The VIX has risen again; investing in the S&P 500 when it exceeds 35 points could yield a 25% return in one year, says Mr. Tetsu Emori

【Trading Strategy for US Stocks】

U.S. stocks are still volatile. There are days when the Dow briefly drops more than $1,000, which is not normal. That alone shows the market is chaotic. In such a situation where AI (artificial intelligence) makes investment decisions based on news headlines, genuine trends are hard to form. However, a direction should emerge eventually. For now, it is crucial to observe market trends calmly. We should avoid buying on rallies and selling on downswings.

The market remains wary. In the United States, new coronavirus infections are rising, making the landscape prone to rising concerns. Also, the prospects for economic recovery and corporate earnings are completely unclear. Yet future stock gains will emerge from pessimism. It is possible to mitigate risk by not trying to buy at the bottom, but gradually buying down. “Rate cuts cannot eradicate the virus” is true, but there is no point in only guarding against the virus. The economy will recover eventually. That should be the baseline for stock investing.

As repeated, U.S. stocks have overcome numerous difficulties. In response to unforeseen events, agile and swift monetary and fiscal policy measures have resolved problems. This time, even if it takes time, it will likely become so. Excessive optimism is dangerous, but being too pessimistic can halt human thinking. Be careful about this. Major economies including the United States have accumulated know-how from past crises. It's time to leverage past experiences.

On the 3rd, with the spread of the coronavirus increasing, the Fed cut by a sizable 0.5 percentage point as the economy faced downward risk. However, the market has priced in further rate cuts. If stock prices do not reverse, the Fed will be forced to implement additional rate cuts at the FOMC on the 17–18. Zero interest rate is approaching, and a deadlock becomes more real. If we don't stem the stock decline here, there will be no room for further rate cuts. The Fed faces a very difficult policy decision. Powell said, “We understand that rate cuts do not reduce the infection rate,” and he has not hidden his vigilance about a prolonged outbreak. The United States has also decided on fiscal stimulus. All that remains is to wait for the market to settle down.

In the U.S. stock market's short-term trading strategy, the rebound of the day turned major indices to “long.” Also, as the VIX declined, the “long” was unwound. I’d like to see whether this trend continues by watching today’s market.

The VIX has risen again, but as I have explained many times regarding timing investments using the VIX: when it exceeds 35, investing in the S&P 500 yields returns of 25% after 1 year, 41% after 2 years, and 45% after 3 years. Also, when the near-month vs next-month VIX futures spread goes into backwardation, that’s a buying opportunity. In such cases, buying the S&P 500 increases the probability of a rise to over 96% after 1 year. If backwardation persists, continuing to buy almost guarantees profits.

Also, I repeatedly highlight that when bonds are being bought too heavily and interest rates have dropped sharply, the future performance of the S&P 500 is extremely favorable. When U.S. Treasuries rise 25% year over year, the S&P 500’s one-month change is on average up 1.11%, three months later up 3.51%, six months later up 6.15%, and twelve months later up 14.08%. This is exceptionally strong performance. When funds flow too much into bonds as now, it indicates that stock prices will eventually rise. So, now seems to be a good opportunity for equity investing.

The Fear & Greed Index has fallen sharply to 9. It remains at an “extremely pessimistic” level. It appears oversold.

For short-term trading strategy, refer to the indicators below. Judgments are based on technical indicators.

In the long-term portfolio strategy, we plan to grow assets over the long term. While maintaining investment in U.S. stocks, we will continue to look for dip-buying opportunities. The baseline return target for this year—8% return plus alpha—may need to be lowered to around 6%. However, for the sake of earning returns, we will steadily implement dip buying.

The dip-buy targets for the S&P 500 have fallen to 3150, 3100, 3045, 3000, and 2965 points. 2965 has been the final target, and since we've reached it, nearly all funds intended for buying on dips have been invested. The result is that we bought at quite a low level. Now we will wait patiently for the rebound. Whether to unwind part of the positions during the rebound will be judged by price movements. The next target was 3100, and I will wait for it to clearly exceed that. The S&P 500 is no longer overpriced; it is at a historically average level.

Basically, I think holding S&P 500 positions alone is sufficient. Diversifying across various assets leads to more stable operation. Since VIX also serves as a hedge, including it in your trading plan allows for broader management. The combination of the S&P 500 and VIX is extremely important.

＜US Stock Market Short-Term Trading Strategy＞
Dow Jones: Close-out selling (mid-term oversold)
S&P 500: Close-out selling (mid-term oversold)
Nasdaq Composite: Close-out selling (mid-term oversold)
Russell 2000: New selling (mid-term oversold)
VIX: New buying (short- to mid-term overbought)

＊(Overbought) implies taking profits (in longs) or adding to shorts; (Oversold) implies buying back (in shorts) or adding to longs; (Overheated zone) should be treated as a short-term overbought indicator. The deviation from moving averages is used as the basis.

Tetsu Emori's Real Trading Strategy