You have probably read many articles discussing risks to the economy and stock market. The real economy and stock market don’t always trade hand in hand, which has been the case for the better part of the past decade. However, Main Street performance will eventually catch up to the stock market. Remember, while it’s good that low interest rates encourage borrowing due to lower costs, prolonged periods of low interest rates leads to debt bubbles. Businesses with good management will not fall into this trap, but many others will spend recklessly, leading to overextension. Prolonged low interest rates aren’t the only risk to the stock market. The list is actually quite long: (For more, see: How to Manage the Risk of Your Own Portfolio.)
- Commodity collapse
- Deflationary conditions in Europe
- China slowing
- Geopolitical tensions in Russia, the Middle East and Africa
- Lack of wage growth opportunities in the United States
- Student debt
- Millennials (largest generation) more cost conscious than Generation X and Baby Boomers
- Reckless car loan practices
- Public companies laying off employees in order to show profitable growth (decreases consumer spending)
- Despite four-month extension, Greece could still lead to a eurozone crisis
As far as commodities are concerned, your mind probably goes straight to oil. If that’s the case, you might think this is more of a supply issue than a demand issue. Oversupply is a factor, but it’s not as much as decreasing demand. If it were more of a supply issue, then other commodities wouldn’t be plunging as well. In Europe, the European Central Bank (ECB) is printing money in an effort to fuel growth. This should be effective in the short run. The long run is a different story. (For more, see: Will the ECB's Quantitative Easing Sink the Euro?)
China’s gross domestic product (GDP) growth slowed to 7.4% in 2014 from 7.7% in 2013. China’s GDP is expected to grow at a 7.3% clip in 2015. This is exceptional growth, but it’s the direction that matters most.
Hopefully, geopolitical tensions can be tamed.
While unemployment has been improving, consider the chart below and pay attention to wage growth:
According to John Burns Consulting, a firm that advises home builders, the student debt situation will lead to 440,000 unsold homes, which will leave $83 billion on the table. This represents approximately 8% of the housing market. This also ties into less spending by Millennials. (For more, see: Student Debt: Is Bankruptcy the Answer?)
The car loan situation can be summed up in one word: subprime. Outstanding auto loan balances increased 9.9% in the third quarter of 2014 year over year, to a record $870 billion. Loans to consumers with subprime credit represented 38.7% of accounts.
The point here is that volatility should eventually pay a lengthy visit to the stock market. Perhaps this will be when interest rates increase, but no one knows for sure. But, there is something that someone knows for sure, and it has to do with VelocityShares Daily 2x VIX Short Term (TVIX) exchange-traded note (ETN). (For more, see: Strategies to Trade Volatility Effectively with VIX.)
Timing is Everything
TVIX tracks two times the daily performance of the Standard & Poor's 500 VIX Short-Term Futures Index. It is enticing because it has the potential to give you massive returns in a very short period of time, but it could be a trap. The only way to win playing TVIX is by having impeccable timing. Unfortunately, the odds of having impeccable timing on a consistent basis are miniscule. This has everything to do with a massive expense ratio of 1.65%. If you were to invest in TVIX long term, you would be a guaranteed loser. Since its 2010 debut, TVIX has depreciated 99.97%. Over the past three years, it has depreciated 88.17%. It has also declined 77.92% over the past year and 49.28% year-to-date. (For more, see: Tracking Volatility: How the VIX Is Calculated.)
There are two other related ways to play volatility, the iPath S&P 500 VIX ST Futures (VXX) ETN and ProShares Ultra VIX Short-Term Futures (UVXY) exchange traded fund (ETF). However, they’re not ideal either, with expense ratios of 0.89% and 0.95%, respectively. Fortunately, there are bearish ETFs with lower expense ratios available (volatility and shorting the market are essentially the same thing). That said, moving to cash is also a good idea. If you think stocks will falter, then you will have a great opportunity to wait for steep discounts. (For more, see: How to Day Trade Volatility ETFs.)
The Bottom Line
It’s possible that you catch lightning in a bottle and make 100% in a week by going long on TVIX, but the odds of initiating a position at the ideal time and selling at the ideal time are low. If you choose to initiate a position in TVIX, you’re playing a very dangerous game.
Dan Moskowitz does not have any positions in TVIX, VXX or UVXY.