Stuck In Neutral

By: Gregory Clay | Sun, Apr 27, 2014
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4/27/2014 7:58:18 AM

Market Summary

Previous Weekly Setup articles mentioned "a lot of investors trade Treasury's to hedge against stock moves. The chart below shows how equities and treasury bonds usually move in opposite directions. The red line in the chart is tracking the current downward move in stocks while treasury bonds rally. investors are looking to safe assets to park funds." Looking at the updated chart below you can see that last week Treasury bond prices crashed as equities moved higher. This week is the opposite story with treasuries returning to higher levels as equities prices pulled back. The market is sending very strong signals that stock prices should be expected to fluctuate in a trading range. The upper level of this range is the recent all-time highs with the lower level being the support level established at beginning of March (where stocks bounced off of when equity prices sank a few weeks ago). Click here to get the previous article

SPX Daily Chart

The April 20th Weekly Setup said ".We discussed how the Biotech and Technology sectors moved into a full blow correction as the overall stock market pullback relatively modestly . Biotech's may have found a bottom. Over the next few days we will find out if this is an oversold bounce leading to what is known as a 'bear trap' where the price continues its downward trend. If the Biotech index does breaks below the support line look out below because it will get even uglier." The updated chart below confirms the long term support line held up and the biotechnology index is actually sending bullish signals - this is further support for our analysis suggesting near term range-bound trading.

IBB Daily Chart

The previous Weekly Setup Summary also stated, ".As with the Biotech index above the Technology index chart below signals a bounce off an established support level. As long as the Tech index remains above support that is a good sign, but if the price does drop below this level look for the February lows as support." In the updated chart below the Technology index remained above support with strong neutral signals pointing to range-bound trading.

XLK Daily Chart

The Weekly Setup also mentioned ".The bull supporters were concerned because another distressing issue was the breakdown in the financial sector. Initial earning releases was the culprit, but subsequent announcements were positive and the financial stocks are leading the market higher." Financial stocks were hit hard when stock prices retrenched a few weeks ago. The updated financial sector chart below confirms that financial stock prices have recovered and are now trading flat in the near term.

XLF Daily Chart

The six worst performers of the last month among those which report earnings this week are Netflix, Biotechs Biogen and Alexion, E*Trade, Facebook and Amazon. These were some of the leaders of the bull market momentum and one benchmark (E*Trade) for investor confidence and activity. After investors fell out of favor with so-called 'momentum' stocks, high-flying biotech and technology shares, they have given most of their attention to energy stocks. Energy stocks have been the best performing sector since the end of February. This group will look to build on these gains next week when major oil companies report 1st quarter results. Market rotation to value stocks limited a broader market sell-off as energy sector funds attracted net fund inflows in nine of the past ten weeks. During the current earnings season 80% of the energy companies reporting have exceeded results, making this the top sector. Evidence of strong investor interest is the Energy Select Sector chart below showing the index at an all-time high.

XLE Daily Chart

The rotation is further reflected in the Consumer staples sector where the chart below shows the Consumer Staples Sector index at the all-time high.

XLP Daily Chart

The other major S&P sector investors are flocking to for value is utility stocks. Last week, utility stocks led the way with shares hitting 52-week highs. Utility stocks tend to move similar to the Treasury bond market since their dividend yields are often comparable to treasury yields. Since they are considered a higher risk compared to Treasury bonds you get a higher dividend payment. Year-to-date the Utilities Select Sector is the top performing S&P sector, and of course you can see in the chart below this group is at an all-time high.

XLU Daily Chart

Market Outlook
The April 20th Weekly Update discussed ".The Volatility Index (VIX) chart below signals that last week's stock price recovery is also reflection of investor diminished volatility concerns as it trades near the lower point of a two-month trading range. The VIX is recognized as indictor of expected market volatility. This premium in options can be loosely defined as risk. Like other forms of insurance, the greater the risk the higher the premium, and the lower the risk the lower the premiums. When the options premium fall the VIX falls and when premiums rise the VIX rises. The buyers and sellers move the option prices, more buyers and the premiums go up, more sellers and the premiums go down." The updated chart graph below shows investors getting nervous at the end of last week which helps explain how easily stocks crashed on Friday.

VIX Chart

The updated AAII Sentiment Survey results continue to work as a reliable contra-indicator for stock price moves. The Weekly Update discussed "a lot of financial analysts have a very strong appreciation for the American Associate of Individual Investors (AAII) sentiment survey as a reliable contra indicator of market direction. Based on the perception that most retail investors usually are on the wrong side of the trend, sentiment extremes usually signal the market will do the opposite." You can see investor sentiment drastically reversed from bearishness to a stronger bullish reading. The contrarian interpretation is this increased bullish sentiment should portend stock prices dropping, which is what happened at weeks end.

Sentiment Surveys

Trading Strategy

The Weekly Setup has contended "If stocks continue to avoid broad-based selling and maintain during earnings season, this should bode well for the near term market... If the current market action is merely sector rotation and the consolidation of overbought conditions from recent highs a few weeks ago, a good move is to identify and monitor stocks you like but were too expensive in the past.avoid the recent high-flyers that are now tanking, that would probably be a bad move because of the risk involved. if this is a price pause before moving higher we can map out some bullish trades where you also have downside protection in case a move higher is just a counter-trend action and stocks continue downward. The best bet is probably range bound trading with prices fluctuating between recent highs and wherever prices bottom out..." Our analysis predicting stock price movement between all-time highs and recent support level is playing out as advertised. Displayed in the S&P 500 index chart below, strength and momentum are flat within the identified trading range. As we have been saying "setting up potential market neutral trades is a good move in case this is what the price action will be. Whatever you trade, right now is the time for patience and discipline with tight stops and conservative risk appetite." With the major stock market indexes in a neutral position, options traders should return to a neutral weighting between bullish and bearish positions. Bullish in the event that stocks regain their upward momentum, and bearish in the event that economic data translates into equity weakness.

SPX Daily Chart 2




Gregory Clay

Author: Gregory Clay

Gregory Clay
Option Strategist
High Value Option Trader
Weekly Income Credit Spreads
Easy Money Options Income

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