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Market Summary

It has already been reported how investors experienced the first 10% correction in the major stock indexes since 2011 as worries of an economic slowdown in China and angst over interest rate policy and when the Federal Reserve will hike rates has taken a toll. Add to those concerns, a meltdown in the commodities markets and growing fears that stocks have climbed to unsustainable valuations, and the net result is a high volatility market. Those worries have sparked a big selloff that has knocked more than half of the stocks in the S&P 500 down more than 20%, which puts those stocks in bear market territory. Investors sought bargains among beaten-down stocks and the recently battered biotechnology index bounced back on the last day of Wall Street's worst quarter since 2011. For much of the third quarter, global markets were rocked by fears of slowing growth in China and uncertainty over timing for a U.S. Federal Reserve hike of interest rates. Biotech had a seven-day selloff kicked off by drug price regulation worries.

For the quarter, the Dow fell 7.6%, the S&P lost 6.9% and Nasdaq fell 7.4%. For September, the Dow fell 1.5% while the S&P dropped 2.6% and Nasdaq fell 3.3%. For the week, the Dow and S&P gained 1% while the Nasdaq ended basically flat gaining .5%.

YTD Performance

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 indicates the recent selloff might be over. The dotted line is the support level established after the "flash crash" at the end of August. You can see that support held this past week, now the question is will prices jump higher or establish a range-bound trend.

S&P500 Bullish Percent Index Daily Chart

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 that even as stock prices are trying to recover, investors are continuing to move heavily into bonds, especially as they perceive the FMOC may not raise interest rate any time soon.

S&P500 Equal Weight ETF Daily Chart

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 note in the updated MTUM chart below how stocks are bouncing off support. Also noted is downward momentum is dissipating and trying to turn higher while strength indicators are signaling an oversold bounce.

MTUM Daily Chart

Market Outlook

No one knows for sure where the S&P is heading, but as the markets move into the best 6 months for stocks in November, a lot of market watchers are going with the yearend statistics that say the markets will move back up at year end. There have been way too many times that stocks sold off in September and October, and followed with a sharp rally. Some analyst refer to October as the "spooky" month, and while there are some historical declines in October, it also known as the "bear killer". More bottoms are made in October than any other month, and while it has a negative stigma, the month overall is solidly bullish on the historical calendar. Furthermore, the final quarter of the year is historically the best performing period.

With the third-quarter earnings season starting next week, investors are starting to factor in what might be the biggest decline in profits for S&P 500 companies in six years. Analysts on average expect third-quarter earnings to decline 4.2 percent, according to Thomson Reuters data. "There are a lot of concerns that a weakening global economy may be impacting the U.S., so that certainly doesn't bode well for earnings," said Peter Cardillo, chief market economist at Rockwell Global Capital in New York. "It's going to be a market where we're going to see more and more volatility and major support levels being tested," Cardillo said.

Quarterly Performance

The dollar tumbled Friday, finishing the week lower after a surprisingly weak September jobs report pushed back expectations for the Federal Reserve's first interest rate increase in nearly a decade. The dollar weakened considerably against most of its rivals after the data. Friday's disappointing jobs report fueled sharp Treasury gains, extending a two-week rally and further pulling down yields as investors continued to flock to U.S. government debt amid faltering stock markets and worries over a global growth slowdown. Treasuries have been gaining ground since the Federal Reserve in mid-September left interest rates unchanged. Investors in U.S. government debt have benefited from a rally that has led yields to their lowest level in five months. The 10-year benchmark Treasury yield fell Friday below 2% for the first time since "Black Monday", the day when the stock market suffered its biggest one-day loss in four years. Treasury yields fall when prices rise and vice versa. Gold futures scored a more than 2% gain on Friday, snapping a five session losing streak after a weak September jobs report led investors to believe the Federal Reserve may further delay raising interest rates. In the chart below you can see how the disappointing jobs report gave dollar-denominated precious metals, including gold, a boost as the greenback pulled back. Gold prices had posted declines in each of the last five trading sessions. Even with Friday's gains, however, gold snapped a two-week winning streak and logged a weekly loss of 0.8%.

UUP daily Chart

We like to compare the DOW Industrials and Transports to confirm the current market trend. As circled in the updated chart below, both the DOW Industrials and Transports bounced off a support level. This is further confirmation the stock market is setting up for a recovery bounce.

Dow 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 VIX higher. You can see in the updated chart below how the VIX is falling as the S&P is trying to creep higher. If the VIX and S&P converge this is a solid indicator that the market may have bottomed out.

VIX Daily Chart

Next week is critical for guidance on whether volatility will wane or remain elevated. The orange line below denotes the current VIX support level. You can see the VIX trended down last week and is threatening to break below support. Also highlighted are momentum indicators starting to turn bearish and if this move continues expect the VIX to continue falling.

VIX Daily Chart 2

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. After investing heavily into puts the past few weeks for downside protection, traders have significantly reduced put exposure. The current Put/Call Ratio indicates investors are content that current market support level will hold up and avoid a bear market decline.

Total Put/Call Ratio

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 9/30/2015. The most recent AAII survey showed 28.10% are Bullish and 39.90% Bearish, while 32.00% of investors polled have a Neutral outlook for the market for the next six months. As a contrarian indicator, the current AAII result is considered near term bullish. Since most individual investors are usually wrong about the market's direction, the current excessively bearish reading suggests the market is due to for a bounce.

AAII Sentiment

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 9/30/2015. Second-quarter NAAIM exposure index averaged 72.84%. Last week the NAAIM exposure index was 21.34%, and the current week's exposure is 16.39%. Professional advisors and newsletter editors are definitely running for the hills. Despite the fact that S&P 500 never took out the 25th of August lows, bullish sentiment has continued to drop and sits at some of the lowest levels in decades. Bearish sentiment has continued its rise since 25th of August as well, because it is just so much easier to be bearish when markets aren't going up. In the chart below you can see professional money managers' equity exposure fall to the lowest level since about this time last year. Also note that immediately after hitting rock bottom last year, equity exposure surged higher for the rest of the year.

NAAIM Number

Trading Strategy

According the Stock Traders' Almanac, October's typical performance appears in the above chart over the recent 21-year span 1994 to 2014. On average, early month weakness has proven to be an excellent buying opportunity, especially for NASDAQ (purple line) as early losses were quickly recouped leading to an average gain of over 3% from early month lows to the close. In the last couple of years, after September 19th, the S&P traded lower into month's end and made a bottom sometime in the early part of October, and in turn rallied into years end. That's exactly what we could see this year as fund managers have seen their year-end bonus disappear with the selloff. They got too short after the initial low was made, and now need to markup stocks with a yearend rally to restore their positive performance.

Typical October Trading 1994-2014

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