either. I continue to advise
recognizing the risk by employing option strategies, such as the stock replacement strategy, in which you sell a stock position and buy calls
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on the underlying to reduce your dollar risk in the market but still partake in upside momentum in a leveraged manner.

If you are in commodities, the energy and copper sectors are among those with the greatest risk, as CoT large speculators are extremely long
copper and oil futures contracts amid so-so price action.

However, gold continues to be a sector within the commodities market that I like, given its strong price action this year. This occurs after this
once-crowded trade has become much less crowded. For example, net long positions among large speculators on gold futures are down
nearly 50% since the 2016 peak -- and this is a group that was overly optimistic on gold into the election and bailed just in time for this year's
advance.

Continuereading:

Indicator of the Week: A Passive Investing Buzzkill in 3 Charts


The Week Ahead: Wall Street Gets Ready for GDP Data, Yellen Speech

Get Bernie Schae er's latest stock market insights direct to your inbox, every Sunday morning, with our free Chart of the Week newsletter.

Article by
Todd Salamone

2017 Schaeer's Investment Research, Inc.


All Rights Reserved. Unauthorized reproduction of any SIR publication is strictly prohibited.

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