Market Pullback Might Have Legs

Market Summary

Recently we have been recommending hedging long-term bullish positions to protect gains in the event of a market pullback like we have now. The updated chart below shows 9 out of the 10 S&P sectors are in negative territory over the past month. The width of the current pullback signals it has legs and might continue for a while. Investors are nervous about whether the Fed will raise interest rates. Also giving them reason to be cautious, are global economic uncertainty and disappointment with corporate earnings growth.

  

The CBOE Volatility Index (VIX) is known as the market’s “fear gauge” because it tracks the expected volatility priced into short-term S&P 500 Index options. When stocks stumble, the uptick in volatility and the demand for index put options tends to drive up the price of options premiums and sends the VIX higher. Implied volatility on Wall Street, as measured by the CBOE Volatility index on Friday, soared 30% to 16.35, the steepest increase since June 24, the day Britain voted to leave the European Union, in a referendum dubbed Brexit. Investors tend to be more fretful of VIX readings of 20 or above, but Friday’s jump was significant for the so-called fear gauge for Wall Street, considering that it has remained around 12 for a sustained period. Also note the last time the S&P 500 index dropped this hard was during the Brexit fallout.

By Gregory Clay

Investment Strategist

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gregoryclay@nellaadvisors.com

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Be Careful During May Expiration Week

Market Summary

First-quarter earnings season is almost over and generally financial results have not been quite as dismal as anticipated for the S&P 500. But for June-quarter earnings, for every company that has given an upbeat preannouncement, 2.3 others have sounded warnings, according to Thomson Reuters I/B/E/S. That has left the S&P 500 trading at about 16.5 times expected earnings, according to Thomson Reuters I/B/E/S. "It's hard to make a case that you're going to have stellar equity market performance. In the context of low interest rates, equity valuations look about right," said Mark Heppenstall, chief investment officer at Penn Mutual Asset Management in Horsham, Pennsylvania. According to a J.P. Morgan report, bond yields’ staying low is actually now becoming the reason why stocks are struggling to perform. In other words, the same jitters about global economic slowdown that have pushed Treasury yields to multi-year lows are also preventing stocks from gaining substantial ground. In the chart below, energy shares exploded higher in the 2^nd quarter as oil and gas prices recovered from the recent bottom. The SPDR Gold Trust is by far the most popular of all ETFs in 2016, with new inflows of $7.6 billion to the $34.1 billion fund, according to FactSet.

  

The National Association of Active Investment Managers (NAAIM) Exposure Index represents the average exposure to US Equity markets reported by NAAIM members. The blue bars depict a two-week moving average of the NAAIM managers’ responses. As the name indicates, the NAAIM Exposure Index provides insight into the actual adjustments active risk managers have made to client accounts over the past two weeks. The current survey result is for the week ending 05/11/2016. First-quarter NAAIM exposure index averaged 45.89%. Last week the NAAIM exposure index was 67.66%, and the current week’s exposure is 49.55%. Recent analysis is confirmed where we said “…Portfolio managers’ will probably cash in some profits as the market is stalling which should further reduce NAAIM exposure…” As quarterly earnings season winds down money managers have become disillusioned with lackluster results and are using market up days to dump shares. 

Trading Strategy

As reported by the Stock Trader’s Almanac, trading around May option expiration is mostly a mixed bag. Only the first day of the week has a solidly bullish bias over the past 34 years. However, trading the rest of the week into Friday, and next week has historically been choppy. DJIA has been down nineteen of the last thirty-four May expiration days. This full-week has a 50/50 record over the same years. More recently, DJIA and S&P 500 have suffered declines in five of the past seven expiration weeks.Projecting that bond yields will stay low, J.P. Morgan analysts also recommended selling cyclical stocks, as their prices are affected by ups and downs in the economy. As the following chart shows, stubbornly low Treasury yields suggest sluggish economic growth, which in turn hurts cyclicals.  In the current environment it is critical to honor stop-loss plans and don’t be afraid to convert to a high cash position.

By Gregory Clay

Investment Strategist

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gregoryclay@nellaadvisors.com

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Investors Eyeing FMOC's Next Move

Market Summary

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The Nasdaq composite index achieved a notable achievement on Thursday when it reached a new closing high for the first time since March 10, 2000. Back then, the Nasdaq swelled as investors were euphoric about the possibilities of many new tech companies that debuted on the public markets. The Nasdaq of today is very different animal compared to 2000. The tech firms are more established and better financed in 2015, and are some of the world's largest firms. “This chapter that the Nasdaq is writing is more suggestive that it's a market that, while still technology-weighted, is much more mature," said Steven Baffico, chief executive officer at Four Wood Capital Partners in New York. "The companies in it reflect that, companies like Cisco and Microsoft.”

For the week, the S&P gained 1.8 percent, the Nasdaq gained 3.3 percent and the Dow added 1.4 percent.The Nasdaq Composite and S&P 500 both chalked up record high closes on Friday, propelled by strong results from tech behemoths Google, Amazon and Microsoft. The Nasdaq Composite added 0.71 percent to end at 5,092.09, its second straight record high close. The S&P 500 rose 0.23 percent to a record high close of 2,117.69 points, barely above its previous high of 2,117.39 set on March 2.

Investment Analysis

While markets are at record highs, March-quarter earnings of S&P 500 companies are expected to dip 1.3 percent, with revenues dropping 3.5 percent as the dollar hurts U.S. multinationals and low oil prices affect energy companies, according to Thomson Reuters data. For the start of the second quarter the graph below shows Energy stocks continuing to lead the other major asset classes. After a sell-off between June and January driven by oversupply, oil prices seem to have found their footing in the last three months, gaining about 20 percent in April. Explosive stock price moves from technology stocks like Amazon and Netflix has the Nasdaq sector soaring recently. Wall Street may get new clues on the timing of an interest rate hike when the Federal Reserve issues a statement following its two-day meeting on Wednesday.

Last week’s analysis is still in play “… In the updated graph below energy stocks are blowing away the other main S&P sectors over the past month. Essentially, all the other sectors are basically breakeven the past 30 days with some groups moderately lower and others slightly higher. With the major S&P sectors struggling to gain traction and economic indicators sending mixed signals smart investors should continue maintaining both bullish and bearish positions. With this strategy you need a reasonable stop-loss plan to bail out of underperformers and ride winning trades…”The November to April best 6 months for stocks is coming to a close and that the old axiom about “Sell in May and Walk Away” is not far off.

By Gregory Clay

Investment Strategist

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gregoryclay@theoptionplayer.com

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Short Sqeeze Rally

Market Outlook

http://www.safehaven.com/article/35650/market-summary

The Bank of Japan drove Friday’s price surge by surprising investors with an announcement that it would increase its bond and asset purchases. "The Japanese central bank has taken the Quantitative Easing (QE) baton from the Fed, and equity traders couldn't be happier," said David Madden, market analyst at IG. Investors were also motivated by speculation that the European Central Bank will follow Japan lead by announcing stepped up stimulus measures at their next policy meeting this upcoming Thursday. This appears to be a classic ‘short squeeze’ as money managers had been mostly sitting on cash the past few weeks and were under-invested. As stocks moved higher last week investors needing to get back into the game bid prices up. Institutional investors who had to deal with end-of-month window dressing needed to get fully invested as the month ended which further exacerbated the short squeeze.

 

Both the Dow and the S&P 500 closed at all-time highs as the month ended. All told, U.S. stocks ended October solidly higher, up 2.3 percent. Strong U.S. corporate earnings were the primary driver of the rebound as well as signs that central banks in Japan and Europe were going to do all they could to stop their economies from dragging everyone else down with them. U.S. companies have been reporting strong quarterly results the last two weeks. Corporate profits are up 7.3 percent from a year ago, according to FactSet, compared with the 4.5 percent investors had expected at the beginning of the month.

Recent analysis played out exactly as advertised “…. It is reasonable to expect the next few weeks will probably be similar to early April and July when price pullbacks were a prelude to a pickup in quarterly earnings announcements where investors bid stock prices back up… If this trend continues and the Federal Reserve doesn't offer a surprise at their FMOC meeting this week stocks can be expected to continue climbing back toward recent highs…” In the updated performance chart below most of the major equity indexes are showing their highest percentage return for the year. The Russell 2000 is the only laggard as the index has just gotten back to breakeven year-to-date. The small cap index needs to go positive for the year for stocks to maintain bullish momentum.

  

Investor Analysis

According to the Stock Trader’s Almanac November maintains its status among the top performing months as fourth-quarter cash inflows from institutions drive November to lead the best consecutive three-month span November-January. November begins the ‘Best Six Months’ for the DJIA and S&P 500, and the ‘Best Eight Months’ for NASDAQ. Small caps come into favor during November, but don’t really take off until the last two weeks of the year. November is the number-three DJIA and S&P 500 month since 1950. Since 1971, November ranks third for NASDAQ. November is second best for Russell 1000 and Russell 2000 third best since 1979. In midterm years, November’s market prowess is relatively unchanged. DJIA has advanced in 12 of the last 16 midterm years since 1950 with an average gain of 2.5%. S&P 500 has also been up in 12 of the past 16 midterm years, gaining on average 2.7%. Small-caps perform well with Russell 2000 climbing in 6 of the past 8 midterm years, averaging 3.9%. The only real blemish in the November midterm-year record is 1974 (DJIA –7.0%, bear market ended in December). 

 

Surprisingly, the rebound in stock prices at the end of October has been driven by the defensive sectors. As seen in the updated graph below, the utility sector has been the best performer, notching up gains of approximately 7% for the month of October. Historically, investors have purchased utilities shares for their robust dividends as protection against stock price drops. Generally, you would expect the demand for utility shares to decline when sentiment is strong, but this has not been the case. Utilities held up better than every other sector during the recent correction and we said they would be a leader when stocks recovered. The question for investors is: Can utilities continue to lead the broader markets higher in the last two months of 2014? Healthcare and Industrials are the other sectors to consider as the market heads higher. Going long the S&P 500 index near the end of October and holding until just before Christmas has been successful 24 of the last 32 years, or 75.0% of the time.

By Gregory Clay

Investment Strategist

http://www.safehaven.com/article/35650/market-summary

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Gold And Commodities Are Moving

Market Summary
The Market got what it wanted to hear from Federal Reserve Chairman Janet Yellen as she signaled stocks are due for more gains. Listening to Ms. Yellen speak is like getting lectured by your grandmother, but nonetheless she is following former chair Ben Bernanke’s philosophy in that whatever is good for the stock market is good for America. Look, you can find 100 or 1,000 analysts who will proffer conflicting opinions on why the market should’ve or shouldn’t have performed as it has since the recession started. But I don’t care who you talk to, no knowledgeable market watcher can seriously deny that the Federal Reserve’s various iterations of Quantitative Easing (QE) is the steroid that has juiced the stock market to stratospheric levels.

We can talk about and debate numerous theories on how to price stocks and what factors will influence whether shares will go up or down. However, at its most basic core, what drives the price of any investment is straight-forward, simple supply and demand. If there are more buyers (demand) than there are sellers (supply) the price has to go up and will continue to rise until there is equilibrium with demand equaling supply. Conversely, if there is more supply (sellers) than there are buyers (demand) the price will always drop until there is equilibrium. You can do quantitative analysis and apply all the advanced economic theory you want, but in the end it is the basic demand = supply equation that will drive the price. The reason all the ‘expert’ financial prognosticators keep getting it wrong about a market correction, crash, etc. is because they ignore that fact the Federal Reserve is supplying unlimited demand ‘QE’ to keep stock prices afloat. Company earnings, U.S. political system dysfunction, global political and economic unrest, chronically poor labor markets, etc., none of it have really mattered. Ben Bernanke started the free money train and Janet Yellen is committed to keeping it rolling, and until it comes to a complete stop, betting against this market is a very risky bet indeed.

Investor Analysis
Recent articles mentioned “…the past few weeks ‘risk on’ categories have been the best performing sectors as small caps, energy and financials are leading the market higher…” The updated performance graph below reflects the two major themes of the past few weeks. Oil and gas prices have gone higher as chaos in the Middle East and Ukraine brings into question whether the world-wide energy supply is at risk. The other theme relates to the discussion above about the Federal Reserve’s continued easy money policy. Janet Yellen’s comments indicate the Fed is not concerned about fighting inflation any time soon. Gold has surged the past few weeks as investors are buying it as the traditional inflation hedge. Conversely, higher inflation expectations are a negative for treasury bonds as prices have dropped in response to higher yields demanded by buyers.

We recently opined “…gold prices appear to have bottomed out a support line that has been in place since the beginning of the year. Now is probably an opportune time to look at setting up trades that will profit if gold does bounce off its support level…Gold appears to be bouncing off a support level that has held up the price all year… your bullish trades to take advantage of the bounce off support should already be profitable with gains continuing to run…” The current gold rush has probably made most of its move and now is the time to takes some profits and/or tightens stops to lock in gains. If the price stalls out at resistance, a price neutral gold trade is probably a low-risk opportunity.

As you can see in the chart below, gold and treasury bonds continue to maintain an inversely correlated relationship. Depending on how your investment portfolio is set up, gold and treasury bonds can be used to hedge against each other and the equity market. For example if you took our suggestion to bet on higher gold prices a few weeks ago you should be showing a nice profit. Long bullish gold trades are now more risky since the price has surged and shorting gold is also a risky move at this point. But a long bullish Treasury bond trade is inexpensive and low-risk right now, and if/when gold drops you can expect bond prices to then move higher. Also, you can expect bond prices to rise if equity prices drop significantly.

By Gregory Clay
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Investors Are Still Biting

Market Summary

Investors are continuing to ‘buy the dips’ as they have been for the past few months which contribute to the current range-bound trading environment. Most of the major equity indexes basically finished the week flat, even though the DJIA and S&P500 managed to hit intraday all-time highs last week. The recent pattern has been investors cashing out gains at high prices, pushing prices down as shorts pile on; then buyers step in to buy the dips, pushing prices higher with a ‘short squeeze’. The smaller capitalization indexes are lagging the broader market as exhibited by the Russell 2000 being stuck below its 200-day SMA, a sign of weak momentum. Investors are concerned about weakness in small caps, biotech and technology sectors being a precursor to overall market losses.

Taking a gander at the year-to-date performance graph below, what is clear is that investors are seeking yield. Note the highest performing sectors are utilities, treasury bonds, and real estate which all provides high yields compared to all the other sectors. Investors are pouring money into U.S. Treasury bonds, considered the world's safest asset and they're loading up on dull, but reliable utility stocks. They are playing it safe by dumping holdings that would get hurt most from a stalled recovery, like stocks of retailers and risky small companies. This clearly confirms investors are nervous about the economy and eschewing high growth stocks in favor of capital preservation. The sector rotation continues from the riskier high-growth and momentum names to conservative high-yielding shares. Pimco's Bill Gross called this new secular investment theme "the new neutral". Gross expects slow economic growth and low real interest rates over the next five years, and this will fuel the hunt for yield.

Investor Analysis

In recent articles we discussed our forecast for stocks prices to nudge toward new highs and then drop back down to a support level in a trading range. As earnings season is winding down, the stock market avoided a broad-based selloff which is consistent with our expectation for continued range-bound trading. Looking under the hood of recent market action we can see sector rotation going on. It appears investors are stepping up to the plate and scooping up some of the high-flying stocks that have dropped in price. While it is still relatively risky to trade a lot of the ‘high momentum’ stocks, if there are shares you really like, it might be worth the risk to buy in if you are prepared to ride out future volatility. Any bullish trades need to be hedged for downside protection as the current bull market is getting tired and traders have become quicker on the trigger with bidding down prices. Market neutral portfolio positioning is currently the best trading strategy to take advantage of prices vacillating between recent highs and support levels.

By Gregory Clay

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