Transports Drive Market Higher
The following is an excerpt from this week’s ‘Weekly Market Letter’ from Market Edge (www.marketedge.com).
A volatile week saw investors grapple with rising coronavirus cases, while analyzing mixed Q2 earnings, improving economic data and positive early results for a vaccine for Covid-19. Pfizer’s (PFE) vaccine for Covid-19 was granted FDA fast track designation on Monday which triggered a 563.79-point surge (+2.1%) in the DJIA at the bell and the NASDAQ to a new record high. However, calls for states to rollback reopening’s erased the gains by the close leaving the Dow flat and the NASDAQ down -2.13%. A shift from big cap technology names into cyclical stocks during the week kept pressure on the tech heavy NASDAQ, snapping a two-week win streak. That allowed the DJIA and S&P 500 to play some catch-up ball as Industrials (XLI), Materials (XLB) and Healthcare (XLV) jumped more than +5% during the week. Utilities (XLU), Energy (XLE) and Financial (XLF) also outperformed. Technology (XLK) and Communication Services (XLC) finished in the red. Defensive sectors gained ground this week as yields inched lower. the five-year T-Bill hit a new low of .26% on Friday and the 30-year mortgage hit a record low on Thursday, falling to 2.9%. That gave a boost to Homebuilders and the DJ Homebuilders Index spiked +6.5% during the week. The Money Center banks reported mixed earnings but shares of Goldman Sachs (GS) and Morgan Stanley (MS) rallied on better than expected results from trading revenues. The DJ Transportation Index and small cap Russell 2000 saw funds rotate their way as both outperformed the broader market with the Transports soaring +6.3% on the week with gains being driven by trucking stocks and railroads. Knight-Swift Transportation (KNX) and JB Hunt Transportation Services (JBHT) hit all-time highs during the period. Next week we get another heavy dose of Q2 earnings but the overhang of the coronavirus and talk of slowing state reopening’s may keep the major averages range bound ahead of preliminary economic data for Q3.
For the period, the DJIA was able to extend its weekly win streak to three, gaining 596.65 points (+2.3%) to close at 26671.95. The S&P 500 was also higher for third consecutive week adding 39.69 points (+1.2%) and finished at 3224.73. The NASDAQ finished lower by 114.25 points (-1.1%) at 10503.19, while the small cap Russell 2000 jumped 50.64 points (+3.6%) and settled at 1473.32.
<B>Market Outlook:</B> The technical condition of the market improved this week as the DJIA, DJ Transportation Index and Russell 2000 were able to join the S&P 500 and NASDAQ trading back above their respective 200-day moving average. That is the first time the major averages (MA) have all been above that line since mid-February. The technical indicators for the different indexes all showed improvement with MACD, a short-term trend indicator, and momentum, as measured by the 14-day RSI, both in bullish ground. While the NASDAQ consolidated some of its recent gains, the broader market was pushing towards new recovery highs led by the DJ Transportation Index and small cap Russell 2000. Leadership in those indexes is likely to send the major averages closer to new highs as we see positive movement towards a vaccine for Covid-19. Several ETF sectors were able to hit new highs this week including Technology (XLK), Communication Services (XLC), Consumer Discretionary (XLY), Healthcare (XLV) and Materials (XLB). Industrials (XLI) also had a strong week but stalled just below its 200-day moving average.
Market breadth remains positive with both the NYSE and NASDAQ Advance/Decline lines at or just below recovery highs. That shows broad participation in the rally and technicians regard the A/D lines as leading indicators of market direction. New 52-week highs have gradually increased over the last few weeks erasing some of the negative divergence seen earlier. Finally, the Market Edge Strength Indexes for the DIA, OEX and QQQ, which measure the percentage of stocks in the indexes that are under accumulation based on U/D Volume calculations, are all back in bullish territory which is supportive of higher prices. Sentiment however, is seeing too many investors moving into the bulls camp which could be a negative going forward. With the backing of Central Banks, global markets look like they can climb the coronavirus ‘wall of worry’ back to new highs later this year, but after having spiked +50% over the last few months and the major averages somewhat overbought, it wouldn’t hurt to see the rally pause here as we digest Q2 earnings .
A chart of these indicators can be found by going to the Market Edge Home page and clicking on Market Recap, which is on the right-hand side of the page just below the Second Opinion Status numbers.
<B>Cyclical Trend Index (CTI):</B> The underlying premise of the CTI is that the market, as measured by the Dow Jones Industrial Average (DJIA), tends to move in cycles that often resemble sine waves. There are five identifiable cycles, each with different time durations at work in the market at all times.
Presently the CTI is Positive at +2, down two notches from the previous week. The CTI was reset as of the week ending 4/03/20 and the bottom for the cycles was 3/23/20 indicating that a new bull market began on that date. Cycles C, D and E are bullish, while Cycles A and B are bearish. While we could see some sideways action over the next few weeks, cycles A and B are projected to reset to Bullish the first week of August indicating the market should remain strong into the fall.
<B>Momentum Index (MI):</B> The market’s momentum is measured by comparing the strength or weakness of several broad market indexes to the DJIA. Readings of -4 and lower are regarded as bearish since it is an indication that a majority of the broader based market indexes are weaker than the DJIA on a percentage basis. Conversely, readings of +4 or higher are regarded as bullish.
The Momentum Index is Positive at +7, up two notches from the previous week. Breadth was positive at the NYSE as the Advance/Decline line gained 2223 units while the number of new 52-week highs out did the new lows on all five days. Breadth was also positive at the NASDAQ as the A/D line added 1679 units while the number of new highs beat the new lows on each day. Finally, the percentage of stocks above their 50-day moving average jumped to 71.9% vs. 52.5% the previous week, while those above their 200-day moving average increased to 43.3% vs. 35.9%. Readings above 70.0% denote an overbought condition, while below 20% is bullish.
<B>Sentiment Index (SI):</B> Measuring the market’s Bullish or Bearish sentiment is important when attempting to determine the market’s future direction. Market Edge tracks thirteen technical indicators listed below that measure excessive bullish or bearish sentiment conditions prevalent in the market. In addition, we track money flows into and out of Equity Funds and ETFs which as of 7/15/20 shows outflows of -$1.5 billion. Currently, the Sentiment Index is Negative at -2, down a notch from the previous week.
<B>Market Posture:</B>Based on the status of the Market Edge, market timing models, the ‘Market Posture’ is Bullish as of the week ending 5/29/2020 (DJIA – 25383.11).
Ask Mr. Seifert
Question: How should I go about locking in profits on a runaway Bullish Billionaire Risk Reversal Trade?
Good question. We recently had a great Billionaire trade for AAPL which started on 05/05/20 and was set to expire on 07/17/20. Here is how you can lock in profits. This strategy works best when the premium in the deferred long call has dropped way down due to a combination of time and how far the option is in the money. The farther in the money it goes, the smaller the premium. When this happens, the premium in the put and call are the same at a given strike. With AAPL trading around $383, the 07/17 – 300 Put is almost worthless because it is $83 out of the money which means the 07/17 – 300 Call has almost no premium in it (it is all intrinsic value) for the same reason. There is very little chance that AAPL will drop 21.6% between now and 07/17/20.
The AAPL Billionaire trade started off with a 07/17 – 300 Call bought for $16.15. When AAPL closed at 383.68, the Call closed at 83.68 – full parity – no premium left. So on the call, we have made $6,753 on $1,615 of risk (83.68-16.15 = 67.53 – $6,753). That works out to a profit of 418.14% over two months and five days (05/5 to 07/10). If you want to lock in some of that profit BUT don’t want to pay a ton of premium, you can roll up to a 07/17 – 382.5 call which will cost 6.98 and you would lock in almost $6,000 ($6,753 – $698) in profit. You would still be long the stock but at 382.5+6.98 = $389.48. The downside risk is 5.40 for the week (the extra premium plus 1.18 in intrinsic risk). At this point you would have paid $540 to lock in almost all of the intrinsic gain.
Alternatively, you could roll up to a 7/17 – 360 call for 24.60. You would lock in some profits ($6,753 – $2,460 = $4,293) and still have $23.68 in intrinsic value in the call. You would have paid 24.60 for the call so subtract the intrinsic value to find the premium paid ($24.60 -$23.68 = $0.92) This means you now have only $2,368 in intrinsic risk instead of the $6,753 as before. You would have locked in $4,293 of profits on the trade or 265.8% (4293/1615=265.8%) which beats a sharp stick in the eye. You still own a call at 360 which gives you $2,368 of intrinsic risk at the cost of $0.91 in premium.
Using the second method, You only have $0.91 in premium to overcome if AAPL continues to rise over the next week instead of $5.40, and you have locked in a huge portion of the run. If there is a blowback next week, you will be upset but you cannot lose all of the gains. A good way to look at it is you spent $91 to take $4,293 off of the table. If the stock does not move over the next week you will cash the call on Friday for $2,368 giving you a total profit of $6,570 ($4,293 + $2,368 = $6,661 – the $91 premium paid) $6570. Still quite a nice return. Is this slick or what!
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