Slowing Economy Stalls Rally
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The following is an excerpt from this week’s ‘Weekly Market Letter’ from Market Edge (www.marketedge.com).
Following a strong start to the New Year, stocks turned weaker as mixed economic indicators point to a slowing economy which is seeking a broader relief package. With Covid-19 cases continuing to rise both domestically and globally and political turmoil continuing to dominate headlines, the broader indexes were lower at the start of the week. Social Media stocks led a decline of -1.3% on the NASDAQ on Monday due to regulation fears as President Trumps accounts were canceled. Despite a softer JOLTS report on Tuesday, the major averages managed to post higher and were led by cyclical and interest sensitive stocks while FAANG stocks continued to get hammered. Following a solid Consumer Price Index (CPI) reading and Fed Chair Powell’s comments that a zero-interest rate environment is likely be extended for the foreseeable future on Wednesday, the NASDAQ was able to recoup some its prior losses as it finished up +56.52 points, but the other major averages underperformed. The need for more stimulus was apparent on Thursday as jobless claims numbers disappointed, jumping from 965K vs. 800K expected. The announcement of President-elect Joe Biden’s $1.9T coronavirus relief package helped equities find firmer footing. Delta Airlines (DAL) also beat on Q4 revenues and projected 2021 to be a turnaround year for the industry. Continued selling in big cap technology and FAANG names ended the session mixed. On Friday, the Commerce Dept reported U.S. Retail Sales fell for a third straight month, declining another -0.7% in December, and the DJIA started the session down more than 300 points before investors bought the dip by the afternoon. Crude oil prices ended the week unchanged after briefly surging near the $54 a barrel area before consolidating those earlier gains. The gains in Crude oil helped the Energy (XLE) sector rise another +3.21% during the period. Yields ended the week slightly lower as the yield on the 10-year Treasury ended at +1.09%. Rate sensitive sectors REITs (XLRE), Utilities (XLU), and Financials (XLF) were the only market sectors to post positive. Communications Services (XLC), Technology (XLK), Consumer Staples (XLP), Materials (XLB) and Consumer Discretionary (XLY) all underperformed during the period.
For the period, the DJIA snapped a three-week winning streak, as it posted lower by 283.71 points (-0.9%) and closed at 30814.26. The S&P 500 tumbled 56.43 points (-1.5%) and settled at 3768.25. The NASDAQ also snapped a three-week winning streak and finished down by 203.48 points (-1.5%) to 12998.50, while the small cap Russell 2000 outperformed picking up 31.18 points (+1.5%) and finished at 2122.84.
Market Outlook:The technical condition of the market was mixed this week as the major averages turned in their worst weekly loss since the end of October, but the DJ Transportation Index, small cap Russell 2000, NYSE and Philadelphia Semiconductor Index broke out to new highs. The technical indicators for the big three indexes deteriorated with MACD ST, which gauges the short-term trend of the index, crossing into bearish ground, while Momentum, as measured by the 14-day RSI, was slipping into Neutral territory. The different indexes worked off some of their overbought condition after the 14-day RSI for the NASDAQ and Russell 2000 fell back below 70. However, the stock market remained overbought by several other measures and further consolidation is needed before moving to new highs. Despite weakness in the major averages, transports, small caps and semiconductors moved higher which bodes well for the broader market. Market technicians would prefer to see these indexes lead the market. The sectors were mixed with Energy (XLE) outperforming followed by gains in REITs (XLRE) and Financials (XLF), while Communication Services (XLC), Technology (XLK), Consumer Staples (XLP) and Materials (XLB) closed in the red. The Energy sector has powered +13.3% y-t-d reaching a new recovery high on Thursday. Weakness in over weighted big cap technology and the FAANG names masked underlying accumulation in smaller cap names in technology. Internal breadth was positive as most stocks were under accumulation and the NYSE Advance/Decline line hit several new highs during the week. The NASDAQ A/D line was at a new recovery high. New 52-week highs also expanded with the number of new highs on the NASDAQ hitting 607 on Thursday, one of the highest daily numbers ever recorded. Investor sentiment remains too bullish however, and several of the indicators monitored are bumping up against extreme readings again. The National Association of Active Investment Managers (NAAIM) jumped to 106.8 this week meaning that institutional investors are buying on margin, while the Percentage of Bullish Advisors landed above 60% for an eighth straight week and has been flirting with its record high of 66.7% recorded in January 2018. The DJIA dropped about -12.5% over the next two months after that extreme reading. These levels do not initiate a sell signal, but they do raise a red flag of caution.
The stock market shrugged off the political turmoil in Washington this week and investors seem to have ‘sold the news’ after Biden’s stimulus plan. Instead, the focus has returned to delays in getting the coronavirus vaccine distributed as the pandemic continues to spread even more rapidly with new variants. Without broad dispersion of a vaccine, global economies are going to see more shutdowns and restrictions before we see what an explosion of pent-up economic activity and demand could be. As vaccines work their way through political red tape, we will see a return to normalcy and for that reason, investors need to stay the course despite what could be a period of increasing volatility. The underlying strength in breadth shows that stocks are under accumulation and we could see a melt up in stock prices once the coronavirus looks to be under control. Dips will continue to be bought and upside targets for this bullish cycle are 32,135 for the DJIA, 3900 for the S&P 500 and 13,700 for the NASDAQ.
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 +9, unchanged from the previous week. Cycles B, C, D and E are bullish, while Cycle A is bearish. The CTI projects a Bullish market cycle through January 2021.
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, down two notches from the previous week. Breadth was positive at the NYSE as the Advance/Decline line gained 711 units while the number of new 52-week highs out did the new lows on four out of five sessions. Breadth was also positive at the NASDAQ as the A/D line gained 1538 units while the number of new highs beat the new lows on four out of five sessions. Finally, the percentage of stocks above their 50-day moving average fell to 81.9% vs. 84.7% the previous week, while those above their 200-day moving average eased to 90.1% vs. 90.2%. 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. In addition, we track money flows into and out of Equity Funds and ETFs which as of 1/13/21 shows inflows of $5.4 billion. Currently, the Sentiment Index is Negative at -4, down a notch from the previous week.
Market Posture: Based on the status of the Market Edge, market timing models, the ‘Market Posture’ is Bullish as of the week ending 11/13/2020 (DJIA – 29479.81). For a closer look at the technical indicators and studies that make up the market timing models, check out the tables located below.
| Market Timing Models | Current Reading | Prior Week | Connotation | ||||||
| Cyclical Trend Index (CTI): | 9 | 9 | Positive | ||||||
| Momentum Index: | 5 | 7 | Positive | ||||||
| Sentiment Index: | -4 | -4 | Negative | ||||||
| Strength Index – DJIA (DIA): | 41.4 | 51.7 | Negative | ||||||
| Strength Index – NASDAQ 100 (QQQ): | 47.9 | 60.4 | Negative | ||||||
| Strength Index – S&P 100 (OEX): | 45.2 | 49.5 | Negative | ||||||
| Dow Jones Industrial Average (DJIA): | 30814.26 | 31097.97 | -0.9% | ||||||
| S&P 500 Index: | , | 3768.25 | 3824.68 | -1.5% | |||||
| NASDAQ Composite Index: | 12998.50 | 13201.98 | -1.5% | ||||||
Ask Mr. Seifert
How does a short-term (one week) long/short stock trading strategy compare to selling bull/bear credit spreads?
Forecasting short-term price movements in stock prices is a tough proposition. However, it can be done with some sort of consistancy and when successful can be a very profitable endeavor. There are five possible scenarios that can occur when implementing a long stock trading strategy. Following is the outcomes for each scenario. Short trade results would be a mirror image of these scenarios.
Possible Scenarios Results
- Stock closes up by lot above the open price. Unlimited % Gain
- Stock closes up a by a small amount above the open price. Small % Gain.
- Stock closes unchanged. No % Gain/Loss
- Stock closes down by a small amount. Small % Loss
- Stock closes down by a large amount. Unlimited % Loss
As can be seen from the table, only two of the possible scenarios result in a gain when trading stocks while a large, adverse move can result in a significant, unlimited loss. While the last scenario can be hedge somewhat by the use of stop loss orders, there is no guarantee that you can limit your downside.
Next we will take a look at the likely outcomes of a one-week trading strategy which involves the selling of bull/bear, vertical credit spreads. Like above, this strategy has five possible scenarios but there are favorable results in four of the likely outcomes. The following are the possible scenarios of selling a weekly, bullish put-credit spread. The opposite scenarios would apply for a bearish, call-credit spread strategy.
- Stock closes up by lot above the open price. Full Win – Full % Gain – Limited
- Stock closes up a by a small amount above the open price. Full Win – Full % Gain – Limited
- Stock closes unchanged. Full Win – Full % Gain – Limited
- Stock closes down by a small amount (less than 1%). Part Win – Small % Gain
- Stock closes down by a large amount. Full Loss- Full % Loss – Limited
As can be seen from the table, four of the five possible scenarios result in a gain. In addition, if the stock closes down by a large amount, the loss is always limited to the width of the spread minus the credit amount. Finally, the credit spread strategy, whether long or short can be profitable in any type of market environment.
Ironically, option trading is typically regarded as a risky proposition. The fact is that selling credit spreads can be a lot less dicey than trading stocks which have unlimited risk. Credit spreads have a defined maximum loss which is the width of the spread minus the credit amount. If a big loss occurs while trading stocks, it could take a long time to get back in the green while the option strategy keeps chugging along. Plus, a trading strategy that produces 60% winners will work great when selling credit spreads but not necessarily when trading stocks because of the unlimited loss potential. Finally, selling credit spreads provide three more profitable outcomes than do trading stocks.
‘Traders’ And ‘Investors’ Results
| ‘Traders’ Results | 21st Century Covered Call Results | ||||||
| Performance Since Week Ending 1/04/19 | Performance Since Week Ending 11/06/17 | ||||||
| S&P 500: | 01/04/19 | 2485.74 | S&P 500: | 11/06/17 | 2591.10 | ||
| S&P 500: | 01/15/21 | 3768.25 | S&P 500: | 01/15/21 | 3768.25 | ||
| S&P 500 Points Gain/Loss: | 1282.51 | S&P 500 Points Gain/Loss: | 1177.15 | ||||
| S&P 500 % Gain/Loss: | 51.6% | S&P 500 % Gain/Loss: | 45.4% | ||||
| Risk Capital: | $15,000 | Risk Capital: | $100,000 | ||||
| Optionomics Traders $ P/L: | $9,399 | Optionomics Covered Call $ P/L: | $31,771 | ||||
| Optionomics Traders % P/L: | 66.9% | Optionomics Covered Call % P/L: | 31.8% | ||||
| Last Week’s Traders % P/L: | 6.4% | Last Week’s Covered Calls % P/L: | -1.0% | ||||
| Put-Call Hedge Results | The Billionaire Risk Reversal Results | ||||||
| Performance Since Week Ending 1/26/18 | Performance Since Week Ending 04/12/19 | ||||||
| S&P 500: | 01/26/18 | 2872.87 | S&P 500: | 04/12/19 | 2907.41 | ||
| S&P 500: | 01/15/21 | 3768.23 | S&P 500: | 01/15/21 | 3768.25 | ||
| S&P 500 Points Gain/Loss: | 895.36 | S&P 500 Points Gain/Loss: | 860.84 | ||||
| S&P 500 % Gain/Loss: | 31.2% | S&P 500 % Gain/Loss: | 29.6% | ||||
| Risk Capital: | $100,000 | Risk Capital: | $50,000 | ||||
| Optionomics Put-Call Hedge $ P/L: | $40,556 | Optionomics Billionaire Trade $ P/L: | $242,242 | ||||
| Optionomics Put-Call Hedge % P/L: | 40.6% | Optionomics Billionaire Trade % P/L: | 484.5% | ||||
| Last Week’s Put-Call Hedge % P/L: | -0.7% | Last Week’s Billionaire Trade % P/L: | -10.9% | ||||
FREE Two-Week Trial Subscription
| The option ‘Trades’ and ‘Strategies’ offered by the Optionomics Group are unique in that they all have limited risk while creating great leverage. Our basic Bullish – Bearish Credit Spread Trade lets you control 100 shares of a $200 stock, a $20,000 position for less than $500 or 40:1 leverage. Your maximum risk is always limited, and our strategies produce winning trades in three out of four possible outcomes.
Optionomics let you become the casino whereby you have a mathematical edge that enables you to grind out consistent returns. These strategies are designed to produce good returns over short to intermediate-term time frames in any type of market environment. Optionomics offers a FREE Two-Week trial to its entire web site with no cost or strings attached. Each of the strategies are explained in a 5-7 page booklet and a video which includes detailed explanations and sample recommendations. During the trial, you can paper trade the various strategies and get a feel for the deal without risking a penny. Simply click on the appropriate tab on the Optionomics’ Home page to access the informative booklets and then sign up for the trail. As a special offer, you can download a FREE copy of my latest book, “Trading Options My Way”. I doubt that you have ever read anything like this. The ‘Traders’ Subscription Includes The Following: · The Bullish – Bearish Credit Spread Trade: A basic strategy to trading weekly credit spreads. · The One Day Wonder Trade: A one day trade with great consistency and upside potential. · The Blow Off Top – Bottom Trade: A lot of action and big moves too. · The Earnings Season Trade: Potential big movers with little or no downside risk. The ‘Investors’ Subscription Includes The Following: · The 21st Century Covered Call Strategy: A modern day alternative to the old-fashioned covered call strategy. · The Low Cost Put-Call Hedge Strategy: Sleep at night knowing your portfolio is protected for little or no cost. · The Billionaire Risk Reversal Strategy: Big time leverage – small time risk. Each Monday morning by 11:00 EST, the recommendations for each strategy are posted on the Optionomics’ web site. In addition, the updated results from the previous week are posted on the Optionomics’ Scoreboard. You can subscribe to either the Traders or the Investors plans at an introductory special of only $39.95 each per month on a month to month basis with no contract or strings attached. That’s $10.00 off the regular monthly subscription rate ($49.95). If you subscribe to both it is only $64.95 per month. I think you will agree that this is a super offer so give it a try. Go to www.optionomicsgroup.com and get started today doing what the pros do – “Don’t Buy Them – Sell Them” Mr. Seifert
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