February 2020

Special Report

The U.S. stock market is extremely volatile once again today and is being driven by fear levels rarely seen. Today's high on the Volatility Index ($VIX) nearly reached 50 and the day's not over, so we could see further fear into the close. That's been the pattern the past several trading sessions - closing at or near the lows of the day. I'd feel much better about trusting a short-term reversal with two signals in place:

(1) A simultaneous move higher in the 10 year treasury yield ($TNX)

(2) An afternoon stock market rally into the close rather than the morning rallies that have fizzled later in the day

For a visual, check this out:

To really support an equity move higher, it would be best to see money rotate out of treasuries, sending the TNX higher. Thus far, that's not happening. The TNX is down another 13 basis points today to an all-time low of 1.16%. My interpretation: The bond market is screaming for a Fed rate cut to help ease the economic impact of the coronavirus. The Fed will absolutely cut rates again. They should do it before their next meeting. In fact, if their March 17-18 meeting does not result in a rate cut, I believe that will start another leg down, right at that 19th to 25th period that we just suffered through. A cut now could help fuel a rebound. Perhaps we'll get one Monday morning. A rally this afternoon, followed by a rate cut on Monday morning could result in the biggest manipulation of our financial markets since the financial crisis.

From a trading perspective, I don't like to be active in a market like this because we can't trust any move - higher or lower - from one minute to the next. Trading in this environment really is gambling. For longer-term money, investing a portion with the Volatility Index ($VIX) near 50 makes perfect sense. Building a trading position isn't a bad idea either, just realize that if you're a day or two off from a bottom, it can get extremely painful. So, in other words, you have to be prepared for the back-and-forth whipsaw action.

As a reminder, here is what has happened in the past when we've seen VIX readings hit or approach 50:

This is a 30 year weekly chart. You can see that VIX readings at 50 or above are extremely rare. Fear like this tends to mark very important price bottoms. Given the high VIX, I decided to begin to put some retirement capital back to work in the SPY and QQQ, two ETFs that track the S&P 500 ($SPX) and NASDAQ 100 ($NDX), respectively. In January 2018, we saw a high VIX level and temporarily bottomed. Later in 2019, we found fresh new lows, so new lows ahead are absolutely a possibility. And just because the market's history tends to do one thing doesn't mean it'll do it this time.

There are a lot of variables with the coronavirus that health experts cannot predict nor explain, so I'm certainly in no position to do so. Historically, however, the stock market tends to deep discount these fearful events, which is why - in my opinion, that bottoms tend to be marked. Everyone must make their own financial decisions, but I do agree with Warren Buffett, who has said on many occasions "buy when everyone is fearful and sell when everyone is greedy".

The current level of the VIX definitely qualifies as fearful.

Happy trading!

Tom