Dow Lower for Third Straight Week
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The following is an excerpt from this week’s ‘Weekly Market Letter’ from Market Edge (www.marketedge.com).
It was an ugly start and finish this week as investors prepared for the start of Q1 earnings against a backdrop of soaring inflation, rising rates, China’s shutdown to fight spreading Covid and the war in Ukraine. Stocks tumbled on Monday as yields climbed to a three-year plus high with the rate on the 10-year Treasury landing at 2.828%. The selloff was across the board with losses in Energy (XLE), after oil fell on demand concerns from China’s lockdown, and Technology (XLK) the biggest drag on the market. A -5.20% drop in NVIDIA (NVDA) after a downgrade sent the Philadelphia Semiconductor Index (SOX) into a Bear market, down -24% from its January high. A hot Consumer Price Index (CPI) on Tuesday, showing prices jumped +8.5% YoY, had a silver lining in that the Core CPI, ex-food and energy, showed a small decrease. Although Wednesday’s Producer Price Index (PPI) spiked +11.2% YoY, core inflation again was less than expected and equities rallied on hopes that we may have seen a ‘peak’ in surging inflation. Growth sectors helped boost the NASDAQ more than +2% on the day. The DJ Transportation Index was also strong led by Delta Airlines (DAL) after the company topped earnings estimates and raised guidance on increasing demand. The major averages were mixed on Thursday as investors turned their focus to earnings. Despite disappointing reports from Money Center Banks JP Morgan Chase (JPM) and Wells Fargo & Co (WFC), investors gave a pass on strong results from Morgan Stanley (MS) and Goldman Sachs (GS) after beating estimates and offering solid guidance. Crude oil prices reversed Monday’s dip after OPEC said it would be impossible to make up for the loss in Russian production and oil prices surged +12% from Monday’s close settling at $106.27 per barrel. The market sectors were mixed for the week with Energy (XLE) and Materials (XLP) finishing higher, while Technology (XLK) dropped -5.13%. Communication Services (XLC), Healthcare (XLV) and Financials (XLF) were the other weakest sectors. The NASDAQ dropped another -2% as the week came to a close leaving the tech heavy index and the S&P 500 down for a second straight week, while the DJIA lost ground for a third consecutive week.
For the period, the DJIA fell 269.89 points (-0.8%) and settled at 34451.23. The S&P 500 gave up 95.69 points (-2.1%) and closed at 4392.59. The NASDAQ dropped 359.92 points (-2.6%) finishing at 13351.08. The small cap Russell 2000 bucked the trend and picked up 10.42 points (+0.5%), finishing at 2004.98.
Market Outlook: The technical condition of the market deteriorated this week as the major averages inched lower and remained below key moving average support levels. The technical indicators for the different indexes are negative with MACD, a short-term trend gauge, in bearish territory and Momentum, as measured by the 14-day RSI, in neutral to negative ground and slowing. Secondary indexes, the small cap Russell 2000 and DJ Transportation Index, were able to bounce back from the previous week’s decline, but the transports were coming off an oversold -6.7% drop that was the worst weekly performance since October 2020. Defensive segments of the market continue to outperform showing investors are concerned with slowing growth or worse, a possible recession with the DJ Utility Index trading just below its all-time high, and the Utilities (XLU), REITs (XLRE), Consumer Staples (XLP) and Healthcare (XLV) sectors at or, near record highs. Primary growth sectors, Technology (XLK), Consumer Discretionary (XLY) and Communication Services (XLC) are down 16%-22% but are holding above the February and March lows which is constructive. A break below those levels would be a negative for the broader market. Underlying breadth remains weak with the NYSE and NASDAQ Advance/Decline lines, leading indicators of market direction, continuing to lose ground, while stocks making new 52-week lows outnumber new highs by a wide margin. In addition, volume is below average and Wednesday’s tepid bounce in the NYSE was on the lowest volume of the year. Finally, investor sentiment remains overly bearish, and the retail investor may be throwing in the towel. While the number may be skewed by the short holiday week, the American Association of Individual Investors (AAII) survey showed only 15.8% of retail investors are bullish, that’s the lowest number of bulls in 30-years, while the bears hit their highest number since mid-March at 48.4%. That extreme low reading in the percentage of retail bulls, however, is considered a positive for contrarian investors. The professionals are also becoming more bearish with the National Association of Active Investment Managers (NAAIM) Exposure Index falling to 63.3%, down from 83.4% a week ago.
Market participants are keeping a keen eye on inflation data with some analysts projecting, or more likely hoping, that we could be seeing a peak in inflationary pressures after this week’s slight decline in core inflation prices. If that is the case, then the presumption is that the Federal Reserve would be able to rein in their aggressive outlook for higher rates in the latter half of the year making a recession less likely. While it is possible that we are seeing a top in prices, the stock market isn’t ready to rally yet, and the bond market is dubious. Former Treasury Secretary Larry Summers in an interview this week noted, “there has never been a moment when inflation was above 4% and unemployment was below 5% when we did not have a recession within the next two years.” Next week Q1 earnings and rising rates will keep volatility high while investors wait on the Fed’s May FOMC Meeting on May 3-4. That should lead to more back and forth trading keeping the major averages range bound over the next few weeks. That range for the DJIA is 33,000 to 35,250 and 4200-4600 for the S&P 500. The NASDAQ should stay between 12,800 and 14,600.
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 +10, unchanged from the previous week. Cycles B, C, D and E are bullish, while Cycle A is bearish. The CTI is projected to remain in a Bullish configuration until June.
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 Neutral at +2, down two notches from the previous week. Breadth was negative at the NYSE as the Advance/Decline line fell 604 units while the number of new 52-week lows exceeded the number of new highs on all four sessions. Breadth was also negative at the NASDAQ as the A/D line lost 1533 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 rose to 46.3% vs. 45.6% the previous week, while those above their 200-day moving average increased to 37.9% vs. 37.3%. 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 markets 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, unchanged from the previous week. In addition, we track money flows into and out of Equity Funds and ETFs which as of 4/13/22 shows outflows of $9.6 billion.
Market Posture: Based on the status of the Market Edge, market timing models, the Market Posture is Bullish as of the week ending 3/18/2022 (DJIA – 34754.93).
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Question: How Do You Calculate The Probability Of Profit (POP) For A Vertical Credit Spread When Using the Think Or Swim (TOS) Platform?
Answer: 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 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.
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