Our investment strategy has been very successful this year, as we advocated buying triple leveraged ETFs when the stock market was near its March 2020 lows.
In mid-March 2020, a number of key market indicators confirmed our thesis that the market was becoming extremely oversold, giving us confidence that we were nearing an important buying opportunity.
Some of these indicators are shown below.
Figure 1 Volatility Index (VIX) vs. S&P 500
Figure 1 (above) shows a long-term perspective on the volatility index, or VIX, going back 14 years to 2006. This indicator is based on volatility data from the options market. In a normal stock market environment, the VIX typically has a low reading in the 10 to 15 range. In a market correction, it will shoot up, and if it rises to a level of roughly 40, that is normally a good indication that the market is near a low (as seen in the chart).
In March 2020 this indicator was skyrocketing to levels that it rarely reaches. On 3-12-20 the VIX shot up to 75, a sign of violent panic selling and a signal that the market was reaching an extraordinarily oversold condition. A few days later the VIX hit a peak of 85.
As seen in the chart above, the last time the VIX rose above 70 was after the market crash of late 2008, which turned out to be a historic buying opportunity in stocks. So the increase in the VIX to the 75 – 85 range in March 2020 provided evidence that the selling frenzy was creating another major buying opportunity.
Another good indicator that showed how the market was reaching an extremely oversold level in March 2020 is shown below in Figure 2. This shows the percent of stocks above their 40-day moving average. In a normal market environment, this indicator will be somewhere in the 40 – 70 range. But in a market correction it will drop sharply, and on rare occasions it drops to single digits.
Figure 2 A reliable market indicator gave a rare buy signal in March 2020
In the rare situations when it falls below 8 or 9, selling has reached an extreme level, indicating a sign of a market bottom, as seen in the chart. In late March 2020 this indicator fell to an extraordinarily low reading of only 2. This showed that the market was extremely oversold, indicating a good time to buy.
Also, the put / call ratio (chart not shown) is another good market indicator that turned bullish in March 2020. This is a contrarian indicator based on investor sentiment. It shows the ratio of puts to calls in the options market. In general, if this indicator falls below 0.60, it means that sentiment is showing too much optimism or complacency, which is bearish from a contrarian standpoint.
On the other hand, a high reading such as 1.20 shows a high level of pessimism, which is bullish from a contrarian standpoint. In March 2020, this ratio rose to a level of 1.40, a very high reading, showing that investor sentiment was extremely pessimistic. This meant that much of the bad news was priced in, and provided more confirmation that the market was near a bottom and was likely to turn up.
In addition the fundamentals were starting to improve by mid-March, as the Federal Reserve, the White House, Congress and the private sector were all starting to work together to address the coronavirus crisis. The Fed had taken action to provide liquidity to the financial markets, Congress was setting up its first large fiscal stimulus program, and the President had declared a national emergency.
Amid these and other developments, investors were beginning to feel more confident that the government was taking significant steps to address the virus crisis.
This combination of technical and fundamental developments provided evidence that the correct strategy in March 2020 was to buy stocks if the market reached an extremely oversold condition. This is what we recommended in our mid-March blog posts.
For a more detailed discussion of how this analysis was very profitable, please see our recent commentary entitled “Our Investment Strategy Has Far Outperformed a Buy-and-Hold Approach This Year.”