U.S. stocks crashed hard Friday, but The Dow Jones Industrial Average took the biggest hit. The Dow suffered its second-worst Friday drop in 2015 on a point and percentage basis, according to Dow Jones data. Blue chips tumbled 289 points, or 1.7%, registering the worst close since Aug. 21, when the Dow plunged by 530 points, or 3.1%, fueled by worries about China's sagging economy. This time around the stock-market rout was inspired by the Federal Reserve's decision to leave rates unchanged due to concerns about emerging-market economies like China. The other main indexes didn't do much better. The S&P 500 lost 32.12 points, or 1.6%, while the Nasdaq Composite Index gave up 66.72 points, or 1.4%. Friday's selloff wiped out the stock market's gains for the week. As seen in the graph below, the Dow is now down 8% on the year, while the S&P 500 is off 5%. Strong performances by technology and biotech stocks have kept the Nasdaq afloat, up 2% this year. For the week, the Dow shed 0.3%, the S&P fell 0.1% and the Nasdaq rose 0.1%.
The turmoil comes one day after the U.S. Fed announced that it was leaving its benchmark interest rate near 0%. Fed chief Janet Yellen said in explanation: "The outlook abroad appears to have become more uncertain." She was referring to the economic slowdown in China and its impact on the rest of the world, including the United States. However, the Fed's comments about market turmoil made investors even more nervous. Major stock markets in Europe, like Germany and France, fell over 2.5%. "What the Federal Reserve has done is increase uncertainty," said David Kelly, chief global strategist at JPMorgan Funds. "The stock market always hates uncertainty." Friday's volatility was also likely exacerbated by Quadruple-Witching when options on stocks and indexes, and futures on indexes and single-stocks all expire, prompting investors to buy or sell shares to cover expiring contracts.
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. Ahead of last weeks' Fed announcement the updated chart below displays a bullish trend with higher highs and higher lows. Now the question is after the FMOC decision, will the market continue the bullish move or follow through on Friday's price crash? The other major equity index BPI charts have a similar setup.
In the chart below, the Aggregate Bond ETF (AGG) represents the "bond" market and the Equal-Weight S&P 500 ETF (RSP) is the stock market benchmark. Equities started selling off after the FMOC decided not to raise interest rates. As evidenced in the chart, after selling stocks investors immediately put the money into bonds for relative safety and minimize risk.
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. As we having pointing out recently, the dotted lines in the chart show the MTUM converging into a tight range. A breakout is inevitable and the question is will the break be up or down. The orange circle highlights strength and momentum indicators turning bullish which suggest a probable upside breakout.
As we have noted the past few weeks "...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..." In the chart below we circle the weekly MTUM technical bullish reversal signal at the 50-Week SMA.
Market Outlook
Fears over slowing global growth hammered stocks in the U.S. and Europe on Friday and lifted prices of government bonds and other assets seen as safe-havens. The selling pushed down major stock indexes in Germany, France and Britain before spreading to the U.S. The S&P 500 slumped to its biggest loss in more than two weeks as all 10 industry sectors of the broad market gauge fell. Energy companies dropped the most as oil plunged. The stock sell-off came a day after the Fed announcement about holding interest rates near zero. This means borrowing costs will remain low for a while yet, a prospect that has in the past typically boosted stocks. But some investors, expecting the Fed would be confident enough to nudge rates up by at least a quarter of a point, interpreted the stance as a sign that the global economy is dangerously weak. "If growth in the strongest economy isn't strong enough to raise rates even a quarter of a point, what does that say about the prospects for global growth?" said Bill Strazzullo, chief strategist at market research firm Bell Curve Trading. The Fed has kept its benchmark rate close to zero for almost seven years. In that time, U.S. stocks have nearly tripled from their financial crisis low. 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.
Last week we said "...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...A higher benchmark rate would likely push treasury prices lower..." The dollar weakened further after the Federal Reserve refrained from raising interest rates. The U.S. currency fell to a three-week low as stubbornly low inflation, an uncertain outlook for global growth and recent financial-market turmoil prompted U.S. policy makers to keep rates at a record low, suppressing the dollar. It slid most against the currencies of commodity-producing nations such as New Zealand and Australia. "Whilst the dollar may be heading lower now, the market is only going to turn its attention to December for the next hike," said Jane Foley, a senior currency strategist at Rabobank International in London. "There might be a little bit of position adjustment now but the market is going to start looking ahead. The dollar weakness has only got so far to run. After the FMOC announcement as equities moved sharply lower, the Treasury market rallied on the news, with prices rising and yields dropping in all maturities. Gold futures on Friday logged their second-highest close for the month of September, as prices rallied on the back of the Federal Reserve's decision to keep interest rates at historically low levels.
We like to compare the DOW Industrials and Transports to confirm the current market trend. Last week's comment "...You can see the Industrials and Transports have diverged. This indicates any move higher will be fragile..." This analysis is confirmed in the updated chart below. The DOW Industrials trend reversed down and the Transports also fell to confirm a pullback.
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. You can see in the updated chart below how the S&P creeped up and the VIX fell leading up to the recent Federal Reserve meeting. The S&P sank after the meeting and the VIX remained above support.
The dotted line in the chart below is the current support VIX support level. The VIX is flashing bullish reversal signs above support, which indicates investors remain cautious. If prices continue the end of week pullback expect the VIX to move back higher.
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. Traders backed off on excessive put buying ahead of the Fed announcement, but expect an increase if stocks follow through on Friday's sell-off.
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 9/16/2015. The most recent AAII survey showed 33.30% are Bullish and 29.10% Bearish, while 37.60% of investors polled have a Neutral outlook for the market for the next six months. As indicated in the updated survey, individual investors don't have a strong feeling for the market direction and primarily are neutral.
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 9/16/2015. Second-quarter NAAIM exposure index averaged 72.84%. Last week the NAAIM exposure index was 26.04%, and the current week's exposure is 31.57%. Don't expect money managers to increase their exposure ahead of the upcoming earnings season.
Trading Strategy
High-frequency trading accounted for 49% of this month's trading volume of about 6.9 billion shares, according to TABB Group. During the peak levels of high-frequency trading in 2009, about 61 percent of 9.8 billion of average daily shares traded were executed by high-frequency traders. Interest rate-sensitive sectors such as Utilities and Real Estate spiked at week's end, following the Fed announcement that benchmark interest rates would remain unchanged for now. And according to some traders, the initial market reaction is a clear buy signal for some of these beaten down categories. "It is definitely a green light to start to incrementally add yield-sensitive instruments back into your portfolio for the short term," Neil Azous, of Rareview Macro, said Thursday on CNBC's "Trading Nation." Larry McDonald of Societe Generale recommended watching gold miner stocks and commodities in addition. He said commodities would benefit from a weaker U.S. dollar. McDonald also said these sectors have a tendency to rally each time the Fed pushes back a rate hike.
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