Are You Sure You Want Crisis Alpha?

In the first couple of hours of Monday equity trading stocks sold off by a decent bit, likely as a reaction to attack on the Gaza Strip. The drop might have been knee-jerk in the face of uncertainty. I certainly do not know what comes next but the fact that stocks closed green on Monday is far from unprecedented. My first exposure to this was MLK Day 1991 when we started bombing Iraq. Stocks had been selling down starting a few months earlier when Iraq first dusted up with Kuwait and the sense that the US would attack "had" to mean stocks would go down more. Of course they didn't. That's a good lesson maybe not to buy an attack but at least don't sell one but I wanted to make a different point in this post.

That first hour or two gave us a useful microcosm of how Crisis Alpha works. I've been building this into portfolios since long before I ever heard that term. The easiest example to point to might be owning gold which I did  for a very long time until last year. It tends to go up when things go bad in the world. Sure enough, the SPDR Gold Shares opened higher by about a buck and a half on Monday, not a big move, but still stocks were down and it was up. 

You might expect defense stocks to bounce on this sort of news and they did. The iShares Aerospace & Defense ETF (ITA) opened 3% higher and drifted up from there. There were some fertilizer stocks that bounced too. Bloomberg cited "concerns over how the conflict could impact global supplies of nutrients used to grow crucial food crops."

Of course various inverse, both actual and should be, worked in that first hour of the day. The Cambria Tail Risk ETF popped by one percent. Unfortunately the Alpha Architect Tail Risk ETF (CAOS) that we've looked at a couple of times recently didn't have an accurate print until much later in the day but when it did have what looked like a real print (my interpretation) the gain was very small, smaller than I would have hoped for if I owned it. 

If you use narrow exposures, industry or sector ETFs and individual stocks, did any of them open higher in the face of the initial decline? If you had any that opened higher, why did they do so? I hold communications hardware stock for clients that jumped a bunch at the open. It's never been much a crisis alpha stock. Maybe there would be increased demand for their equipment in a protracted war but it didn't get that sort of lift when Russia first went into Ukraine. Sometimes stocks go up for no reason at all which I think is the case with this one. 

Another name though that has had crisis alpha attributes before is CBOE Holdings (CBOE). I've long been a believer in owning publicly traded exchanges, I've had CBOE for going on ten years. The reason I think it has crisis alpha attributes is that when bad things happen, the VIX usually jumps like it did this morning. VIX products trade on the CBOE. I do not believe this is an iron clad effect with the name but I've seen it happen quite a few times over the years I've held it. CBOE actually has a pretty low correlation to the S&P 500. Portfoliovisualizer has it at 0.35.

The yellow circles show examples of where the low correlation helped and times that it didn't. Even if you don't think there's any crisis alpha in the name, humor me for a minute. You can tell from the chart there have been long periods where it has underperformed. This is an important observation. At times it is a tough hold. You could think of it as having taken a very different path to a similar result as the S&P 500. If I had written this post three months ago, that last sentence would have said very different path to the exact same result.

I frequently say "if everything in a portfolio goes up together, then it is all likely to go down together too." There have been plenty of rallies that CBOE has sat out and some of the other more direct crisis hedges never participate when the market goes up. Portfolio construction of this nature, which I believe in wholeheartedly, requires patience. When I say something like "if gold is your best performer then chances are things in the rest of the world aren't going so well" I am talking about the patience to hold onto diversifiers as the market goes higher which is does most of the time. That obviously only applies to people who believe in this concept as I do because as Mark Yusko says, risk happens fast like it did over the weekend.   

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