One of the top performing CTAs that we follow during this crisis period has been Hoffman Asset Management, a traditional type of managed futures program with a long volatility, trend following profile. He was out with a letter to clients yesterday, and had an interesting view of the volatility spike as a technical breakout from a rather long term downtrend from the high levels of 2008.

View from outside Attain:

Trend following equity curves, for the most part, have broken out sharply to the upside. This is from a combination of trends such as being short the stock market, long gold, short crude oil, long bonds and long the Swiss franc.

As a market technician, I rarely put much weight into fundamentals (the news), but I do feel the recent and historic downgrading of United States Debt to an AA status from an AAA status is significant and could alter markets for some time by making them much more volatile.

With trend following a strategy that is “long volatility”, I believe the changes the debt downgrade brings about will be advantageous, for us trend followers.

While trend following tends to benefit during periods of higher volatility, it appears to me that something more involved is going on here.  One of the most popular volatility indices is the VIX, showing the underlying volatility in the S&P market.

The recent implosion in the S&P has sent the VIX shooting higher (which in general is good for long volatility), but what I’m more interested in seeing is that this move higher has caused it to break out of a long-term (multi-year) downtrend (see below).

And taking a look at managed futures in general over the last few years, it is clearly visible that in 2007 and 2008 when volatility was rising, so were managed futures; and when volatility went into a free fall during 2009 and 2010, returns were flat to negative. This can also be seen in the current environment, when we had the recent breakout in the VIX, the equity curve for the trend following systems also broke out. [past performance is not necessarily indicative of future results]

What I am getting at, is that I think there is a possibility that trend followers just put in a significant low and are getting ready for a multi-year rally.  If this is correct, then it would be highly likely that this is an excellent time to start trading any reliable trend following systems or CTAs.

An investor who agrees that rising uncertainty should lead to rising volatility should talk to their broker. They can discuss their best options for getting started trend following.

–          Dean Hoffman

Interesting take to be sure, saying not that things are crazy and managed futures is the place to be during crisis periods, but a more technical view that managed futures is long volatility, and there appears to be a breakout in volatility to higher levels.

Question is…. Where does volatility go from here? That is the million dollar question? Are we at mid 07, about to see 18 more months of high volatility; or are we at the end of 08, where volatility is about to drop drastically… (looks like we just came up with our next blog post – more on that later).