The Stock Market is Oversold — but Investors Don’t Believe It Yet

The U.S. stock market, represented by the S&P 500 Index (SPX), has been declining persistently, despite the presence of oversold conditions that are becoming more pronounced. However, it's essential to understand that being oversold doesn't automatically translate to a buying opportunity, and we haven't received any confirmed buy signals yet.

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While there are potential buy signals emerging in various areas, we are exercising caution and will not act on them until they are verified. It's worth noting that the stock market can experience significant drops even when it's oversold, as exemplified by events in October 2008 and March 2020. Currently, the SPX is in a well-defined downtrend, characterized by a series of lower highs and lower lows (illustrated by the red lines on the accompanying SPX chart). This alone is a compelling reason to maintain a "core" bearish stance.

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Resistance levels are apparent in the range between 4330 (the former support level) and 4400, where a gap exists on the SPX chart. Although oversold rallies can occur at any time, they often prove short-lived and tend to fade after reaching the declining 20-day Moving Average (currently at 4380 and decreasing). These levels represent obstacles for any potential rallies. The previous resistance points at 4540 and 4600 remain but are less significant as long as the SPX remains in its current downtrend.

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There is support around 4200, as it previously acted as resistance (indicated by the blue line on the chart). Additionally, the 200-day Moving Average of the SPX, which is still ascending, is positioned near 4200.

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Despite the ongoing decline, the SPX has consistently closed below its -4σ "modified Bollinger Band" (mBB), an oversold condition that sets the stage for a potential "classic" mBB buy signal. Such a signal would materialize when the SPX closes above its -3σ Band, which would happen if the SPX closes above 4267. However, this alone doesn't complete the McMillan Volatility Band (MVB) buy signal, requiring further confirmation.

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Both equity-only put-call ratios are surging as put volume escalates significantly after the market dropped below the critical support level at 4330. Both of these equity-only ratios are currently on sell signals, and they will remain so until they reverse their trend and begin to trend lower. Furthermore, the total put-call ratio is rising and has entered oversold territory. This ratio will generate a buy signal when it reverses its trend and forms a local maximum on its chart.

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As an additional data point, the CBOE equity-only put-call ratio surpassed 1.0 on October 4, indicating a rare oversold condition. If this condition recurs within the next five trading days, it could signal a buy opportunity for the stock market.

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Market breadth has been decidedly negative, consistent with the SPX trading below its lower bands. Both breadth oscillators remain on sell signals, despite being deeply oversold. They will not generate buy signals until at least two, and probably three, days of positive breadth are observed.

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The NYSE-based "New Highs vs. New Lows" indicator remains on a sell signal, with New Lows continuing to dominate. Some stocks hitting new lows are trading at prices nearly as low as those seen in March 2020. This indicator will remain bearish until there are at least 100 New Highs on the NYSE for two consecutive days.

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The volatility complex, which has been one of our more bullish indicators throughout the year, still retains its strength, although it has shown some wavering recently. VIX (Volatility Index) is in "spiking" mode, and during such periods, stocks can experience sharp declines. A "spike peak" buy signal will be issued when VIX eventually drops at least 3.0 points from its peak. So far, the highest recorded VIX level during this spiking period is 20.88.

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The previously identified trend of the VIX buy signal, which began in November 2022, has been stopped out. Currently, there is no discernible trend in the VIX chart according to our definition, as VIX is above the 200-day Moving Average, while the 20-day MA is below it. If the 20-day MA crosses above the 200-day MA, and VIX remains above the 200-day MA, it would signal an intermediate-term sell signal.

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Lastly, the configuration of volatility derivatives warrants some concern. As long as the term structures of the VIX futures and CBOE Volatility Indices slope upward, all is well. However, the VIX futures term structure has flattened considerably, which could be a cause for concern. If the front-month October VIX futures rise above November's, it could be a highly bearish warning sign, as observed in February 2018 and February 2020 when such a development preceded market collapses.

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In summary, our stance remains "core" bearish, and we are awaiting confirmed buy signals. Oversold conditions have persisted for an extended period, and while setups for potential buy signals have emerged, we emphasize the need for confirmation, not just relying on oversold conditions, before considering long positions.

New Recommendation: Potential VIX "spike peak" buy signal:

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We previously made this recommendation, but VIX has not yet exited its "spiking" mode. Even though stocks can decline sharply during this phase, a VIX "spike peak" buy signal will eventually materialize. Specifically, it will trigger when VIX closes at least 3.0 points below the highest price reached during this recent "spiking" mode. So far, the peak is at 20.88, but continue monitoring VIX to see if it rises higher before eventually retreating.

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If VIX closes at least 3.00 points below its highest price from September 27th onwards (currently 20.88), execute the following trade: Buy 1 VIX Nov (17th) at-the-money call and Sell 1 VIX Nov (17th) call with a striking price 15 points higher.

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This signal, if confirmed, will remain in effect for 22 trading days and would be stopped out if VIX closes higher than the triggering high point.

New Recommendation: Energy Select Sector SPDR (XLE) puts

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Energy stocks have experienced a breakdown recently, leading to a new weighted put-call ratio sell signal for XLE (and several individual oil stocks as well).

Execute the following trade: Buy 3 XLE Nov (17th) 86 puts in line with market conditions.

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XLE: 85.75 Nov (17th) 86 put: 2.99 bid, offered at 3.05.

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Hold these puts as long as the weighted put-call ratio maintains its sell signal for XLE.

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