Hawkish Fed Comments Sink Stocks
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The following is an excerpt from this week’s ‘Weekly Market Letter’ from Market Edge (www.marketedge.com).
Higher and faster were the key words on rates this week that kept downward pressure on the major averages bringing an end to a three-week win streak for the S&P 500 and NASDAQ. The bulls followed Elon Musk to solid gains to start the week after the Tesla CEO revealed he owned a 9% stake in Twitter (TWTR) and announced that Tesla (TSLA) would deliver a record number of cars in the first quarter. Twitter’s +27.02% spike and Tesla’s +5.61% surge gave a boost to growth and tech stocks and the NASDAQ jumped 271.05-points (+1.90%) on the day. The rally was short-lived however as hawkish comments from Fed Governor Lael Brainard on Tuesday erased all of Monday’s rally and then some. Saying the Federal Reserve would begin reducing the Fed balance sheet more rapidly than expected beginning in May and that a tighter monetary policy will remove stimulus and keep policy neutral sent yields sharply higher and the 10-year T-Bill rate landed at 2.71% on Friday, a three-year plus high. The 30-year mortgage rate crossed 5% for the first time since 2013. That pressured home building stocks and the iShares US Home Construction ETF (ITB) traded down to its lowest level since January 2021. The release of the March FOMC Meeting minutes on Wednesday confirmed that the Federal Reserve was behind the curve on rates and yields would rise higher and faster to fight inflation. The major averages sank at the open extending their losses for a second-straight session. Thursday’s mostly better than expected jobs report, which saw Initial Jobless Claims fall to 166k, its lowest level since 1968, brought buyers back in and the different indexes traded mixed on Friday. Defensive sectors again outperformed with Healthcare (XLV) and Energy (XLE) jumping more than 3%, while Consumer Staples (XLP), Utilities (XLU) and REITs (XLRE) were also strong. Growth sectors Technology (XLK), Consumer Discretionary (XLY), Industrials (XLI) and Communication Services (XLC) were the weak links.
For the period, the DJIA eased 97.15 points (-0.3%) and settled at 34721.12. The S&P 500 gave up 57.58 points (-1.3%) and closed at 4488.28. The NASDAQ dropped 550.50 points (-3.9%) finishing at 13711.00. The small cap Russell 2000 tumbled 96.55 points (-4.6%), finishing at 1994.56.
Market Outlook: The technical condition of the market deteriorated this week as the major averages tried to hold key moving average (MA) support levels but lost their grip on Friday ending below. Starting with the DJIA, the index traded down to its 50-day MA but closed above it. The blue-chip index remains below both its 100 and 200-day MA. MACD, a short-term trend gauge, and momentum, as measured by the 14-day RSI, are neutral. The S&P 500 struggled to hold above its 200-day MA during the week but remains below its 100-day MA. MACD crossed into bearish ground, while momentum is neutral. The NASDAQ gapped down to its 50-day MA on Wednesday and held on but slipped below both its 50 and 200-day MA on Friday, a bearish condition. MACD is bearish, while momentum is neutral but slowing. The secondary indexes, the small cap Russell 2000, DJ Transportation Index and Philadelphia Semiconductor Index, which market technicians like to see lead the broader market higher and lower, all closed the week below their respective 50-day MA and their technical indicators are in bearish ground. In addition, the secondary indexes continue to underperform the broader market with the Transports down -6.7%, its worst week since October 2020, and the semi’s falling -7.3%. In contrast, the DJ Utility Index hit several new record highs during the period highlighting the move to defense. Internal breadth was negative with the NYSE and NASDAQ Advance/Decline lines showing most stocks are under distribution and both exchanges recorded more new 52-week lows than highs. The number of new lows expanded during the week, though the numbers were skewed by selling in preferred stocks and closed-end bond funds that are sensitive to rising rates. Investor sentiment remains bearish but is no longer considered at extreme levels. While money managers saw a small uptick in bullishness, the American Association of Individual Investors (AAII) survey showed only 24.7% of retail investors are bullish, down from 31.9% the previous week. More telling is a drop in retail bears to 41.4% from only 27.5% the prior week.
Investors continued to rotate into defensive sectors this week as Fed Committee members became more hawkish on rates to contain the worst inflationary environment in 40-years. As the week ended, the CME Group FedWatch puts a 78.8% probability that the Federal Reserve will increase rates 0.50-point at the May 4 FOMC Meeting. This rapid rise in rates has at times led to an inversion in the yield curve, a precursor that the economy could be headed towards a recession within the next year. Historically, according to Blackrock Advisors, Utilities, REITs and Consumer Staples underperform the broader market as rates move higher as the higher dividends offered by these stocks become less attractive. Conversely, these sectors outperform when the economy slows down or slides into a recession. If you believe the Fed will be able to maneuver a soft landing for the economy, it may be time to be a little cautious and begin to lighten up on some of these defensive positions. However, if you’re in the camp that worries higher rates could lead to slower growth or a recession, perhaps this rotation into defensive sectors is hinting that you’re on the right track. Either way, remember to practice sound portfolio management or talk to a financial advisor to protect your assets during this volatile pivot in monetary policy.
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 +10, 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 remain in a Bullish configuration 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 +4, down five notches from the previous week. Breadth was negative at the NYSE as the Advance/Decline line lost 3683 units while the number of new 52-week lows exceeded the number of new highs on three of the five sessions. Breadth was also negative at the NASDAQ as the A/D line fell 5205 units while the number of new lows out did the new highs on four days. Finally, the percentage of stocks above their 50-day moving average fell to 45.6% vs. 55.8% the previous week, while those above their 200-day moving average slipped to 37.3% vs. 41.4%. 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. The Sentiment Index is Positive at +3, up a notch from the previous week. In addition, we track money flows into and out of Equity Funds and ETFs which as of 4/06/22 shows outflows of $253 million.
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).
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Question: How Do You Calculate The Probability Of Profit (POP) For A Vertical Credit Spread When Using the Think Or Swim (TOS) Platform?
Answer: The key element when calculating POP is the Break-Even (BE) price of the credit spread. For example, if you sell a Bullish 100.0 – 95.0 vertical put credit spread for a $2.00 credit (40%) when the underlying is trading at $100.00, the POP calculation is as follows: Subtract the $2.00 credit from the short put strike price (100.0) to get the BE price ($98.00) for the trade. If the underlying settles at $98.00 or higher, the trade will make at least a $0.01 profit. Now click on the Analyze tab and enter the symbol for the underlying. Put the cross hair on the expiration date at the bottom of the chart (x axis) and scroll to the breakeven price on the left side of the graph (y axis). The percentage above the BE price line is the POP for the bullish, put-credit spread.
If you are initiating a Bearish 100.0 – 105.0 vertical call-credit spread, add the credit ($2.00) to the short call strike price (100.0) to get the BE price ($102.00) for the trade. If the underlying settles at $102.00 or lower, the trade will make at least a $0.01 profit. Check the TOS, Analyze screen. The percentage below the BE price line is the POP for the bearish call-credit spread.
Bullish Vertical Put Credit Spread: 1) Subtract The Credit From Short Put SP = BE Price. 2) The % Above The BE Price On The Analyze Screen Is The POP For The Trade.
Bearish Vertical Call Credit Spread: 1) Add The Credit To The Short Call SP =BE. 2) The % Below The BE Price On The Analyze Screen Is The POP For The Trade.
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