IWM - SPY: 3 Buy Signals I Am Waiting For

2023-10-27 15:21:45 ET

Summary

• Equities have now pulled back some 10% since the start of August, placing the market in official 'correction' territory.
• The pullback in stocks has coincided with a big rise in the 10-Year Treasury yield as well as increased volatility in the market.
• Three things need to happen before I get more bullish on equities.  They are highlighted in the paragraphs below.

Fear cuts deeper than swords. "? George R.R. Martin.

My regular Seeking Alpha and Real Money Pro readers know that I built up a decent position of out of the money, long-dated bear put spreads against the SPDR® S&P 500 ETF Trust ( SPY ) in June and July, when the S&P VIX Index (VIX) traded in the 12-14 range and option premiums were lower.

I did this as a form of portfolio insurance to protect my long holdings should equities encounter a bear market which seemed like it had a high probability. So far, that bet has worked out well as the market has recently reached the " correction" stage, which is a 10% fall from recent highs.

However, I am hardly a permabear, and I took some huge profits in my bear put spreads against Vicor Corporation ( VICR ) Wednesday as the shares had nearly been cut in half since I slapped a Sell on the stock on August 8th. I will also deploy " dry powder" back on the long side of the market if I see these three items which combined will be my " buy signal" to get much less bearish on the S&P 500 (SP500).

VIX Above 25

While the overall market just entered correction territory, the pullback in equities has been largely orderly. We haven't seen a day yet when the market has had a major " hiccup ." A day where the Nasdaq ends down three to five percent and the S&P 500 is off at least two percent on the day.

I don't need to see capitulation to get more constructive on equities, but I do at least need to see some fear from the investor population before I am willing to put some more ' ammo ' to work. A good indicator of fear is the VIX, which as of Thursday's close is just above 20. While that is significantly higher than in June and July before this downturn began, it is not quite the 26.5 level it hit in March when Silicon Valley Bank and two other major regional banks went belly up. I would like to see the VIX rise above 25 to confirm some real fear has come into the market before I get more positive on stocks.

De-escalation In The Middle East

The second thing I think needs to happen to be more confident in taking a more bullish stance with equities is we need to have some de-escalation in the Middle East. It is going to be tough for a lot of investors and fund managers to be aggressively long the market going into the weekend, when they could come back to work Monday morning with oil (CL1:COM) over $100 a barrel and the futures down over two percent as the conflict has expanded in the region.

The world is still awaiting what full actions Israel will take in response to the horrific atrocities perpetrated by Hamas on the country on October 7th. Right now, the Israeli Defense Forces, or IDF, are " prepping" the battlefield for a wide-scale incursion into Gaza to root out the terrorist organization that killed some 1,400 Israelis some three weeks ago.

Iran has warned that a full-scale invasion of Gaza may mean they will enter the conflict, via their proxies in Lebanon, Iraq and Syria or perhaps more directly. The U.S. just hit targets in Syria held by Iranian proxies in response to attacks on U.S. military bases in the region. There is no reasonable clarity right now on how these events will play out. Until there is, this will be another source of significant anxiety for investors even as the largest land war in Europe since WWII continues to rage on in Ukraine.

Stabilization In The Treasury Markets

One of the triggers for the pullback that started four weeks into the third quarter was that the yield on the 10-Year Treasury yield (US10Y) rose 74bps during the quarter. So far in October, we have seen the 10-Year Treasury touch the five percent level for the first time since July 2007, right before the Great Financial Crisis washed over the nation. Last week, the yield on the 10-Year Treasury rose 33bps, which is a huge move for the treasury markets.

The rise in treasuries has been triggered by setbacks on the inflation front. The third quarter started with the June CPI reading hitting 3.0%, down substantially from its high of 9.1% in June 2022. Unfortunately, by the end of the quarter, the CPI had backed up to 3.7%, an increase of 70bps. This is in line with the move up in the 10-Year Treasury yield during the quarter.

The stronger than expected initial reading of Q3 GDP that came out yesterday was not helpful for this cause as the GDP Price Deflator for the quarter was a positive 3.5%, up sharply from the 2.1% rate of the second quarter and another setback on the inflation front.

Treasury yields don't have to go down sharply from here for me to be more positive on the market. However, they can't broach five percent in any meaningful way, and it would be helpful if they would settle in within the 4.5% to 5.00% range without any more of the violent moves that we saw last week in the treasury market.

And those are three signals I am watching to see, before I move away from my bearish view on equities.

Fear is a phoenix. You can watch it burn a thousand times and still it will return ."? Leigh Bardugo.

For further details see: