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The following is an excerpt from this week’s ‘Weekly Market Letter’ from Market Edge (www.marketedge.com).
April Ends On High Note
A volatile week ended with the major averages higher as the DJIA, S&P 500 and NASDAQ closed out April at their highest level since February. Investors processed a slew of earnings from big cap technology companies, and economic data that showed slowing growth, but sticky inflation. Despite better-than-expected Q1 earnings from the likes of Microsoft (MSFT) and Alphabet (GOOGL) during the period, equities traded lower to start the week on recession and debt ceiling concerns. Investors also were cautious ahead of next week’s FOMC Meeting where another 0.25-point rate hike by the Federal Reserve is expected. The DJIA dropped 573.53 points (-1.7%) through Wednesday, while the DJ Transportation Index sank 1020.29 points (-7.0%), pulled down by a -10% slide in United Parcel Service (UPS) after coming up short on earnings and issuing weak guidance. The major averages turned it around on Thursday however, as disappointing data on Q1 GDP and inflation was offset by continued strength in consumer spending and the jobs market that blunted fears of a recession. The Dow Jones nearly erased its two-day tumble and put up its best day since January, with the NASDAQ, getting a boost from a +13.93% spike in Meta Platforms (META) on blowout earnings, soaring +2.43% and moving into positive territory for the week. The different indexes were able to push higher again on Friday on solid earnings and hopes that the Federal Reserve would announce a pause next week in its tightening policy. The market sectors were mixed but mostly higher with Communication Services (XLC), Technology (XLK), REITs (XLRE) and Consumer Staples (XLP) outperforming, while Utilities (XLU), Industrials (XLI) and Healthcare (XLV) moved lower. Yields edged down with the rate on the 10-year Treasury easing to 3.43% and the two-year T-Bill sliding to 4.03%. Despite volatile trading, the major averages were able to post positive on the week with their sights set on new highs for the year.
For the period, the DJIA gained 289.20 points (+0.9%) and settled at 34098.16. The S&P 500 added 35.96 points (+0.9%) and closed at 4169.48. The NASDAQ jumped 154.12 points (+1.3%) finishing at 12226.58, while the small cap Russell 2000 fell 22.52 points (-1.3%) finishing at 1768.99.
Market Outlook: The technical condition of the market held its positive bias after the selloff and rebound during the weekend as the major averages were able to close at the top of their trading range, close to their February highs. The technical indicators improved with MACD, a short-term trend gauge, close to crossing into bullish territory for the DJIA, S&P 500 and NASDAQ, while Momentum, as measured by the 14-day RSI, was positive and moving higher. The DJIA and NASDAQ were also able to bounce off key MA support this week, which points to the possibility that the major averages could add to recent gains and make a run to new highs for the year. The secondary indexes, however, continue to show negative divergence and ended the period down across the board. The DJ transportation Index, small cap Russell 2000 and Philadelphia Semiconductor Index also remain below key MA resistance. It wasn’t all bad however, as the DJ Transportation Index was able to cross back above its 200-day MA on Friday, while the Philadelphia Semiconductor Index was able to bounce off support at its 100-day MA during the week. The stock market will need to pick up support from the secondary indexes if a rally off a Fed pause is going to stick.
Underlying breadth was mixed with the NYSE Advance/Decline line modestly higher, but the NASDAQ Advance/Decline line lower showing the majority of stocks remain under distribution. The A/D lines are considered leading indicators of market direction and can foretell market direction. New 52-week lows however, outnumbered the new highs on both the NYSE and NASDAQ and expanded on the NASDAQ continuing to show narrow leadership. Investor Sentiment is neutral but both retail and the pros saw another uptick in bearishness. Retail investors saw a drop in the bulls to only 24.1%, while according to the American Association of Individual Investors (AAII), the bears hit their highest mark, 35.1%, since late March. The National Association of Active Investment Managers (NAAIM) Exposure Index shows money managers trimmed equities to 50.8% from 78.3% the prior week. That’s also the lowest exposure to equities since March.
Next week many investors are hoping that the Federal Reserve will announce a pause in raising rates after another -.25-point hike, with some expecting rate cuts as early as September. Investors may want to be careful about what they wish for. A study at Bloomberg shows that the average time before the Fed’s first rate cut after raising rates is six-months. When a rate cut occurs before that, it historically has meant that the Fed has gone too far in its tightening cycle and a deteriorating economy leads to a sharp decline in equities or, like in 1987, a stock market crash. The stock market could breakout of its trading range next week if the Fed announces a pause, but before chasing any market rally take note, Bloomberg also points out that after rate hike headwinds are removed, the rally usually fizzles out as the focus returns to a deteriorating economy and earnings. That notion is supported by negative divergence in underlying breadth and should keep investors wary of any breakout in prices next week if the Fed announces a pause in rate hikes.
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 Positive at +2, down two notches from the previous week. Cycles A, B and D are bullish, while Cycles C and E are bearish. The CTI is projected to change to a negative configuration in the next few weeks.
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 +2, down four notches from the previous week. Breadth was mixed at the NYSE as the Advance/Decline line gained 418 units while the number of new 52-week lows exceeded the number of new highs on three sessions. Breadth was negative at the NASDAQ as the A/D line lost 1385 units while the number of new lows out did the new highs on each day. Finally, the percentage of stocks above their 50-day moving average slipped to 40.4% vs. 45.5% the previous week, while those above their 200-day moving average fell to 44.7% vs. 50.3%. 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, unchanged from the previous week. In addition, we track money flows into and out of Equity Funds and ETFs which as of 4/26/23 shows outflows of $2 billion.
Market Posture: Based on the status of the Market Edge, market timing models, the Market Posture is Bullish as of the week ending 3/24/2023 (DJIA – 32237.53).
Ask Mr. Seifert
Is it possible to sell a credit spread that has less risk than reward?
Yes, it is possible to sell a credit spread that has less risk than reward. The trade is called a 60/40. It is an aggressive directional spread. Here is how it works. Normally when we sell a credit spread, we sell the ATM strike and buy a strike that is further out of the money. If you use a 60/40, we would sell a spread that is slightly in the money. We are not taking a neutral position. We are trying to predict the direction that stock will move. So instead of selling a 5.0 wide spread for $220 and assuming a $280 risk we would sell the spread for $280 and assume a $220 risk. We never risk more than the difference between the strikes minus the premium we collect from the spread. The difference is in the 60/40 spread, if the price doesn’t move in our favor, we will not collect the entire $280. We will collect a portion of the spread as a profit. The 60/40 is a spread that many professional traders use when they are confident that the price will move in their favor.
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