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The following is an excerpt from this week’s ‘Weekly Market Letter’ from Market Edge (www.marketedge.com).
DJIA Hits New Low For The Year
Fed officials declared the resilient US economy too hot for their taste sending yields higher and equities sharply lower this week. Hawkish comments from Fed members to start the period sent investors heading towards the exits on Tuesday as the major averages turned in their worst daily session since mid-December. The DJIA dropped 697.10 points (-2.06%) and slipped into negative territory for the year, while the NASDAQ sank -2.5%. The release of the FOMC Meeting minutes on Wednesday did little to calm market participants, but a strong earnings beat from chip maker Nvidia (NVDA) on Thursday trumped another better-than-expected jobs report giving the bulls a one-day reprieve from falling stock prices. A +14% surge in Nvidia helped send the Philadelphia Semiconductor Index (SOX) up +3.3%. Equities headed sharply lower again on Friday however, as the January core-Personal Consumption Expenditures Index (PCE) jumped +0.6% MoM vs. +0.4% expected and +4.7% YoY, also above consensus. The inflationary report pushed yields to their highest levels since 2007 with the 10-year Treasury rate landing at 3.947% and the two-year T-Bill to 4.803%. The US Dollar jumped to its highest mark since November also weighing on stocks. Expectations for more rate hikes triggered recession fears and kept equity buyers on the sidelines as the period closed as analysts flip-flopped on whether the Fed’s aggressive tightening would send the economy into a hard landing, soft landing or no landing. While Energy (XLE) eked out a small gain every other sector closed in the red with REITs (XLRE), Technology (XLK), Consumer Discretionary (XLY), Communication Services (XLC) and Utilities (XLU) suffering the biggest hits. When the dust settled the major averages were all lower with the DJIA down for a fourth consecutive week and negative for the year.
For the period, the DJIA dropped 1009.77 points (-3.0%) and settled at 32816.92. The S&P 500 fell 109.05 points (-2.7%) and closed at 3970.04. The NASDAQ lost 392.33 points (-3.3%) finishing at 11394.94, while the small cap Russell 2000 gave up 55.88 points (-2.9%) finishing at 1890.48.
Market Outlook: The technical condition of the market deteriorated this week as the major averages finished the period sharply lower. The technical indicators are in negative territory with MACD, a short-term trend gauge, firmly in bearish ground, while upside Momentum, as measured by the 14-day RSI, continues to weaken. The major averages were able to find support at key MA levels during the week, but were unable to hold those levels on Friday, which doesn’t bode well for the market over the near-term. However, if the major averages can regain those support levels during the next few sessions, we could see the major averages finding themselves in a trading range until the economic data from February begins to roll in. The next level to watch is the 50.0% retracement of the December to February rally for the S&P 500 and NASDAQ. That would target the 3920-3940 area for the S&P 500 and 11220-11230 for the NASDAQ. Unfortunately, the different bullish breakout chart patterns mentioned over the last two weeks have been negated and the major averages look to be at a pivot point dependent on yields. Several of the market sectors also broke below key MA support levels, but we did see a few sectors hold above support that would suggest they could be market leaders going forward. The Financial (XLF) and Technology (XLK) sectors remain above their 50-day MA, while Communication Services (XLC), Consumer Staples (XLP), Materials (XLB) and Industrials (XLI) have outperformed and should lead the market off the most recent selloff.
Underlying breadth was mostly negative as the NYSE and NASDAQ Advance/Decline lines showed broad distribution, while new 52-week lows outnumbered the new highs throughout the week and expanded. Investor Sentiment remains neutral, but we saw a big move down in bullishness in both retail and professionals. The American Association of Individual Investors (AAII) percentage of bulls fell for a second straight week dropping to 21.6% from 34.1% the previous week. That’s the lowest percentage of bulls since the first week of January. The National Association of Active Investment Managers (NAAIM) Exposure Index also saw a big drop tumbling to 57.1% from 81.4% which is the least exposure to equities since early January, as the pros raised more cash.
Hotter than expected inflation data this week threw a wrench into Wall Street’s hopes for a pause in the Fed’s tightening policy by May. This week’s data surprised market participants as inflation increased more than estimated pointing to more work to do for the Federal Reserve, aka. higher rates. As of Friday the CME Group FedWatch now shows a 29.9% probability of a 0.50-point bump in rates, up from only 2.8% a month ago. Another increase looks to be in the cards at the May FOMC Meeting, getting the Fed Fund’s rate up to 5.25-5.50%.
While some level of a recession seems imminent, there’s a reason bulls are so eager to jump back into equities. According to RBC, going back to 1990, the S&P 500’s median gain in the six-months after the Fed final rate hike is +13%. In addition, the Technology (XLK) sector will lead the market during that time frame with an average gain of +19%. We know that rates are heading higher, but it is also apparent that we’re closer to the end of this cycle than the beginning. Depending on your investment goals and risk tolerance, you may want to look into locking in current rates on bonds with a portion of your portfolio. However, it also seems prudent to allocate a small portion of your stock assets to dip buying when the different indexes find support. Check with your financial advisor to determine if this action should be a part of your longer-term investment goals.
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 negative at the NYSE as the Advance/Decline line lost 2339 units while the number of new 52-week lows exceeded the number of new highs on two sessions. Breadth was also negative at the NASDAQ as the A/D line dropped 4570 units while the number of new lows out did the new highs on all four days. Finally, the percentage of stocks above their 50-day moving average fell to 60.2% vs. 70.1% the previous week, while those above their 200-day moving average slipped to 57.7% vs. 65.6%. 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 +2, up two notches from the previous week. In addition, we track money flows into and out of Equity Funds and ETFs which as of 2/22/23 shows outflows of $5.5 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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