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The following is an excerpt from this week’s ‘Weekly Market Letter’ from Market Edge (www.marketedge.com).
Stocks Struggle As Rates Tick Higher
The NASDAQ snapped its five-week win streak this week as a push higher in yields sent equities lower. Still troubled by the blockbuster jobs report from the previous period, investors were cautious to start the week as they waited on Fed Chair Jerome Powell to address the spike in January payrolls. Powell gave both the bulls and bears something to chew on and the DJIA whipped higher and lower in a 600-point range before ending the session higher on strength in oil related stocks and semiconductors. The major averages took a dive on Wednesday led lower by a -3.14% drop in the Communication Services (XLC) sector as Alphabet (GOOGL) tumbled -7.68% on fears that its new AI search engine, Bard, was inferior to Microsoft’s (MSFT) new search engine for Bing. Despite a jump in Walt Disney Co (DIS) after beating earnings on Thursday, the different indexes surrendered early gains as yields ticked higher on comments from Fed officials and JP Morgan Chase (JPM) CEO Jamie Dimon that the Fed Funds target rate was headed to 5-5.25%. The rate on the one-year Treasury flirted with 5% and the CME Group FedWatch projected a 90% probability of a 0.25-point hike in March and another in May. The yield on the 10-year Treasury closed the week at 3.74%, a six-week high, while the rate on the two-year T-Bill landed at 4.51%, last seen in November. The DJIA traded in a 645-point range in volatile trading before a split session on Friday ended mixed despite consumer sentiment jumping to a 13-month high. The back-and-forth trading left every sector except Energy (XLE) in the red as crude oil prices closed in on $80 a barrel after Russia announced a 500,000 barrel a day production cut in response to Western sanctions. The Energy sector soared +4.94%. Communication Services (XLC), Consumer Discretionary (XLY), REITs (XLRE) and Materials (XLB) were the weakest sectors. Despite a strong start to the year, the rally could be running out of gas, as the weight of higher rates left the major averages lower for the week.
For the period, the DJIA eased 56.83 points (-0.2%) and settled at 33869.27. The S&P 500 fell 46.02 points (-1.1%) and closed at 4090.46. The NASDAQ dropped 288.83 points (-2.4%) finishing at 11718.12. The small cap Russell 2000 gave up 66.72 points (-3.4%) finishing at 1918.81.
Market Outlook: The technical condition of the market deteriorated this week as volatile trading left the different indexes lower across the board. Most of the major averages remain above key MA support but the DJIA struggled to stay above its 50-day MA at 33647, while the S&P 500 was unable to hold support at 4100, the November and December highs. The technical indicators are currently mixed with MACD, a short-term trend gauge, crossing into bearish territory for the indexes, while Momentum, as measured by the 14-day RSI, is neutral and slowing. This week’s consolidation did, however, help the different indexes work off their overbought condition. The major averages finished the week back below the August highs after the DJIA, DJ Transportation Index and Philadelphia Semiconductor Index had previously broken above that resistance area, while the Russell 2000 pulled back from its bearish Double Top chart pattern at its August and February highs. In addition, after breaking out of Bullish Point & Figure chart patterns the NASDAQ and Russell 2000 have aborted those breakouts and are now trading in a bearish P&F formation. Finally, the secondary indexes including the DJ Transportation Index, the small cap Russell 2000 and the Philadelphia Semiconductor Index, underperformed the major averages showing negative divergence which could signal more weakness ahead. These indexes often lead the broader market higher and lower.
Underlying breadth was negative as the NYSE and NASDAQ Advance/Decline lines lost ground, and on Friday, the NASDAQ turned in more new 52-week lows than highs for the first time since December. Both the NYSE and NASDAQ saw contraction in the number of new highs. Investor Sentiment remains neutral, but we saw an uptick in bullishness in both retail and professionals. The American Association of Individual Investors (AAII) percentage of bulls jumped to 37.5%, which is the historical average, but also the highest percentage of bulls since December 2021! The National Association of Active Investment Managers (NAAIM) Exposure Index jumped to 85.4% and that’s the most exposure to equities the pro’s have had since January 2022.
This week’s tick higher in yields took some of the wind out of the market’s sails. Fed officials are saying to expect more than one hike in rates and that we could see the Fed Funds target rate hit 5-5.25% before we see a pause in monetary policy. On Tuesday, we get the latest read on the Consumer Price Index (CPI) and with economic data beginning to show signs of slight improvement and January’s blowout jobs report, the Federal Reserve may not be satisfied with the numbers. Currently, the Federal Reserve Bank of Cleveland is predicting January CPI at +0.4% and core-CPI also up +0.4%. That works out to about a +7% YoY rate of inflation, a far cry from the Fed’s 2% target, and could induce the Federal Reserve to tighten policy more than expected. With the two-year Treasury yield at a three-month high and the 10-year T-Bill at its highest mark since early January, investors may want to take a cautionary step to the sidelines ahead of Tuesday’s CPI. A hotter than expected number would be trouble for stock investors.
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 -3, unchanged from the previous week. Cycles C and D are bullish, while Cycles A, B and E are bearish. The CTI is projected to remain in a negative configuration through February.
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 +6, down two notches from the previous week. Breadth was mixed at the NYSE as the Advance/Decline line lost 1815 units while the number of new 52-week highs exceeded the number of new lows on all five sessions. Breadth was also mixed at the NASDAQ as the A/D line dropped 4937 units while the number of new highs out did the new lows on four of the five days. Finally, the percentage of stocks above their 50-day moving average dropped to 68.7% vs. 82.3% the previous week, while those above their 200-day moving average slipped to 64.7% vs. 74.5%. 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 Neutral at +0, down a notch from the previous week. In addition, we track money flows into and out of Equity Funds and ETFs which as of 2/08/23 shows inflows of $111 million.
Market Posture: Based on the status of the Market Edge, market timing models, the Market Posture is Neutral as of the week ending 1/13/2023 (DJIA – 34302.61).
Ask Mr. Seifert
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 then On Probability Analysis. 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 Verticle 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 Verticle 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.
Another way to do it is to set up your trade is to click on the TOS Trade tab. Then right click in the red area at the bottom of the screen. Right clock on Select Analysis Trade and click on the Risk Profile tab at the top of the page. You will see two graphs, one is blue and one is magenta. You are concerned with the blue graph which is the P/L projection for the trade through expiration. Make sure the date in the Date box (upper right corner) is the expiration date for you spread. You will see a small red vertical line in the center area of the blue graph. That is the Breakeven price for the trade and is listed below on the x-axis. Drag the closest brow-dash vertical line over the small red lime. You will see percentages both to the right and the left of the brown dash line. If your spread is a bullish put spread, POP is the total of the percentages located to the right of the dashed – breakeven line. If your spread is a bearish call spread, POP is the total of the percentages located to the left of the dashed – breakeven line.
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