Stocks Are Only Game In Town

By: Gregory Clay | Sun, Aug 7, 2016
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Market Summary

U.S. stocks notched their best day in a month on Friday, with the S&P 500 and Nasdaq closing at record highs after a second straight month of robust labor market data boosted optimism that U.S. economic growth is accelerating. The current momentum is providing a strong catalyst for the next leg higher. The S&P 500 notched its eighth closing high of the year, powered by gains in financial company stocks which would be primed for a profit boost should the Federal Reserve raise interest rates. For the week, the S&P 500 Index finished up a modest 0.4% and the Blue Chip-heavy Dow Jones Industrial Average rose 0.6%. The Nasdaq rose a solid 1.3% while the small cap Russell 2000 finished up 1%.

YTD Performance

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. Like many of the technical market internal indicators, it is used both to confirm a move in the market and as a non-confirmation and therefore divergence indication. The uptrend line in the updated chart below supports recent analysis where we said, "...Nasdaq stocks are leading the market higher as quarterly earning numbers have enticed investors. Strength in technology and small cap stocks are primarily propping up the market. As long as the BPCOMPQ remains in an uptrend expect the overall stock market to remain near all-time highs..."

NASDAQ Composite Bullish Percent Index Daily Chart

Last week we wrote ".... the DJ Industrials and Transports confirm a downtrend..." You can see in the updated chart below how the DOW Industrials and Transports reversed course and both are now trending higher to confirm the current bullish market move.

Dow and Transports Daily Chart

In the updated chart below, the dollar strengthened last week after the strong July jobs report was seen increasing the likelihood of a Federal Reserve interest-rate hike before the end of 2016. Treasury prices tumbled; pushing up yields after July's stronger-than-expected jobs report was interpreted as potentially giving the Federal Reserve reason to raise interest rates. The move being most pronounced in short-term yields, which are most sensitive to changes in the Fed-funds rate and tend to spike when the market's rate-hike expectations rise. Gold notched a hefty loss Friday, tumbling the most in about 2 1/2 months following the stronger-than-expected jobs report. Higher rates can boost the value of the dollar and undercut the appeal of commodities priced in the currency, making them more expensive for buyers using other monetary units. A rate hike also diminishes the appeal of owning gold, which does not offer a yield.

UUP Daily Chart


Market Outlook

On the heels of a tepid second-quarter growth report, the jobs data painted a rosier picture of the economy. Recent data has shown solid consumer spending, including higher-than-expected outlays in June as households bought more goods and services. "Anything that really would suggest that the consumer is starting to step up and pick up a little bit more of the load would give you some optimism that maybe we can get an earnings break-out at some point," said Bruce McCain, chief investment strategist at Key Private Bank in Cleveland, Ohio. With two-thirds of the consumer discretionary sector reporting so far, second-quarter earnings are expected to have climbed 12.5 percent, better than the 9 percent rise expected at the start of July, according to Thomson Reuters I/B/E/S. "The consumer, in our mind, is a lever that could cause equities to trend higher," said Terry Sandven, chief equity strategist at U.S. Bank Wealth Management in Minneapolis. "Next week will be telling ... If retail sales suggest that spending is beginning to pick up that could bode well for performance." Stocks head into next week on a positive note, with the S&P 500 rising to a fresh intraday all-time high on Friday after two weeks of little change to the benchmark index. In the updated graph below, technology and smaller cap stocks are leading the market higher in the third-quarter as investors rotate out of large cap stocks.

Quarterly Performance

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 remains at extremely low levels as the major indexes hit all-time highs. With earnings season winding down and in the middle of slow summer months, the Volatility Index will probably remain suppressed for the near-term.

Weekly VIX 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 08/03/2016. The percentage of individual investors describing their short-term outlook for stocks as "neutral" is at its highest level in two months, according to the latest AAII Sentiment Survey. At the same time, optimism is back below 30%. Pessimism is lower as well. Bullish sentiment, expectations that stock prices will rise over the next six months, declined 1.5 percentage points to 29.8%. Optimism was last lower on June 29, 2016 (28.9%). This is the 39th consecutive week and the 72nd out of the past 74 weeks with a bullish sentiment reading below its historical average of 38.5%. Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, rose 3.1 percentage points to 43.4%. Neutral sentiment was last higher on June 8, 2016 (44.3%). This week's increase keeps neutral sentiment above its historical average of 31.0% for the 27th consecutive week. Bearish sentiment, expectations that stock prices will fall over the next six months, declined 1.6 percentage points to 26.8%. The decrease keeps pessimism below its historical average of 30.5% for the fifth consecutive week.

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 08/03/2016. Second-quarter NAAIM exposure index averaged 60.52%. Last week the NAAIM exposure index was 101.02%, and the current week's exposure is 93.05%. Many investors view equities as the only game in town. Meager bond yields and the elevated dollar continue to put downward pressure on the value of commodities. The market may be starting another bullish leg higher; therefore it is reasonable to the equity exposure index to remain elevated.

NAAIM Number


Trading Strategy

Some individual investors are concerned about stock valuations and the crazy presidential election is having an impact, as well as headlines about the Dow Jones industrial average's recent seven-day drop. The S&P 500 is trading at 17.1 times earnings estimates of its component companies over the next 12 months, well above its average of 14.5 times over the past five years. In addition to prevailing valuations and the election, global economic uncertainty (including Brexit) and disappointment with corporate earnings growth are giving some individual investors reasons to be cautious or pessimistic. Others feel that the perceived lack of viable investment alternatives, economic growth and generally upward momentum in stock prices will result in higher stock prices over the next six months. "The US economy may not be going gangbusters but it remains the best equity alternative of any worldwide index," said Michael James, managing director of equity trading at Wedbush Securities. "The most important takeaway from the positive jobs report is an indication of a continued grind higher in the US economy." With about 85 percent of the overall S&P 500 already reported, second-quarter earnings are expected to have fallen 2.6 percent, not as dire as feared at the start of July. You can see in the graph below how technology shares continue to lead the charge higher. But also note the best trading opportunity might be financial stocks, which are surging on the expectation of a Fed rate increase.

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

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