Looking For The Bounce

Market Outlook

It took Friday’s best one-day performance for the Dow Jones Industrial Average and S&P 500 index since March 4^th to spur the indexes to their modest gains for the week. Obama’s targeted air strikes in Iraq this week intensified the risk in one of the world’s biggest oil-producing nations jolted the energy markets, sending crude prices higher. The updated graph shows the Nasdaq 100 and S&P 500 indexes up year-to-date, while the Dow Jones Industrial Average and Russell 2000 down for the year.

Buying stock market dips has been a very profitable strategy this year. Declines in the S&P 500 index have lasted an average 1.5 days…using dips to get better prices on stocks you have been eyeing has generally paid off…the S&P 500 index has recovered its losses from each price pullback…Investors found little reason to move money into stocks, faced with the growing geopolitical concerns in Israel and Ukraine, as well as banking problems in Europe…investors moved funds out of equities and invested in treasury bonds and gold as these assets prices moved higher… The updated chart shows as market volatility edges up, investors park funds into treasuries and gold on days they are selling equities and pulling money out the next day to bid equities higher.

The late July stock market decline turned the month into a loss and snapped the consecutive five-month winning streak for the Dow Jones Industrial Average and S&P 500 indexes. And of course, the NASDAQ and Russell 2000 ended down as well, with the Russell losing a whopping 6.1%. This was the worst month for the Russell 2000 since May 2012. Market weakness was broad based with 27 of the 29 S&P sectors tracked posting declines last month. For the current quarter investors are playing it safe by investing in safe-haven assets. Equities have experienced selling pressure the past few weeks as investors have been cautious about high stock valuations and worried about geopolitical crisis in Ukraine and Middle East. Bonds and gold are the primary ‘risk off’ assets investors are using at the expense of equity investments.

  

Investor Analysis

According to the Stock Trader’s Almanac Next week is options expiration week and mid-August is often better performing than the beginning and the end of the month. This strength is punctuated with a four-day string of bullish days that wrap the weekend from August 14 to 19. A bullish day is defined as a trading day in which the S&P 500 has risen greater than or equal to 60% of the time over the past 21 years. Unfortunately, this bullish cluster has not always resulted in full-week gains during option expiration. Both DJIA and S&P 500 have suffered a weekly loss in three of the last four August expiration weeks. Historically speaking, the consumer sector tends to begin its favorable period near the end of September and typically remains strong until the beginning of June in the following year. Back-to-school and holiday spending combined with the effects of the “Best Six Months” is the most likely driving force behind this seasonality.

As displayed in the updated graph below, over the past 90 days the biggest winners in the equity market have been technology and healthcare stocks. The technology sector has been booming primarily because it consists of a lot of high beta stocks that recovered sharply from the tech crash that happened earlier this year. Healthcare stocks are benefiting from the Affordable Care Act (also known as Obamacare). Also, some of the healthcare shares belong to pharmaceutical companies that are considered high beta stocks. The current price pullback might be a good opportunity to purchase some of these hi flyers at a cheaper price before the market surges higher again.

These recent trading strategy suggestions are still valid "...options traders should return to a neutral weighting between bullish and bearish positions. Bullish in the event that the indexes regain their upward momentum, and bearish in the event that bonds and commodities prove to be correct and economic uncertainty translates into equity weakness…” The updated graph below confirms recent weakness in equity shares, especially cyclicals. Those investors who took our advice and executed bearish positions to hedge long trades should still be showing a net gain. And of course when the market does bounce back, the long positions should sustain profits… we consider the current market action to be a ‘trader’s market’ with triple-digit daily up and down price moves. Traders can get short-term profits from bearish positions on down days, and gain from bullish plays on price recoveries…”

By Gregory Clay

Investment Strategist

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