Stocks Have Room to Run

By: Gregory Clay | Sun, Mar 6, 2016
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Market Summary

The S&P 500 has enjoyed a four-session winning streak for the first time since last October. And for the first time since early January, the Dow Jones industrial average rose above the 17,000 mark while the S&P 500 ended a fraction below 2,000, levels that some traders see as psychologically important. The S&P 500 has gained in 10 out of 15 sessions since its February low and closed above its 100-day moving average for first time this year. Half of 10 S&P sectors - including energy, which had been severely beaten down - are now positive for the year. For the week, the S&P 500 Index advanced 2.7% while the Blue Chip Dow Jones Industrial Average rose 2.2%. The Nasdaq added 2.8% while the small cap Russell 2000 led the major indices exploding 4.31% for the week. Treasury prices have flattened. As confirmed in the chart below gold stocks are going even higher following raw gold settlement prices at the highest level in a year.

YTD Performance

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 orange line in the updated chart below shows the uptrend continues with strong bullish momentum and plenty of space for the move to continue further.

MTUM 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. The orange line in the chart below confirms recent analysis where we mentioned, "...The Nasdaq Composite Bullish Percentage Index (BPCOMPQ) chart below highlights a price uptrend line. Nasdaq stocks tend to lead the market and if recent behavior is a guide, investors bidding up Nasdaq stocks usually lead to higher near-term stock prices...continues trending higher" The Nasdaq Composite Bullish Percentage Index is approaching an overbought level. Don't be surprised if stock prices stabilize to absorb overbought conditions.

NASDAQ Composite Bullish Percent Index Daily 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. The current Put/Call Ratio indicates traders are using call contracts to bet on bullish stock moves.

Put/Call Ratio

Investors see the Fed as holding off on rate hikes for now, helping stocks in recent weeks, said Donald Selkin, chief market strategist at National Securities in New York. A majority of Wall Street's top banks expect the Fed to raise interest rates only two more times by the end of the year, a downgrade of earlier expectations, according to a Reuters poll on Friday. If this is true you would expect a boost in treasury prices. In the chart below treasury bonds are actually sinking as the S&P 500 goes higher. Apparently when stock prices sold off during the crash investors parked the funds into safe-haven treasury securities. As stocks are trending higher investors are liquidating bond investments to get funds to buy shares.

SPX Daily Chart


Market Outlook

As discussed above, the bullish trend has been strong since the middle of February and strategists are cautiously optimistic the rebound will continue. Investors are counting on economic data continuing to support an improving economy, since upbeat reports in recent weeks have eased fears the United States may be headed for a recession. "If you were pricing this thing for a recession, you've got to take it back out," said Jim Paulsen, chief investment officer at Wells Capital Management in Minneapolis. He added that the S&P 500 could test its high from May 2015, when it closed at a record 2,130.82. He and others are expecting data to continue to support the view that the United States will avoid a recession, though they said plenty could still derail the market. In the updated graph below, most of the equity classes have a ways to go to make for the mid December crash. With gold prices at the highest in over a year, market technicians expect the precious metal to remain elevated.

Performance since Dec 15, 2015

The chart below is evidence of how equity and energy prices have been trading in lock step all year. Market pundits have offered various analyses on why this is happening. There is usually unique asset classes associated with the movement of stock prices, e.g. dollar, bonds, interest rates, etc. Until this relationship is broken, some investors are observing energy prices as a clue to stock movement, especially for day trading.

SPX Daily Chart 2

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 the VIX higher. VIX is currently near its lowest level for the year, which is noteworthy as equity markets began the year trading with extended volatility. Recently we said "...after reaching its highest level in the middle of the month the VIX is in a downtrend which coincides with the surge in "risk-on" trading...you can see the S&P 500 cross above the VIX for the first time since the beginning of the year. If investors continue "risk-on" trading expect the Volatility number to keep falling lower..." In the updated chart the Volatility Index continues falling to the lowest level since the end of last year. As investors have become more confident in the U.S. economy and near term direction of the stock market, expect the VIX to fall near November lows.

VIX Daily 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 03/02/2016. The most recent AAII survey showed 32.00% are Bullish and 38.70% Bearish, while 29.20% of investors polled have a Neutral outlook for the market for the next six months. Recent comments are playing out as advertised where we stated, "...retail investors are getting more optimistic as the bullish percentage jumped last week. As a reliable contra-indicator the current AAII survey signals continued follow through on a countertrend bounce... The latest AAII survey signals the current bullish trend has more room to run..." The stock market should continue higher according to the most recent AAII sentiment survey.

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 03/02/2016. Fourth-quarter NAAIM exposure index averaged 44.61%. Last week the NAAIM exposure index was 31.65%, and the current week's exposure is 54.44%. The current bullish move has inspired money managers to come off the sidelines. Professional traders lifted the NAAIM exposure index to the highest percentage of the year. Expect investors to continue increasing equity exposure, as they understand the upcoming months are historically the best for the stock market.

NAAIM Exposure Index


Trading Strategy

"Expectations went too far on a recession expectation. That's why the market has rallied in the past two weeks. It's pricing out a chance of a recession," said Jim Paulsen, chief investment officer at Wells Capital Management in Minneapolis. In the updated graph below "all systems are on go" as all the major S&P sectors are positive over the past 30 days. As recession talk subsides and potential Fed rate increases fall off the table investors are increasingly willing to take on more risk. In the graph below the best performing sectors are considered the highest risk equity classes. We are currently in the middle of what is considered the "best six months of the year" for the stock market. We like undervalued or oversold shares to bid on because the current bullish trend has more room to run.

30-Day 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
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