Expect a Dead Cat Bounce

By: Gregory Clay | Sun, Jan 24, 2016
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Market Summary

The stock market ended the week higher for the first time this year. Stocks followed the lead from oil prices as they recovered higher during the last few days of the week. Helping boost the market were comments on potential central bank stimulus. Both Europe and Asian central bank officials released statement about more help for their respective economies. For the week, the S&P 500 Index rose 1.4% while the Dow Jones Industrial Average's finished up a modest 0.7%. The Nasdaq led the major indexes by rising 2.9% while the small cap Russell 2000 index jumped 1.2% for the week. The chart below confirms investors are trading "risk-off" as they have been fleeing to the relative safety of treasury bonds for the past six months. Conversely, riskier equity investments have tanked into a correction with smaller caps like the Russell 2000 and gold stocks in bear market territory.

Performance since July 15, 2015

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. The updated chart below indicates the stock market is setting up for a "dead cat" bounce. As highlighted, equities are excessively oversold and displayed a bullish reversal sign at weeks end. As noted, downward momentum is dissipating which supports a short-term recovery.

MTUM Daily Chart

As noted in the weekly chart below, the MTUM is oversold to the level where it normally recovers higher. As highlighted, MTUM has converted from a long-term uptrend into trading range established last summer. As long as it remains within the range it is reasonable to expect a near-term recovery bounce.

MTUM Weekly Chart

As evidenced in the chart below, investors are seeking the safety of treasury bonds and dollars in response to the massive selloff in global equites. Signs of a global recession have reduced inflation fears and pushed down the value of gold, which is considered an inflation hedge.

T-Bonds, Dollar and Gold Daily Charts


Market Outlook

Stock indexes are having one of the worst Januarys since at least 1950, based on data from the Stock Trader's Almanac. China's economy is going into a recession and oil prices are in the nastiest slump in a decade. Tensions in the Middle East continue to percolate. These particular issues are not new concerns. But now analysts project the quarterly S&P 500 earnings and revenue recession will continue, plus the possibility of further rate hikes by the Federal Reserve, turbulence in the junk bond markets and relatively high stock valuations are weighing on investor sentiment. The graph below confirms investors trading "risk off" since the start of December as the only positive asset classes remain bonds and gold.

Performance Since Dec 1, 2015

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. We recently said, "...the 'Fear Gauge' climbed back up to the high levels established during the last correction at the end of last summer. As long as the VIX stabilizes below the current level we can expect a near term counter-trend relief bounce..." The Volatility Index fell 17% during the end-of-week rally but remains up near the top of the trading range as investors display uncertainty over the stock market.

VIX Weekly Chart

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 01/20/2016. The most recent AAII survey showed 21.50% are Bullish and 48.70% Bearish, while 29.80% of investors polled have a Neutral outlook for the market for the next six months. The current AAII Survey bearish percentage continues to elevate much higher than during the correction last summer. The current AAII survey signals a short-term counter trend bounce is overdue based on retail investors' extremely bearish sentiment.

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 01/20/2016. Fourth-quarter NAAIM exposure index averaged 44.61%. Last week the NAAIM exposure index was 34.50%, and the current week's exposure is 26.32%. Last week's comment is coming to fruition "...Similar to the market correction at the end of last summer, professional money managers continues to reduce equity exposure during the current market selloff. Don't be surprised if the NAAIM exposure index falls to the lows from the beginning of October..."

NAAIM Exposure Percent


Trading Strategy

In evaluating your investment performance, understand your individual portfolio is not the only one taking a hit. Last year was a very tough one for stock pickers and so far 2016 has been just as challenging. Small capitalization stocks especially fell out of favor last year. Even among large-cap stocks, most of the positive returns were concentrated among the largest growth stocks and this trend continues into 2016. Over any given period of time, even the best strategies sometimes underperform. If a strategy has been successful over the long term and is based on a sound methodology, don't abandon it simply because the recent returns fell short. Expect volatility to continue as the upcoming week will be filled with important economic news, especially the FOMC announcement due Wednesday about global risks and the growth outlook. Right now cash is king along with high quality bonds and defensive stocks like Utilities and Health Care shares. Otherwise, the current market is a day-traders nirvana with daily triple-digit moves.

S&P Sector Performance 30-Day Chart

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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