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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How Investors Are Hedging The Fed

Market Summary

Investors appear to be hedging against a Fed rate policy decision by focusing on domestic growth stocks. In the updated perf graph below, the Russell 2000 index (RUT) small capitalization index is clearly outperforming the larger cap indexes after the Brexit vote. The Russell 2000 index is an index measuring the performance approximately 2,000 small-cap companies in the Russell 3000 Index, which is made up of 3,000 of the biggest U.S. stocks. The Russell 2000 is comprised of a specific diversified category of small-cap domestic stocks.

Stocks in the larger capitalization indexes have more exposure to overseas economies and are further impacted by volatile energy pricing. Higher interest rates are generally presumed to adversely impact large multinational companies more dependent on the global economy. Higher rates should strengthen the U.S dollar and have a negative effect on companies attempting to convert foreign currencies into dollars. Also, a stronger dollar puts U.S. companies at a competitive price disadvantage when exporting to overseas markets.

You can see in the graph how investors are buying smaller capitalization index stocks at the expense of large cap shares.  Investors concern about higher rates is also reflected in the relative under-performance of treasury bonds and gold stocks over the past few months.

By Gregory Clay

Investment Strategist

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Good Time To Hedge Bullish Positions

Market Summary

A standard chart that we use to help confirm the overall market trend is the Momentum Factor ETF (MTUM) chart. Momentum Factor ETF is an investment that seeks to track the investment results of an index composed of U.S. large- and mid-capitalization stocks exhibiting relatively higher price momentum. This type of momentum fund is considered a reliable proxy for the general stock market trend. We prefer to use the Heikin-Ashi format to display the Momentum Factor ETF. Heikin-Ashi candlestick charts are designed to filter out volatility in an effort to better capture the true trend. The updated chart below shows that, technically the stock market remains extremely overbought. It might be difficult for the major indexes to keep pushing higher until the overbought condition is absorbed. Also the chart highlights that the technical momentum indicator is stuck in neutral even as stocks continue climbing higher on a wall of worry. Putting hedges in place to protect long bullish positions is smart move in case the market follows through on the overbought technical signal.

Below is the S&P Sector ETF graph highlighting performance results over the last month. You can see in the graph below how technology shares have been the outstanding performer. The major concern is that the market advance is not broad-based. Tech shares leading the market higher are not dragging along the other S&P sectors which might indicate underlying market weakness. The smart move is hedge long-term bullish trades to protect gains in the event of a market pullback.

By Gregory Clay

Investment Strategist

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Stocks Are Only Game In Town

Market Summary

On the heels of a tepid second-quarter growth report, the jobs data painted a rosier picture of the economy. Anything that really would suggest that the consumer is starting to step up and pick up a little bit more of the load would give you some optimism that maybe we can get an earnings break-out at some point," said Bruce McCain, chief investment strategist at Key Private Bank in Cleveland, Ohio. "The consumer, in our mind, is a lever that could cause equities to trend higher," said Terry Sandven, chief equity strategist at U.S. Bank Wealth Management in Minneapolis. "The most important takeaway from the positive jobs report is an indication of a sustained growth in the US economy." Stocks head into next week on a positive note, with the S&P 500 rising to a fresh intraday all-time high on Friday after two weeks of little change to the benchmark index.

Some market pundits are concerned about stock valuations and the crazy presidential election is having an impact, as well as headlines about the Dow Jones industrial average's recent seven-day drop. The S&P 500 is trading at 17.1 times earnings estimates of its component companies over the next 12 months, well above its average of 14.5 times over the past five years. Other analysts feel that the perceived lack of viable investment alternatives, economic growth and generally upward momentum in stock prices will result in higher stock prices over the next six months. "The US economy may not be going gangbusters but it remains the best equity alternative of any worldwide index," said Michael James, managing director of equity trading at Wedbush Securities. With about 85 percent of the overall S&P 500 already reported, second-quarter earnings are expected to have fallen 2.6 percent, not as dire as feared at the start of July. You can see in the graph below how technology shares continue to lead the charge higher. But also note the best trading opportunity might be financial stocks, which are surging on the expectation of a Fed rate increase.

By Gregory Clay

Investment Strategist

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What's Propping Up Stock Market

Market Summary

A tool to help confirm the overall market trend is the Bullish Percent Index (BPI). The Bullish Index is a popular market “breadth” indicator used to gauge the internal strength/weakness of the market. Essentially it is the percentage of stocks that have buy signals. If the market is strong and moving up, the BPI should also be moving higher as more and more stocks are purchased. Nasdaq stocks are leading the market higher as quarterly earning numbers have enticed investors. Strength in technology and small cap stocks are primarily propping up the market. As long as the BPCOMPQ remains in an uptrend expect the overall stock market to remain near all-time highs.

 The Fed continues its Dovish outlook despite better economic data and a solid economy. You can see in the graph below how small and midcap stocks are holding up better than the large caps of the Dow and S&P 500 as group rotation into technology, health care and real estate continues to absorb any selling. The S&P 500 remains extended, and that’s one reason for the swap to the smaller cap and tech stocks.

By Gregory Clay

Investment Strategist

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Investors Overreact To Brexit Vote

Market Summary

As we said last week “…Uncertainty about the Fed and Brexit will cap upside movement until there is clarity on both,” said Uri Landesman, president of Platinum Partners. Investors are nervous so the market is likely to remain depressed for now, he added…” MarketWatch.com reported how as global markets plunged in the aftermath of the victorious “leave” vote in the U.K.’s referendum on EU membership, investors rapidly adjusted their expectations for the Fed. Markets are now projecting that the central bank won’t raise U.S. rates until early 2018. What’s more, minorities of fed-funds futures traders are now betting that the U.S. central bank could actually cut interest rates at its next meeting, in July. “We walked in this morning and the probability of a rate cut at any of the upcoming meetings from July to November was at 15%,” said Anthony Valeri, investment strategist at LPL Financial.

Britain’s decision to exit the European Union in a referendum spread chaos through markets on Friday, but the shock isn’t likely to amount to echo the 2008 “Lehman moment” that left the global financial system on the brink of collapse. Britain’s Brexit vote does not require the government to pull the trigger immediately because the referendum is not legally binding. And just how long the U.K. might wait has grown as a key tactical debate in the few days since Thursday’s vote to leave the trading bloc.For the U.S. economy, the consequences of Brexit should be minimal, but it might not turn out that way. Policy makers and business leaders are subject to overreact to political issues. The real risk of Brexit is that emotion overwhelms fundamental logic, causing one irrational decision to beget another until we really do have the recession or growth slowdown that seemed implausible before the vote. In the chart below investors are trading “risk-off” assets during the current period of market uncertainty.

Trading Strategy

Last week’s analysis played out as exactly as advertised where we said “…An article published in MarketWatch.com reported on how the long-anticipated “Brexit” referendum on the U.K.’s membership in the European Union is set for Thursday. Polls released in recent weeks showed gathering support for the “leave” vote, an outcome that many economists say would spark widespread turmoil in global markets and possibly sink the U.K. into a recession...the week after Triple-Witching Day is horrendous. This week has experienced DJIA losses in 23 of the last 26 years with average losses of 1.1%. S&P 500 and NASDAQ have fared slightly better during the week after over the same 25 year span, declining 0.7% and 0.2% respectively on average…” We also said “…If the market does pull back, that might be a good opportunity to “buy the dip” with shares in the leading sectors…” Now the question is where will the market bottom out? The best bet is that investors overreacted to the Brexit vote and stocks will eventually bounce back, especially since some pundits believe there is a possibility the FOMC could lower rates at one of their upcoming meetings.

By Gregory Clay

Investment Strategist

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Why Investors Survey Signal New Market Highs

The American Association of Individual Investors (AAII) Sentiment Survey measures the percentage of individual investors who are bullish, bearish, and neutral on the stock market for the next six months; individuals are polled from the ranks of the AAII membership on a weekly basis. The current survey result is for the week ending 05/25/2016. The AAII reports that the percentage of individual investors optimistic about short-term gains occurring in the stock market is at its lowest level in 11 years. At the same time, the percentage of investors describing their outlook as neutral is at its highest level in 16 years, according to the latest AAII Sentiment Survey. Optimism is below 20% and neutral sentiment is above 50% on the same week, for just the sixth time in the survey’s history. Bullish sentiment, expectations that stock prices will rise over the next six months, declined 1.6 percentage points to 17.8%. This is the lowest level of optimism recorded by the survey since April 14, 2005 (16.5%). It is also the 29th consecutive week and the 62nd out of the past 64 weeks that bullish sentiment has been below its historical average of 39.0%. Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, jumped 6.3 percentage points to 52.9%. Neutral sentiment was last higher on April 12, 1990 (56.0%). Neutral sentiment has now been above 40% for 12 consecutive weeks and above its historical average of 31% for 17 consecutive weeks, as well as for 69 out of the past 73 weeks. As a contrarian indicator the current AAII reading points to a continued short-term bounce toward the market highs.

 

The questions posed in an article published in the Reformed Broker is has the market corrected through time, rather than through price, enough to spark the next bull leg higher? Since the AAII Sentiment Survey started in June 1987, a neutral sentiment reading above 50% has only been recorded 28 times. Only six of those readings were recorded after 1989 (January 1991, July 1991, August 1994, February 2003, December 2015 and this week). The remaining 22 readings are all from the approximate two-year span of December 1987 through October 1989. On average, the S&P 500's 26- and 52-week returns following such occurrences were 8.4% and 20.5%, respectively. Even rarer is having bullish sentiment below 20% and neutral sentiment above 50% on the same week. This week is just the sixth time such a combination has happened. It previously occurred four times in 1988 and once in 1989. On average, the S&P 500's 26- and 52-week returns following those five occurrences were 11.2% and 25.7%, respectively.

By Gregory Clay

Investment Strategist

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Beware Of Stocks Worst Six Months

Market Summary

The Dow and S&P 500 have not hit new all-time highs since this time a year ago. The major indexes are still about 5% below these peaks. Many market pundits believe that there are no compelling reasons for stocks to hit new records anytime soon. Investors should prepare for daily triple digit price moves. "Investors had gotten used to a low volatility environment but they have been rudely awakened. This could be the beginning of a multi-year period of volatility," said David Jilek, chief investment strategist at Gateway Investment Advisers.

“The markets are just treading water here. Normally markets rally on strong earnings and we've seen lackluster corporate earnings," said Stephen Kalayjian, chief market strategist of KnowVera. "A lot of companies are also talking about cost cutting and that usually means layoffs," he added. U. S. equities are at a critical juncture. May is the first month of the Worst Six Months for the stock market. Stocks made a brief high 4/20, then technical signals began to deteriorate. Weekly advancing issues on the NYSE have been falling the four weeks while declining issues have been on the rise and greater than advancers the past 2 weeks. New 52-week highs have expanded the past three weeks, but so have new lows, albeit not by much. 

The Ned Davis definition of a bear market requires a peak to trough decline of 13% or more after 145 calendar days. The 364 days since the last all-time-closing high is an issue. History shows that similar gaps between market peaks tend to bode poorly for the stock market's direction. "The longer the S&P 500 goes without registering a new high, the more likely that it is a bear market," Michael O'Rourke, chief market strategist at Jones Trading in Greenwich, Connecticut said in a May 16 note to clients. Starting with the S&P 500 closing all-time highs since 1929, finds 13 previous times where S&P 500 spent more than 1-year before closing at a new all-time high. With the exception of 1994, there was always a bear market. Using a 20% decline, S&P 500 avoided a bear market just 3 times out of 13. In other words, there is a 76.9% chance that the current all-time-high dry spell will not end before there is a 20% or greater S&P 500 decline.

  

Trading Strategy

The release of the FOMC minutes from the last meeting on April 27 suggested that a rate hike in June is quite possible. Inflation, retail sales, disposable income and the dollar index are on the rise in conjunction with a firm labor market. The Stock Barometer says the word June was used 8 times in the minutes in close proximity to the increased possibility of a rate increase, leaving open the possibility of an increase in the federal funds rate at the June FOMC meeting. It also mentioned, Perhaps a surprise hike from the Fed in June might be the straw that will knock the market down. As we suggested last week, 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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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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Fed Still Feeding The Bulls

Market Summary

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Feb. 11th was the 2016 low for the stock market. Since then easing concerns about slowing growth in China, as well as a possible U.S. recession, have triggered an explosive rally that in five weeks wiped out Wall Street's worst start ever to a year. After a sixth straight winning week the Dow Jones industrial average staged its biggest comeback from a deficit during a quarter since 1933. U.S. stocks erased losses for the year as the Federal Reserve's scaled-back path for interest-rate increases sparked demand for riskier assets. Crain’s reported that actions by central banks to stimulate growth have fueled a rebound in risk assets from equities to raw-material prices, after almost $9 trillion was erased from global stocks at the start of the year. The Fed's updated projections indicate two quarter-point increases this year, down from four forecast in December. “Never underestimate the power of the Fed to impact the markets. The doves are clearly winning the argument resulting in yesterday’s dovish announcement, which dragged the Fed back far more in line with market views on the potential for rate hikes in 2016,” said Richard Perry, analyst at Hantec Markets, in a note. For the week, the S&P 500 Index advanced 1.4% while the Blue Chip Dow Jones Industrial Average rose 2.2%. The Nasdaq added 1.0% while the small cap Russell 2000 crawled up 1.3% for the week. As confirmed in the chart below, the Fed’s dovish interest rate comments have stabilized treasury prices and continue to catapult gold stocks.

A standard chart that we use to help confirm the overall market trend is the Momentum Factor ETF (MTUM) chart. Momentum Factor ETF is an investment that seeks to track the investment results of an index composed of U.S. large- and mid-capitalization stocks exhibiting relatively higher price momentum. This type of momentum fund is considered a reliable proxy for the general stock market trend. We prefer to use the Heikin-Ashi format to display the Momentum Factor ETF. Heikin-Ashi candlestick charts are designed to filter out volatility in an effort to better capture the true trend. Last week’s analysis played out as advertised as we opined “…Next week is critical for determining the market trend…stocks are in a trading range. Most market technicians believe the most likely scenario is the MTUM will break out and continue higher in the direction of the current trend…” Technical analysis suggests there is still plenty of room for the uptrend to continue.

  

Trading Strategy

A few weeks ago we discussed the relationship between stocks and energy price when we said “…equity and energy prices have been trading in lock step all year. Market pundits have offered various analyses on why this is happening. There is usually unique asset classes associated with the movement of stock prices, e.g. dollar, bonds, interest rates, etc. Until this relationship is broken, some investors are observing energy prices as a clue to stock movement, especially for day trading…” Regardless of the driver, the oil rebound is putting Wall Street in a buying mood. The oil crash was viewed by many as a sign of impending economic collapse, causing the stock market to tank at the beginning of the year. But now the Dow has recouped all of its losses for the year, up from a stunning loss of nearly 2,000 points at one point. As mentioned previously, February 11^th was the market low and the graph below displays asset performance since. In the graph you can see the results since the February correction are equivalent to more than an entire year of gains. What’s notable is that the smaller cap higher risk stocks are leading the way, which confirms investors are committed to trading “risk-on”.

Last week we mentioned “…As reported in the Stock Trader’s Almanac… March’s option expiration week…has a bullish bias…However, the week after tends to be bearish for DJIA and S&P 500…” The Trader’s Almanac also says next week is a shortened trading week due to Good Friday and Easter. The days before Good Friday are generally positive and the shortened week also has a bullish slant. Rallies by industrial, raw-material and energy stocks helped the equity indexes climb all the way back from losses that reached over 11% a little over month ago. The graph below confirms our recent trading suggestions are working out as we said “…all systems are on go as all the major S&P sectors are positive over the past 30 days. As recession talk subsides and potential Fed rate increases fall off the table investors are increasingly willing to take on more risk…the best performing sectors are considered the highest risk equity classes. We are currently in the middle of what is considered the “best six months of the year” for the stock market. We like undervalued or oversold shares to bid on because the current bullish trend has more room to run…”

By Gregory Clay

Investment Strategist

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gregoryclay@nellaadvisers.com

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Stocks Have Running Room

Market Summary

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The S&P 500 has enjoyed a four-session winning streak for the first time since last October. And for the first time since early January, the Dow Jones industrial average rose above the 17,000 mark while the S&P 500 ended a fraction below 2,000, levels that some traders see as psychologically important. The S&P 500 has gained in 10 out of 15 sessions since its February low and closed above its 100-day moving average for first time this year. Half of 10 S&P sectors - including energy, which had been severely beaten down - are now positive for the year. For the week, the S&P 500 Index advanced 2.7% while the Blue Chip Dow Jones Industrial Average rose 2.2%. The Nasdaq added 2.8% while the small cap Russell 2000 led the major indices exploding 4.31% for the week. Treasury prices have flattened. As confirmed in the chart below gold stocks are going even higher following raw gold settlement prices at the highest level in a year.

  

A standard chart that we use to help confirm the overall market trend is the Momentum Factor ETF (MTUM) chart. Momentum Factor ETF is an investment that seeks to track the investment results of an index composed of U.S. large- and mid-capitalization stocks exhibiting relatively higher price momentum. This type of momentum fund is considered a reliable proxy for the general stock market trend. We prefer to use the Heikin-Ashi format to display the Momentum Factor ETF. Heikin-Ashi candlestick charts are designed to filter out volatility in an effort to better capture the true trend. The orange line in the updated chart below shows the uptrend continues with strong bullish momentum and plenty of space for the move to continue further.

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 03/02/2016. Fourth-quarter NAAIM exposure index averaged 44.61%. Last week the NAAIM exposure index was 31.65%, and the current week’s exposure is 54.44%. The current bullish move has inspired money managers to come off the sidelines. Professional traders lifted the NAAIM exposure index to the highest percentage of the year. Expect investors to continue increasing equity exposure, as they understand the upcoming months are historically the best for the stock market.

Trading Strategy

The bullish trend has been strong since the middle of February and strategists are cautiously optimistic the rebound will continue. Investors are counting on economic data continuing to support an improving economy, since upbeat reports in recent weeks have eased fears the United States may be headed for a recession. "If you were pricing this thing for a recession, you've got to take it back out," said Jim Paulsen, chief investment officer at Wells Capital Management in Minneapolis. He added that the S&P 500 could test its high from May 2015, when it closed at a record 2,130. He and others are expecting data to continue to support the view that the United States will avoid a recession, though they said plenty could still derail the market.

"Expectations went too far on a recession expectation. That's why the market has rallied in the past two weeks. It's pricing out a chance of a recession,” said Jim Paulsen, chief investment officer at Wells Capital Management in Minneapolis. In the updated graph below “all systems are on go” as all the major S&P sectors are positive over the past 30 days. As recession talk subsides and potential Fed rate increases fall off the table investors are increasingly willing to take on more risk. In the graph below the best performing sectors are considered the highest risk equity classes. We are currently in the middle of what is considered the “best six months of the year” for the stock market. We like undervalued or oversold shares to bid on because the current bullish trend has more room to run.

By Gregory Clay

Investment Strategist

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gregoryclay@theoptionplayer.com

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This Might Be A Dead Cat Bounce

Market Summary

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U.S. stocks ended the week with a massive rally, which helped generate the second consecutive week of gains. Oil recovered last week and Federal Reserve comments provided the fuel for a counter-trend bounce. The Bank of Japan also helped rally global stocks after unexpectedly adopting a negative interest rate policy for the first time. Even though the Dow surged 397 points on Friday, it still lost 5.5% of its value in January. That is the deepest monthly decline since the market correct last August. The Nasdaq fared even worse, sinking nearly 8%, its worst month since May 2010 when the infamous flash crash spooked investors. January got off to a terrible start, with panic about the slowdown in China and crashing oil prices sending the Dow to its worst 10-day start to a year on record going back to 1897. For the week, the S&P 500 Index jumped 1.7% while the Blue Chip-heavy Dow Jones Industrial Average’s lead the major indices by rising 2.3%. The Nasdaq finished the week flat up a minimal 0.03% while the small cap Russell 2000 rose 1.5% for the week. As seen in the chart below, the major equity indexes finished January in a deep hole as investors sold off equities and deposited the funds into safe-haven assets like Treasuries and Gold.

A standard chart that we use to help confirm the overall market trend is the Momentum Factor ETF (MTUM) chart. Momentum Factor ETF is an investment that seeks to track the investment results of an index composed of U.S. large- and mid-capitalization stocks exhibiting relatively higher price momentum. This type of momentum fund is considered a reliable proxy for the general stock market trend. We prefer to use the Heikin-Ashi format to display the Momentum Factor ETF. Heikin-Ashi candlestick charts are designed to filter out volatility in an effort to better capture the true trend. Last week’s analysis stated “…the stock market is setting up for a “dead cat” bounce… equities are excessively oversold and displayed a bullish reversal sign at weeks end. As noted, downward momentum is dissipating which supports a short-term recovery…” This playing out as predicted with the updated chart below highlighting additional bullish reversal signs from the oversold bounce. More definitive is the momentum change from bearish to bullish.

The American Association of Individual Investors (AAII) Sentiment Survey measures the percentage of individual investors who are bullish, bearish, and neutral on the stock market for the next six months; individuals are polled from the ranks of the AAII membership on a weekly basis. The current survey result is for the week ending 01/27/2016. The most recent AAII survey showed 29.80% are Bullish and 40.00% Bearish, while 30.30% of investors polled have a Neutral outlook for the market for the next six months. Last week’s comment is coming to fruition”… The current AAII survey signals a short-term counter trend bounce is overdue based on retail investors’ extremely bearish sentiment…” The bearish reading dropped last week and the bullish number rose, but they signal a follow-through on the current counter-trend bounce.

 

   

Investment Analysis

As reported by The Stock Trader Almanac, the January Barometer has only been wrong eight times since 1950 for an 87.9% accuracy ratio. This indicator adheres to propensity that as the S&P 500 goes in January, so goes the year and including the eight flat years yields a .758 batting average. Following the Santa Claus rally’s “no-show,” January’s First Five Days were the worst on record. The Dow Jones Industrial Average violated its December closing low of 17128.55 on the third trading day and today the January Barometer is officially negative. The January indicator trifecta is negative across the board. Since 1950, this is only the eighth time that all three indicators were negative and the DOW’s December closing low was violated. Of the previous seven occasions, February was up just twice with an average loss in all seven of 1.9% for S&P 500. However, the next 11 months and full-year S&P 500 was mixed, up four and down three albeit with a negative average performance. The graph below confirms investors trading “risk off” since the start of the year, as the only profitable asset classes are bonds and gold.

By Gregory Clay

Investment Strategist

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gregoryclay@theoptionplayer.com

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Why Stock Market Is Ready To Bounce

Market Summary

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The stock market is reacting to the four "black swan" events since the year started (the heated Iran/Saudi Arabia conflict, China's stock market drop, North Korea's bomb testing and China's Yuan devaluation). The S&P 500 posted a weekly loss of 6% and the Dow Jones Industrial Average dropped 6.2%. It was the worst weekly percentage loss for stocks since September 23^rd, 2011. This also marks the worst opening week of the year in history for both the S&P 500 and the Dow. Meanwhile, the Nasdaq Composite ended down 7.3% over the week. The chart below indicates stocks have actually been in the crapper the past six months. During this time the major equity indexes have only briefly been above water before the bottom really fell out the past few weeks. Treasury bonds are the only asset class to hold up consistently.

  

A standard chart that we use to help confirm the overall market trend is the Momentum Factor ETF (MTUM) chart. Momentum Factor ETF is an investment that seeks to track the investment results of an index composed of U.S. large- and mid-capitalization stocks exhibiting relatively higher price momentum. This type of momentum fund is considered a reliable proxy for the general stock market trend. We prefer to use the Heikin-Ashi format to display the Momentum Factor ETF. Heikin-Ashi candlestick charts are designed to filter out volatility in an effort to better capture the true trend. Taking a look at the weekly MTUM chart shows the price is at the 50-week moving average support level. As highlighted in the chart, this support has held firm for several years and the MTUM usually recovers higher the week after falling to this point.

  

The American Association of Individual Investors (AAII) Sentiment Survey measures the percentage of individual investors who are bullish, bearish, and neutral on the stock market for the next six months; individuals are polled from the ranks of the AAII membership on a weekly basis. The current survey result is for the week ending 01/06/2016. The most recent AAII survey showed 22.20% are Bullish and 38.30% Bearish, while 39.60% of investors polled have a Neutral outlook for the market for the next six months. Individual investors have been turning extremely negative as the market moves into correction territory. As a reliable contra indicator the current AAII survey signals a short-term counter trend bounce based on retail investors’ overly bearish sentiment.

  

Investment Analysis

If there is any consolation to the miserable start to the New Year, it may be that the sizable selloff has triggered a “buy” signal from a technical perspective with 88% of all global equity markets trading below their 200-day moving average and 50-day moving average according Michael Hartnett, chief investment strategist at Bank of America Merrill Lynch. There hasn't been a bear market in the U.S. since the Great Recession. And even after the atrocious start to the current year, Wall Street still is not approaching a bear market. The major indexes have to plunge 20% below their previous high to be in bear market territory. The S&P 500 is down about 9% from its record highs of last year. The Dow and Nasdaq ended the week down 10%, officially falling into correction mode. But lurking beneath the surface, the outlook appears a lot worse. As of Friday almost half of the stocks in the S&P 500 have crumbled at least 20% below their 52-week highs, according to FactSet data. Small-cap stocks are considered more risky than large caps and are getting hit a lot harder. The average small-cap stock is now down nearly 30% from its peak, putting it firmly in bear-market status. "So many things are breaking down that the chance of the overall market breaking down is higher than at any time in several years," said Ryan Detrick, an independent market strategist. "I don't see another bear market. The true bear markets happen when the economy goes into recession. This economy is not falling off a cliff," said Detrick.

As mentioned previously, some technical indicators are signaling an imminent countertrend recovery bounce and there is still a lot of time for the market to rebound and finish January with a gain. A positive January Barometer reading improves the full-year outlook, especially with the recent penchant for the market to rebound just as sharply as it sells off. In the graph below the only winning S&P 500 sector over the past month is Utilities. Similar to Treasury bonds, investors are putting funds into Utility company stocks as a safe-haven during the current market turmoil. FANG stocks (Facebook, Amazon, Netflix and Google) are holding up better than the rest of the market. These stocks might be the best bet for investors looking to trade a countertrend bounce because they will probably lead the recovery. Also, the Dollar was the top-performing asset last year excluding dividends, so sitting on cash is always a sound investment during market uncertainty.

  

By Gregory Clay

Investment Strategist

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Most Crucial Week Of Year For Stocks

Market Summary

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A standard chart that we use to help confirm the overall market trend is the Momentum Factor ETF (MTUM) chart. Momentum Factor ETF is an investment that seeks to track the investment results of an index composed of U.S. large- and mid-capitalization stocks exhibiting relatively higher price momentum. This type of momentum fund is considered a reliable proxy for the general stock market trend. We prefer to use the Heikin-Ashi format to display the Momentum Factor ETF. Heikin-Ashi candlestick charts are designed to filter out volatility in an effort to better capture the true trend. Last week we said, “…after recovering from the market bottom to start the fourth-quarter, the overall stock market has been contained inside a trading range… Expect this trend to continue until after the Federal Reserve interest rate decision in a few weeks…” Despite last week’s market pullback and Friday’s massive drop, you can see in the updated chart below how stocks remain in a long term trading range. However, as highlighted, technical indicators are signaling a market sell-off with momentum starting to turn bearish. Next week is absolutely critical with the Fed interest rate decision on Wednesday and triple-witching option expiration at weeks end. If the market follows up on last week’s downturn it jeopardizes the year-end price recovery.

  

As reported by the Bank of America, on June 29, 2006, the Federal Reserve did something it would not do again for (at least) nine and a half years: it hiked rates by 25 basis points, its 17th consecutive rate hike. Everyone knows what happened afterwards (approximately a year later the market topped out and then descended into a bear market). This coming Wednesday, the Fed is expected to do something it hasn't done for 3,457 days: hike interest rates, ending the longest period in US history (84 months) of zero interest rates. How has the world changed in the interim? Some quick observations from BofA: Back then US housing starts were booming (2¼ million per annum), a stock market bubble was taking place in Saudi Arabia, another one was forming in China, no one had heard of “Quantitative Easing” and there was no such thing as the iPhone. Today, US housing starts are moribund (around 1 million per annum), the Saudi’s credit rating has just been downgraded, Chinese debt deflation has reduced China’s “growth” opportunity set to babies, tourists & capital outflows, central banks have purchased a remarkable $12,400,000,000,000 of financial assets since Bear Stearns, and the iPhone now powers retail sales. And here is the biggest difference: back then total debt/GDP was 61%, with total debt just over $8 trillion. Now, it is 104%, with the total US debt just shy of $19 trillion.

 

Investment Analysis

Next week is absolutely critical for setting up how the stock market can be expected to perform for the year 2015. If the FOMC announces a rate hike on Wednesday as most pundits expect and signals that future rate hikes will be small and gradual, then that could cause stocks to pop. Investors may interpret the Fed's move as a sign that it is still confident about the economy and job market despite the worries about commodity prices and slowing economic growth overseas. "As long as the Fed hikes rates, there could be a relief rally," said Michael Arone, chief investment strategist with State Street Global Advisors. The S&P 500 and Nasdaq indexes have already fell more than 3% this month. Investors may be pushing the expected start of the Santa Claus rally earlier and earlier each year, similar to retailers putting out their Christmas merchandise the day after Halloween. But the market typically jumps higher at the end December after many traders start holiday vacation. Stocks can have exaggerated moves on low volume. "After the Fed meeting, a lot of big investors are off to St. Kitts or the slopes," Arone quipped. "There will be a lack of liquidity that could drive stocks higher." The chart below confirms that's exactly what happened last year. As noted in the weekly S&P 500 Index weekly chart below, stocks plunged at exactly this time last year, only to recover in the following weeks. If the market does not replicate last year’s behavior and bounce back after the FOMC meeting and option expiration next week that will jeopardize the major equity indexes positive gains for the year.

  

By Gregory Clay

Investment Strategist

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gregoryclay@theoptionplayer.com

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Market Subdued Ahead of Fed Announcement

Market Summary

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Year-to-date, most of the major asset classes are basically flat, but the graph below suggest a stellar fourth-quarter performance for the equity indexes. The market has basically decided that the Fed will moderately raise interest rates at the FOMC meeting in a few weeks and have priced that expectation into stock valuations. Keep in mind the reason this quarter’s performance appears so strong is that stock prices had bottomed out to start the quarter and the market recovery accentuated the quarterly gain. Note, that even after the strong bullish move from the market crash, the major indexes have yet to attain their highs for the year. The graph also confirms the FOMC rate increase expectation is depressing interest rate sensitive asset classes such as bonds and precious metals.

We are betting that most of the major indexes end the year marginally higher based on December being one of the strongest months for average performance and frequency of gains. After the melodrama over the FOMC increasing interest rates for the first time in a decade subsides in a few weeks, stocks are setup to finish strong going into year-end. If the Fed does as everyone expects and moderately raises rates, the removal of uncertainty should catapult stock prices higher. Remember that investors disdain uncertainty and that has been holding back stock prices. Investors are currently ignoring global geopolitical events and unless there is some unexpected major economic crisis, expect stocks to move back toward yearly highs before the end of the month.

Investment Analysis

The updated graph below supports the historical trend for the market’s fade after the thanksgiving holiday as money managers go through year-end sector rotation and tax selling. You can see that after a strong fourth-quarter start, all of the major S&P sectors have pulled back over the past month. The energy sector is the biggest loser and it is probably a good idea to bail out of these stocks until prices stabilize. We believe now is a good time to identify entry opportunities for stocks on your watch list. As recently discussed in the Almanac Trader, pre-election Decembers have been stronger than average with the S&P up 3.2% and NASDAQ up 4.9% in Decembers in the third year of the 4-year cycle. Also, December is usually up sharply in the seventh year of a two-term president’s reign and after a strong October performance like we had this year.

In the weekly S&P 500 Index weekly chart below the green rectangle highlights the fall 2014 market crash and year-end price recovery. We are betting on similar behavior this year. You can see in the chart how this fall’s chart pattern is eerily similar to last year. Stocks began the fourth-quarter in a swoon, but have been trending higher after bottoming out in September. Investors are showing solid gains for the quarter and appear to be cashing in profits by selling into strength (which helps explains the recent triple-digit daily price moves). As evidenced in the chart below, the recent rally will probably soften over the next few weeks until the Fed announces its interest rate decision on December 16th and tax-loss selling starts slowing down. Similar to last year, the stock market is setting up for a strong year-end move as traders perform sector rotation and balance sheet “window dressing”.

By Gregory Clay

Investment Strategist

Click here to Connect on LinkedIn

gregoryclay@theoptionplayer.com

P.S. click on http://www.theoptionplayer.com/ to sign up for a free trading newsletter