It is a very interesting question where the equity markets will bottom. At first glance, it appears to be that this week we started seeing that process but I will never know until time passes which is not really useful.
My idea is that maybe by modeling the COVID-19 confirmed cases we can detect if we have a real improvement in the situation.
To speculate on the markets these days it has been difficult. For example, I did take the risk by trying to bottom fish the market and it didn't work as expected using volatility levels as my guide but I have to accept my mistake of underestimating this crisis. (I should have followed Mohamed El-Erian advice on this)
My idea is that maybe by modeling the COVID-19 confirmed cases we can detect if we have a real improvement in the situation.
To speculate on the markets these days it has been difficult. For example, I did take the risk by trying to bottom fish the market and it didn't work as expected using volatility levels as my guide but I have to accept my mistake of underestimating this crisis. (I should have followed Mohamed El-Erian advice on this)
So I am trying to create a methodology that will help me navigate in the markets during the COVID-19 market regime.
The idea is simple:
1.- Use actual data to estimate a Gompertz curve and observe how the upper asymptote is behaving.
2.- Use the VIX as a guide.
3.- If we see an improvement in the forecast of COVID-19 confirmed cases and if we see that volatility peaked maybe we are getting a signal that will allow us to buy into the equity markets.
2.- Use the VIX as a guide.
3.- If we see an improvement in the forecast of COVID-19 confirmed cases and if we see that volatility peaked maybe we are getting a signal that will allow us to buy into the equity markets.
We can see that parameter b establishes the upper asymptote which will need to monitor. If the isolation policies start working then we could expect that confirmed cases will stabilize by July-August of this year. If we are more optimistic we can think that the upper asymptote can be reduced as well. Math will tell with time.
Please comment.
VIX closed at a maximum of 82.69 on the 16th of March 2020 the day after the FED slashed interest rates by 0%. After that day volatility topped and I was hoping to find the bottom during the following days but this crisis will produce a huge worldwide recession and therefore it seems to me that the reasoning at the moment was naive at best.
The US is planning a $2T aid package and the size of the US economy is $21.7T, therefore, this package represents 9.2% approximately of the US GDP. This aid package could help Americans a lot during the recession.
So it appears that we have policies that will help the US economy but maybe the markets will need to see something more happening in order to change its mode from bear to bull market. I speculate that now the evolution of COVID-2019 can become a key indicator.
It is important to consider that not only the US will be at a recession but the whole world this means that there are reasons that could make the bear market longer. For the US the FED is very proactive nowadays and they will try to contain risks related to the financial system. But what about all the other countries especially those countries that have not implemented preventive risk containing policies? Somehow they will need to develop policies for the emergency.
So if a set of rules need to be created for finding a market bottom in this current bear market I would say that the bottom will appear once the VIX starts going up and peaks again combined with an improvement on the expectation on when people can return to work which will be guided by the trend of parameter b in the regression which it should go down.
Also, the bond market must show less volatility and a change of correlation between rates and the stock market price action.
If the trend of confirmed cases continues as of today I could make a forecast by the end of December of 2020 where the number of infected people will be $17.5 million and I speculate that the case fatality rate will be higher than in China and if I try to guess I think it can reach 10% or more.
The issue that worries me is related to politics. How politics will evolve in the future after this crisis? Maybe we will see a change in how things are mandated by some governments.
We all know that forecasting market bottoms and tops are quite difficult but I want to be able to do it that is why I study how bear and bull markets behave and when I write my observations I am able to analyze my reasoning which I hope can help me to improve.
Please comment.
Humberto Aguilar
You can also follow me on twitter: https://twitter.com/HumbertoP2019
Warning: This is a highly speculative exercise and I do not recommend doing any kind of trade or strategy with the information in this article. I am only trying to share what it can be a potential strategy to find the bottom of the market but it can be wrong. Use this information at your own risk.
