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The following is an excerpt from this week’s ‘Weekly Market Letter’ from Market Edge (www.marketedge.com).
Volatile Week Ends Mixed
Another week of extreme volatility left the major averages mixed as investors chewed over higher-than-expected inflation reports in the September PPI and CPI that probably locked in another 0.75-point rate hike at the November FOMC Meeting. Stocks tried to bounce to start the week but were pulled down by selling in technology shares after the US imposed more restrictions on China’s access to semiconductors. The Philadelphia Semiconductor Index sank -3.45% to a one-year low on weakness in Nvidia (NVDA), Advanced Micro Devices (AMD) and Lam Research (LRCX) before closing the week down -8.2%. Equities were lower again on Tuesday as recession fears grew after China enforced more lockdowns as Covid cases increased. Crude oil prices slipped below $90 a barrel on demand concerns despite OPEC’s production cut the previous week. A hotter-than-expected Producer Price Index (PPI) report on Wednesday showed inflation had yet to be tamed as several Fed Committee members came out saying that rates needed to keep moving higher to prevent inflation from becoming embedded in the economy, and a more restrictive policy is needed to restore price stability. An early dip was bought but prices faded again at the close as the S&P 500 finished lower for a sixth-straight session. Inflation flexed again on Thursday as the Consumer Price Index (CPI) came in above expectations. Roller coaster trading sent rates higher and equities sharply lower at the bell, but the different indexes surged higher as quant models kicked in off technical trading and triggered a short covering rally. The DJIA spiked 827.87 points (+2.83%) and the NASDAQ +2.23% in a broad-based rally led by more than 4% moves in the Financial (XLF) and Energy (XLE) sectors. The bi-polar market regained its senses on Friday as the major averages gave up much of the previous days surge as yields moved higher. The yield on the 10-year Treasury crossed above resistance at 4% and landed at 4.017%, while the 2-year T-Bill closed above 4.51%. A strong US dollar weighed on commodities and crude oil prices lost about -8% on the week and settled at $85.78 a barrel. The Consumer Staples (XLP), Healthcare (XLV) and Financial (XLF) sectors managed to post positive for the period, while Consumer Discretionary (XLY), Technology (XLK) and rate sensitive groups Utilities (XLU) and REITs (XLRE) were the weakest market sectors. While the DJIA was able to hold on to some of Thursday’s gains to close higher for a second consecutive week, the S&P 500 and NASDAQ finished lower.
For the period, the DJIA gained 338.04 points (+1.2%) and settled at 29634.83. The S&P 500 lost 56.59 points (-1.6%) and closed at 3583.07. The NASDAQ dropped 331.01 points (-3.1%) finishing at 10321.39. The small cap Russell 2000 gave up 19.75 points (-1.2%), finishing at 1682.40.
Market Outlook: The technical condition of the market was mixed this week as volatile trading saw a midweek rally fade on Friday. The DJIA outperformed the broader market on strength in healthcare and financial components, but the S&P 500 and NASDAQ struggled on more weakness in technology and retail stocks. While the technical indicators for the Dow Jones nudged into neutral ground, the numbers remain negative for most of the other indexes leaving most in oversold territory. The Market Edge/S&P Short Range Oscillator (SRO) ended the period at a marginally oversold -3.72%. On Thursday the S&P 500 finally hit its downside target after retracing 50% of the rally from the March 2020 low to the January 2022 high as the bellwether index traded down to 3491. If that level fails to hold, the next downside target would be 3405. The NASDAQ had previously retraced more than 50% of its March 2020-November 2022 rally and this week broke below support at its 61.8% retracement around 10300 and traded just below our target of 10268. If that level is broken, next support for the NASDAQ is measured at 10,000-10,020 followed by 9440. The DJIA has outperformed the other indexes and hasn’t reached our target of 27940. That target is followed by its 50% retracement level at 27580-27600. Underlying breadth remains weak with the NYSE and NASDAQ Advance/Decline lines, considered leading indicators of market direction, continuing to show the majority of stocks are under distribution and have fallen back to a level last seen in November 2020. New 52-week lows continue to outpace the new highs and both the NYSE and NASDAQ recorded more than 900 new lows on Thursday. After a small uptick in bullish sentiment the previous week, we saw those numbers fall back to extreme bearishness again. The American Association of Individual Investors (AAII) survey shows only 20.4% of retail investors are bullish on the market, while the National Association of Active Investment Managers (NAAIM) Exposure Index fell back to 19.8% exposure to equities after increasing to 38.1% previously.
Thursday’s insane rally in stocks had some traders asking if we could have finally had a capitulation bottom or ‘selling climax’ in this Bear market. Unfortunately, it didn’t meet the tenets of what market technicians would consider a bottom. However, in general, signs of extreme volatility can be an indication that the market is getting close to a top or, in this case, a bottom. Since 09/15/22 the DJIA has closed with a triple-digit gain or loss on 18 of 21 trading days with seven sessions of more than 500-points! That doesn’t include intraday swings like Thursday where the DJIA had a trading range of 1508-points! If you’re waiting for an opportunity to put money back to work, here’s a trader’s tip that you might use to possibly catch the bottom. A selling climax occurs in the final stage of a bear market and can signal the end of a market correction. This set-up usually occurs as the majority of investors are ‘throwing in the towel’ as an index breaks support and experiences a sharp drop in price on high volume. The selling climax occurs when an index or stock opens sharply lower, reverses course, and on heavy, heavy volume finishes up on the day. If one looks at a bar-chart, the bar will make a lower low but close at a higher high. If the next trading day is another up day, traders will use that as confirmation that a bottom could be in. What makes the selling climax noteworthy is that the high volume indicates a change in the psychology of the underlying investor and is an indication that the bulls are back on board. Clearly, with Friday’s drop, we still haven’t seen a capitulation bottom. Stocks may look cheap as we head into earnings season, but they can always get cheaper and investors should stay cautious and hold cash while the Market Edge Market Posture, Bearish as of the week ending 8/26/2022 (DJIA – 32283.40), remains Bearish. 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, unchanged from the previous week. Cycles A and E are bullish, while Cycles 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 -10, down two notches from the previous week. Breadth was negative at the NYSE as the Advance/Decline line lost 2918 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 dropped 3029 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 eased to 22.6% vs. 23.1% the previous week, while those above their 200-day moving average slipped to 19.2% vs. 19.5%. 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 three notches from the previous week. In addition, we track money flows into and out of Equity Funds and ETFs which as of 10/12/22 shows outflows of $2.7 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 ñ 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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