SG: VXX - Critical period ahead may bring heightened volatility‏

VXXUS• Critical Nov-Dec 2015 period

• Key decisions from Fed, ECB, BOJ ahead

Hedge portfolio with 5%-10% VXX position

Uncertainties during critical Nov-Dec 2015 period may foment volatility
We enter into a critical period in Nov-Dec 2015 with closely watched economic data and key central bank decisions from the Fed, the ECB and the BOJ. The Fed is deemed likely to hike rates for the first time in almost a decade; the ECB could ease monetary policy further, setting up divergence between the Eurozone and the US; and the BOJ may similarly ease further to support its economy. Incremental economic color from China will also be in focus as the market assesses the severity of its slowdown and impact on the global economy. While the US economy appears to be on sturdy footing after a strong Oct jobs report (271k versus 180k consensus), we believe that unabated uncertainties remain over the potential economic drag from a stronger dollar, uncertain global growth (with particular attention on the slowdown in China and emerging markets) and the impact of higher rates ahead. This overall backdrop is fertile soil for volatility in equities.

Quantitative model points to possibility of higher VIX ahead
Our quantitative analysis also highlights UST yield volatility and EM FX volatility to have significant relationships with the VIX, which measures the implied volatility of the S&P 500 Index. With the odds for the Dec rate hike still in flux and the fairly wide divergence between Fed and market expectations for the pace of rate increases ahead, we see some scope for UST yield volatility going forward. EM FX volatility may persist given a perfect storm of uncertain growth outlooks, falling oil prices, softening commodities demand and a strengthening dollar. Finally, heightened geopolitical uncertainties after the recent Paris terror attack could weigh on market sentiments over the near term.

Hedge equity portfolio over Nov-Dec 2015 with a 5%-10% position in VXX
We believe the iPath S&P 500 VIX Short-Term Futures ETN (VXX US) can effectively hedge against market volatility over a short-term horizon. The VXX is the most liquid ETN that offers exposure to 1st and 2nd month VIX futures contracts and has a 77.5% directional correlation YTD with the VIX. Our recommendation is that investors hedge their equity portfolios with a 5% - 10% position in the VXX over Nov-Dec 2015. We will establish the VXX position at US$22.50 or below, and will either close the position at US$28.00 or at the end of Dec 2015. (Read Report)

Source : OCBC Investment Research

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