Stocks have been under pressure this week as the Dow shed more than 100 points Tuesday, but so far exchange traded funds that profit from higher market volatility aren’t signaling widespread investor fear.
However, investors have been shifting their sector preferences and this could be a more subtle indication of a change in mood.
The $1.4 billion iPath S&P 500 VIX Short-Term Futures ETN (NYSEArca: VXX) rose fractionally Tuesday. The exchange traded note, which tracks futures based on the CBOE Volatility Index or Wall Street’s fear gauge, was down 35.7% so far this year through Monday’s close, according to Morningstar.
Aside from a spike in March, VIX-futures products have trended lower this year, suggesting investors are growing more comfortable with the market.
“Our basic view is that while the U.S. market can continue higher, the gains are likely to be accompanied by more volatility than we witnessed during the first 4 months of 2011,” writes Russ Koesterich, a strategist in the iShares ETF business at BlackRock, in a recent blog.
“With the exception of the spike around the time of the Japanese earthquake, U.S. market volatility has been its lowest since 2007, with the VIX Index – which measures implied volatility on S&P 500 options – hitting a four year low of below 15 in April,” the strategist said.
Koesterich says volatility looks to set to heat up this summer, so he favors defensive sectors such as healthcare and cutting exposure to small-cap stocks.
Volatility is simply too low, he argues. “Over the past 20 years volatility on U.S. large cap stocks has averaged around 20% a year,” he wrote. “Given the current environment, which is characterized by the continuing unrest in the Middle East, the lingering US sovereign debt issues, and the lingering European sovereign debt issues, it is hard to justify below average volatility.”
Although the S&P 500 is about flat over the past month, the real story for U.S. stocks has been about sector rotation, says Nicholas Colas, ConvergEx Group chief market strategist.
“Investors have forsaken old favorites (silver ETFs and energy stocks, for example) and migrated to the unloved (healthcare), ignored (utilities) and boringly stable (consumer staples),” Colas wrote in a note to subscribers Tuesday. “The same dynamic has been working its way through the options market, repricing risk as market attention shifts.”
ProShares VIX Short-Term Futures (NYSEArca: VIXY)
