U.S. stocks closed out the week with a whimper, turning big opening gains in the S&P 500 and Nasdaq Composite into losses by Friday's close. A sharp selloff in biotech and health-care stocks spread to broader markets, weighing on sentiment. "A selloff in biotechs took the wind out of the rally. And in this low-volume environment traders are selling first and asking questions later," said Ryan Larson, head of equity trading, U.S. RBC Global. The main indexes declined in six of the past seven trading days, since the Federal Reserve left its key borrowing rate unchanged on Sept 17, citing concerns over slowing global growth. The Dow remained in correction territory, or more than 10% away from its 52-week high. The Nasdaq also fell back into correction mode, while the S&P 500 was about 9.5% away from its 52-week high. The S&P 500 is on course for its first back-to-back losing August and September since 2011. As seen in the graph below, the Dow is now down 9% on the year, while the S&P 500 and Russell 2000 are both off 7%. Biotech stocks crashed this week to help drop the Nasdaq down 1% this year. For the week, the Dow shed 0.3%, the S&P fell 1.4% and the Nasdaq fell 2.9%.
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. Last week we said, "...the question is after the FMOC decision, will the market continue the bullish move or follow through on Friday's price crash..." the updated chart below confirms the major equity indexes continuing to sell off.
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. The updated chart below shows investors continued selling off equities and buying bonds.
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. We have been reporting recently "...the MTUM converging into a tight range. A breakout is inevitable and the question is will the break be up or down..." The MTUM broke below the dotted uptrend line. Also the orange circle highlights strength and momentum indicators turning bearish which confirms the downside breakout.
Market Outlook
"The shutdown in Washington could roil markets next week," reports Kate Warne. "People are putting that off because they don't know whether we know what will happen until the last minute. I think this time we know it's going to go down to the wire.(Boehner's resignation makes it more likely). With Boehner resigning, although not until next month, it clearly reflects on lack of Republican (consensus) in the House. It makes it more likely that there's a temporary government shutdown... and it would tend to trigger a negative market reaction but fortunately that doesn't tend to last very long." Lance Roberts, head of Streettalklive.com, said a key focus is "the posturing and threats from the Administration will likely cause additional market angst given an already weak market. This was the same backdrop as 2011 when we debated over the debt ceiling then."
Wall Street is bracing for a grim earnings season, with little improvement expected anytime soon. Analysts have been cutting projections for the third quarter, which ends on Wednesday, and beyond. If the declining projections are realized, already costly stocks could become pricier and equity investors could become even more skittish. Forecasts for third-quarter S&P 500 earnings now call for a 3.9 percent decline from a year ago, based on Thomson Reuters data, with half of the S&P sectors estimated to post lower profits thanks to falling oil prices, a strong U.S. dollar and weak global demand. The weak forecasts have some strategists talking about an "earnings recession," meaning two quarterly profit declines in a row, as opposed to an economic recession, in which gross domestic product falls for two straight quarters. As the stock market is goes through the end of quarter rebalancing you can see Treasuries are the only asset class with a quarterly gain as investors dump shift funds from equities to treasuries.
The circle in the chart below highlights the unusual occurrence when the dollar, treasury bonds and gold prices all converge together. The dollar index hit its highest intraday level since Aug. 19th after Federal Reserve Chairwoman Janet Yellen said the central bank would likely raise interest rates in 2015. Treasury prices finished the week lower after rising to their highest level in a month, following news Friday that the U.S. economy grew in the second quarter at a faster pace than what had been initially reported. The news boosted investor confidence, sparking an early morning stock market rally and a bond-market selloff. Typically, when investors buy into riskier assets, like stocks, they sell safer investments like U.S. government bonds. The Treasury selloff pushed prices treasury prices lower and drove yields, which move in the opposite direction, higher. Gold managed a weekly gain of about 0.6%. The prospect of an interest rate hike sometime this year dulls the appeal of gold because it doesn't bear interest. Higher rates also boost the dollar, which can make the dollar-denominated asset less attractive to buyers in other currencies.
Cash is on track this year to outperform both stocks and bonds, something that hasn't happened since 1990, according to Bank of America Merrill Lynch. And it might all be down to the notion that central bank-fueled liquidity has peaked. Year-to-date annualized returns are negative 6% for global stocks and negative 2.9% for global government bonds, according to analysts led by Michael Hartnett in a Friday note. The dollar is up 6% and commodities are down 17%, while cash is flat. In the chart below you can see the dollar's move to the highest level in over a month put downward pressure on commodities.
We like to compare the DOW Industrials and Transports to confirm the current market trend. The updated chart below confirms the stocks downtrend reversal as both the DOW Industrial and Transports dropped.
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 sank after the recent FMOC meeting and the VIX trended higher. This supports the historical trend for September being the worst month for stock performance.
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. Last week we said "...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 update ratio show increased put buying.
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 9/23/2015. The most recent AAII survey showed 32.10% are Bullish and 28.70% Bearish, while 39.20% of investors polled have a Neutral outlook for the market for the next six months. Individual investors remain cautious and continue to wait on the market to start another bullish move.
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 9/23/2015. Second-quarter NAAIM exposure index averaged 72.84%. Last week the NAAIM exposure index was 31.57%, and the current week's exposure is 21.34%. Professional money managers' equity exposure is near historical lows. We need to get favorable revenue and future guidance numbers during the upcoming quarterly earnings season to substantially increase equity exposure.
Trading Strategy
The health-care sector closed below the Aug. 24 lows. It is a bad sign when a former market leader is now leading on the downside. Stock Trader's Almanac reports how Presidential front-runner Hilary Clinton's tweet on high drug prices drove Biotech stocks down about 5% across the board. Many investors consider this a great long-term buying opportunity. It is the beginning of its seasonal bullish period that historically runs from August to March with the bulk of the move occurring from October to March. The iShares Nasdaq Biotechnology ETF had its worst day since April 2014, falling in record trade volume to below its closing low from the Aug. 24 "flash crash." The index closed in bear market territory, or more than 20 percent below its 52-week high. Forty-five percent of the Nasdaq 100 also closed in bear market territory. According to MarketWatch, bearishness has reached an extreme not seen at least since the top of the Internet bubble in early 2000. Yet this is a bullish omen, according to the inverse logic of contrarian analysis, extreme levels of bearishness indicate that there is a very robust "wall of worry" for the market to climb. Having some put option strategies available, as a hedge is good move until the market reverses higher.
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