Warnings From Fed Funds, VIX Futures

It always strikes me that when markets are at a crossroads we start reaching for expert opinions. We hate uncertainty, which creates doubt and usually the wrong decision. For so many of us being long the market has been the right decision --yet the game has to turn at some point, right? And who wants to be left holding the bag when everyone else has cleaned house? How do we get out of the way, and when will we know it?

That, of course is a market timing bet -- and as a stock picker I abhor trying to time the market. My batting average trying to time a top or bottom years ago was abysmal, and I soon realized it was just a loser's game. My advice is: stay away from the prognostication game and stick with stock picking in the right environment. The market tells us when it's time.

We have been in a great spot for picking stocks over the last few years. Correlations are low, which makes selection the utmost importance. The charts/technicals are my guide here; they tell me more about the market than a pundit's comment on TV. With a leap of faith you can decipher the meaning of market moves and project the next timeframe for price based on patterns, trends and behavior.

So, as it relates to market information I will focus on two structures we have talked about before: fed funds Futures and VIX Futures. These tools may help explain the market behavior and further give us some insight of what we can expect down the road.

Much of the discussion this past week centered on the Fed and some speeches, namely the one Friday by Chair Janet Yellen. While most were trying to glean some clues from her comments, the fed funds Futures moved modestly into the hawkish camp.  

Regardless of the rhetoric applied by Yellen or other Fed governors, the markets are telling us what the situation is. The futures market is seeing the potential NOW for small, incremental rate hikes.

The Sept/Oct future is now 100% priced for a 10bps rate hike, Jan 2016 for a second 10bps move.  Beyond that we see acceleration into 2016, and a full 50bps priced in by May next year. I suspect the market is reacting to the Chair's notion of a strong economy and better employment data to come.  As always, the market looks ahead.

As for the VIX futures, we see the market is complacent about risk. With a 12% volatility reading, there is little worry about market rumbles in the short term, and with futures priced accordingly the term structure is in bullish form.

The normal contango condition exists in the term structure of the futures, so the expectation is for future volatility to be higher. Yet, bets on future volatility have rarely paid off, except for short instances.

S&P 500 ¿ Daily

View Chart »View in New Window »

As the S&P 500 is up 2% for the month (through May 22) and other indices are up solidly too, there are some red flags in place. Complacency is high and the markets are ripe for some selling, which can be painful in the short term. 

Current conditions are dangerous if you are not carrying some protection. It could be helpful if the sellers get active.