DJIA and S&P 500 Post New Highs
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The following is an excerpt from this week’s ‘Weekly Market Letter’ from Market Edge (www.marketedge.com).
It was a roller coaster week as investors were whipsawed by sharp moves in the major averages, both up and down. A bounce in technology shares on Monday, following the previous week’s drubbing, sent the tech heavy NASDAQ up +1.23%, but the rebound stalled at its 50-day moving average (MA). The rally was short-lived however, as expanding shutdowns in Europe threatened to slow the global economic recovery, and testimony on Capital by Fed Chair Jerome Powell and Secretary-Treasurer Janet Yellen took a more cautious tone on the US recovery. A second-day of testimony on Wednesday saw an early bounce erased by the close and the major averages ended the session at the lows of the day. Despite Initial Jobless Claims falling below 700K for the first time since last April, the different indexes tumbled again at the opening bell on Thursday. This time however, buyers came in after the S&P 500 held support at its 50-day MA and equities rallied into the close with the DJ Transportation Index hitting a new all-time high. The bulls were leaning forward again on Friday and a higher opening picked up steam in the afternoon and the major averages surged into the weekend. The late rally pushed the DJIA, S&P 500 and DJ Transportation Index to new record highs. The rally took on a more defensive posture this week as REITs (XLRE), Consumer Staples (XLP), Energy (XLE) and Utilities (XLU) were the strongest sectors, while Communication Services (XLC) and Consumer Discretionary (XLY) lagged the broader market and closed lower. Communication Services was hit by 50% drops in shares of media stocks Viacom (VIAC) and Discovery (DISCA). Commodity traders were in a tug of war with crude oil prices swinging +/- 4% on several days while straddling $60 a barrel before ending at $60.82. Speeches by several Fed Committee members helped settle inflation fears and interest rates held steady for most of the period with the 10-year T-Bill yield closing Friday at +1.68%, but inflation concerns lingered in the background. That helped bring the VIX below 20 for the first time since February 2020 as traders grew more at ease with the recent increase rates. After the dust settled, the major averages closed out the week mixed as cyclical and reopening stocks benefited from ongoing rotation out of technology shares. While the DJIA and S&P 500 finished higher, the NASDAQ and small cap Russell 2000 closed lower for a second straight week.
For the period, the DJIA added 444.91 points (+1.4%) and closed at 33072.88. The S&P 500 gained 61.44 points (+1.6%) and settled at 3974.54. The NASDAQ lost 76.52 points (-0.6%) to close at 13138.72, while the small cap Russell 2000 dropped 66.07 points (-2.9%) finishing at 2221.48.
Market Outlook:The technical condition of the market was mixed this week as the major averages struggled for direction in volatile trading early, but managed to rally into the Friday’s close. The technical indicators for the DJIA and S&P 500 are mostly positive and Momentum, as measured by the 14-day RSI, is bullish. The technical indicators for the NASDAQ and Russell 2000 however, have slipped into negative ground. Momentum is bearish for the NASDAQ and neutral for the small cap Russell. Stochastics for the NASDAQ and Russell 2000 fell into the 30’s which are a sign the indexes are close to being oversold and due for a bounce. Key moving average (MA) support levels were successfully tested this week with the S&P 500 bouncing off its 50-day MA, while the NASDAQ was able to find support at its 100-day MA. The NASDAQ also found support at this level during selloffs in November and early March, which marked the bottom during those periods of weakness and could help boost prices. The small cap Russell 2000, which had corrected -10% off its high earlier in the week, managed to reclaim its 50-day MA on Friday. The Philadelphia Semiconductor Index (SOX) also was able to clear that hurdle after surging +3.2% on the week. The DJ Transportation Index continues to outperform, and this week the Airlines and Trucking Industry Groups were two of the strongest which bodes well for cyclical stocks and the Industrial sector. Breadth was weaker however, and is showing negative divergence with the NYSE Advance/Decline line eking out a small gain, while the NASDAQ A/D line dropped 3394 units. New 52-week lows topped new highs several times during the period for the first time since late October which is also a red flag. This negative divergence in internal breadth needs to be monitored over the coming week. Despite this weakness, the A/D line for the NYSE is still only about 2000 units off its all-time high showing the distribution in shares has been limited on the NYSE.
Investor bullish sentiment has been creeping up and bears watching. There are mixed signals here as the National Association of Active Investment Mangers (NAAIM) cut exposure to 57.5 this week, but according to the American Association of Individual Investors (AAII), retail investors are at their most bullish (50.9%) since the first week of January. In addition, FINRA Customer Margin Balance hit a record high of $813,680,000, while short interest at the NYSE jumped +2.8% mid-March, and the NASDAQ short interest spiked +5.6%! Some of these are contrarian indicators and again show conflicting outlooks for the market going forward.
The negative divergence and conflicting signals, coupled with the Market Edge Cyclical Trend Index (CTI), which is projected to turn bearish over the next few weeks, are clouding the market outlook and investors may want to consider taking a more defensive position. While interest rates were steady this week, they could easily begin to rise again if economic data continues to come in better than expected. Stimulus checks are due to arrive this week and along with increased vaccinations, should give the US economy another boost which will once again stoke inflation fears. Market momentum should carry the major averages higher over the next few weeks but heading into Q1 earnings, valuations are going to become a problem for this bull market. It may not be an accident that defensive sectors were the best performers this week.
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 +8, unchanged from the previous week. Cycles A, B, C and E are bullish, while cycle D is bearish. The CTI is projected to remain in Bullish Territory into April.
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 Negative at -4, down five notches from the previous week. Breadth was mixed at the NYSE as the Advance/Decline line added 184 units while the number of new 52-week lows out did the new highs on three of the five sessions. Breadth was negative at the NASDAQ as the A/D line dropped 3394 units while the number of new lows beat the new highs on three days. Finally, the percentage of stocks above their 50-day moving average fell to 56.4% vs. 65.5% the previous week, while those above their 200-day moving average eased to 84.8% vs. 86.4%. 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 3/24/21 shows inflows of $10.9 billion. That marks a seventh consecutive week of inflows. Currently, the Sentiment Index is Negative at -3, down 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 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.
| Market Timing Models | Current Reading | Prior Week | Connotation | ||||||
| Cyclical Trend Index (CTI): | 8 | 8 | Positive | ||||||
| Momentum Index: | -4 | 1 | Negative | ||||||
| Sentiment Index: | -3 | -2 | Negative | ||||||
| Strength Index – DJIA (DIA): | 55.2 | 48.3 | Positive | ||||||
| Strength Index – NASDAQ 100 (QQQ): | 49.0 | 52.1 | Negative | ||||||
| Strength Index – S&P 100 (OEX): | 51.6 | 47.3 | Positive | ||||||
| Dow Jones Industrial Average (DJIA): | 33072.88 | 32627.97 | 1.4% | ||||||
| S&P 500 Index: | , | 3974.54 | 3913.10 | 1.6% | |||||
| NASDAQ Composite Index: | 13138.72 | 13215.24 | -0.6% | ||||||
| **Connotation is Positive or Negative Divergence from the DJIA | |||||||||
Ask Mr. Seifert
How does a short-term (one week) long/short stock trading strategy compare to selling bull/bear credit spreads?
Forecasting short-term price movements in stock prices is a tough proposition. However, it can be done with some sort of consistancy and when successful can be a very profitable endeavor. There are five possible scenarios that can occur when implementing a long stock trading strategy. Following is the outcomes for each scenario. Short trade results would be a mirror image of these scenarios.
Possible Scenarios Results
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- Stock closes up by lot above the open price. Unlimited % Gain
- Stock closes up a by a small amount above the open price. Small % Gain.
- Stock closes unchanged. No % Gain/Loss
- Stock closes down by a small amount. Small % Loss
- Stock closes down by a large amount. Unlimited % Loss
As can be seen from the table, only two of the possible scenarios result in a gain when trading stocks while a large, adverse move can result in a significant, unlimited loss. While the last scenario can be hedge somewhat by the use of stop loss orders, there is no guarantee that you can limit your downside.
Next we will take a look at the likely outcomes of a one-week trading strategy which involves the selling of bull/bear, vertical credit spreads. Like above, this strategy has five possible scenarios but there are favorable results in four of the likely outcomes. The following are the possible scenarios of selling a weekly, bullish put-credit spread. The opposite scenarios would apply for a bearish, call-credit spread strategy.
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- Stock closes up by lot above the open price. Full Win – Full % Gain – Limited
- Stock closes up a by a small amount above the open price. Full Win – Full % Gain – Limited
- Stock closes unchanged. Full Win – Full % Gain – Limited
- Stock closes down by a small amount (less than 1%). Part Win – Small % Gain
- Stock closes down by a large amount. Full Loss- Full % Loss – Limited
As can be seen from the table, four of the five possible scenarios result in a gain. In addition, if the stock closes down by a large amount, the loss is always limited to the width of the spread minus the credit amount. Finally, the credit spread strategy, whether long or short can be profitable in any type of market environment.
Ironically, option trading is typically regarded as a risky proposition. The fact is that selling credit spreads can be a lot less dicey than trading stocks which have unlimited risk. Credit spreads have a defined maximum loss which is the width of the spread minus the credit amount. If a big loss occurs while trading stocks, it could take a long time to get back in the green while the option strategy keeps chugging along. Plus, a trading strategy that produces 60% winners will work great when selling credit spreads but not necessarily when trading stocks because of the unlimited loss potential. Finally, selling credit spreads provide three more profitable outcomes than do trading stocks.
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