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The following is an excerpt from this week’s ‘Weekly Market Letter’ from Market Edge (www.marketedge.com).
DJIA Gains for Third Consecutive Week
It was a strong start and finish to another volatile week as investors were upbeat on earnings, while keeping an eye pegged on rising rates. The DJIA crossed above 30,000 on Monday and the rally picked up steam on Tuesday as better-than-expected earnings from Bank of America (BAC), Goldman Sachs (GS), Lockheed Martin (LMT) and others helped send the Dow Jones surging 888.97 points (+3.0%) and the NASDAQ +4.2% over the two-day period. Every sector participated in the run. The major averages opened higher again on Wednesday, but investors faded the gains as political turmoil in the UK disrupted global markets. Crude oil prices jumped despite the Biden administration releasing 15 million barrels from strategic reserves settling at $85.12 a barrel. Higher rates slammed another bounce on Thursday, erasing a 400-point spike in the DJIA, after St. Louis Fed President James Bullard made reference to a 0.75-point rate hike in November and December to corral inflation seemed appropriate. That fed recession fears and the different indexes traded lower for a second day. Although earnings from Verizon (VZ), American Express (AXP) and Snap (SNAP) were mixed on Friday, investors bought an early dip on comments from San Francisco Fed President Mary Daly that it was time to slow rate hikes by year-end. Yields inched lower giving a boost to equities after yields hit their highest mark since 2007. The rate on the 10-year Treasury touched 4.33% before closing the period at 4.22%, while the 2-year T-Bill settled at 4.49% after hitting 4.635%. Every sector posted positive with Energy (XLE) taking the lead, up +8.28%, followed by strong gains in Technology (XLK), Materials (XLB), Consumer Discretionary (XLY) and Industrials (XLI). The DJIA closed higher for a third consecutive week, while the S&P 500 and NASDAQ were able to bounce back from last week’s dip to finish higher.
For the period, the DJIA jumped 1447.73 points (+4.9%) and settled at 31082.56. The S&P 500 added 169.68 points (+4.7%) and closed at 3752.75. The NASDAQ spiked 538.33 points (+5.2%) finishing at 10859.72. The small cap Russell 2000 picked up 59.84 points (+3.6%), finishing at 1742.24.
Market Outlook: The technical condition of the market improved as the major averages were able to bounce back from new lows for the year, hold the lows from the previous week and close the period higher. The technical indicators improved with most pushing into bullish readings. MACD, a short-term trend gauge, is positive for the different indexes, while Momentum, as measured by the 14-day RSI, is positive and rising. The DJIA closed the period higher for a third consecutive week for the first time this year, but the rally stalled at its 50-day MA. After mostly hitting our downside targets, the DJIA, S&P 500 and NASDAQ look poised to extend this week’s gains over the near-term. However, investors may want to remain cautious as there are some mixed signals. For one, the DJ Transportation Index and small cap Russell 2000, which market technicians like to see lead the market higher and lower, underperformed the broader market. The Philadelphia Semiconductor Index, which has lagged the market for several weeks, surged +8.1% which is a positive for stocks, but is coming off a very oversold low. Finally, when the DJIA outperforms all the other indexes, it’s considered a cautious warning. This negative divergence adds a tone of caution to the ongoing rally until we can see some strength in these indexes. In addition, underlying breadth is showing negative divergence which is a red flag. The NYSE and NASDAQ Advance/Decline lines, leading indicators of market direction, made new lows for the year last Friday and were only showing marginal gains before Friday, showing stocks remain under distribution. New 52-week lows, though off the previous week’s totals, expanded during the week pointing to fewer stocks leading the markets advance. Finally, although investor sentiment remains Bearish, we saw an uptick in the number of Bulls in both retail and professional investors. The American Association of Individual Investors (AAII) survey saw retail bulls increase to 22.6%, offsetting a small uptick in the number of bears. Of note however, was a big jump in the National Association of Active Investment Managers (NAAIM) Exposure Index which jumped to 43.3% from 19.8% the previous week. That’s the most exposure to equities since the last week August when it hit 54.9%. While we could see some consolidation over the next week, upside targets for the major averages are 31,300-31,400 for the DJIA and 3900 for the S&P 500. The NASDAQ could trade u to 11550-11600.
The stock market has been held hostage by soaring rates this year which sent the major averages into a bear market, with many stocks losing far more than -20% from their peak, the decline that defines a Bear market. Despite hawkish comments from Fed policymakers that rates will need to go higher until we see a significant break in inflation, we’ve seen several sharp rallies in equities throughout the year as investors hope for a pivot in policy. Friday’s surge in the different indexes was triggered by San Francisco Fed President Mary Daly saying that it’s time to start talking about slowing rate hikes and that the Fed should avoid pushing the economy into an unforced downturn by raising yields too high, too fast. That is the first real hint that we’ll see the Federal Reserve blink ahead of the December FOMC Meeting. The CME Group FedWatch Tool, which shows the probabilities of the Fed’s next move, dropped the odds of a 0.75-point rate hike in December from 75.4% on Thursday, to 48.5% on Friday. It’s my opinion that we’ll begin to see cracks in inflation as we head into the November FOMC Meeting triggering a sharp rally in equities ahead of the meeting. I know after a year like we’ve had that market participants will be ready to jump in, but I caution against chasing the rally and being fully invested. Goldman Sachs and others warned this week that the US economy could see a significant slowdown and a recession in 2023 is likely. That means equities still face headwinds and could struggle once a relief rally over a pause in rates runs its course. If a recession is on the horizon, you’ll want to limit exposure to high growth stocks and keep some powder dry for the next buying opportunity.
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 +13, up 24 notches from the previous week. Cycles A, B, C and D are bullish, while Cycle E is bearish. The CTI is projected to remain in a positive configuration into 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 -5, up five notches from the previous week. Breadth was mixed at the NYSE as the Advance/Decline line gained 1931 units while the number of new 52-week lows exceeded the number of new highs on all five sessions. Breadth was also mixed at the NASDAQ as the A/D line added 2586 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 increased to 23.1% vs. 22.6% the previous week, while those above their 200-day moving average eased to 18.9% vs. 19.2%. 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. The Sentiment Index is Positive at +4, down three notches from the previous week. In addition, we track money flows into and out of Equity Funds and ETFs which as of 10/19/22 shows inflows of $4.1 billion.
Market Posture: Based on the status of the Market Edge, market timing models, the Market Posture is Neutral as of the week ending 10/21/2022 (DJIA – 31082.6).
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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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