Stocks Struggle On Stalled Stimulus
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The following is an excerpt from this week’s ‘Weekly Market Letter’ from Market Edge (www.marketedge.com).
A volatile, seesaw week left the major averages in the red as trading in big cap technology shares dominated market direction. Investors came back from the Labor Day holiday and sold stocks for a third consecutive session on Tuesday after Congress was unable to come to terms on the next coronavirus stimulus package. The NASDAQ traded down to its 50-day moving average after a roughly -10% selloff before the bulls had had enough. Technology shares picked themselves up off the floor on Wednesday and the DJIA was able to regain 439.58 points (+1.60%) and the NASDAQ 293.87 points (+2.71%). Shares of Microsoft (MSFT), Apple Inc. (AAPL), NVIDIA (NVDA) and new Dow component salesforce.com (CRM) led the reversal. The major averages opened higher again on Thursday but were unable to hold on to the gains after a coronavirus stimulus plan was blocked again in Congress. The different indexes gave back all the gains but held Tuesday’s lows. The selling during the week carried over to almost all sectors as only Materials (XLB) eked out a gain. Energy (XLE), Technology (XLK), Financials (XLF) and Communication Services (XLC) were the weakest groups. Energy sank -6.42% after crude oil prices were hit hard as inventories saw a much larger than expected buildup. There were pockets of strength however, as casinos, hotels and travel related stocks outperformed on coronavirus treatment progress and the return of the NFL, while Home Builders also remained strong bolstered by record low interest rates. Blowout earnings from home exercise maker Peloton Interactive (PTON), Oracle (ORCL) and home furnishings retailer RH (RH) all traded sharply despite the market weakness. The bulls gave it another shot on Friday and pushed equities back into the plus column before ending the session mixed leaving the major averages down for a second straight week.
For the period, the DJIA lost 467.67 points (-1.2%) and closed at 27665.64. The S&P 500 tumbled 85.99 points (-2.5%) and settled at 3340.97. The NASDAQ dropped 459.58 points (-4.1%) to 10853.55, while the small cap Russell 2000 gave up 38.03 points (-2.5%) and finished at 1497.27.
Market Outlook:The technical condition of the market deteriorated last week as the major averages were whip-sawed by a lack of progress on the next coronavirus stimulus package and the NASDAQ and S&P 500 traded down to their respective 50-day moving average (MA). It was the first test of that moving average support level since the March selloff. The technical indicators slipped into neutral to bearish readings while MACD, a short-term trend indicator, was in bearish ground for the different indexes. For a second straight week the DJIA and DJ Transportation Index outperformed the broader market, with the transports posting positive, but the small cap Russell 2000 diverged from the broader market and closed the week below its 50-day MA. Traders will need to keep an eye on the small cap index as continued weakness in the small caps could drag the broader market down with it. The NASDAQ and S&P 500 were able to bounce off their 50-day MA on Friday, but a break below that level opens the door for a deeper correction.
The SPDR Technology (XLK) and Communication Services (XLC) sectors also struggled to hold support at their 50-day MA, while Healthcare (XLV) was unable to hold its 50-day MA and closed below it. The Energy ETF (XLE) continued to weaken on supply and lack of demand issues and is now trading at April levels. Financials (XLF) were trying to hold above the 50-day MA on Friday and remained below its 200-day MA. In addition, during the NASDAQ’s last leg up, the VIX was showing negative divergence nudging higher, while the market was rising. This negative divergence in the VIX and some of the leading market sectors during the rally off the March lows could be indicating that the market is preparing to take another leg down if the current support levels are broken.
Breadth deteriorated further and has been signaling a market top is in for several weeks. The NYSE and NASDAQ Advance/Decline lines, leading indicators of market direction, are showing negative divergence as they have been moving lower as the major averages have been rising showing that more stocks are under distribution and the new highs were made on strength in a few big cap stocks. Furthermore, new 52-week highs have been contracting for several weeks and the NASDAQ has had more stocks hitting new 52-week lows than highs on several days over the last two weeks. Again, negative divergence that indicates stocks may have further to fall.
Investor sentiment has been reigned in somewhat as the market trades lower and is now mixed. While the Percentage of Bullish Advisors has been signaling a warning that advisors are too bullish for seven weeks, hedge fund managers have gone from 106.6% equity exposure to 53.1% exposure in two weeks. That indicates that fund managers were on margin two weeks ago but have cut equity exposure in half. The American Association of Individual Investors (AAII) is also becoming less bullish and this week the percentage of bullish retail investors fell to its lowest reading since the first week of August.
It is still possible that the major averages will stay in a trading range, but at this stage, after the NASDAQ’s 10% correction, a deeper selloff may be in the cards. The back and forth trading helped the different indexes work off their overbought condition, but the market isn’t oversold. Big cap tech shares still look expensive and may have further to fall before becoming attractive to buyers. If the 50-day MA doesn’t hold next week for the NASDAQ and S&P 500 next support will come in at 10500 for the NASDAQ and 3250 for the S&P 500.
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.
Cyclical Trend Index (CTI): 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 +11, down two notches from the previous week. Cycles B, C, D and E are bullish, while cycle A is bearish. The CTI is projected to stay positive into September.
Momentum Index (MI): 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 +4, down two notches from the previous week. Breadth was mixed at the NYSE as the Advance/Decline line lost 2141 units while the number of new 52-week highs out did the new lows on all five days. Breadth was also mixed at the NASDAQ as the A/D line fell 1414 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 dropped to 45.0% vs. 63.3% the previous week, while those above their 200-day moving average fell to 51.0% vs. 55.5%. Readings above 70.0% denote an overbought condition, while below 20% is bullish.
Sentiment Index (SI): 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 9/09/20 shows outflows of $1.9 billion. Currently, the Sentiment Index is Negative at -2, up a notch from the previous week.
Market Posture: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). For a closer look at the technical indicators and studies that make up the market timing models, check out the tables located below.
| Market Timing Models | Current Reading | Prior Week | Connotation | ||||||
| Cyclical Trend Index (CTI): | 11 | 13 | Positive | ||||||
| Momentum Index: | 4 | 6 | Positive | ||||||
| Sentiment Index: | -2 | -3 | Negative | ||||||
| Strength Index – DJIA (DIA): | 51.7 | 75.9 | Positive | ||||||
| Strength Index – NASDAQ 100 (QQQ): | 46.9 | 55.1 | Negative | ||||||
| Strength Index – S&P 100 (OEX): | 47.9 | 66.0 | Negative | ||||||
| Dow Jones Industrial Average (DJIA): | 27665.64 | 28133.31 | -1.7% | ||||||
| S&P 500 Index: | , | 3340.97 | 3426.96 | -2.5% | |||||
| NASDAQ Composite Index: | 10853.55 | 11313.13 | -4.1% | ||||||
| **Connotation is Positive or Negative Divergence from the DJIA | |||||||||
Ask Mr. Seifert
Question: What is ‘The Three O’Clock Ting’ and how do I handle it?
If you have ever been short an option (put or call) you have probably experienced what we call ‘The Three O’Clock Ting’ which happens on expiration day if your option is trading in the money. Since all of the Optionomics strategies involve the selling of one form or another of a credit spread, you are going to run into this situation from time to time.
When you are short one option, you can be assigned the underlying stock which means that if you are short a put, you could end up being long 100 shares of the underlying at the close on expiration day. If you are short one call, you could end up being short 100 shares of the underlying. If your short option is either in or near to being in the money, your friendly broker will usually either call you or send you an e-mail to see what you want to do. This usually happens around 3:00 on expiration day which is usually Friday. The following is an example of an e-mail you may receive if you sold a CVX 90 – 92 call credit spread and the stock is trading above $90.
Your CVX short – $90 call option expires today. If CVX closes above $90, you’ll likely be assigned to sell 100 shares of CVX for $90 per share leaving you short 100 shares of stock.
or
Your CVX long – $92 call option expires today. It will exercise automatically if CVX closes above $92 leaving you long 100 shares of stock at $92. If you can’t buy 100 shares of CVX, we’ll sell your option about an hour before market close
If this happens, here are your options:
- If your short option is out of the money and you think it will expire worthless, don’t do anything. Pocket the doe and move on.
- If the option is in the money and looks like you will be assigned, you can buy back the short option and that would be the end of it. You will either have a small profit if the option is trading below where you sold it or a small loss if the option is trading above where you sold it.
- If you have sufficient funds in your account, the broker should leave things alone and let you get assigned. You will end up on Monday morning with either a long (short put) or short (short call) position of 100 shares of the underlying stock.
- If you don’t have sufficient funds in your account to cover an assignment, your broker will cover the short part of your credit spread at around 3:00 at the market price which is usually a bad deal. Here is why.
Remember, the reason you are short the option in the first place is to take advantage of the inherent time decay (theta) of the option’s premium which occurs as it approaches expiration. You would be surprised how much premium can be remaining in an option with only one hour remaining until expiration. Assuming the underlying stock’s price remains the same through the close, that premium should be yours, not the market maker. The only way to keep this remaining part of the premium is to be able to wait it out which you can do if you have sufficient funds in your account to cover the asssignment. This way you can close the position closer to 4:00 and book the doe which can add up over time.
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