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The following is an excerpt from this week’s ‘Weekly Market Letter’ from Market Edge (www.marketedge.com).
Stocks Rally As Yields Ease
The major averages put a dismal February in the rear-view mirror this week and the DJIA was able to snap a four-week losing streak despite rising rates. Coming off the worst week for stocks of 2023 the different indexes charged out of the gate on Monday but concerns over inflation from Friday’s PCE report nearly erased the gains. Choppy trading left the market mixed midweek as recession fears mounted and the yield on the 10-year Treasury nosed above 4%. A better-than-expected jobs report on Thursday kept upward pressure on rates but comments from Atlanta Fed President Bostic that he was firmly in the camp for a 0.25-point rate hike at the March FOMC Meeting sent stocks sharply higher in the afternoon. The major averages were able to build on those gains on Friday after the ISM Services Index showed a drop in prices paid for goods in February. The rate on the 10-year T-Bill closed the period back below 4% at 3.96%, while the two-year Treasury yield landed at 4.86%. Crude oil prices nudged higher as China’s reopening gained momentum but remained under $80 a barrel. Leading the market higher was strength in Materials (XLB), Industrials (XLI), Energy (XLE), Communication Services (XLC) and Technology (XLK) sectors, while defensive sectors Utilities (XLU) and Consumer Staples (XLP) lagged the broader market and finished lower. The major averages were able to kick off the new month on a positive note with the major averages all higher on the week for the first time since the week ending January 27.
For the period, the DJIA jumped 574.05 points (+1.7%) and settled at 33390.97. The S&P 500 added 75.60 points (+1.9%) and closed at 4045.64. The NASDAQ soared 294.07 points (+2.6%) finishing at 11689.01, while the small cap Russell 2000 picked up 37.77 points (+2.0%) finishing at 1928.26.
Market Outlook: The technical condition of the market steadied this week as the major averages stopped the bleeding and finished higher across the board. The technical indicators are mixed with MACD, a short term trend gauge, still bearish, but Momentum, as measured by the 14-day RSI, neutral but improving. On a positive note, the major averages were able to regain lost support in the form of key moving averages (MA). The DJIA closed back above its 100-day MA, while the S&P 500 was able to bounce off its 200-day MA and finish above its 50-day MA. The NASDAQ crossed back above its 200-day MA on Friday. Another bullish sign that the different indexes may be ready to recover is positive divergence in the secondary indexes. The DJ Transportation Index, small cap Russell 2000 and Philadelphia Semiconductor Index are outperforming the major averages and managed to stay above their respective 50-day MA during the recent selloff. In addition, we saw the 100-day MA cross above the 200-day MA on the DJ Transportation Index and Russell 2000 which helps to confirm that the medium-trend is bullish. The Financial (XLF), Technology (XLK), Communication Services (XLC), Materials (XLB) and Industrials (XLI) are all above their respective 50-day MA, a bullish condition, and a look at the charts show the Industrials (XLI) and Materials (XLB) sectors closing in on a new 52-week high. These sectors should lead the overall market higher from here while defensive sectors continue to lag.
Underlying breadth was mostly positive as the NYSE and NASDAQ Advance/Decline lines both moved higher, while new 52-week highs outnumbered the new lows throughout the week and expanded on the NYSE. The new lows held a small edge on the NASDAQ. Investor Sentiment is getting overly bearish, and we saw a big move down in bullishness in both retail and professionals for a second straight week. The American Association of Individual Investors (AAII) percentage of bulls was little changed but the percentage of bears jumped to their highest level, 44.8%, since the last week of December. The National Association of Active Investment Managers (NAAIM) Exposure Index dropped for a third consecutive week falling to 47.4% from 85.4% just three weeks ago. That’s a lot of cash that can find its way back into equities if next week’s economic data shows progress on inflation. Next Friday we get the February jobs report and that will be the deciding factor whether the Fed can hike rates a 0.25-point at the March FOMC Meeting. A number below 250,000 jobs created would be a step towards the Fed pausing on future increases on rates. Market participants may also want to tune in to Fed Chair Powell’s testimony on Tuesday and Wednesday for hints on policy.
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 return to a bullish configuration next week if the DJIA can remain above 32500.
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 2254 units while the number of new 52-week highs exceeded the number of new lows on each sessions. Breadth was mixed at the NASDAQ as the A/D line added 2354 units while the number of new lows out did the new highs on three days. Finally, the percentage of stocks above their 50-day moving average fell to 51.0% vs. 60.2% the previous week, while those above their 200-day moving average eased to 57.2% vs. 57.7%. 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 Positive at +4, up two notches from the previous week. In addition, we track money flows into and out of Equity Funds and ETFs which as of 3/01/23 shows outflows of $13.5 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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