Warnings signs from iPath S&P 500 VIX Short Term Futures TM ETN (NYSEARCA:VXX)

The Markets are starting to break down technically, monetary policy is not what is was during the 2013 rally, a slight hangover from the injections still exists, and the macroeconomic environment is awful.  This combination has the VIX in play again.

When I look at the VIX I focus on iPath S&P 500 VIX Short Term Futures TM ETN (NYSEARCA:VXX), which is the double long ETF combining the front and second month VIX contracts.  Before I continue with this discussion please understand that this is one of the most heavily manipulated ETFs on the street, it has significant deterioration as a result, and although this ETF can increase extremely fast, given that deterioration and the fact that the market has moved higher steadily since the beginning of 2013 this has also been a much better play on the short side after spikes like this.

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The important point in the paragraph above is to differentiate the conditions that exist today from those that existed in 2013; we have a different monetary policy today than we did back then.  The real net stimulus that existed in 2013 was $20,000,000,000 after offsetting the operations of the U.S. treasury department.  However, with that same observation in mind, the 2014 net real stimulus, currently, is well into negative territory.  That means the combined efforts of the U.S. treasury department and Federal Reserve are now draining liquidity from the Financial System.

This economic environment is not like what it was back then for more than one reason, and the second comes from our macroeconomic work, The Investment Rate.  The Investment Rate tells us that the natural state of our economy is much weaker than what it currently seems to be.  The only reason the economy is where it is today is because of the stimulus efforts of the Federal Reserve, but in order for the economy to continue these levels those stimulus dollars will need to continue to flow and net real stimulus will need to be positive, but that's not the cases currently.

As a result, the thesis I have presented to all of my clients is that without positive net real stimulus the economy will eventually revert to its naturalized state, which, as defined by The Investment Rate, is materially weaker than today.  If that happens, we would expect significant declines in the stock market, but the identification of those declines rests more on the price levels of the stock market than on our overall macroeconomic evaluation.  Given the breaks that have occurred in the Russell 2000, NASDAQ, and this week in the Dow Jones industrial average, however, the technicals are supporting this thesis. 

Given that observation I have already provided clients ways of protecting their longer term assets from substantial market decline, I have given some of them tools to do it themselves, and I have given others a means of having it done for them, but in every way I have presented clients with a thesis and a plan to not only protect assets but also possibly take advantage of market declines. 

Coming back to our discussion about the VIX, if I am right about my observations VXX is going to skyrocket, but I have not recommended this and I do not intend on recommending this to clients because of its deterioration risk.  But the if my observations suggest that the technical up channels in the markets we follow our breaking, those upward sloping channels that began in the early part of 2013, and notwithstanding my macro economic analysis the technicals alone suggest that a material breakdown to market levels that existed in early 2013 are likely.  That should send the VIX and VXX through the roof, but be warned that this measure of fear, volatility, and risk is itself extremely volatile and should only be approached by seasoned investors.

Additionally, if my macroeconomic analysis, The Investment Rate, is also correct the market is likely to fall much further than the technicals already suggest.

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