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The following is an excerpt from this week’s ‘Weekly Market Letter’ from Market Edge (www.marketedge.com).
Major Averages Finish Volatile Week Mixed
A volatile week ended with the major averages mixed as investors juggled higher yields and the prospects of lowered earnings revisions for Q4. Economic data was also mixed as weaker-than-expected housing numbers and builders’ sentiment was offset by continuing strength in the jobs market. Back and forth daily swings in equities left the different indexes little changed and investors wondering if Santa would be a no-show, but the major averages did manage to close out the period with modest gains on Friday. The Energy (XLE) sector was strong, up +4.26%, as crude oil prices ticked higher throughout the week, briefly crossing above $80 a barrel on Friday on an expected drop in Russian exports after a price cap. Utilities (XLU), Financials (XLF), Consumer Staples (XLP) and Healthcare (XLV) also outperformed. Selloffs in shares of Tesla (TSLA), Apple (AAPL), semiconductors and big cap tech technology kept pressure on Consumer Discretionary (XLY) and Technology (XLK) sectors which were the weakest market groups. The Bank of Japan joined global Central Banks in raising rates to battle inflation and the yield on the 10-year US Treasury responded by closing the period at 3.75%, while the two-year T-Bill rate landed at 4.32%. Friday was the official start to what is referred to as the Santa rally, which spans the last five-trading days of December and the first two-days of January. While we’re off to a positive beginning, wicked weather threatens to ground St. Nick before he gets started. The DJIA inched higher on the week, but the S&P 500 and NASDAQ extended their losses for a third consecutive week as the major averages head into the holidays.
For the period, the DJIA added 283.47 points (+0.9%) and settled at 33203.93. The S&P 500 eased 7.54 points (-0.2%) and closed at 3844.82. The NASDAQ dropped 207.55 points (-1.9%) finishing at 10497.86, while the small cap Russell 2000 gave up 2.49 points (-0.1%) finishing at 1760.93.
Market Outlook: The technical condition of the market was little changed keeping its negative slant as the major averages finished the period mixed. The technical indicators for the different indexes are in negative territory with MACD, a short-term trend gauge, bearish and Momentum, as measured by the 14-day RSI, negative and slowing. While the DJIA remains above its 200-day MA, the blue-chip index struggled to hold support at its 50-day MA. The Dow Jones is also battling its descending trend line off the January-October highs and the blue-chip index is once again trading below its August high having retraced 38.2% of the October-December rally. Next support area for the DJIA is 32200-32450. The S&P 500 is now trading below its 200, 100 and 50-day MA but found support at 3800 this week. A break below that level would open the door to a move down to 3700-3720 over the near-term followed by support at 3570. The NASDAQ is below its 50-day MA and remains in a range between 10200 and 11400 that has been in place since September. The tech heavy index has also retraced more than 50% of the October-December bounce which should present a retest of the October low at 10080. The secondary indexes aren’t providing any support or positive divergence suggesting more weakness in January. While the DJ Transportation Index and Philadelphia Semiconductor Index found support at their 50% retracement level of the October-December rally, a small win for the bulls, the small cap Russell 2000 fell below that support area and targets 1675, another -4.5-5% downside. Underlying breadth remains bearish with the NYSE and NASDAQ Advance/Decline lines losing ground for a third consecutive week showing the majority of stocks are under distribution. New 52-week lows outdid the new highs on both exchanges and continue to expand. The NASDAQ last recorded more new highs than lows in a week in mid-August. Investor sentiment took a turn for the worse with more Bears appearing in both retail and professional surveys. According to the American Association of Individual Investors (AAII) only 20.3% of retail investors are bullish, the lowest percentage since the end of September. The National Association of Active Investment Managers (NAAIM) Exposure Index saw a drop from 71.6% equity exposure to only 39.4%. That’s the lowest percentage since the stock market bottomed in October. These sentiment indicators are considered contrarian indicators when they reach extreme levels and could hint at an upside surprise in January. Finally, Refinitiv Lipper US Fund Flows reported negative Equity Fund Outflows for a fifth straight week. December usually will see positive fund flow into equities due to an influx of money coming in from end of year bonuses and retirement plan contributions and this reinforces that investors remain bearish on equities. We’ve seen $68.3 billion in Equity Fund Outflows since the last week of November.
Earnings for Q4 will roll out the third week of January and they are not expected to give equities much support. According to FactSet Research, earnings for the S&P 500 are expected to be lower by -2.8%. That’s a revision down from an expected increase of +3.7% at the end of Q3. While eight of the eleven sectors are projected to show YoY gains, weighing on results will be declines in Financials (XLF), Communication Services (XLC) and Consumer Discretionary (XLY), expected to report double-digit losses. January historically has been a prime time for investors to wade into the market but market participants may want to practice some restraint this year. With 63 S&P 500 companies already issuing lower earnings guidance for Q4 we’re likely to get more cuts over the coming weeks. In addition, with the Federal Reserve planning on more rate hikes in the coming months, forward guidance is likely to be closely scrutinized as well. 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 +6, unchanged from the previous week. Cycles B, C and D are bullish, while Cycles A and E are bearish. The CTI is projected to remain in a positive configuration through December.
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 -4, up a notch from the previous week. Breadth was negative at the NYSE as the Advance/Decline line lost 137 units while the number of new 52-week lows exceeded the number of new high on all five sessions. Breadth was also negative at the NASDAQ as the A/D line dropped 1644 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 fell to 35.4% vs. 38.0% the previous week, while those above their 200-day moving average decreased to 54.7% vs. 56.0%. 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 12/21/22 shows outflows of $19.5 billion.
Market Posture: Based on the status of the Market Edge, market timing models, the Market Posture is Bullish as of the week ending 10/21/2022 (DJIA – 31082.6).
Ask Mr. Seifert
Question: My advisor says to buy debit spreads since they have less risk than a credit spread. Is he right?
Answer: Your broker is referring to the fact that a debit spread will always have less premium risk than a credit spread. However, that doesn’t mean that it has less risk. In fact, it has more risk than a credit spread with the same strike. Here is why. For the debit spread to be profitable it must overcome the premium you paid plus it must move in the price direction that you predicted when you bought it. Even if you are correct in predicting the price movement, it may not move enough to overcome the debit. In short, you have to be right and right. On the other hand, a credit spread can win three ways. The price moves in the direction you predicted, the price doesn’t move at all, or the price moves against you but not as much as the credit you sold. For my money, I would rather have three ways to win and take the larger premium risk. In the long run you can’t beat a credit spread.
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