Markets, Volatility (VIX) and Credit Spreads

By Jeff Kelly on January 28, 2022

A nice move in the markets today however volatility continues. If we agree markets advance over time, the natural question is when does a decline become a buying opportunity. Traders can pick points to buy or sell in any market environment. For longer term investors one guide to use is the Volatility Index, VIX.

When the VIX is below 20 the broad markets are investable. You can buy and hold with some confidence. You may see spikes during these periods to 30, but they will likely be episodic and not trending.

Markets where the VIX stays between 20 and 30 are choppy and difficult. We may see this market stay in this range until the fall of 2022.

Markets where the VIX moves above 30 are very volatile and filled with emotion. These are markets where we question if long term investing has any value. It’s also the place where the worst decisions (emotional selling) can be made. These are areas where good longer-term investments can be made if there is discipline and a plan. If we look back at March of 2020, we observe the VIX traded as high as 80!

The chart above goes back over 20 years. When the VIX has traded above 40 it has proven, over time, to be a good spot to be a buyer. This pertains only to the major large cap Indexes, not any individual stocks. We came very close to 40 on Monday of this week. The VIX traded just above 39. Interesting, despite all the volatility this week we have not taken out the low on that day for the S&P 500. Adding incrementally to holdings when the VIX is high is a sensible way to allocate capital for longer term investing. No one knows where or when the low in the market will be achieved. It may have happened on Monday, or it may happen in the future. Having a method that helps to allocate when fear is high has proven to be a winner over time. We plan to follow this advice in the weeks and months ahead.

CHARTS FROM THE WEEK PAST

Earnings so far.

Of 272 S&P 500 companies reporting average earnings up 25.8%, revenues up 13%. Why is the market going down on these good numbers? It think this is as good as it gets.

Some context on the market decline.

Average Stock in Russell 3000 is down -35%
Average Stock in Nasdaq is down -50%
Largest 10 US stocks are down -20%
With this in mind, -11% drawdown in S&P 500 is masking the severity of this sell-off. Market already in Bear Market territory but without recession in sight.

Source: JP Morgan

Alfie looking at the Futures pretty much any night this week.

Poor little guy. He hates bear markets.

The yield spread between the 10-year treasury and the 2-year treasury.

When positive and up sloping signals growth, when negative and down sloping signals slowing growth.

Fiscal thrust is fading as government consumption’s contribution to 4Q21 GDP growth came in at -0.5%, lowest since 4Q 2013.

Quite a large contribution from inventories in 4Q 2021, +4.9% vs. +2.2% last quarter.

Crazy stuff, make of it what you will.

China container ships exits falling again.

Not great. More supply chain woes.

Bear Markets are not all in one direction events.

Usually, we will get rallies along the way to the destination. But that destination is usually lower. Put volume (hedging risk) almost as high as March 2020. This can lead to a tradeable low.

Spread between American Association of Individual Investors bulls and bears at lowest (most bearish sentiment) since 2013.

This is a contrary indicator and a positive for the markets.

There sure is a lot of QQQ (NASDAQ 100) short sale volume.

The most in the last 7 years!

Fed looks behind the curve.

Sadly, can’t catch up as the economy slows. But maybe they will try. It will likely be hard on the markets if they raise more than once into a slowing economy.

Hmmmmm……

Covid is vitally important.

But lots of other stuff is out there. Let’s acknowledge it and keep moving. Others are.

So true!

A couple days old but cases falling fast.

I just wish we reported on it as much on the way down.

Russian Equities not doing so well vs. Europe.

Gonna need some VODKA!      

Ark following a pattern.

Berkshire got game!

Not speed but game.

Peloton may not be selling many bikes, but they do have happy customers!

Utilities breaking out vs. the S&P 500.

Another slowdown scenario.

Previous tightening cycles have delivered positive returns for equities.

High Yield spreads are widening and may be breaking higher.

Not a good thing.

Europe does a lot of business with Russia.

It’s always hard to put the genie back in the bottle.

We are looking for improvement in the supply chain.

Still looking worse.

Put/Call ratios are very elevated.

Many betting against the market. Many will be right for a while. Then feel emboldened. Then wrong for a long time.

WEEKEND HOMEWORK

A great look at overcoming fears, anxiety, and depression. Inspirational.

Jay Glazer—a top NFL insider on Fox NFL Sunday, an MMA coach, actor, and a veteran advocate and founder of MVP (Merging Vets and Players)—offers honest, in your face advice and insights gleaned from his fight through depression and anxiety, his successful careers in NFL journalism and business, as well as his work with military vets struggling with PTSD; the result is a relentless, unapologetic, and no-nonsense approach to overcoming your self-doubts, fears, and excuses… with the goal of becoming Unbreakable.

Have a great weekend!