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The following is an excerpt from this week’s ‘Weekly Market Letter’ from Market Edge (www.marketedge.com).
Choppy Week On Wall Street
The major averages rallied ahead of key inflation reports to start the week, but finished mixed as it appeared the Fed had more work to do as the numbers came in hotter than expected. Coming off the worst week of 2023, the different indexes were able to reverse the losses to kick off the period as buying in growth and technology stocks led the NASDAQ on a three-day wind streak. Strong economic data in the form of a +3% jump in January Retail Sales, a second month of improving Builders Sentiment and an uptick in manufacturing data suggested to some analysts that the US economy might be able to avoid a recession. Equities nudged higher despite rising rates as the yield on the six-month T-Bill crossed above 5% for the first time since 2007 on Wednesday and the 10-year Treasury rate hit a new high for the year before landing at 3.82%. The rally stalled on Thursday however, as wholesale prices rose more than expected sending the major averages sharply lower. Adding pressure to the selloff was hawkish comments from Fed Presidents Loretta Mester and James Bullard saying they supported a 0.50-point rate hike and that the Fed Funds Rate may need to increase to 5.25% and hold longer than the market expects. The pullback in equities carried over to Friday but the different indexes battled back in the afternoon to finish mixed. Crude oil prices were lower after the White House said it would release another 26 million barrels from the Strategic Petroleum Reserves and renewed slowdown concerns. That weighed on the Energy (XLE) sector which was the week’s biggest loser, down -6.35%. REITs (XLRE), Materials (XLB) and Technology (XLK) were the other weak links. Defensive sectors Utilities (XLU) and Consumer Staples (XLP) finished higher, while Consumer Discretionary (XLY) and Industrials (XLI) also closed higher. The DJIA and the S&P 500 ended the period lower for a second straight week, but the NASDAQ and small cap Russell 2000 were able to hold on to early gains.
For the period, the DJIA eased 42.58 points (-0.1%) and settled at 33826.69. The S&P 500 fell 11.37 points (-0.3%) and closed at 4079.09. The NASDAQ gained 69.15 points (+0.6%) finishing at 11787.27, while the small cap Russell 2000 picked up 27.55 points (+1.4%) finishing at 1946.36.
Market Outlook: The technical condition of the market was little changed this week as the major averages finished the period mixed. The technical indicators slipped back into neutral to negative territory with MACD, a short-term trend gauge, crossing into bearish ground, while Momentum, as measured by the 14-day RSI, is neutral, but slowing. On a positive note, the major averages remain above key MA support levels keeping the uptrend intact. The DJIA struggled to stay above its 50-day MA before Friday’s bounce, while the S&P 500 was unable to hold support at 4100. Another positive was the outperformance of the NASDAQ, Russell 2000 and DJ Transportation Index which all closed higher. Unfortunately, the different bullish breakout patterns mentioned over the last two weeks have mostly failed. At this stage the major averages look to be at a pivot point dependent on yields. That could keep the major averages range bound over the near-term.
Underlying breadth was positive as the NYSE and NASDAQ Advance/Decline lines gained units, while new 52-week highs outnumbered the new lows throughout the week. Investor Sentiment remains neutral, but we saw a small move down in bullishness in both retail and professionals. The American Association of Individual Investors (AAII) percentage of bulls backed off to 34.1% bulls from 37.5% the previous week, which is the historical average, The National Association of Active Investment Managers (NAAIM) Exposure Index eased to 81.4% from 85.4% which was the most exposure to equities the pros have had since January 2022.
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 but several cycles are close to bottoming.
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, unchanged from the previous week. Breadth was positive at the NYSE as the Advance/Decline line gained 125 units while the number of new 52-week highs exceeded the number of new lows on all five sessions. Breadth was also positive at the NASDAQ as the A/D line added 807 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 rose to 70.% vs. 68.% the previous week, while those above their 200-day moving average increased to 65.6% vs. 64.7%. 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, unchanged from the previous week. In addition, we track money flows into and out of Equity Funds and ETFs which as of 2/15/23 shows outflows of $1.7 billion.
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 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.
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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