Reason Stocks Are Due For A Pause

By: Gregory Clay | Sun, Jul 10, 2016
Print Email

Market Summary

The market surged to finish the week on a high note as stocks have fully recovered from post-Brexit lows and are looking to make new highs. For the week, the benchmark S&P 500 Index finished up 1.3% settling within 1 point of last May's record close of $2130.82. The Blue Chip-heavy Dow Jones Industrial Average rose 1.1%. The Nasdaq led indices to the upside jumping 2% while the small cap Russell 2000 rose 1.2%. Despite the recent strong rebound, the major equity indexes are still barely above water year-to-date. Slow methodical stock price appreciation for the year has been offset by damage from the February correction and recent Brexit crash. Investors have been piling into safe-haven assets like gold and treasuries for the first half of the 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 updated chart below displays stocks recent uptrend. However the orange circles denote overbought levels where in the past the market advance consistently has stalled out. We recently discussed how investors overreacted to the Brexit vote and oversold stocks and therefore the market was due for a robust bounce back from the Brexit selloff. Technically and fundamentally the major indexes are due for a pause. Stocks are overbought and buyers will probably sit tight ahead of quarterly earnings season that kicks into high gear in a few weeks. Usually price action is subdued at the start of earnings announcements, plus most investors don't want to get overly aggressive until they can get a read on what the FOMC will decide at their next meeting in a few weeks.

MTUM Daily Chart

Global demand for U.S. assets is driving up the dollar. Despite the rise in equities, the demand for Treasury bonds drove prices even higher this week. Gold also continues to be in demand as currency concerns mount. Analysts also pointed to international investors' preference for U.S. government bonds, which hold notably higher yields than government bonds in comparable developed markets like Britain, Japan and Germany. "There is such a tremendous appetite for (U.S. Treasuries) that any selloffs are bought very quickly" said Dan Heckman, senior fixed income strategist at U.S. Bank Wealth Management in Kansas City, Missouri. Increased buying in Treasuries pushes up prices, which move inversely to their yields. Gold rose as a traditional safe-haven asset all saw gains despite the rally in stocks. The precious metal rose 1.5% for the week and is up over $100 post Brexit.

UUP Daily Chart


Market Outlook

Earnings Season also unofficially begins with the release of Alcoa's (AA) results on Monday. However some investors remained concerned about the effects of "Brexit" and the upcoming earnings season. Near record lows in 10- and 30-year U.S. government bond yields underscored those concerns. "I am maintaining a cautious outlook for the next couple of months," said Phil Orlando, chief equity market strategist at Federated Investors in New York, citing Brexit, uncertainty about rate hikes and the November U.S. presidential election. "I think investors are just whistling past the graveyard here; there is a lot of ugly stuff on the horizon that everyone is just sort of ignoring. It just strikes me there are just too many things that can go wrong over the next couple of months." "The equity market is telling you the second quarter economy looks better than the first quarter," said Art Hogan, chief market strategist at Wunderlich Securities in New York. He said if earnings season, which begins in earnest next week, provides investors with a strong outlook; the S&P will likely break the record and has a chance at rallying from there. "The old high has been resistance and if you break it and see earnings growth and relatively good guidance, people will probably try to get in front of that," said Hogan. You can see in the 2nd quarter graph below how investors primarily focused on "safe-haven" assets like real estate and gold.

Quarter Performance

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. Put/call ratios have rolled back up to buy signals from selling. The current ratio indicates traders are extremely bullish ahead of quarterly earnings as they load up on option call contracts to bet on higher stock prices.

Total Put/Call Ratio

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. Option volatility reflected the market rally as the Volatility Index fell 10% for the week. The 'Fear Gauge' is showing little concern for any downside risk at this point, as investors may be getting too complacent in equity markets. The VIX has swung wildly since the June 23 vote by Britons to leave the European Union, ended at its lowest level since late May.

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 07/06/2016. Optimism among individual investors about the short-term direction of stock prices is near a three-month high in the latest AAII Sentiment Survey. Pessimism pulled back for a third consecutive week, while neutral sentiment rebounded. Bullish sentiment, expectations that stock prices will rise over the next six months, rose 2.1% to 31.1%. Optimism was last higher on April 20, 2016 at 33.4%. Nonetheless, bullish sentiment remains below its historical average of 38.5% for the 35th consecutive week and the 68th out of the past 70 weeks. Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, jumped 4.6% to 42.3%. The rise keeps neutral sentiment above its historical average of 31.0% for the 23rd consecutive week. Bearish sentiment, expectations that stock prices will fall over the next six months, fell 6.8% to 26.7%. This is lowest level of pessimism since April 20, 2016 at 23.9%. The historical average is 30.5%. This is just the eighth week this year with more than three out of 10 individual investors describing their short-term outlook for stocks as "bullish." (Optimism was at 30.0% on March 16.) In contrast, more than four out of 10 respondents have described their outlook as "neutral" on 15 out of this year's first 27 weeks. As far as pessimism goes, bearish sentiment has topped 30% 14 times this year. The rise in optimism occurred as prices rebounded, with large-cap stocks trading back near their record high.

AAII Sentiment

The National 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 07/06/2016. Second-quarter NAAIM exposure index averaged 60.52%. Last week the NAAIM exposure index was 74.52%, and the current week's exposure is 65.43%. As we said recently "...The equity exposure index will probably stabilize over the next few weeks as money managers' dress up their books for quarterly reporting and reserve funds for the upcoming earning season..."

NAAIM Exposure Percent


Trading Strategy

According to the Stock Trader's Almanac the average price tendency is for a summer sell-off that usually begins in mid-July and lasts until mid-October. Part of the reason is perhaps due to the fact that July starts the worst four months of the year for NASDAQ and also falls in the middle of the worst six months for DJIA and S&P 500. Mid-July is also when we typically kick off earnings season, where a strong early month rally can fade, as active traders may have "bought the rumor" or bought ahead on anticipation of good earnings expectations and then turn around and "sell the fact" once the news hits the street. Our recently analysis was realized where we asked, "...Now the question is where will the market bottom out? The best bet is that investors overreacted to the Brexit vote and stocks will eventually bounce back, especially since some pundits believe there is a possibility the FOMC could lower rates at one of their upcoming meetings. If this prediction comes to fruition the current pullback might be great opportunity to bid on undervalued shares...If the market does pull back, that might be a good opportunity to "buy the dip" with shares in the leading sectors..." We discussed above our prognostication suggesting the market is due for a pause. If this analysis plays out that might be another opportune time to bid on shares in "risk-off" defensive stock groups which are the leading sectors in the updated graph below.

S&P Sector ETF 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
Easy Money Options Income

Important Disclosure
Futures, Options, Mutual Fund, ETF and Equity trading have large potential rewards, but also large potential risk. You must be aware of the risks and be willing to accept them in order to invest in these markets. Don't trade with money you can't afford to lose. This is neither a solicitation nor an offer to buy/sell Futures, Options, Mutual Funds or Equities. No representation is being made that any account will or is likely to achieve profits or losses similar to those discussed on this Web site. The past performance of any trading system or methodology is not necessarily indicative of future results.

Performance results are hypothetical. Hypothetical or simulated performance results have certain inherent limitations. Unlike an actual performance record, simulated results do not represent actual trading. Also, since the trades have not actually been executed, the results may have under- or over-compensated for the impact, if any, of certain market factors, such as a lack of liquidity. Simulated trading programs in general are also subject to the fact that they are designed with the benefit of hindsight. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown.

Investment Research Group and all individuals affiliated with Investment Research Group assume no responsibilities for your trading and investment results.

Investment Research Group (IRG), as a publisher of a financial newsletter of general and regular circulation, cannot tender individual investment advice. Only a registered broker or investment adviser may advise you individually on the suitability and performance of your portfolio or specific investments.

In making any investment decision, you will rely solely on your own review and examination of the fact and records relating to such investments. Past performance of our recommendations is not an indication of future performance. The publisher shall have no liability of whatever nature in respect of any claims, damages, loss, or expense arising out of or in connection with the reliance by you on the contents of our Web site, any promotion, published material, alert, or update.

For a complete understanding of the risks associated with trading, see our Risk Disclosure.

Copyright © 2014-2016 Gregory Clay

All Images, XHTML Renderings, and Source Code Copyright © Safehaven.com