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The following is an excerpt from this week’s ‘Weekly Market Letter’ from Market Edge (www.marketedge.com).
Bulls Stagger Into Q3
Bulls were hoping to build on the previous week’s gains as June was coming to a close, but hawkish comments from the Federal Reserve coupled with rising recession fears doused the rally. Better than expected economic data to start the week left the major averages mixed as yields ticked higher, but defensive groups outperformed, and pharmaceutical companies Eli Lilly (LLY), Merck & Co (MRK) and Bristol-Myers Squibb (BMY) were a pocket of strength hitting new 52-week highs. Fed Committee members tripped up the bulls on Tuesday after raising expectations for a 0.75-point rate hike in July, while data showed consumer spending was slowing. The DJIA reversed a 400-point opening bounce to close with a 490-point (-1.56%) loss with every sector lower except one. Crude oil prices jumped on reports that China would ease travel restriction quarantines for international travelers as it reopened, and Energy (XLE) was the only sector to post positive. The NASDAQ dropped -2.98% on weakness in semiconductors the same day. Equities continued to struggle as the week progressed as recession fears mounted on contracting economic data, but investors tried to put June behind them and ended Friday higher. Despite yields moving lower into the weekend, investors remained defensive sending Utilities (XLU) up +4.12% on the week. Energy (XLE), Consumer Staples (XLP), Healthcare (XLV) also posted positive. Economically sensitive sectors were sharply lower with Consumer Discretionary (XLY), Technology (XLK), Communication Services (XLC) and Materials (XLB) all down more than -3.5%. The yield curve threatened to invert with the yield on the 10-year Treasury sliding to 2.894%, against the 2-year at 2.837%. Commodities were also sharply lower on slowing growth concerns with copper hitting a 17-month low on Friday. Wheat fell more than -10%. Despite Friday’s bounce, the major averages finished down for the fourth time in five weeks as the S&P 500 closed out the worst first-half start of the year since 1970.
For the period, the DJIA lost 403.42 points (-1.3%) and settled at 31097.26. The S&P 500 fell 86.41 points (-2.2%) and closed at 3825.33. The NASDAQ dropped 479.77 points (-4.1%) finishing at 11127.85. The small cap Russell 2000 gave up 37.98 points (-2.2%), finishing at 1727.76.
Market Outlook: The technical condition of the market deteriorated this week as the major averages failed to hold the previous week’s rally. The selloff pulled the technical indicators back into mostly neutral ground. Momentum, as measured by the 14-day RSI, is neutral and while MACD, which gauges the short-term trend, remained bullish. The secondary indexes performed in line with the major averages during the period, but the Philadelphia Semiconductor Index showed negative divergence, sinking -9.6% and hitting a new 19-month low. On a positive note, the iShares Biotechnology ETF (IBB) finished positive and was able to stay above its 50-day MA. IBB is the first index to retrace its June selloff. Last week upside targets, which are still in play, were given for the major averages, but the different indexes will need to hold above the intraday lows from the week ending 6/17/22 for a summer rally to materialize. A close above last week’s intraday high of 3945 on the S&P 500 would be a signal that a summer rally is still in play. The last time stocks lost ground in July was 2014. Underlying breadth also deteriorated with the NYSE and NASDAQ Advance/Decline both losing ground. In addition, we saw new 52-week lows expand daily on both the NYSE and NASDAQ. Despite remaining overly bearish, we saw a small uptick in bullish investor sentiment after last week’s rally.
For all the back-and-forth rhetoric from analysts on whether the Federal Reserve will be able to navigate a soft landing while raising rates, we may have gotten our answer this week. Q1 GDP surprised market participants by showing negative growth and on Thursday, the Federal Bank of Atlanta released its GDPNow tracker which projected Q2 GDP contracted -1.0%. The definition of a recession is two-quarters of negative GDP growth accompanied by a significant rise in unemployment. While the economy doesn’t always fall into a recession after successive negative quarters, and unemployment remains stubbornly low, it’s consumer spending that will tip the scale. Investors are hurting from the worst six-month start of the year for the S&P 500 in 50-years, and I’m not sure consumers are going to feel like spending to prevent a recession. With Q2 earnings being released soon, and estimates and forward guidance being cut, I think we need to keep the defense on the field a while longer.
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 +7, unchanged from the previous week. The CTI is projected to remain positive into August.
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 +5, up a notch from the previous week. Breadth was negative at the NYSE as the Advance/Decline line lost 974 units while the number of new 52-week lows exceeded the number of new highs on all five sessions. Breadth was also negative at the NASDAQ as the A/D line fell 3399 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 increased to 21.4% vs. 19.0% the previous week, while those above their 200-day moving average rose to 16.0% vs. 13.4%. 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 +5, down two notches from the previous week. In addition, we track money flows into and out of Equity Funds and ETFs which as of 6/29/22 shows outflows of $8.0 billion.
Market Posture: Based on the status of the Market Edge, market timing models, the Market Posture is Bullish as of the week ending 6/24/2022 (DJIA – 31500.68).
Ask Mr. Seifert
How Do You Calculate The Probability Of Profit (POP) For A Vertical Credit Spread When Using the Think Or Swim (TOS) Platform?
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 then On Probability Analysis. 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.
Check out the TOS educational video at https://www.google.com/search?q=options+probability+calculator+thinkorswim&rlz=1C1CHBF_enUS750US750&oq=Options+probability+&aqs=chrome.6.0i512l2j69i57j0i512l7.24995j0j15&sourceid=chrome&ie=UTF-8#kpvalbx=_vsK1Yt78H8CckPIP-_yymAs83
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