A Major Warning From Tom McClellan : "Can This Possibly End Well?"

In one of his tweets yesterday, Tom McClellan, whose parents created the famous McClellan Oscillator and Summation index used by thousands of traders everywhere as a market timing tool, pointed out something disturbing: the number of shares outstanding of the VXX, the VIX tracking ETN, has soared exponentialy in recent weeks.


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As McClellan cautions: "VIX futures ETF extremely popular now. Can this possibly end well?"

So what does this mean: is the surge of investor interest into VXX a contrary indicator and suggesting that the rally will continue? Not quite - as McClellan adds this is a "double-contrary indicator" and references the following explanation given in mid-February when the market had bottomed and when the number of VXX shares outstanding had tumbled.

Here is McClellan's explanation from February 18 why "VXX Shares Outstanding Data Work Differently."

One of the more popular new market sentiment tools among technical analysts is to look at the changes in the number of shares outstanding in various ETFs and ETNs.  As traders get more bullish or bearish, they move into or out of these instruments, and that shows up as changes to the numbers of shares outstanding. 

Normally, a high number of shares outstanding shows intense investor interest, and thus a topping condition for prices of that ETF and its associated market index.  Similarly, low levels mean nobody likes that ETF, and thus it is likely a bottom for that ETF’s price and thus for the market.

But this principle works differently in VIX-related ETNs like VXX and XIV.  VXX is designed to track the VIX positively by owning VIX futures, although it has big problems over time with slippage due to the roll from one futures contract to the next.  XIV is an inverse-VIX ETN, again by using VIX futures, so its share price goes up as VIX futures fall (or down as the VIX rises).

If VXX worked like other ETFs, then as the SP500 falls and the VIX rises, more investors would chase after it and drive up the total number of shares outstanding in VXX.  But instead we see the opposite behavior in the chart above.  Right now, VXX shares outstanding are at one of the lowest readings of the past couple of years [ZH: this was written on February 18], and such low readings are reliably associated with meaningful price bottoms for the SP500.  So rather than seeing the “hot money” piling into VXX as the VIX rises, its shares outstanding data acts more like a depiction of the “smart money”.


By the same token, XIV’s share price has fallen in 2016 as the VIX has risen, and investors have responded by pouring more money into XIV and thus driving up is number of shares outstanding:

I do not have an explanation for precisely why these ETNs work differently in how their shares outstanding data behave versus the behavior of SPY or QQQ shares outstanding.  But even if we cannot explain a phenomenon, that should not stop us from noticing that it does work differently.  And when we see it working reliably for long enough, the quest for “why” fades in importance.

Users of eSignal and QCharts (Interactive Data Corp.) can track these data under the symbols $VXX.SO and $XIV.SO.  The data on shares outstanding for many other ETFs are also available using the same symbol convention.  Other data vendors may also have it, so check with your own data company.

Right now, both VXX and XIV shares outstanding data are showing us that there should be some more upward movement for the stock market before we get the next downturn toward the April low.

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McClellan wrote the above just over two months ago, when he accurately bottom-ticked the market. He is now out with the opposite warning, and suggesting that the record number of VXX shares outstanding is an indicator that the top, at least according to this technical indicator, is now in and a sharp drop may follow.