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The following is an excerpt from this week’s ‘Weekly Market Letter’ from Market Edge (www.marketedge.com).
Bears Take Control
Investors looking for signs that the Federal Reserve was nearing the end of its tightening cycle were disappointed this week as a hawkish Fed Chairman signaled rates were still headed higher and for longer. Market participants tip-toed into the week ahead of Fed Chair Powell’s testimony before Congress after the major averages were able to all post positive for the first time last week since the end of January. Powell’s hawkish remarks on Tuesday however sent equities sharply lower, rates higher, and the market priced in a high probability of a 0.50-point rate hike at the March FOMC Meeting. The DJIA dropped 574.98 points (-1.72%) with the yield curve between the two and 10-year Treasury the most inverted it’s been since 1981. Recession jitters kept a grip on Wall Street on Thursday after SVB Financial (SIVB) announced a +1.75 billion stock sale to shore up its balance sheet sending the Dow Jones down another 543.54 points (-1.66%) to its lowest level since early November. Questions about several other regional banks reserves on Friday rattled investors and the S&P Regional Bank ETF (KRE) fell -4.39%, to its lowest level since January 2021. That overshadowed mixed data on jobs which showed signs of slowing as the period ended. The turbulence in the banking industry as the week was ending pulled rates to a six-week low and the yield on the 10-year Treasury closed at 3.69%, while the two-year landed at 4.57% after crossing above 5% earlier. After projecting higher than a 70% probability earlier in the week of a 0.50-point rate hike in March, the CME Group FedWatch flip-flopped to a 61% probability of a 0.25-point hike on Friday. Crude oil prices also moved lower on fears of an economic slowdown. After crossing above $80 a barrel on Tuesday, the April contract closed at $76.51. Weakness was across the board with every sector finishing lower led down by a -8.50% slide in Financials (XLF). Materials (XLB), REITs (XLRE), Consumer Discretionary (XLY) and Energy (XLE) were the other laggards falling more than -5.0%. The next read on inflation comes on Tuesday as the February CPI is released and unless we see better progress on inflation it could be another bumpy ride for equity prices. When the dust settled the major averages closed out their worst week of the year with the DJIA lower for the fifth time in the last six weeks, and the S&P 500 down for a fourth time in five.
For the period, the DJIA dropped 1481.33 points (-4.4%) and settled at 31909.64. The S&P 500 lost 184.05 points (-4.5%) and closed at 3861.59. The NASDAQ tumbled 550.12 points (-4.7%) finishing at 11138.89, while the small cap Russell 2000 shed 155.56 points (-8.1%) finishing at 1772.70.
Market Outlook: The technical condition of the market deteriorated this week as the major averages turned in their worst percentage performance since last September. The technical indicators are all negative with MACD, short-term trend gauge, and Momentum, as measured by the 14-day RSI, bearish. Several of the indexes, however, are in oversold territory with stochastics dipping into the teens and the Market Edge/S&P Short Range Oscillator (SRO) closing Friday at -5.05%. The different indexes tumbled back below key moving average (MA) support levels pointing to a possibility of further weakness. The DJIA and S&P 500 fell below their respective 200-day MA on Friday and are also back below their 50 and 100-day MAs. The NASDAQ dropped below its 50 and 200-day MA and was sitting on its 100-day MA on Friday. The Russell 2000 is below its 50, 100 and 200-day MA and joined the DJIA in trading below its December low, a negative for the broader market. There is positive divergence however in the DJ Transportation Index and Philadelphia Semiconductor Index which have remained above their 200-day MA in the selloff. The transports were able to find support and bounce at its 38.2% Retracement off the October-February rally, while the semiconductors remain above that retracement level as well as a rising trend line off the October and January lows. The DJIA and S&P 500 fell below their 38.2% Retracement of the October-February rally opening the door for a drop to their 50% retracement to find support followed by the December low for the S&P 500. That leaves a target of 31750 for the Dow Jones and 3780 for the S&P 500. The NASDAQ broke its 50% Retracement on Friday at 11200 and could see 10900-10920.
Besides the DJIA, almost half of the sector ETFs are now negative for the year. They include Consumer Staples (XLP), Energy (XLE), Financials (XLF), Healthcare (XLV), REITs (XLRE) and Utilities (XLU). Furthermore , only four sector ETFs are trading above their 200-day MA. They include Communication Services (XLC), Energy (XLE), Industrials (XLI) and Technology (XLK), with Technology in the best technical condition trading above tis 50, 100 and 200-day MA. These sectors would lead the market coming off a bottom.
Underlying breadth was bearish as the NYSE and NASDAQ Advance/Decline lines both lost significant ground, while new 52-week lows outnumbered the new highs almost throughout the week. The NASDAQ turned in the most new 52-week lows in a session, 551, since mid-October. Investor Sentiment nudged back to a neutral setting, but most of the data came in ahead of Powell’s testimony and the job reports.
Rising rates and recession fears have weighed on investors for the last year and this week’s collapse of SVB Financial is sure to ratchet up more worries. The rapid pace of rate hikes brings down the value of fixed assets and our banking system is full of Treasury Notes that are losing face if required to liquidate to shore up reserves. That’s due to an outflow of deposits as consumers search for higher rates than are available in bank savings accounts. Although this doesn’t look like another 2007 financial crisis, we’re sure to hear more about it over the weekend. One glimmer of hope however is that this may force the Federal Reserve’s hand to pause rate hikes. The Market Edge Market Posture has been Neutral since the beginning of January, but a more cautious stance is in order as we await this week’s CPI report on Tuesday for progress on inflation and the following week’s FOMC Meeting announcement on rates. 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 Neutral at +1, down five notches from the previous week. Breadth was negative at the NYSE as the Advance/Decline line lost 7038 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 dropped to 31.1% vs. 51.0% the previous week, while those above their 200-day moving average fell to 46.9% vs. 57.2%. 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 Neutral at +2, down two notches from the previous week. In addition, we track money flows into and out of Equity Funds and ETFs which as of 3/08/23 shows outflows of $735 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 ñ 34302.61).
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What is a collar and how does it protect my portfolio?
A collar can be used in many ways. It is used to avoid paying taxes in this period for a stock position that has a large profit. It can also be used for any purpose where you want to keep the stock and have no market risk. The collar is put in place by selling a call above the current market price of the stock and buying a put below the price. As an example, let’s assume that you own 100 shares of TSLA that you bought last year at $150. The stock is now trading at $300 but you don’t want to sell it. To put the collar in place, you would sell the $305 call and buy the $295 put. They both will have the same amount of premium so whatever you lose in the call you make in the put and vice versa. You have collared the stock and locked in its value at $300. When you want the stock to trade freely again you can either let the options expire if they are both out of the money or you can buy back the collar if one or the other is in the money. In either case you have protected your investment for the time period of the option serial that you selected.
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