Investors pulled another $19 billion from stock funds over the past week, seeking safety in government bond funds, which have enjoyed the longest run of inflows in four years, said Bank of America/Merrill Lynch. U.S. stocks rose last week and the S&P 500 posted its biggest weekly gain since July as investors weighed whether the Federal Reserve will raise interest rates next week. At this point, the likelihood of a Fed hike is being viewed as low based on the CME Group's FedWatch tool, which has the probability of a rate increase in September at 23%. For the week, the S&P was up 2.1% and the Nasdaq rose 3.0%, registering their biggest weekly percentage gains since mid-July. The Dow was up 2.1% for the week, its best weekly percentage increase since late March.
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 updated chart below signals the beginning of a price recovery with higher highs and higher lows. The other major equity index BPI charts have a similar setup.
In the chart below the Aggregate Bond ETF (AGG) to represent the "bond" market and the Equal-Weight S&P 500 ETF (RSP) for the stock market benchmark. Bonds are outperforming stocks as money flows into relative safety and shuns risk. Overall, relative strength in bonds reflects risk aversion in the financial markets. Relative strength in bonds also indicates that investors should prefer bonds over stocks right now. Like all market dynamics, it is subject to change, but current trends favor bonds until there is evidence to the contrary.
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 dotted lines track the MTUM converging into a tight range and due for a breakout. Note the orange circle highlighting the strength and momentum indicators starting to turn bullish, this suggest a probable upside breakout.
Recently we said "...the MTUM is displaying technical reversal signals at its 50 Week SMA. Notice how every time the ETF falls to the SMA it recoils higher..." As circled in the chart below, the weekly MTUM has stalled at the 50-Week SMA and is trying to bounce higher.
Market Outlook
The stock market has been volatile since China devalued its currency in August amid concerns of sputtering growth in the world's second-largest economy. The S&P 500 has had moves of at least 1% in 11 sessions since Aug. 20. Investors are awaiting next week's Fed monetary policy meeting and news on whether it will raise benchmark U.S. rates for the first time in almost a decade. "It's really Fed watch. That's what traders are waiting for," said Tim Ghriskey, chief investment officer of Solaris Group in Bedford Hills, New York. "There's speculation the Fed might hold off, and if they do, I think we'll see stocks rally. But to us, it's not a question of if the Fed raises rates but when. It's going to happen."
Horan Capital Advisors have noted that initial Federal Reserve rate increases tend to not have a negative impact on stock prices. Further evidence can be seen in the below chart. The red dots on the S&P 500 Index chart line denote the first rate hike in a Fed tightening cycle. The yellow line represents the yield curve (30 year treasury minus 3 month treasury bill) and one can see why investors focus on equity performance when the yield curve inverts. As the red dots clearly show, the onset of a tightening cycle isn't necessarily a precursor to poor equity market performance. The stock market does tend to exhibit weakness initially; however, the weakness tends to be short lived.
According to Sentiment Trader research with data going back to 1980s, whenever bearish newsletter advisors outnumbered bullish ones for the first time in a year (as it does now), three month stock returns were positive 100% of the time. The average return was about 8% gain in the coming 12 week timeframe. In the graph below you can see Treasuries are the only asset class with a quarterly gain as investors dump equities and park the funds in bonds.
The dollar posted a weekly decline as investors adjusted their positions ahead of the weekend to reflect declining expectations for a Federal Reserve interest-rate increase next week. But analysts said the currency's moves likely had more to do with end-of-week position adjustments because the poor sentiment reading was hardly a surprise. Gold posted third straight week of losses as investors awaited the Federal Reserve's interest rate announcement. The Fed's two-day policy meeting may set the tempo for gold's moves, at least in the short term. Treasury bonds finished the week lower ahead of a highly anticipated FMOC meeting that could feature a significant shift in monetary policy. If the Fed does vote to raise rates, it will be the first increase since 2006. A higher benchmark rate would likely push treasury prices lower. In the absence of key data drivers ahead of the Fed's pivotal rates meeting, Treasuries were driven by supply-demand fundamentals that included a steady flow of newly issued corporate and sovereign bonds, which put pressure on Treasury prices.
We like to compare the DOW Industrials and Transports to confirm the current market trend. You can see the Industrials and Transports have diverged. This indicates any move higher will be fragile until both indexes converge again.
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 VIX higher. The updated chart below supports a market bottom as the VIX is falling and the S&P creeps back up.
After the biggest surge since May 2010, the VIX has been trending down with lower highs and lower lows. If the VIX breaks below the dotted support line it would confirm that the market has bottomed. Also the orange circle highlights the VIX's downward momentum.
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 overallmarket sentiment. Option premiums remain high as traders buy put protection during the market correction.
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 9/09/2015. The most recent AAII survey showed 34.60% are Bullish and 35.00% Bearish, while 30.30% of investors polled have a Neutral outlook for the market for the next six months. Traders in the pits are saying the algorithmic trader in the futures and stock markets are taking advantage of the increased volatility and scaring the pants off the public. We already discussed how the High Frequency guys and algo's are extending out the up and down price moves, and it's starting to panic individual investors.
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 9/09/2015. Second-quarter NAAIM exposure index averaged 72.84%. Last week the NAAIM exposure index was 23.85%, and the current week's exposure is 26.04%. According to the Investor Intelligence newsletter and advisor survey, bullish sentiment has dropped to levels we have not seen since March 2009 lows. Apart from the Lehman bankruptcy and the aftermath market crash of October 2008, there has been no other time bullish sentiment was this low in the last two decades. The Asian Financial Crisis in 1997, Russian default in 1998, Tech crash in early 2000s, September '11 attacks, World dot com bankruptcy and all other panics have not scared the bulls as much as the first potential Federal Reserve interest rate hike since 2006. It is very clear that market participants have gotten use to extremely loose monetary policies via all major central banks. Furthermore, for the first time since the Eurozone entered a recession in 2011, bearish newsletter advisors have now outnumbered the bullish ones.
Trading Strategy
Large gains in excess of 2.5% occur primarily during downtrends and they cause short squeezes and bull traps. Recently we suggested "...Remain defensive, and use any celebrations on Wall Street to buy puts and other forms of insurance more cheaply..." The reason is that you cannot trust the markets big "up days". Typically, they occur when the market has already run into trouble, and are often technical in nature. An analysis by Michael Batnick at the Irrelevant Investor showed that 22 of the 25 best days since 1970 occurred under the 200-day moving average. That implies they were oversold rallies with some element of short covering. Traders may like them, but long-term investors would much rather see three 100-point days than one 300-point day. The more gradual gains reflect a healthier accumulation and not a reflexive reaction. Selling into strength continues to be a good strategy to profit from short term moves and to liquidate the biggest losers in the chart below.
Feel free to contact me with questions,
