Investors React To Hawkish Fed

By: Gregory Clay | Sun, Aug 28, 2016
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Market Summary

For the week, the Blue Chip-heavy Dow Jones Industrial Average fell 0.8% while the S&P 500 Index fell 0.7% and the Midcap S&P 400 dropped .2%. The small cap Russell 2000 actually rose a minimal amount due to early week strength as the Nasdaq slid a modest 0.4%, snapping an 8-week win streak. All the major asset classes are in the black year-to-date.

YTD Performance

In the chart below you can see that the dollar is rebounding after Fed Chairperson Janet Yellen's Jackson Hole, Wyoming comments opened the door for an interest rate hike before the end of the year. Conversely, dollar denominated assets like treasury bonds and gold are weakening after the Federal Reserve suggested rate hikes might be imminent.

UUP Daily 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 the VIX higher. In the chart below the Volatility Index exploded over 20% last week to the highest level since the beginning of July. Several Fed comments hinted at higher interest rates, which are making investors nervous and increasing volatility.

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 08/24/2016. Pessimism among individual investors about the short-term direction of stock prices is at a two-month high in the latest AAII Sentiment Survey. Optimism fell to back below 30%, while neutral sentiment rebounded modestly. Bullish sentiment, expectations that stock prices will rise over the next six months, plunged 6.1 percentage points to 29.4%. Optimism was last lower on June 29, 2016. This is the 75th week out of the past 77 that optimism is below its historical average of 38.5%. Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, rebounded by 2.9 percentage points to 40.9%. The rebound puts neutral sentiment above 40% for the fourth time in five weeks. It also keeps neutral sentiment above its historical average of 31.0% for the 30th consecutive week. Bearish sentiment, expectations that stock prices will fall over the next six months, rose 3.3 percentage points to 29.6%. This is the highest reading of pessimism since June 29, 2016 (33.4%). The increase is not large enough to prevent bearish sentiment from staying below its historical average of 30.5% for the eighth consecutive week, however. This week's decline in optimism follows what had been a five-week high. Meanwhile, pessimism rose from what had been a five-week low.

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 08/24/2016. Second-quarter NAAIM exposure index averaged 60.52%. Last week the NAAIM exposure index was 98.79%, and the current week's exposure is 97.80%. We need to closely watch equity exposure in the upcoming weeks to monitor investors' response to perceived hawkish Fed comments. Federal Reserve Chair Janet Yellen said the case for raising rates had strengthened but did not indicate when the Fed would act.

NAAIM Number


Trading Strategy

Though the major U.S. indexes were relatively unchanged over the past seven days, concerns about valuations and the presidential election continue to temper individual investors' expectations. Also keeping some individual investors bearish or at least giving them reason to be cautious are global economic uncertainty and disappointment with corporate earnings growth. The updated graph below indicates overall market weakness. Recently we have been recommending hedging long-term positions to protect gains in the event of a market pullback.

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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