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The following is an excerpt from this week’s ‘Weekly Market Letter’ from Market Edge (www.marketedge.com).
Dow Slides to New Low for the Year
The DJIA and S&P 500 were on a six-day losing streak to start the week as yields nudged higher after the Federal Reserve hiked rates by 0.75-point the previous week. The 10-year T-Bill rate flirted with 4% while the 2year Treasury yield hit 4.32%, its highest mark since 2007. Better than expected economic data added to market volatility as the Dow surged 350-points on Tuesday before erasing the morning rip to close lower. The “good news is bad news” market kept pressure on stocks as several Fed Committee members emphasized that rates were going to stay higher for longer to corral inflation. Investors debated whether the tightening monetary policy was throwing the economy into a recession and both the DJIA and S&P 500 put in new lows for the year. The Bulls got a relief rally on Wednesday after the Bank of England announced it would be buying bonds to prop up their economy and pension programs, and the major averages turned in their best daily performance since July 19, with the DJIA surging 548.75 points (+1.88%), the NASDAQ +2.05%, and the small cap Russell 2000 +3.30%. A strong jobs report on Thursday however, sent investors running for the exits once again as Initial Jobless Claims fell 16k and dropped below 200k for the first time since April. The different indexes erased the previous day’s gains, as the jobs data opened the door for a 0.50- or 0.75-point hike in November. The August PCE came in hotter than estimates on Friday with core-PCE up +4.9% YoY vs. +4.7% the prior month helping to trigger another selloff. Crude oil prices briefly traded back above $80 a barrel before closing at $79.76 which helped the Energy (XLE) sector finish the period higher. Rate sensitive sectors were some of the weakest market groups with Utilities (XLU), REITs (XLRE) and Consumer Staples (XLP) sharply lower, followed by losses in Technology (XLK), Consumer Discretionary (XLY), Communication Services (XLC) and Industrials (XLI). At Friday’s close, investors were glad to bid September adieu as the major averages fell for a third consecutive week and wrapped up their worst month since March 2020, sitting at new lows for the year.
For the period, the DJIA lost 864.90 points (-2.9%) and settled at 28725.51. The S&P 500 gave up 107.61 points (-2.9%) and closed at 3585.62. The NASDAQ dropped 292.31 points (-2.7%) finishing at 10575.62. The small cap Russell 2000 slipped 14.87 points (-0.9%), finishing at 1664.72.
Market Outlook: The technical condition of the market deteriorated this week as the major averages traded sharply lower for a third consecutive week with most indexes at new 52-week lows. The technical indicators remain in negative ground with stochastics showing the different indexes are in an oversold condition. The DJIA, S&P 500, DJ Transportation Index and Philadelphia Semiconductor Index closed the period at their lowest levels since November 2020. While the NASDAQ and Russell 2000 were able to hold support at their June lows, both indexes have retraced more than 50% of their March 2020 low to November 2021 high leaving next support at the 61.8% retracement. The DJIA and S&P 500 are both close to retracing 50% of their rallies which will be a closely watched support level for traders. Despite this week’s selloff, we haven’t yet seen a capitulation bottom and further weakness is probable. Although the VIX spent the week above 30, we need to see a spike to at least 40 before a selloff would be considered a capitulation bottom. With the major averages oversold, by several measures, an oversold bounce is likely over the near-term. Underlying breadth deteriorated with the NYSE and NASDAQ Advance/Decline lines showing strong distribution and are now below the levels reached at the June lows. The A/D lines are looked upon as leading indicators of market direction and the slide in the NASDAQ A/D line points to the index most likely taking out support at the June low soon. New 52-week lows continue to expand, and the NYSE recorded more than 1,000 on Monday. Investor sentiment is at an extreme level indicating that investors may be throwing in the towel. Extreme readings are looked at as contrarian indicators which also suggests that we could be nearing a market bottom. The American Association of Individual Investors (AAII) survey showed more than 60% of retail investors are bearish for a second week. Previous to this, we last saw this many retail bears in 2009 at the bottom of the Financial Crisis. Professionals are also surrendering, with the National Association of Active Investment Managers (NAAIM) Exposure Index falling to 12.6%, down from 71.6% in mid-August. With Q3 earnings out in two weeks, look for continued volatility as analysts trim estimates, keeping pressure on equities. The downside target for the DJIA is 27942 followed by the 50% retracement of the March 2020-January 2022 rally at 27580-27600. The S&P 500 target is 3528 followed by its 50% retracement of the March 2020-January 2022 rally at 3490-3500. The NASDAQ has already retraced 50% of its rally and has support at 10268.
While many analysts have focused on the inverted yield curve between the 10-year/2-year Treasury, the Federal Reserve seems to focus on the 10-year/3-month T-Bill, which gives some insight as to why Fed Chair Powell believed he could still navigate a soft landing for the economy in the face of soaring rates. The Federal Reserve Bank of New York prints a table of Estimated Recession Probabilities for Probit Model Using the Yield Curve Spread. The yield spread at the end of August was 0.215, which put a recession probability at about 25%, 12-months out but has risen to 0.62 on Friday as September ended. That could put pressure on the Federal Reserve to tap the breaks to prevent a policy error that brings on a recession. Like any leading indicator or forecasting tool, one needs to use caution when interpreting its usefulness, but this yield spread has accurately predicted each of the last seven recessions. You can check in on how the current yield changes the probability of a recession by going to https://www.newyorkfed.org/medialibrary/media/research/capital_markets/Prob_Rec.pdf
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 Negative at -11, down three notches from the previous week. Cycle E is bullish, while Cycles A, B, C and D are bearish. The CTI is projected to remain in a negative configuration into October.
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 -8, down a notch from the previous week. Breadth was negative at the NYSE as the Advance/Decline line lost 2412 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 2319 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 dropped to 12.6% vs. 16.6% the previous week, while those above their 200-day moving average fell to 12.3% vs. 17.4%. 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 +7, up two notches from the previous week. In addition, we track money flows into and out of Equity Funds and ETFs which as of 9/28/22 shows outflows of $11.8 billion.
Market Posture: Based on the status of the Market Edge, market timing models, the Market Posture is Bearish as of the week ending 8/26/2022 (DJIA – 32283.40).
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What is the VIX Index and how is it calculated?
VIX is the ticker symbol for the CBOE’s volatility index. It shows the market’s expectation of 30-day volatility. It is constructed using the implied volatilities of a wide range of S&P 500 index options. This volatility is meant to be forward looking and is calculated from both calls and puts. It is a widely used measure of market risk and is also referred to as the “investor Fear Gauge”.
The CBOE designed the VIX to create various volatility products. VIX was the first successful attempt at creating and implementing such an index. Introduced in 1993, it was originally a weighted measure of the implied volatility of eight S&P 100 at-the-money put and call options. Ten years later, in 2004, it was expanded to use options based on a broader index, the S&P 500, which allows for a more accurate view of investors’ expectations of future market volatility. VIX values greater than 30 are generally associated with a large amount of volatility because of investor fear or uncertainty, while values below 20 generally correspond to less stressful, even complacent times in the markets.
VIX is a computed index, much like the S&P 500 itself, although it is not derived based on stock prices. Instead, it uses the price of options on the S&P 500, and then estimates how volatile those options will be between the current date and the option’s expiration date. The CBOE combines the price of multiple options and derives an aggregate value of volatility, which the index tracks.
While there is not a way to directly trade the VIX, the CBOE does offer VIX options, which have a value based on VIX futures and not the VIX itself. Additionally, there are 24 other volatility exchange-traded products (ETPs) for the VIX, bringing the total number to 25.
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