Market Summary

By: Gregory Clay | Sun, Aug 30, 2015
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The S&P 500 Index posted its biggest rally since November 2011; a much-needed rebound for the market after a recent pullback in the stock market erased over $2 trillion from share values. Wall Street had a tumultuous week as investors had to deal concerns that a September rate rise was more likely than some investors expected. After several volatile sessions early in the week that pushed the S&P 500 to its lowest level since October 2014, the three major U.S. indices ended the week with gains. The S&P remains down more than 5% from when the market began to sell off on August 18. The turmoil has prompted several strategists to cut their end-of-year forecasts for the major indexes. U.S. stocks actually started sinking the prior week, mostly over signs of a slowdown in China, the world's second-biggest economy. Before the six-day losing streak had ended, the Dow had plummeted 1,900 points and the S&P 500 was undergoing its first "correction," in nearly four years. But a midweek "short squeeze" cut the Dow's losses nearly in half, in a rally analysts attributed to bargain-hunting, signs that the Federal Reserve may hold off raising interest rates this fall, and a new report that said the U.S. economy is growing at a more robust rate than previously believed.

The week started off with a flash crash caused by one of the strangest selloffs we have ever seen. The action was very similar to the flash crash of May 2010, though the 2010 crash was longer in duration and happened in the middle of the day. By one metric, investors would have to go back 75 years to find the last time the S&P 500's losses were this abrupt. Bespoke Investing Group observed that the S&P 500 has closed more than four standard deviations below its 50-day moving average for the third consecutive session. That's only the second time this has happened in the history of the index. May 15, 1940, marked the end of the last three-session period in which this occurred. This string of sizable deviations from the 50-day moving average is a testament to just how severe recent losses have been compared to the index's recent range. "Not even the crash of 1987 got this oversold relative to trend," writes Bespoke.

For the week, the Dow gained 1.1%, the S&P rose 0.9% and the Nasdaq finished strong up 2.6%. Volume was lighter than in recent days. About 7.8 billion shares traded on U.S. exchanges, compared to an average of 11.2 billion in the past five sessions, according to BATS Global Markets.

YTD Performance

The dollar finished with weekly gains against the euro and the pound as U.S. stocks stabilized and a spate of strong U.S. economic data helped assuage investors' fears of sustained market turmoil. The dollar is sensitive to investors' interest-rate hike expectations, because higher interest rates would increase the return on assets denominated in dollars, making the U.S. currency more attractive to foreign investors. Comments from Federal Reserve Vice Chairman Stanley Fischer, suggesting that the door was still open to an interest-rate increase at the Fed's next meeting, helped push the dollar higher. Remember that treasury yields move inversely to prices, rising rates equate to lower Treasury bond prices. Treasury yields finished a tumultuous week higher Friday as comments from Federal Reserve Vice Chairman Stanley Fischer revived hopes for a Federal Reserve rate increase in September. It was the largest one-week gain for both the 10-year and two-year Treasury notes since June. This is reflected in the chart below where you can see Treasury Bonds plunged from last week's highs. Gold futures logged their first gain in five sessions on Friday, but still suffered from their worst weekly loss in about a month. Higher rates would benefit the U.S. dollar but may dim the appeal of dollar-denominated gold for buyers purchasing the asset in other currencies.

UUP Daily Chart


Market Analysis

The Financial Times noted that computers now represent more than half of each day's activity in the stock market. Which means they are mostly trading amongst and against each other? As reported in The Reformed Broker newsletter, machines can only do what they've been programmed to do. There's no art, there's no philosophy and there's no common sense involved. And volatility-shy trading programs have been programmed to de-risk when prices get wild and wooly, period. Their programmers can't afford to have an algo blow-up so the algos are set up to pull their own plug, regardless of any qualitative assessment during a special situation that is obvious to the rest of the marketplace. Don't think for a second that actual human beings sold the Dow Jones Industrial Average down over 1,000 points Monday morning, the biggest drop ever, then 15 minutes later bid the index up 500 points. I don't know of many people who are capable of analyzing and processing market data, and then executing trade orders that fast. There may talented souls who might be able to pull a few trades that rapidly, but certainly not the volume of traders that would have been required to move the market the way it did. The best bet is that quantitative strategies largely blew a gasket on Monday, especially the really risk-averse ones, the ones that are directed to sell first and ask questions later. On Monday, it paid to ask questions first. Unfortunately, that function isn't in the code.

A District court legitimized market manipulation when major U.S. stock exchanges and Barclays on Wednesday won the dismissal of nationwide litigation in which pension funds and other investors accused them of rigging markets to benefit high-frequency traders. U.S. District Judge Jesse Furman in Manhattan said federal law affords exchanges "absolute immunity" from the plaintiffs' key claims, including over the creation of "complex order types" and proprietary data feeds that can benefit rapid traders, because of their status as self-regulatory organizations. The Judge wrote, "...critics of HFT may be right in arguing that it serves no productive purpose and merely allows certain traders to exploit technological inefficiencies in the markets at the expense of other traders..." What the court said is that it is up to U.S. legislators to even the playing field and prevent cheating, yeah, good luck with that one!

Last week's comments "...The venerable Dow Theory, the oldest stock market timing system that remains in widespread use today, flashed a "sell" signal at Thursday's close. As circled in the chart below, the DOW Industrials and Transports are crashing to confirm the current downtrend..." As circled in the chart below, both the DOW Industrials and Transports moved higher to confirm the price recovery.

Dow Jones Daily Chart

Many chart watchers believe a death-cross indicates that a shorter-term decline will develop into a longer-term downtrend. The "death cross" pattern is spreading fast through the stock market like a bearish virus. The chart below notes how the Dow Jones Industrial Average 50-day SMA has crossed below the 200-day average. On Friday, 18 Dow stocks, or 60%, had death crosses hanging over them.

Dow Jones Daily Chart 2

As circled in the chart below, the S&P 500 index became the latest victim. There were 263 stocks within the S&P 500, or about 53%, that had a 50-day moving average (MA) below their 200-day MAs through afternoon trade Friday. The S&P 500's last death-cross appeared on Aug. 12, 2011. It bottomed about six weeks later after falling a further 6.3%.

S&P500 Daily Chart

A tool to help confirm the overall market trend is the Bullish Percent Index (BPI). The Bullish Index is a popular market "breadth" indicator used to gauge the internal strength/weakness of the market. It is the number of stocks in an index (or sector) that have point & figure buy signals relative to the total number of stocks that comprise the index (or sector). So essentially it is the percentage of stocks that have buy signals. Like many of the market internal indicators, it is used both to confirm a move in the market and as a non-confirmation and therefore divergence indication. If the market is strong and moving up, the BPI should also be moving higher as more and more stocks are purchased. As circled in the chart below, the S&P 500 BPI confirms the stock market price recovery and indicates it was more than just a "short squeeze". The other major equity index BPI charts have a similar setup.

&P500 Bullish Percent Index Daily Chart


Market Outlook

After China threw the biggest scare into Wall Street in years, U.S. stocks came surging back and ended the week slightly higher to suggest the worst might be over for now. But, investors are buckling down for continued volatility in the weeks ahead, something that history backs up. September has been the worst performing month for stocks. Concerns that triggered the recent sell-off remain, slumping oil prices, a slowing Chinese economy, weak corporate earnings forecasts and uncertainty over interest rates. Despite the bounce-back this week, stocks are on course for their worst monthly performance in more than three years. The graph below shows treasury bonds is the only major asset class to generate a quarterly gain. Even with the wild price fluctuation this week, investors are paying close to $18 for every $1 of earnings in the S&P 500, above the $15 investors have historically paid for stocks after World War II. "It's still an expensive market," said Kevin Dorwin, managing principal of San Francisco-based Bingham, Osborn & Scarborough. "We still need to see earnings growth or valuations improve, and absent that, it's hard to see how the market can move up."

Performance since July 1

A standard chart that we use to help confirm the overall market trend is the Momentum Factor ETF (MTUM) chart. Momentum Factor ETF is an investment that seeks to track the investment results of an index composed of U.S. large- and mid-capitalization stocks exhibiting relatively higher price momentum. This type of momentum fund is considered a reliable proxy for the general stock market trend. We prefer to use the Heikin-Ashi format to display the Momentum Factor ETF. Heikin-Ashi candlestick charts are designed to filter out volatility in an effort to better capture the true trend. Our recent analysis is being confirmed as we said "...Momentum Factor ETF indicates the market is ready for a countertrend bounce...the strength indicator is grossly oversold, plus its long-term support line holds up the current MTUM pullback. Also note the Momentum Factor ETF ended exactly at its 200-day SMA, which should provide further support..." The orange circle below shows downward momentum is ending and starting to turn bullish.

MTUM Daily Chart

Last week's analysis played out as advertised "...the Momentum Factor ETF weekly chart supports the analysis that prices are due for a rebound. As highlighted in the chart, the MTUM is displaying technical reversal signals at its 50 Week SMA. Notice how every time the ETF falls to the SMA it recoils higher..." Unless we get a "dead cat bounce" expect the market to follow through and continue to recover over the next few weeks.

MTUM Weekly Chart

The CBOE Volatility Index (VIX) is known as the market's "fear gauge" because it tracks the expected volatility priced into short-term S&P 500 Index options. When stocks stumble, the uptick in volatility and the demand for index put options tends to drive up the price of options premiums and sends VIX higher. Last week the VIX surged to its largest ever-weekly percentage increase as the major stock indexes sold off for six straight days. Investors can expect the volatility to continue because it normally increases in September and October after the summer doldrums.

VIX Daily Chart

On the weekly chart below you can see that volatility spiked to 53, the biggest surge since May 2010.

VIX Weekly Chart

Put/Call Ratio is the ratio of trading volume of put options to call options. The Put/Call Ratio has long been viewed as an indicator of investor sentiment in the markets. Times where the number of traded call options outpaces the number of traded put options would signal a bullish sentiment, and vice versa. Technical traders have used the Put/Call Ratio for years as an indicator of the market. Most importantly, changes or swings in the ratio are seen as instances of great importance as this is commonly viewed as a change in the tide of overall market sentiment. Over the past few weeks the Put/Call Ratio has predominately remained excessively bearish as traders invested in put contracts to protect against a downtrend.

Total Put/Call Ratio

The American Association of Individual Investors (AAII) Sentiment Survey measures the percentage of individual investors who are bullish, bearish, and neutral on the stock market for the next six months; individuals are polled from the ranks of the AAII membership on a weekly basis. The current survey result is for the week ending 8/26/2015. The most recent AAII survey showed 32.50% are Bullish and 38.30% Bearish while 29.20% of investors polled have a Neutral outlook for the market for the next six months. Recent analysis is confirmed where we said "...The current AAII survey contra-indictor signal indicates the market is oversold and due for a countertrend bounce."

AAII Sentiment

The Nation Association of Active Investment Managers (NAAIM) Exposure Index represents the average exposure to US Equity markets reported by NAAIM members. The blue bars depict a two-week moving average of the NAAIM managers' responses. As the name indicates, the NAAIM Exposure Index provides insight into the actual adjustments active risk managers have made to client accounts over the past two weeks. The current survey result is for the week ending 8/26/2015. Second-quarter NAAIM exposure index averaged 72.84%. Last week the NAAIM exposure index was 41.48%, and the current week's exposure is 28.31%. The current equity exposure is at all-time lows, which substantiates our recent comments "...Money managers usually take vacation during this slowest trading period of the year and algorithmic traders take over. Traders sitting on the sideline precipitated the market's current correction. Lack of participation equates to lack of buyers to bid up stocks when sellers start selling..."

NAAI Exposure Percent


Trading Strategy

Given the volatility we've seen over the few weeks, you need to focus on the process of investing instead of what impact the daily and intraday gyrations of stock prices are having on your trading account. For day-traders, however, the past few weeks have been paradise. Any time stocks incur a significant drop like they did late last week and early this week, an unrealized financial loss occurs. The hard part is that we don't always get a V-shaped bounce. And sometimes, the bounce isn't permanent, just a bear trap to suck more buyers in. But you won't know in advance, so it's probably not a great idea to overreact to the most hysterically bearish or bullish narrative you can find. Managing the mental ups and downs is more important than trying to manage the market's ups and downs for most investors.

Nobody wins from corrections except for perma bears, which usually mostly means computer programs. Holding cash provides meager returns, but it does allow investors to make tactical purchases of equities on dips. When the market sunk early this week, smart traders did the right thing. They recognized that companies like JPMorgan and Facebook and Netflix should not have printed at prices down 15 to 20% within the first few minutes of trading and they reacted with buy orders, instead of selling.

30-Day S&P Sector Performance

Feel free to contact me with questions,

 


 

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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