Has the Post-BREXIT Run Ended?
The Standard and Poor's 500 Index (SPX) set a new all-time high on August 15th and tried to reach that number again on August 23rd, but it has faltered since then. Janet Yellen spoke at the Jackson Hole economic conference at 10 am ET this morning, and SPX made its intraday high a few minutes later. But then the party ended. Traders decided another interest rate hike is coming and sold off. SPX reached a low around 2:30 pm ET but then recovered a bit to close at $2169, down $3. The second quarter GDP growth numbers, announced earlier this morning, with an annualized growth rate of 1.1%, probably didn't help. That is pretty weak. FACTSET released the final earning results for the S&P 500 for the second quarter, down 3.2%. This is the fifth consecutive quarter of earnings declines. This is the first time we have seen a five quarter string of declines since 2008-2009.
However, SPX is holding up rather well. $2160 has set up as a solid support level and that is where SPX bounced today. If we break $2160, the next level to watch is the 50-day moving average (dma) at $2144. Trading volume in the S&P 500 companies has run below the 50 dma since August 8th. This market is certainly out of steam, but that doesn't necessarily mean it is going over the cliff. SPX has been very resistant to the bearish arguments.
The Russell 2000 Index (RUT) just traded modestly higher this week, but closed at $1238 today, down two dollars. RUT was not able to match its highs from last year during this strong post-BREXIT run, a bearish sign.
After trading near 2016 lows last week, the SPX volatility Index (VIX) moved higher this week, opening Monday at 12.5% and closing today at 13.7%. Perhaps more significantly, VIX moved as high as 15% earlier today. I would guess the bounce of SPX off support at $2160 calmed some nerves.
1) Traders are buying with renewed confidence that the Fed won't raise interest rates before the end of the year.
2) We may be seeing the effects of global cash flows seeking a safe haven in our stock market. The global economy is slowing and, even though the U.S. economic data are mediocre at best, we are looking better than most.
With the market's reaction to Yellen's comments today, perhaps we are left with the "best house in the bad neighborhood" theory. It may be significant that the market did not trade lower this morning after the weak GDP growth numbers. Poor economic data continue to be ignored by this market. It appears to be primarily Fed driven, which would argue that a pull back won't come until the FOMC actually raises interest rates. But will Yellen and company raise rates before the election? I doubt it. They don't want to be seen as adding fuel to the fire for either side's arguments.
Be cautious. This is a nervous market. As evidence, look at the three point intraday range of the VIX today.
The title of this song from one of my favorite bands, Queen, came to mind today as I thought about today's price action. This bull market, that by all measures should not be continuing higher, did just that again today. SPX tacked on another six points to close at $2190, while RUT spurted higher by $12 to close at $1242. And the NASDAQ Composite did not want to be outdone, gapping open this morning and gaining $29 to close at another all-time high at $5262. All-time highs are becoming passe.
Many valuation measures, such as the price to earnings ratio and the average dividend yield of the S&P 500, suggest a pricey market. We are nearing the end of the second quarter earnings announcement cycle, and earnings have declined once again on a year over year basis. When you think about it, the only way the P/E for the S&P 500 may continue to rise is that share prices are rising faster than earnings are declining. At its most fundamental level, stocks are priced on the value of the discounted cash flow of the projected earnings. Yet prices continue higher as earnings decline.
Don't misunderstand. I am not trying to say the market has it all wrong. The ultimate arbiter is the market price. But that brings me back to the title, Another One Bites the Dust. In this context, another bear covers his shorts. Where does it end? No one knows. But it is clear that we are increasingly on thin ice.
I am continuing to play bullish stocks as they trade higher. But I am using diagonal call spreads to give myself some safety margin on the downside, just in case the market pulls back one of these days.
I am closing profitable trades early to lock in gains. If I can bank 70-75% of the potential gains on a trade, I take it.
As I position my non-directional trades, I am allowing for more safety margin on the up side. I am not betting against the bull.
I am as nervous as a long tailed cat in a room full of rocking chairs.
Make money while you can, but be careful out there.
After Friday's huge move higher, it was natural to expect a little bit of a slowdown today. SPX lost $2 to close at $2181 and RUT was down a dollar to close at $1230. Volatility was essentially unchanged with the VIX at 11.5%. Trading volume slowed with 1.9 billion shares of the S&P 500 companies trading. Trading volume declined 10% on the NYSE and dropped 20% on NASDAQ.
Many of the big names have already made their earnings announcements for this cycle. We have NVDA later this week and CSCO and WMT next week. 86% of the S&P 500 have already reported and 69% beat analyst estimates, but that ignores the fact that earnings continue to decline on a year over year basis. According to FACTSET, the current earnings decline for the second quarter is -3.5%. If that number holds, it will be the fifth consecutive quarter of earnings declines. That has not happened since 2008-2009. In addition, guidance for the third quarter has been largely negative with 67% of companies offering lower guidance. FACTSET reports that the price to earnings ratio (P/E) of the S&P 500 now equals 17.0 on an 12 month forward looking basis. The five year average P/E is 14.7 and the ten year average P/E is 14.3. These data offer a quantitative basis for the commonly heard opinion that this market is overbought. However, overbought markets may remain overbought longer than I have funds to short the market.
But we are left with the question: What is driving this market higher? As we have seen above, the run higher certainly isn't based on stronger earnings streams. Maybe traders are buying with renewed confidence that the Fed won't raise interest rates before the end of the year. Another possibility is that we are seeing the effects of global cash flows into our stock market, i.e., the "best house in the bad neighborhood" theory. Our economic data are mediocre at best, but the U.S. stock market looks better than many other global markets.
So we are left with a quandary. The market's most probable direction is to continue higher, but a pull back or correction is overdue. We just don't know what may trigger the sell off or when that might occur.
I am continuing to trade bullish positions in this market, but I am favoring diagonal bull call spreads because those positions offer some downside protection if the stock or index pulls back. I am also positioning my non-directional trades with additional safety margin on the upside. And my stops are on a hair trigger.
The big news today was the announcement from the FOMC meeting and there were no surprises. Interest rates remain unchanged. The Fed says "near term risks to the economic outlook have diminished". Only one member of the committee voted to raise rates. Most Fed observers believe interest rates will remain unchanged until the December meeting, due to a reluctance to be seen as interfering with the presidential election.
Markets traded weakly all morning, but rebounded after the FOMC announcement to close roughly unchanged for the day. SPX closed down $3 at $2167 and RUT closed up $2 at $1219. The VIX declined slightly to 12.8%. Trading volume was much higher with 2.5 billion shares of the S&P 500 trading today. Trading volume rose 20% on the NYSE and increased 4% on NASDAQ.
$2160 appears to be a strong support level on SPX. The lower shadows of the candlesticks have been consistently hitting around $2160 and bouncing higher for about the last ten trading sessions.
Several significant economic reports were issued yesterday and today. Durable goods orders declined 4.0% in June, even worse than May's 2.8% decline. But on the flip side, real estate data continue to be positive. New home sales increased to an annualized rate of 592 thousand in June, up from 572 thousand. Pending home sales increased 0.2% in June, up from a negative 3.7%. The Case Schiller housing price survey stayed north of 5% with an annualized rate of 5.2% in May, down from 5.4%. The Conference Board's consumer confidence survey was flat for June at 97.3, virtually unchanged from May's 97.4. The real estate story remains positive, but general economic growth remains weak.
It will be interesting to see tomorrow's markets. Often the traders appear to consider the FOMC announcement overnight and come back the next day, moving strongly one way or the other. Have the markets been coiling for a spurt higher with the flat sideways trading of the past couple of weeks? Or are we due for a correction of an overbought market? In view of the weak economic data, I am inclined to the latter view.
After the BREXIT panic, the markets roared back and simply never stopped. SPX bounced back over 8% from June 28th to today's close at $2175. But SPX has looked pretty flat for the past seven trading sessions. Is the bull running out of steam? The Russell 2000 Index (RUT) closed today at $1213, up $9. RUT remains about $83 below its all-time high set last year. RUT would have to rally nearly 7% from here to set a new high. So RUT and SPX are telling entirely different stories. The NASDAQ Composite Index is somewhere in between. NASDAQ closed at $5100 today, and only has to move another one percent to match its previous all-time high at $5155. But NASDAQ's chart looks more like SPX; it is trending upward in steady fashion - no plateau there.
Why is this comparison of the major market indices useful? The small caps that make up the Russell 2000 are the classic high beta stocks. When the bull market runs, small caps typically lead the action as the big institutional firms go "risk on". But they also lead the corrections as well, as everyone looks for safety in the blue chips of the S&P 500. So the fact that RUT has traded higher for the past few weeks, but much more slowly than SPX may be significant. Maybe the bullish activity is more conservative than we may think. If that is the case, then the apparent flattening of the S&P 500 index may be telling.
If we look for hard economic data to support this bullish run, we are going to come up short. Part of the reason SPX is slowing is the lack of glowing reports from the current earnings cycle. Maybe this run is based on renewed confidence that the Fed won't raise interest rates again anytime soon. Another possibility is the "best house in the bad neighborhood" theory. The global economy is slowing and, even though the U.S. economic data are mediocre at best, we are looking better than most of the developed economies. Perhaps we are seeing the effects of global cash flows into our stock market.
As long as RUT lags behind, I am inclined to be cautious about jumping on the bulls' band wagon. I am playing some bullish trades and I am hedging some of my short call spreads positioned above the market, but I am watching it closely. At best, I'm a nervous bull.
The new market highs led the news yesterday, but the markets took a breather today. SPX closed unchanged at $2152 and RUT pulled back $5 to close at $1201. Volatility continued to contract with the VIX closing at 13.0%, down another half point. Trading volume has been at or below the 50 day moving average (dma) for the past eight trading sessions. Trading in the S&P 500 declined again today to 1.9 billion shares. trading volume decreased 15% on the NYSE and pulled back 11% on NASDAQ.
If we look at the longer term charts on SPX, RUT and NASDAQ composite, one thought is on many traders' minds: We've been trapped in this sideways market for several months; is this really a break-out or is this market just teasing us? Many of us have an almost automatic response to a rational, cause and effect explanation of the markets. We try to determine whether the price "makes sense". We look at price to earnings ratios, dividend yields and much more. But ultimately, the market price is correct. We may not understand it or it may not agree with our careful analysis, but it is what it is. An alternative approach is more statistical.
SPX has now gapped open at the first trade four days in succession. Today's open was very muted, but it was technically higher. But today ended the Russell 2000 Index's string of gap opens higher. The NASDAQ Composite's string of gap opens higher ended today and NASDAQ pulled back $17 to close at $5006. In fact, the all time high of NASDAQ at $5219 from last July remains unchallenged. If we apply the Bollinger bands to our price charts (plus and minus two standard deviations around the 20 dma), we would expect the index price to remain within the bands about 95% of the time, purely on a statistical basis. In fact, it works out just that way. Plot the Bollinger bands on your favorite stock or index and you will see what I mean. For the previous two days of trading, SPX was running right along the upper edge of the band. But SPX pulled back a bit today. RUT actually closed outside the upper edge of the band yesterday, but pulled back within the band today. NASDAQ matched SPX's price action, running right along the upper edge of the band, but pulling back today. We expect the small cap stocks in RUT to lead the market higher if, in fact, we are breaking out to a new bullish run. It is the classic "risk on" trade.
That's the positive case. But there are many negatives: BREXIT, a slowing economy in China, a couple of tepid GDP numbers for the U.S., and much uncertainty surrounding our presidential election.
What? You're waiting for the answer? Unfortunately, my crystal ball is as murky as yours. Those confident gurus on CNBC must know the secret, or at least they have mastered sounding confident. For me, I hedge positions as necessary, and slowly add bullish positions as I see the bullish strength of this market continue. But I remain cautious. We hit some relatively high numbers in December before we went over the cliff. Betting the farm on this bullish run is a good way to lose the farm.
You wouldn't know it, but it was only a few days ago that the market was in a panic about the BREXIT vote. Today SPX closed up $11 at $2100, nearing recent highs. RUT joined in with an increase of $8 to close at $1147. And volatility is coming in, with VIX dropping a half point to 15.1%. It must be a tough business being one of the perennial bears. They are all called for interviews on the financial cable networks whenever the market tumbles. But then they are quickly sent back to their caves. Trading volume remains modest. Trading in the S&P 500 reached the 50 dma at 2.3 billion shares. Trading volume increased 6% on the NYSE and gained 10% on NASDAQ.
It was only seven trading sessions ago that we were nervously looking over that steep cliff and listening to a long litany of worries from all of the financial pundits. The only question was "How far down will it go?" Fibonacci retracement levels and discussions of previous flash crashes occupied many blogs. Now it's "Happy days are here again." If the market were a human being, we would prescribe antidepressants. What is a trader to do?
The markets over the past two to three years have become very volatile. The so-called V-bottom has become a common phrase. And the width of the V-bottom hit a minimum with this BREXIT trade; it only required two sessions to tumble and the market recovered in four trading sessions - hold onto your seat.
Maybe some significantly bullish economic data is fueling this rebound. The ISM services index reported today at 56.5 for June, up from 52.9. That's good, but not stellar. Yesterday, we were told that factory orders declined one percent in May after increasing 1.8% in April. The minutes from the last FOMC meeting were released this afternoon. Those minutes were far from bullish on the economy. The committee appears concerned about raising interest rates further with such a weak economy. And BREXIT has them worried too. So it is obvious. Buy the market. Everything is rosy. Hmmm... I think we will be remaining in the sideways trading range of the past few months.
Allow me to return to the "What's a trader to do?" question. One of the most fundamental financial axioms is diversification. That not only includes which stocks or bonds. It also includes strategies. Market neutral strategies have been working well in the midst of this volatility. If you don't have a few of those working for you, you might consider adding them to the mix.
The BREXIT vote surprised the markets last Friday and SPX plunged $76 or 3.6% from Thursday's close to Friday's close. But the markets didn't calm over the weekend. SPX gapped open lower on Monday to close down at $2001. But the last four days have been truly straight up! Today SPX closed at $2103, almost back where it closed on June 23rd before the BREXIT vote was in. We have seen a lot of price volatility in the markets over the past 2-3 years and the so-called V-bottom has become a familiar phenomenon. But I think this V-bottom set records - down nearly 4% in 2 days and essentially fully recovered in 4 days. We went from speculating about global recession to an aggressive bull market in record time.
The Chicago PMI jumped to 56.8 for June, up from 49.3 in May. The ISM manufacturing index increased again in June, up to 53.2 from May's 51.3. But construction spending remains weak, declining 0.8% in May; but that was an improvement over the 2.0% decline in April. Today's economic news was reasonably strong, but I don't think this huge turnaround is fully based on economic data. I think it has been a classic example of traders simply freaking themselves out. They panicked and sold, and just as quickly, decided it was overdone and bought back in with both hands. Volatility came in another point with VIX closing at 14.7%. This isn't the kind of price action that investors find comforting.
Many market participants left early for the long holiday weekend; trading volume was down 25% on the NYSE and down 19% on NASDAQ.
Another record turnaround came from Investors Business Daily this week. Their market assessment went from Confirmed Uptrend to Market in Correction and back to Confirmed Uptrend in just 3 days. That's a V-bottom.
Have a great Fourth of July Weekend. Fly the flag and eat a hot dog! We are fortunate to be Americans.
The British vote took the bookies and the market pundits by surprise. The bookies lost a bundle and now it's our turn. SPX lost $76 Friday and then gapped open lower this morning and dove to $2001, down $37 on the day. On Friday SPX broke down through the 50 dma and then broke a strong support level at $2040. Today SPX broke the 200 dma.
What about the small caps? The Russell 2000 (RUT) has fared even more poorly than SPX. That fact alone is a bearish signal. Small caps always lead, whether in a bullish trend or a bearish trend. RUT broke its 50 dma Friday and broke down through the 200 dma today, closing at $1090, down $38. But today's price action on RUT broke the August flash crash low. By contrast, SPX remains about $130 above its flash crash lows.
The question on many traders' minds is simple. Is there hard economic justification for this sudden plummet? My answer is no. The bulk of the analysis I am reading addresses the huge uncertainties and uncertain time frames for the effects to be known, much less work through the global markets. Certainly, financial stocks are taking it on the chin because of their currency exchange positions and the huge moves in the Euro and the dollar. But are all of the S&P 500 stocks suddenly worth 5% less? I don't think so. When traders are unsure of the risk and are hearing talk of the sky falling, their first reaction is to sell, watch and wait.
So how should we handle this situation? Even though I don't see the justification, I can't ignore price action. Many trailing stops are being hit. I closed the put spreads in my July and August iron condors today. When I see signs of stabilization, I will replace those spreads. Some have suggested selling call spreads above this market, but I think that is risky. Go back and study the corrections of October 2014, August 2015 and during the first quarter this year. In all three cases, the snap back rally was quick and steep. You don't want to find yourself in front of that train.
One of the things I watch is the long lower shadow on the candlesticks. That suggests many traders are buying the lows of the day and driving the price higher. But don't jump too quickly. Look back at January 20th. That was tempting, but it was a fake out. February 11th was the low. Then March was a strong month. You want to be a little late to this party. Today's lower shadow on SPX was pretty anemic. We may be in for an extended period of pain before the market calms.
In my last blog, I outlined the trade that I had developed over the past week, the iron condor on SPX with the weekly options that expired today, the 2030/2040 put spreads and the 2130/2140 call spreads. I sold the 2030/2040 put spreads on Thursday of last week, based on the strong bounce off of $2050 that day. Earlier this week, that position looked very solid and I added the 2130/2140 call spreads. I was patting myself on the back. I was confident my put spreads were "money in the bank" and the 2130/2140 calls were far enough OTM to be quite safe.
But then the Brits surprised us and the markets went crazy. When I checked the S&P futures early this morning, they were around $2025. This was after a close at $2113 yesterday - wow! SPX opened this morning and traded down to $2056 in the first ten minutes of trading and the VIX spiked as high as 26% intraday and closed at 25.8%. But intraday trading in SPX was pretty steady and calm throughout the day. This was even more surprising when considering the huge volume spike, up over 100% on the NYSE and NASDAQ. If today had been a normal trading day, I could have easily closed those 2030/2040 put spreads this afternoon for a modest debit. But not today, the market makers didn't want to let me out for a reasonable debit. I would have closed at a loss.
My credit was $325 per contract, so breakeven for the entire position was $2036.75. At that price, my 2040 calls would lose $325 per contract and the position would break-even. About 2-3 minutes before the close of trading today, SPX was above $2040 and I was poised to achieve my maximum gain. I felt like Charlie Brown as Lucy pulled the ball away, and SPX traded down to $2037.41. My 2040 puts expired ITM by $2.59, thus leaving me with a gain of $66 per contract or +10%. That was frustrating, but on a day like today, a 10% gain is blissful.
The iron condor positions in my Flying With The Condor™ service were actually helped by today's pullback; both the July and August positions are up several percent. There is a lot to be said for trading far OTM iron condor positions with 60+ days to expiration.
Are We Waiting On The Fed?