Just before I had a chance to take a position on ProShares Ultra VIX Short-Term Futures ETF (UVXY) for the second time, President Donald Trump announced a 90-day pause on additional tariffs, and the market flirted with euphoria for a day. The president then went on to announce exemptions for various consumer electronics from the U.S. tariffs on China. However, the arguments made in my second thesis, and my first, which gained 34% in just a few days, are still valid. I expect to redeploy the UVXY and adding on to that, the 2x Long VIX Futures ETF (UVIX), as a riposte to the current disruptive phase of radical uncertainty. This will happen when I think it is, basically, a no brainer. Till then, I thought I would go over my thinking.
UVIX and UVXY Overview
Both the UVIX and UVXY offer leveraged exposure to VIX futures. While UVXY generally aims for 1.5× daily performance of short-term VIX futures, UVIX targets a higher multiple. These instruments are designed to profit in a volatility spike; however, their daily rebalancing and contango roll costs usually induce a decay when held in a low-volatility or mean-reverting environment. In a regime of high and sustained volatility, these products can track, and even magnify, the downward volatility surge. This is a key empirical observation behind using volatility ETFs as tactical tools during periods of systemic stress.
A feature of capitalism is inherent in its name: the accumulation of capital, which has the effect of reducing the cost of capital. For example, a paper by the Bank of England found that in the last eight centuries, interest rates have been heading toward zero. With this comes an easing of volatility. Today’s investor is far more protected against the slings and arrows of outrageous fortune than a merchant sending ships out to trade a millennium ago. What this means is that instruments like the UVIX and UVXY do not tend, in the modern world, to be good buy-and-hold instruments. As capital accumulates, it demands to be invested, and that bids up the price of assets. The S&P 500 will never fall to the price it was in 1871 or even 2000. So, if you held the UVIX or UVXY from their inception in 2022 and 2011, respectively, to date, one would have lost all one’s money.
In an age of radical uncertainty, time is accelerated. This has profound implications for investors: one of the features of risk is that wealth, in the long run, tends toward its own destruction. Under uncertainty, wealth destruction happens much faster, and downside volatility is more pronounced. In the long run, investing in stocks -or more correctly, in stock market indices-, is by far the best investment that anyone can make, but there are periods in history where stocks underperform other assets.
There have been periods in which betting on the downside has proven profitable. The CBOE Volatility Index’ (^VIX) best periods have been the current moment, during the Covid-19 stock market crash and the Great Recession of 2008. There is no data pre-1990, but I imagine that the crash of 1987 and the Great Depression would be other analogies. In these periods, volatility indices or products based on VIX futures surged while broad equity indices suffered significant declines. In the last year, the UVXY has gained 21.9% compared to just over 2% for the SPDR S&P 500 ETF (SPY). That is not supposed to happen. According to Fidelity,
There is wide variation for how long volatility tends to last, but one thing’s for sure: Volatility is common. Since 1980, the S&P 500 has experienced a drop of 5% or more in 93% of calendar years. Despite those frequent declines, the market’s average calendar-year return over the same period has been more than 13%.
There have been many bouts of volatility that haven’t led to steep declines, though at times it has. Research shows corrections (generally considered a decline of 10% from recent highs) have lasted an average of 115 days and bear markets (at least a 20% decline) have lasted a median of 19 months.
The UVXY is designed for short-term, tactical attacks on the stock market; it is not supposed to be a buy-and-hold instrument, and certainly not the sort of thing one holds for an entire year. In the year-to-date (YTD), the UVXY is up 101.7%, and the UVIX is up 106%, while the SPY is down 10.5%. I do not know of a single investor who can match those numbers. My contention is that, in an age of uncertainty, the stock market has become dangerous.
The Market Expects Relative Calm
The S&P 500’s 30-day implied volatility (30-day) is currently 0.3522, compared to a historical volatility for the same period of 0.4922. This gulf has been present for some time and illustrates that the market’s current options pricing is forecasting that future volatility over the next 30 days will be lower than what was realized over the past 30 days. Implied volatility is derived from option prices and reflects the market’s consensus of how volatile the S&P 500 will be in the future. An implied volatility of 0.3522 suggests that, based on current option premiums, market participants expect the asset’s returns to fluctuate at an annualized rate of about 35.22% over the next month. Historical Volatility is calculated from past price data, and shows what the asset’s volatility has been recently. A historical volatility of 0.4922 indicates that over the past month, the asset’s returns have fluctuated at an annualized rate of roughly 49.22%. In essence, the market is priced for greater calm and views the high historical volatility as an anomaly or as the consequence of short-term factors that are not expected to persist.
The market value of the S&P 500 is not an objective fact that market participants merely react to, it is shaped by market participants and their views in what George Soros referred to as “reflexivity”, in his book, “The Alchemy of Finance”. Despite their brief flirtation with euphoria, the Keynesian “animal spirits” are perceiving an increasingly unattractive U.S. stock market, and even U.S. Treasuries have suffered. In this market, the U.S.’s Magnificent Seven have been outperformed by China’s Seven Titans. Having underestimated market risks for so long, investors have still to grapple with the risks inherent in the U.S. stock market, as seen by their day of euphoria. A hidden vulnerability is now becoming visible, making instruments such as the UVIX and UVXY attractive for hedging or speculative gain. Investor sentiment is bearish, and this will shape markets. Euphoric highs need euphoric sentiments and sentiments right now are pessimistic. The AAII Investor Sentiment finds that this week, 58.9% of investors are bearish. In the year ending April 2, 2025, bearish investor sentiment infected 61.9% of investors surveyed. It is noteworthy that the last bullish high was in the year ended July 17, 2024 and that the historic average for bearish sentiment is 31%. BlackRock, the world’s largest asset manager, has already started reporting a slow-down of inflows, as a consequence of growing investor pessimism. This can be seen with how quickly the market’s euphoric response to the president’s announcement of 90-day pause to additional tariffs faded. One of the oddities of that response is that stocks that are clearly harmed by tariffs on China -which are now effectively 145%-, went up by over 10%, with the Magnificent Seven tech stocks regaining $1.8 trillion in market value, a one-day record in which NVIDIA (NVDA) rose 19%, Tesla (TSL) shot up 23%, and Apple (AAPL), and Meta Platforms (META) –whom I have written about– added 15%. This was before the president announced his carve-out for consumer electronics. Not only did the then-current tariff position leave the Magnificent Seven weaker, it also compelled a downward re-rating of the S&P 500. The day after that euphoric response, markets slumped, and the UVXY and UVIX once again triumphed.
In uncertain environments, investor sentiment can swing widely. I abandoned my attempt to enter this position for a second time because I believed that the losses would be huge. I think the UVXY was down around 36%, which would have meant I would need a 55% bounce to get back to where I started. However, I could have entered it regardless, because in an environment of wildly changing investor sentiment, it is easy to make up such losses, as latent overconfidence gives way to panic or massive downward re-pricing. Regime uncertainty will cause extreme movements in volatility, again justifying a bet on VIX-linked instruments.
Causes for Sustained Downward Volatility
The Aggregate Investor is Overinvested in Stocks
In some ways, this period of intense downward volatility was predictable. Even without tariffs, portfolio allocation was already too heavily tilted toward stocks. An era of prolonged wealth accumulation and stability led to progressively riskier portfolio allocations until the U.S. aggregate investor reached historic levels of equities-allocation. If the previous period of low-volatility and easy wealth accumulation has led to a widespread underestimation of risk, a “Minsky moment” of sorts is plausible, leading to a sudden surge in volatility. In the first and second theses, I pointed out that, using a measure I call, “equity preference”, as of the end of Q4 2024, the aggregate investor’s portfolio was 52.18% allocated to stocks, the highest level since the Fed started collecting the component data in Q4 1945. If equity preference refers to the demand for future 10-year returns, and those returns are relatively inelastic, then, as equity preference rises, the price of those future returns rises, even as their supply declines. A regression analysis I did last year, pre-Q4 2024, when equity preference rose slightly, pointed to 10-year returns of around 1% a year. So even before the new tariffs were put in place, investors had rational reasons to exit the S&P 500. An equity reference of around 45% is probably needed to allow investors to gain 5% plus returns per year over the next decade. That means an enormous exit of capital, and a fall in the price of stocks.
Regime Uncertainty
We are in a revolutionary moment that suggests that a prolonged bout of elevated downward volatility may be emerging due to systemic pressures, accumulated risk, and macroeconomic imbalances. Perhaps controversially, in the second thesis on UVXY, I argued that, regardless of one’s opinion on tariffs, the Trump Admin. has powerful motives for supporting them:
- The China Shock has gutted the manufacturing industries of countries across the world, such that, despite the broad wealth created, working class people have been left behind, stoking populist outrage. Such a system is unsustainable.
- In a military contest with China, the economic benefits of a global division of labour pale beside the risks of relying on a trade partner that builds the things that America will need to wage war.
- From the perspective of economic competition, the current division of labour is not static, and China can use it to achieve parity with the U.S. in those areas in which the U.S. is currently a world leader. BYD’s stunning success is an example of this.
I stressed that it really does not matter if one agrees with the administration’s motives, just that they are powerful enough that one should not expect tariffs to end completely. At a minimum, tariffs on China are likely to stay, even under a Democratic administration, all that is to be decided is the size of those tariffs. The Magnificent Seven, the most profitable businesses in human history, are a third of the S&P 500. Tariffs will erode their profitability and force investors to look elsewhere for investments, and that “elsewhere” will not benefit from the same premiums-to-value that the Magnificent Seven does, and that implies a downward revision in the price of the S&P 500.
There was another obvious wrinkle:
There are two tiers of tariffs, with 30 countries having special tariffs, and the rest of the world having a flat 10% tariff, while Canada and Mexico can be said to belong to a third tier whose tariffs were negotiated earlier. Although the U.S. successfully used tariffs to force reforms in Japan in the 1980s and 1990s, tariffing the globe presents obvious problems. First, trade negotiations take time, they are not something that can be finished in a few weeks or a month. The Peterson Institute for Economics found that the U.S. takes an average of one and a half years to negotiate and sign a bilateral trade deal, and three and a half years to get to the implementation stage. Jordan has been the quickest off the mark, taking four months to get a free trade deal with the U.S. and eighteen months to get to the implementation stage, while the free trade deal with Panama took thirty-eight months to negotiate and one hundred and two to get to the negotiating stage. Negotiating thirty to nearly two hundred trade deals within a one-to-two year window, especially with a government reduced in size, seems very challenging to me. Key trade partners such as Japan may be given priority, but this would still leave many countries without a trade deal or even the beginnings of a negotiation, for some time.
Trade wars similarly take time, and this is important with regards to China. To get a base rate for how long trade wars take, I used a list of important trade wars from Wikipedia’s page on the subject. In the pre-modern era, the average length was 222 years, with a sample size of just 5. In the twentieth century, the average length was 19.7 years, with a sample size of just 7. In the 21st century, the average length is 12.6 years, with a sample size of 23. The current U.S.-China trade war has been going on since 2018, without meaningful resolution. When I looked at trade wars from the post-Second World War era involving more than five countries, I found the Chicken Wars in the 60s, which lasted 6 years, the beef hormone controversy which lasted 19 years, the Tuna-Dolphin case that lasted 50 years and the Trump-era trade wars that have been going on for 7 years. Simply, trade wars seldom fade out very quickly, largely because negotiations are protracted and each side sees it as being of such strategic importance to win that a collapse of one counterparty to the other’s terms is highly unlikely.
Consequently, the best case scenario is that definitive trade deals will only emerge within the next two years and that whatever is agreed now will be provisional and therefore changeable.
What this means is that there will be no substantive trade deals within 90-days. Like the TikTok deal, these trade deals will require an extension. Tariffs alone destroy both demand and supply, and the resulting attenuated regime uncertainty is an additional cost of doing business, a dis-incentive to invest that will hurt the stock market and the broader economy. I think those in favour of tariffs and those opposed to them are both united in accepting that there will be pain on the road to the final outcome. Regime uncertainty is an idea developed by Robert Higgs to understand how economic agents respond to profound changes in the economic regime, and his work found that investors adopt a “wait and see” approach, lest the rules of the game change again. The only way the president can quicken the pace is by dropping blanket tariffs and substituting them with more focused sector/product tariffs, but even doing that will likely take at least six months to a year, and with 75 or so trade deals to negotiate, it is likely that the U.S. will make mistakes that compel them to demand a renegotiation of some terms. The Wall Street Journal (WSJ) makes a similar point, explaining that the Trump Administration is racing to strike ad hoc trade deals with over 70 countries, while warning that any agreements are “likely to fall short of the kind of fully-fledged trade pacts that traditionally shape global trade.” The WSJ goes on to say that,
Traditional free-trade agreements typically take several years to negotiate. Narrower deals covering specific industries that Trump reached with nations such as China, Japan and Korea in his first term took several months. The White House now needs to speed-run negotiations much faster and with dozens of nations at the same time—something that is worrying lawmakers on Capitol Hill who are eager to see deals reached that can avoid the tariff-induced stock selloff of the past week.
The deals aren’t likely to be fully developed free-trade agreements, which typically need to be passed by Congress. Instead, Sen. Bill Hagerty (R., Tenn.), Trump’s first-term ambassador to Japan, said the administration might settle for written commitments from foreign governments to make certain economic reforms, akin to a term sheet that precedes an investment or business deal. That perspective was backed up by a foreign-government official in contact with the U.S.
Sen. Bill Hagerty (R., Tenn.), who served as Trump’s first-term ambassador to Japan, believes, at least according to the WSJ, that these 90 days will only result in the parameters of a deal. National Economic Council Chairman Kevin Hassett added that countries would need to offer “some kind of extraordinary deal to go below” the 10% base tariff. tariffs are here to stay.
The combination of the government’s need for tariffs to compete with China and other hostile actors, and to reform the system, and the pressure to do this by the mid-terms, is such that, although the president faces market pressure, he also faces a pressure to deliver. Research shows that, whatever the public believes about politicians, politicians tend to try and do what they campaigned on. The revolution is not over.