|Dear Investors, Partners, and Friends,|
As expected, the competing economic outlook optimism and its opposing concern over the forward interest rate guidance from the Federal Reserve heavily influenced stock markets in August. After a strong rally to begin the month that resulted in the S&P 500 Index (“S&P”) climbing 4.8% in two weeks, the rally lost its momentum and steadily declined -8.3% to end August with a loss of -4.2%. At the end of the month, the Federal Reserve (“Fed”) gathered at the Jackson Hole Symposium, where they reiterated their intention to take aggressive measures to tame inflation. This hawkish rhetoric sent stocks lower and set the stage for continued market pessimism.
While the first half of August provided few opportunities for the ratio put spreads held by the Directional Spread Strategy to become profitable, a few similar trades near the end of the month more than offset those costs and resulted in a net gain. The strong recovery of almost 19% from mid-June resulted in what we believed to be a significantly overbought stock market. To capitalize on this condition, we continued to hold low-cost ratio put spreads, anticipating a market reversal. When it materialized in the second half of August, we were able to take advantage of the decline and realize gains for the program.
Similarly, in previous months in 2022, the realized volatility in the stock market in August turned out to be greater than the expected volatility. This characteristic reduces the opportunity set for many trades we often use in the Tactical Strategy, but we were able to record a small net gain. While we anticipate this unique volatility environment to abate, we are keenly aware of its ability to turn without notice, possibly on one innocuous headline, and therefore have opted to trade conservatively until we see potential rewards that exceed current market risks.
If it turns out that the Fed is actually resolute in its goal to quash inflation, as they have continually voiced, that will engender some second-order effects that market participants may not have fully discounted. Taming inflation will significantly slow the housing market, put downward pressure on commodity prices (barring further supply disruptions), and perhaps most impactful of all, weigh on broad equity prices. In fact, Fed President Neel Kashkari said that he was “happy” to see the stock market decline after the Fed’s hawkishness expressed at Jackson Hole. If inflation suppression is going to take precedence over stock market stability, then current valuations may need to be repriced lower. We expect volatility to reprice higher in that scenario, yielding an environment with increased trading opportunities.
The Volatility Capture component of the portfolio has been affected negatively by the environment expressed above. It seems as though, for the time being, the VIX will stay muted until the market either capitulates in a meaningful way or the lows of the year are taken out, and the market approaches pre-pandemic levels.
As always, thank you for supporting Le Mans Trading and entrusting us with your investment capital. If you would like to learn more or have any questions, please feel free to reach out via the contact information below.