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The following is an excerpt from this week’s ‘Weekly Market Letter’ from Market Edge (www.marketedge.com).
Stocks Snap June Swoon
The official start to the summer kicked off with a broad-based summer rally that snapped a three-week losing streak for the major averages. After hitting their lowest levels in 20-months, the different indexes rallied as inflation indicators showed some signs of receding. Despite testimony during the week from Fed chair Jerome Powell that the Federal Reserve was “unconditionally” committed to reining in inflation by raising rates, economic data showed growth was already slowing. That fed recession fears and yields moved lower during the week. The S&P 500 soared more than 2% on choppy trading Monday on above average volume, but the major averages were flat on Tuesday as crude oil prices dropped almost 4% on recession concerns. Both the 2-year and 10-year Treasury flirted with a 3% yield on Thursday sparking a two-day surge in equities as investors scooped up beaten down technology and growth stocks to close out the short week. Every sector except Energy (XLE) finished positive this week with Consumer Discretionary (XLY) Healthcare (XLV), Technology (XLK) and Communication Services (XLC) some of the strongest groups. Slower growth concerns also gave a boost to defensive sectors as REITS (XLRE), Utilities (XLU) and Consumer Staples (XLP) also outperformed. Crude oil prices bounced on Friday on supply concerns, but most commodities were sharply lower during the week including Natural Gas, Copper, Lumber, Wheat and Corn. The CRB (Commodities) Index has fallen more than 13% from a high just two-weeks ago. The major averages went into the weekend on a high note and put up their best weekly performance since the end of May.
For the period, the DJIA gained 1611.90 points (+5.4%) and settled at 31500.68. The S&P 500 picked up 236.90 points (+6.4%) and closed at 3911.74. The NASDAQ jumped 809.27 points (+7.5%) finishing at 11607.62. The small cap Russell 2000 added 100.05 points (+6.0%), finishing at 1765.74.
Market Outlook: The technical condition of the market improved this week as the major averages snapped a three-week losing streak, surging off deeply oversold conditions. The rally pulled the technical indicators into neutral to bullish ground with Momentum, as measured by the 14-day RSI, rising and close to crossing the 50 level. MACD, a short-term trend gauge, crossed into bullish territory for several of the different indexes. As mentioned last week, the market was setup for an oversold bounce and despite this week’s rally, parts of the market remain oversold, hinting that we could see more gains over the next few weeks. The Market Edge/S&P Short Range Oscillator (SRO) finished Friday at -3.73%, while only 19% of stocks followed by Market Edge are trading above their 50-day MA. This week’s market advance retraced about 50% of the June high-to-low slide and the major averages will face resistance at those previous highs. For the DJIA, 33200-33225 is the initial upside target. That level is also the 50% retracement of the January-June selloff and could be a turning point to determine if the summer rally is just a rally in a Bear market. The S&P 500 faces stiff resistance at 4200-4220, which also represents the June high. The NASDAQ can run to the 12320 area before it hits resistance, with 12700 a 38.2% retracement of its November-June tumble. Secondary indexes the DJ Transportation Index, Philadelphia Semiconductor Index and small cap Russell 2000 kept pace with the major averages during the period which is bullish, while the iShares Biotechnology ETF (IBB) outperformed spiking +9.6% and crossed back above its 50-day MA.
Underlying breadth was supportive of the move higher with the NYSE and NASDAQ Advance/Decline lines showing solid accumulation, while the number of new 52-week lows showed sharp contraction from the previous week. Volume was heavy on equity index rebalancing during the week showing renewed buying interest. Investor Sentiment is about as Bearish as you can get and this is interpreted as bullish and a contrarian indicator. The American Association of Individual Investors (AAII) shows only 18.2% of retail investors are bullish, while the bear camp also welcomed more professionals. The National Association of Active Investment Managers (NAAIM) Exposure Index dropped to 19.9% from 50% just two weeks ago. In addition, the Percentage of Bullish Investment Advisors fell to 26.5%, its lowest number since 2016, while the Percentage of Bullish Investment Advisors dropped to 26.5%, last seen in 2016. Finally, the -17.6 bull-bear spread is the biggest margin since a -25 difference in late October 2008!
While investors debate whether aggressively hiking rates to battle inflation will throw the US economy into a recession, there were signs this week that could have big implications for market participants. Most notable is the decline in commodities as consumers adjust their spending habits to rising prices. That reflects slower growth/demand and has already found its way to the bond market. When the week began the CME Group FedWatch projected a 93% probability of a 0.75-point hike in rates at the July FOMC Meeting on 7/26-27. With this week’s weaker than expected economic data, that number closed Friday at 83%. In addition, the chance of a 0.50-point hike in September has backed off to 63% with some analysts believing we could possibly see the Federal Reserve pause in September. I wouldn’t count on that, but it doesn’t mean the stock market is doomed until we see Fed policy return to neutral. Recessions come in all shapes and forms. And while we may be in ‘unchartered’ territory due to excessive stimulus, Russia’s invasion and China’s lockdowns; consumer and business spending remains positive. In addition, unlike previous recessions like the dot.com bust and financial crisis, the Federal Reserve is committed to stopping runaway inflation that could blow-up the economy. In that sense, a shallow recession brought on by hiking rates a little too far, would be a better option than a significant downturn that takes years to recover from.
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 +7, down five notches from the previous week. The CTI is projected to remain positive into August.
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 +4, up 11 notches from the previous week. Breadth was mixed at the NYSE as the Advance/Decline line gained 4066 units while the number of new 52-week lows exceeded the number of new highs on all four sessions. Breadth was also mixed at the NASDAQ as the A/D line added 4354 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 jumped to 19.0% vs. 12.5% the previous week, while those above their 200-day moving average rose to 13.4% vs. 12.4%. 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 +7, unchanged from the previous week. In addition, we track money flows into and out of Equity Funds and ETFs which as of 6/22/22 shows outflows of $5.4 billion.
Market Posture: Based on the status of the Market Edge, market timing models, the Market Posture is Bullish as of the week ending 6/24/2022 (DJIA – 31500.68).
Ask Mr. Seifert
How Do You Calculate The Probability Of Profit (POP) For A Vertical Credit Spread When Using the Think Or Swim (TOS) Platform?
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.
Check out the TOS educational video at https://www.google.com/search?q=options+probability+calculator+thinkorswim&rlz=1C1CHBF_enUS750US750&oq=Options+probability+&aqs=chrome.6.0i512l2j69i57j0i512l7.24995j0j15&sourceid=chrome&ie=UTF-8#kpvalbx=_vsK1Yt78H8CckPIP-_yymAs83
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