Short Sellers Got Squeezed Hard

By: Gregory Clay | Sun, Nov 13, 2016
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Market Summary

According to Jeff Hirsh in the Stock Trader's Almanac, S&P 500 has correctly predicted the outcome of the last 19 Presidential Elections 16 times. When the S&P 500 gains in the three months August through October, the incumbent party retained the White House 9 of 11 times. When S&P 500 was down during those three months the incumbent lost 7 of 8 times. S&P 500 was down for August to October in 2016 and the incumbent party lost. Despite the market's "surprise" plunge on Election night, it had already indicated an incumbent defeat. The Dow Jones industrial average ended at a record closing high on Friday, capping off its best week since 2011 after Donald Trump's unexpected victory in the U.S. presidential election.

For the week, the benchmark S&P 500 Index finished strong up 3.8%, its best weekly gain in two years, while the Blue Chip-heavy Dow Jones Industrial Average surged 5.4%. The Nasdaq jumped 10.00% and the small cap Russell 2000 was the biggest winner jumping 10.22%. Gold has been a best performer for most of the year but is now in freefall as investors expect an imminent rate increase which normally has an adverse effect on precious metals.

YTD Performance

A standard chart that we use to help confirm the overall market trend is the r 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 overall 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. Last week we said "...If the market doesn't stage a recovery bounce after the November election the downtrend will probably continue heading into the December Fed meeting..." The many traders who took short positions ahead of the presidential election got chased out of those trades last week after the market started a recovery bounce. The updated MTUM chart below signals the overall market has bottomed out ahead of the December Fed meeting. November is normally a strong month for stocks which are setting up to move higher off of the recent lows.

MTUM Daily Chart


Market Outlook

As reported in Reuters, since his triumph on Tuesday, investors have been betting on Trump's campaign promises to simplify regulation in the health and financial sectors and boost spending on infrastructure. "Wall Street is going to be watching a lot of (Trump's) appointments and policy announcements to see whether it validates the more optimistic tone we've seen in the markets in the past few days," said Alan Gayle, senior investment strategist and director of asset allocation at RidgeWorth Investments in Atlanta, Georgia. Jeff Hirsh notes in the Stock Trader's Almanac that DJIA has been leading the post-election charge and is poised to continue to stay out in front. Aside from its construction of many Trump sensitive stocks that should benefit from infrastructure building and regulatory reduction, DJIA outperforms the other major indices during the week before Thanksgiving and Options Expiration week of which next week is both. The Russell 2000 index of small cap stocks has been doing even better than DJIA, but its record next week is not as strong. In the updated chart below you can see the Russell 2000 is already leading equities higher since the S&P 500 Index attained all-time highs in the middle of August, with the DJIA next in line.

Performance since Aug 15

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. The Volatility Index crashed hard this week reversing the previous week's 40 percentage point move higher. As confirmed in the updated chart below, after traders got over the initial shock of an unexpected Donald Trump election, they started aggressively budding up equity prices. Conversely, the VIX sank as investors determined that a Republican congress and executive branch will be pushing more business-friendly economic policy initiatives. Most probably the VIX will pullback and stabilize around the October 24th support level.

VIX versus S&P500 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 11/09/2016. Optimism among individual investors about the short-term direction of the stock market surged to its highest level since last November in the latest AAII Sentiment Survey. Neutral sentiment plunged to its lowest level in more than 10 months. Bearish sentiment is lower as well. Bullish sentiment, expectations that stock prices will rise over the next six months, jumped 15.3 percentage points to 38.9%. Optimism was last higher on November 4, 2015 (39.0%). The large increase puts bullish sentiment above its historical average of 38.5% for the first time in 53 weeks and just the third time during the past 88 weeks. This week's jump in bullish sentiment is the largest since an 18.4 percentage-point spike on July 15, 2010. It is also the biggest one-week change in either direction since a 16.2 percentage-point drop on April 11, 2013. This week's large upward move follows what had been the 104th lowest level of optimism registered over the 29-year history of our Sentiment Survey. Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, plunged 10.3 percentage points to 31.8%. This is the lowest neutral sentiment has been since January 27, 2016 (30.3%). Even with the large drop, neutral sentiment remains above its historical average of 31.0% for the 41st consecutive week. Bearish sentiment, expectations that stock prices will fall over the next six months, fell 5.0 percentage points to 29.3%. Pessimism remains in the approximate 10-point range it has fluctuated within over the past 11 weeks. This week's drop does, however, put bearish sentiment below its historical average of 30.5% for the first time in four weeks.

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 11/09/2016. Third-quarter NAAIM exposure index averaged 80.32%. Last week the NAAIM exposure index was 58.08%, and the current week's exposure is 72.96%. Last week was the ultimate "short squeeze" where investors had to chase prices higher. On the night of the presidential election overnight futures were down 800 points. After the election results came in, traders reversed course and all the short sellers that had piled on the previous week were forced to cover their short positions and chase prices higher. The NAAIM Exposure Index will probably trend higher leading up to the December FMOC meeting.

NAAIM Exposure Percent


Trading Strategy

Giving some individual investors reason for optimism are the perceived lack of investment alternatives, corporate earnings, low/stable energy prices and sustained, albeit slow, economic growth. Causing others to have reason for concern is this fall's previous weakness in stock prices and the possibility of the stock market experiencing a larger drop, valuations, global economic uncertainty, the pace of corporate earnings growth and a forthcoming rate hike. Our recently analysis is coming to fruition were we said "...November maintains its status among the top performing months as fourth-quarter cash inflows from institutional investors drive November to lead the best consecutive three-month span November-January...investors seem to be anticipating a Fed rate increase which generally benefits the bottom line of financial institutions. Now might be good time to look for an entry price for stocks on your watch list or consider low priced option call spreads to minimize trading risks while waiting on the market to rebound..."

30-Day Performance

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Gregory Clay

Author: Gregory Clay

Gregory Clay,
http://www.theoptionplayer.com/

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