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Why the VIX says it’s time to buy, not sell!

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If you’re like many investors who have seen US stocks fall precipitously over the past two weeks, you might be feeling a little bad. At one point, the S&P 500 was down more than 10% from its all-time high. The Nasdaq 100 fell more than 14%. The Russell 2000 almost hit 20%. It’s uncomfortable to watch, that’s for sure.

We have been spoiled in 2021, however. A single 5% year-to-date decline and even that ended in a matter of weeks? It’s not normal. What is happening now is normal. Maybe not the sharpness of the decline, but stocks down 10%, 20%, or even more is not unusual. This is normal when it comes to investing in risky assets. It’s by no means fun to experience, but it’s not unusual.

In fact, you may have just seized an opportunity.

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In 2020, I co-authored a research paper with Michael Gayed of the Lead-Lag Report in which we looked at using the VIX as a buy/sell signal to see if and at what levels it could allow investors generate above-average returns over time. . The answer is yes, and the paper won the NAAIM Founders Award that year for outstanding investment research.

The concept behind the paper is a variation on the traditional idea of ​​buy low/sell high. The VIX tends to spike during market declines and stay low during quiet and bullish market periods. Our theory was that if you invest when the VIX is skyrocketing, you are essentially buying low. If you hold and only sell when the VIX crosses a certain floor, you will sell high.

Research has proven this theory to be true (at least historically). You can see in the table below the 500 trading day forward yields by sector based on the VIX level at that time.

The trend here is pretty clear. The higher the VIX when you invest, the higher the prospective returns have been. The best returns, unsurprisingly, come from the cyclical and growth sectors. The reverse is also true. Some of the lowest forward returns came when markets were quieter. That’s not to say an old-fashioned buying strategy is a bad idea, but there are opportunities to exploit the markets if you’re willing to swim against the tide and be a buyer when the herd swells. probably sell.

So what is the ideal VIX level to start buying? Our research has indicated that optimal returns (again, at least historically) have been achieved when the VIX breaks above 33. On the other hand, it’s time to sell if the VIX breaks below 12 .

I’m pointing this out because the VIX just topped the 33 mark for only the second time in the last year.

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You can see that opportunities to invest when the VIX is above 33 are rare, but we are at one right now. As you can see, just because the VIX goes above 33 doesn’t mean it can’t go higher. This isn’t necessarily an indication of a bottom either, but it does put you in a much better position to capture above average gains going forward. It takes a bit of a strong stomach and a willingness to zig-zag when most other investors zig-zag. You’ll be somewhat of an outsider in your thinking, but research has shown you could be the winner in the end.

A few quick thoughts on the market right now…

Markets had been swinging from growth to value for several weeks as interest rates rose in anticipation of the Fed hike later this year. Now it looks more like a pure sale. Large caps are down about 7% since the start of last week. Small caps fared worse, as did technology and high-beta stocks. All defensive asset classes – utilities, consumer staples, Treasuries and gold – either outperformed or generated gains.

The reason for this, in my view, is the fear that the Fed will aggressively hike at precisely the wrong time and push the US economy back into recession. GDP growth estimates for 2022 are already revised downwards. Inflation is at or near its peak. The Fed’s tightening of monetary policy conditions at a time when the economy is maturing and slowing is the opposite of what you would like to see happen.

The biggest tell-tale could be the yields of TIPS. The Fed has bought almost the entire TIPS market over the past year and a half, so it may not be the most independent indicator, but it does show equilibrium rates, or expectations regarding future inflation rates, are falling. Markets are starting to price in less inflation concerns and giving more weight to the idea of ​​mounting deflationary pressures.

The Fed’s meeting this week could provide some insight into the central bank’s latest thinking given the market’s reaction in recent weeks to the idea of ​​excessive tightening. In the past, the Fed has looked to changes in financial markets. Let’s see if they can stick to their warmongering rhetoric this time around.

That being said, let’s look at the markets and some ETFs.

ETF Focus Report Master - SECTOR TECHNICAL REPORT-11-page-001

Unsurprisingly, there are weaknesses almost everywhere. The energy sector is the only sector showing some semblance of near-term relative strength, but even that is beginning to falter. Utilities and consumer staples are predictably outperforming in a broad market decline, but even this pair is in a firm downtrend.

More importantly, especially if you’re a signal trader, is the fact that the S&P 500 closed below its 200-day moving average for the first time in a year and a half. The Nasdaq, Russell 2000 and 8 of the major GICS sectors are also trading below theirs. In my view, sentiment is about as negative as it has been since the worst of the COVID recession. Does that mean it’s a background? It’s hard to say, but it wouldn’t be surprising to see stocks bounce back a bit here. Monday’s trading saw a strong rebound from the midday lows, so there may be some bargain seekers here looking to get back. With volatility high right now, the range of possible outcomes this week is wide.

ETF Focus Report Master - Sector Perf_Flows Report-10-page-001

Technology is just a huge sea of ​​red on every level. Every subsector has lost at least 10% year-to-date, with more than half down at least 14%. Even investor favorites such as semiconductors and blockchain stocks weren’t immune to the damage. Tech ETFs have seen more than $1 billion in outflows in the past week. That may seem like a lot, but it still represents less than 1% of the total assets of these funds.

Its growth peers did not perform much better. Almost all of the subgroups here are also in oversold territory, which could support the idea of ​​a rebound from these levels. Telecom stocks are also in oversold territory, but they haven’t performed as badly as the sector’s Netflixs. Names, such as Verizon and AT&T, provide some support here, but it’s mostly rouge across the board.

Staples has been the best performing sector over the past few weeks and is starting to see entries follow after the 8% gain over the past three months.

ETF Focus Report Master - Sector Perf_Flows Report-10-page-002

Energy remains the one sector with perhaps the best near-term relative strength, but even that has begun to falter. This has only matched the performance of the market over the past week and a half, but this could also be seen as a good thing since this group has often been a big loser during these types of market corrections. Financial and energy ETFs have attracted large investors over the past month at the expense of technology and growth ETFs.

The materials sector is holding up relatively well here thanks to recent strength in precious metal miners. Gold, in particular, has shown little ability to generate any positive momentum, even though inflation is high and equity sentiment is terrible. Gold and silver miners behave somewhat like a game of safety, but it’s hard to see that sticking around for too long unless the gold itself makes a bigger move.

ETF Focus Report Master - Sector Perf_Flows Report-10-page-003

Healthcare and real estate still look weak despite the outperformance of consumer staples and utilities. Health care, in particular, has bounced all over the place and is struggling to develop any kind of narrative. The “more technological” side of health care – equipment, biotechnology and genomics – continues to show significant weaknesses.

The commodity story, as it has for some time, revolves around crude oil and metals. Oil continues to rise in anticipation of stronger demand later this year, and while more people are talking about a $100 a barrel price coming, I just don’t see it. I think energy stocks can still be a market leader here, but I think a break from the recent rally is more likely in the near term.

Precious and industrial metals performed well here. Timber prices have come down significantly in the last week, but I don’t know if it’s still the start of a downtrend. The dollar finally seems to be regaining some balance after its recent pullback.

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