The key to Yellen’s deceptive banter yesterday was found in just two words, “appreciably lower.” This overly dovish tone leads us down a few different paths for equities.
1. US equities drift higher with more central bank accommodation
2. The market realizes the US economy (and earnings) aren’t as strong as investors are hoping, and stocks pull back.
We think it’s the latter.
One year chart of the SPY Index – In our opinion, the upside is limited to a few percent vs the downside of 20% over the next few months.
Over the last two years, as the VIX curve has gone into deep contango (as represented by the front month and the 8th month – White line well below the Green line), this has been a sell signal for US equities.
Today, we’re in contango and we believe VIX protection is cheap at these levels.
On February 11th, the VIX was in backwardation (front month more expensive than the outer months). Investors were paying up for front month protection as they got more and more nervous. Today, it’s the opposite.