Stocks Stay Positive on Stimulus Hopes
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The following is an excerpt from this week’s ‘Weekly Market Letter’ from Market Edge (www.marketedge.com).
The major averages were able to post record highs this week as Covid-19 vaccines from Pfizer (PFE) and Moderna (MRNA) began distribution around the globe. It was an uphill climb however, as members of Congress failed to pass a relief bill to help workers and businesses affected by the coronavirus, as well as a bill to keep the government open beyond the weekend. The market traded mixed on Monday, but the NASDAQ and Russell 2000 were able to hit all-time highs on Tuesday after legendary investor Warren Buffett threw his support into the fray for needed stimulus. The NASDAQ punched another record high on Wednesday after the December FOMC Meeting concluded and left interest rates unchanged, leaving no doubt that the Federal Reserve would keep monetary policy accommodative to help the economy recover from the coronavirus slowdown. The Fed’s dovish outlook helped move mortgage rates to a record low giving a boost to Home Builders and the iShares Home Construction ETF (ITB) soared more than +7% on the week. The US Dollar moved to its lowest level since 2018 giving a boost to commodities and emerging markets. The iShares Emerging Markets ETF (EEM) traded at an all-time high, while copper, a leading indicator of economic growth, hit a seven-year high. Bitcoin surged 27% this week and the crypto currency was flirting with $23000 as the period ended. Technology (XLK) was the best performing sector, up more than +3% for the week, while Consumer Discretionary (XLY), Materials (XLB) and Healthcare (XLV) also outperformed. Interest sensitive sectors REITs (XLRE) and Utilities (XLU) were also higher. Energy (XLE) dropped -4.22% and was the only sector in the red. Small caps continued to lead the stock market rally as the Russell 2000 stepped higher for a seventh straight week and is up a whopping +28% since the end of October! Investors held out hope that our elected leaders would end their party infighting and come to the rescue of their constituents on Friday, but stocks sold off on discouraging news out of Washington and a positive week ended on a sour note.
For the period, the DJIA added 132.68 points (+0.4%) and closed at 30179.05. The S&P 500 gained 45.95 points (+1.3%) and settled at 3709.41. The NASDAQ outperformed adding 377.77 points (+3.1%) to 12755.64, while the small cap Russell 2000 picked up 58.29 points (+3.0%) and finished at 1969.99.
Market Outlook: The technical condition of the market remained positive this week as the major averages punched new record highs on Thursday before consolidating the gains on Friday. The technical indicators are positive, and Momentum belongs to the Bulls. Small caps and semiconductors continue to lead the rally, which is a positive going forward. The different indexes did finish overbought by several measures once again, however. More than 90% of stocks are now trading above their 200-day moving average (MA) and the S&P 500 trades about 16% above its 200-day MA. Both of those indicators need to be reined in and call for some consolidation and a return to the mean over the near-term. The rally remains widespread as every sector is at or near recovery highs, while Technology (XLK) and Consumer Discretionary (XLY) traded at all-time highs. Underlying breadth is also strong with the NYSE Advance/Decline line, which shows whether stocks are under accumulation or distribution, hitting a new high this week. New 52-week highs are expanding showing broad leadership in the rally. As has been the case for several weeks however, investor sentiment remains too bullish and complacent. Margin debt is at its highest level since May 2018 and as last week’s IPO frenzy showed, speculation could be nearing a ‘bubble’. While this isn’t a reason to sell the market, it is a red flag, and it wouldn’t hurt investors to take a more cautious approach.
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.
Currently, the CTI is Positive at +12, unchanged from the previous week. Cycles A, B, C, D and E are bullish. The CTI projects a Bullish market cycle into the first of the year.
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 +6, up a notch from the previous week. Breadth was positive at the NYSE as the Advance/Decline line added 802 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 picked up 2317 units while the number of new highs beat the new lows on each session. Finally, the percentage of stocks above their 50-day moving average rose to 84.6% vs. 81.7% the previous week, while those above their 200-day moving average increased to 90.2% vs. 89.8%. 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 12/16/20 shows outflows of $11.8 billion. Currently, the Sentiment Index is Negative at -5, unchanged 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 11/13/2020 (DJIA – 29479.81). For a closer look at the technical indicators and studies that make up the market timing models, check out the tables located below.
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Ask Mr. Seifert
What is the anatomy of the Basic Strategy – Bull-Bear Credit Spreads?
The Basic Strategy Credit Spreads Trades have favorable outcomes in three out of four possible scenarios and should be profitable in any type of market environment. The following is an example of the possible outcomes of a weekly, bullish put credit spread. The opposite scenarios would apply to bearish, call credit spreads.
Possible Scenarios Results
- Stock closes up, above the short option strike price. Full Win– 100% of the credit amount.
- Stock closes unchanged, at the short option’s strike prices. Full Win– 100% of the credit amount.
- Stock closes down by a small amount (less than 1%). Partial Win– A percentage of the credit amount.
- stock closes down by a large amount. Full Loss – The width of the spread less the amount of the credit.
Example Of A Weekly, Bullish Put Credit Spread:
Stock Price = $100.00
Spread Width = 5.0 Points
Credit Spread = Short Weekly 100.0 Put, Long Weekly 95.0 Put (5.0 Wide Spread).
Spread Credit (40%) = 2 Points or $200.
- Stock Closes Higher – $100.00 or higher. Spread Closes @ 0.0. Full Win $200.
- Stock Closes Unchanged – $100.00. Spread Closes @ 0.0. Full Win $200.
- Stock Closes Lower (-1%) – $99.00. Spread Closes @ 1.0. Part Win $100.
- Stock Closes Lower – $95.00 or lower. Spread Closes @ 5.0. Full Loss $300.
Like a casino, winning is a fine line and is predicated on the percentage amount of credit spread and the correct forecasted direction of the stock. Breakeven results should occur if over time you sell the spread for a 40% credit, are right on the stock’s direction by 52.0% (Full Win) and not wrong by more than 1% – 62.0% (Full & Part Win). If the Full Win percentage increases to 55.7% and the Full & Part Win percentage increase to 66.6%, approximately a 4% improvement, the results should look like the following:
Risk Capital: $3,000 (10 x Maximum Risk Per Trade)
Five Trades Per Week – Full Win = 55.7%. Full & Part Win = 66.6%. Full Loss 33.4%.
- Full Win 8 Trades $5.57
- Part Win .5 Trades $ .55
- Full & Part Win 3 Trades $6.12
- Full Loss 7 Trades $5.01
- Net Weekly Win 0 Trades $1.11
- Weekly % Gain 0 Trades 3.7%
- Annualized % Gain 250 Trades 191.5%
The ideal situation is when you get the direction of the stock right and have a 40% or higher credit. The second ideal situation is when you get the direction of the stock almost right (small stock loss) and have a 40% or higher credit. The worst situation is when you get the direction of the stock wrong by a lot and have less than a 40% credit.
Credit spread amounts – 40% the width of the spread.
1.0 point wide = $ 0.40
2.0 point wide = $ 0.80
2.5 point wide = $ 1.00
5.0 point wide = $ 2.00
The computer algorithms used to pinpoint stocks for both Long and Short credit spreads are the same that are used to generate identify Long, Neutral and Avoid Opinions on the Market Edge web site. The Market Edge Opinions have a history dating back to 1995. Over that period of time, they have demonstrated a history of being correct better than 70% of the time with the winners outperforming the losers by a 3:1 ratio. Since the holding period for the option selections is very short, usually less than a week, the time periods used in the Market Edge algorithms have been shortened considerably.
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