Major Averages Post Best Gains Of The Year
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The following is an excerpt from this week’s ‘Weekly Market Letter’ from Market Edge (www.marketedge.com).
Cautious trading on Monday gave way to a powerful four-day rally that saw the major averages turn in their best weekly gains of the year. While investors were waiting on Wednesday’s announcement from the FOMC Meeting on rates, a drop in crude oil prices as China shuttered several cities and plants to contain spreading covid cases triggered a surge in equities. Oil dropped below $95 a barrel and every sector except Energy (XLE) traded higher. The Federal Reserve hiked rates 0.25-point on Wednesday as expected but signaled that they needed to be more aggressive to keep inflation from becoming entrenched. Fed Chair Jerome Powell indicated rate hikes would be live at every meeting with another six anticipated by year-end to corral inflation. Yields moved higher with the 10-year Treasury rate landing at 2.15% and the 2-year at 1.95%. The different indexes initially reversed on the news but turned it around and surged into the close. Better-than-expected economic data on jobs and manufacturing on Thursday helped boost stocks again, and positive comments on peace talks between Russia and Ukraine on Friday kept the rally running into the weekend. While Energy (XLE) snapped a three-week win streak, every other sector finished the period sharply higher. Growth sectors Consumer Discretionary (XLY), Technology (XLK), Financial (XLF), Healthcare (XLV) and Communication Services (XLC) were all up more than +6%. The DJIA closed in the plus column for a fifth-straight session on Friday for the longest daily win streak since December 2021 and the major averages closed the period with their best weekly performance since November 2020.
For the period, the DJIA gained 1810.74 points +5.5%) and settled at 34754.93. The S&P 500 picked up 258.81 points (+6.2%) and closed at 4463.12. The NASDAQ jumped 1050.03 points (+8.2%) finishing at 13893.84. The small cap Russell 2000 added 106.47 points (+5.4%), finishing at 2086.14.
Market Outlook: The technical condition of the market improved this week as the major averages turned in their best weekly gains of the year. The technical indicators are bullish with MACD, a short-term trend gauge, crossing into bullish territory and Momentum, as measured by the 14-day RSI, positive and improving. Despite this week’s surge in prices only the DJ Transportation Index finished the period overbought with stochastic in the 90’s. After making a series of lower highs and lower lows since the beginning of the year the major averages were able to reverse that bearish pattern. The different indexes stayed above last week’s low’s and traded above their March highs. The different indexes are now trading above their respective 50-day MA but remain below their 200-day MA, with the S&P 500 rally stalling at that resistance level. In addition, the indexes have crossed above downward sloping trend lines that served as resistance for several months. This week secondary indexes, the DJ Transportation Index and Philadelphia Semiconductor Index outperformed the broader market which is also a plus. The semi’s surged +9.2%, while the transports soared +8.3% and the transports are now up on the year. Finally, the different indexes have mostly now retraced 38.2% of the January-March decline and are close to retracing 50%. The DJIA has retraced 50% of its decline, a bullish condition. While this is where market technicians expect strong resistance, a move above the 50% level would trigger additional upside. For the S&P 500 it is 4470.
Underlying market breadth improved this week with the NYSE and NASDAQ Advance/Decline lines moving sharply higher showing the rally was broad based. New 52-week lows contracted but still outnumber new highs. This is expected with the indexes so far below former highs but the NYSE posted more new highs than lows on Friday. Investor sentiment still shows investors are overly bearish. This is a contrarian indicator at extreme levels and is bullish at market bottoms. We should see these indicators make a strong move to neutral next week as market participants rush off the sidelines in order not to miss the rally. While retail investors are just as bearish as they were in April 2020, the National Association of Active Investment Managers (NAAIM) Exposure Index shows professionals have been buying equities over the last two weeks and are now 46.7% invested, compared to only 30.3% the first of March.
This week’s rally in the face of the Federal Reserve hiking rates for the first time since 2018 caught some investors off guard. Historically, stocks pullback at the first sign of rate hikes. However, in this case there are several extenuating circumstances that allowed investors to shake off the impact. For one, Fed Chair Jerome Powell made it clear that the economy was strong enough to weather the storm of a series of rate hikes. Kathy Jones, Chief Fixed-Income strategist at Schwab, notes, the rate hike seems very much like [the Federal Reserve] wanted to send a message that they are fighting inflation and they are going to fight it fast and get it under control. In addition, some positives in peace negotiations between Russia and Ukraine are beginning to trickle in which could send global markets sharply higher. Lastly is the rebound in China’s Shanghai Index after the government pledged to support and calm financial markets. That sent Chinese stocks sharply higher during the week recouping 25-30% of losses. Looking ahead, it remains to be seen whether the Fed can navigate a soft landing and side-step a recession as rates rise and sanctions trim growth. While that is a big headwind, at least for now, investors are giving the Fed the benefit of the doubt making this week’s rally looking more like the real thing rather than just a relief rally.
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 +14, up 17 notches from the previous week. Cycles A, B, C, D and E are bullish. The DJIA was able to hold above the previous week’s low allowing for a reset of Cycles A, B and C. This positions the CTI with a Bullish configuration that should remain until June.
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 10 notches from the previous week. Breadth was mixed at the NYSE as the Advance/Decline line gained 4639 units while the number of new 52-week lows exceeded the number of new highs on four of the five sessions. Breadth was also mixed at the NASDAQ as the A/D line added 5741 units while the number of new lows out did the new highs on each day. Finally, the percentage of stocks above their 50-day moving average jumped to 46.9% vs. 32.7% the previous week, while those above their 200-day moving average increased to 39.9% vs. 32.6%. 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. The Sentiment Index is Positive at +6, down a notch from the previous week. In addition, we track money flows into and out of Equity Funds and ETFs which as of 3/16/22 shows outflows of $3.1 billion.
Market Posture: Based on the status of the Market Edge, market timing models, the Market Posture is Bullish as of the week ending 3/18/2022 (DJIA – 34754.93).
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
- 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.
- 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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