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The following is an excerpt from this week’s ‘Weekly Market Letter’ from Market Edge (www.marketedge.com).
Stocks Struggle After US Credit Downgrade
Cautious trading kept the major averages mixed to kick off August, but a surprise downgrade of the US credit rating from AAA to AA+ mid-week sent stocks spiraling lower into the weekend on increased volatility. Long-term T-Bill yields rose to their highest levels since last November after the downgrade and the rate on the 10-year Treasury touched 4.198%. A weaker than expected July jobs report on Friday, however, brought the yield back down to 4.055%. Earnings were mostly ahead of estimates with FactSet Research reporting that 80% of S&P 500 companies have delivered upside surprises. Crude oil prices nudged higher for a fifth consecutive week after OPEC+ extended their production cuts and inventories in the US saw a larger drawdown in stockpiles that expected. Crude oil prices closed at $82.63, the highest level since April. The rise in yields weighed on rate sensitive and growth sectors with Utilities (XLU) the weakest market group dropping -4.55%. That was followed by losses in Technology (XLK), Communication Services (XLC), REITs (XLRE) and Healthcare (XLV), all down more than -2%. Energy (XLE) was the only sector to post positive on strength in oil stocks. Friday’s selloff sent the major averages to their low point for the week snapping a three-week win streak for the DJIA and S&P 500 , while the NASDAQ was down for a second time over the last three weeks.
For the period, the DJIA lost 393.67 points (-1.1%) and settled at 35065.62. The S&P 500 fell 104.20 points (-2.3%) and closed at 4478.03. The NASDAQ dropped 407.42 points (-2.8%) finishing at 13909.24, while the small cap Russell 2000 slid 24.08 points (-1.2%) finishing at 1957.46.
Market Outlook: The technical condition of the market deteriorated this week after the S&P 500 and NASDAQ backed off of 16-month highs. The technical indicators saw some slippage as MACD, a short-term trend gauge, is now bearish and Momentum, as measured by the 14-day RSI, neutral and slowing. The secondary indexes which include the DJ Transportation Index and small cap Russell 2000 continue to show Relative Strength which is a positive sign going forward, but the Philadelphia Semiconductor Index (SOX) underperformed this week, down -4.0% and flirted with support at its 50-day MA this week at 3635. A break below that level would be a sign that we could see additional weakness, especially in the tech heavy NASDAQ. As mentioned last week, the chart on the Russell 2000 shows a bearish double-top pattern and needs a breakout above 1980-1990 to abort the pattern. The index briefly traded above that area on Monday but was unable to hold the breakout. Traders will again be watching that level for signs that the market rally is broadening out and ready to make a run at the old highs.
Underlying breadth was mixed as the NYSE and NASDAQ Advance/Decline lines both lost ground and the NASDAQ saw more new 52-week lows than highs during the period. The NYSE however, recorded more new 52-week highs on each day, though there was contraction in the numbers. The breadth readings weren’t weak enough to imply that this week’s pullback was anything more than some consolidation of the recent equity gains but as earnings season begins to wrap up, equities may need a catalyst to continue higher. Investor Sentiment is close to reaching extreme bullish levels which is a concern. The American Association of Individual Investors (AAII) saw a tick higher in bullish retail investors after a step lower last week. That survey is still below the read from two weeks ago that saw the most retail bulls since November 2021. After four consecutive weeks of higher equity exposure the pros took some profits. The National Association of Active Investment Managers (NAAIM) Exposure Index dropped from 101.8% last week down to 78.5%. However, the Percentage of Bullish Investment Advisors moved higher for a third straight week hitting 57.1%, which is the highest mark since November 2021 when the NASDAQ last peaked.
Earnings for Q3 continue to surprise to the upside indicating that higher rates are not hurting the bottom line as much as feared. FactSet Research notes that 80% of the companies in the S&P 500 reporting have delivered an upside surprise. That doesn’t hide the fact that earnings are down -5.2% YoY for the quarter but up from the -7.0% projected at the end of June. While it may seem out of whack that stocks are nearing new highs as earnings are down, currently, analysts say we will see a reversal of this trend in Q3. As the stock market tends to look out six-months ahead, the valuation for equities may not be as stretched as you think. FactSet Senior Earnings Analyst John Butters is looking for Q4 earnings growth of +7.6% YoY and revenue growth of +3.4%. If that holds, then the forward P/E for the S&P 500 is 19.2, which is only slightly above the five-year average of 18.6. Like any forecast, however, these numbers are subject to adjustments and susceptible to changes in yields brought on by the Fed’s fight to tame inflation. Still, in my opinion, despite entering a historically tough month for equities, investors should be looking to buy the dips, rather than selling the rips over the second half of the year.
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 +3, unchanged from the previous week. Cycles B, C and D are bullish, while Cycles A and E are bearish. The CTI is projected to change to a negative connotation over the next week or two.
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 +0, down eight notches from the previous week. Breadth was mixed at the NYSE as the Advance/Decline line lost 1624 units while the number of new 52-week highs exceeded the number of new lows on all five sessions. Breadth was negative at the NASDAQ as the A/D line dropped 2526 units while the number of new lows out did the new highs on three of five days. Finally, the percentage of stocks above their 50-day moving average fell to 63.4% vs. 73.5% the previous week, while those above their 200-day moving average eased to 59.5% vs. 63.2%. 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 Negative at -4, up a notch from the previous week. In addition, we track money flows into and out of Equity Funds and ETFs which as of 8/02/23 shows outflows of $1.9 billion.
Market Posture: Based on the status of the Market Edge, market timing models, the Market Posture is Bullish as of the week ending 7/21/2023 (DJIA – 35227.69).
Ask Mr. Seifert
My advisor says to buy debit spreads since they have less risk than a credit spread. Is he right?
Your broker is referring to the fact that a debit spread will always have less premium risk than a credit spread. However, that doesn’t mean that it has less risk. In fact, it has more risk than a credit spread with the same strike. Here is why. For the debit spread to be profitable it must overcome the premium you paid plus it must move in the price direction that you predicted when you bought it. Even if you are correct in predicting the price movement, it may not move enough to overcome the debit. In short, you have to be right and right. On the other hand, a credit spread can win three ways. The price moves in the direction you predicted, the price doesn’t move at all, or the price moves against you but not as much as the credit you sold. For my money, I would rather have three ways to win and take the larger premium risk. In the long run you can’t beat a credit spread.
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