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SPX closed today at $2359, down four dollars, after bouncing off the 50 dma at $2341. This mirrors last Monday, when the 50 dma provided support for SPX. I am paying close attention to the 50 dma as my trigger for adjusting and closing positions. The Russell 2000 Index behaved even more bearishly today, breaking down through the 50 dma, and closing down $16 at $1370. But the NASDAQ Composite is still holding up rather well, closing today at $5895, down $17, but near the top of its recent trading range.
SPX and RUT are solidly in sideways trading patterns, but seem to have enough bullish support to hold the line when the bears mount a charge to the downside. My concern is what event might finally rattle the bulls. This rally was built on expectations of a better economy under the new administration, but Washington gridlock appears to remain the norm. When the bulls lose faith, it could get ugly.
Will the jobs report this Friday be the seminal event?
In the meantime, classic delta-neutral trades are a good fit for this market.
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Market analysts have been nervous since last Tuesday's meltdown. The "sky is falling" gurus have been preaching correction to anyone who would listen. But the balance of last week's trading was somewhat reassuring - sideways beats going farther down. But the doomsday gurus appeared to be getting their wish this weekend as the futures plunged. The SPX futures this morning were downright ugly and SPX opened at $2329 and traded down as far as $2322 before finding support. Then a steady grind higher began that lasted virtually all day, hitting its high for the day at $2345 just a few minutes before the close at $2342, down two dollars on the day. The 50 day moving average (dma) stands at $2332, so technical analysts will observe that support at the 50 dma held, even though it briefly dipped below support intraday. The other positive piece of data was found in today's trading volume in the S&P 500 companies: 1.9 billion shares with the 50 dma at 2.1 billion shares. The final positive indicator came in VIX, the volatility of the S&P 500. VIX spiked to over 15% this morning, but immediately began its retreat, closing at 12.5% for the day. The trends in volatility and trading volume show that traders didn't panic.
Tomorrow's opening will be crucial to see if the market follows through on today's reversal, but the preponderance of the evidence seems to point to the bulls retaining control of this market.
The Russell 200 Index (RUT) displayed a similar trading pattern to SPX, opening weak, hitting a low at $1335, but then recovering at close at $1357, up three dollars on the day. This close for RUT places it squarely within the sideways trading channel of the past four months.
Looking forward this week, the only significant economic data scheduled to report is the final estimate of fourth quarter GDP on Thursday. Unless there is a big revision downward, that report isn't likely to move the market; we already know last year's growth was anemic. Maybe the risk to the bulls is in the political realm, but predicting Washington political moves makes predicting market tops and bottoms look easy.
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Here we are once again, with the market treading water as we await the results of the meeting of the Federal Open Markets Committee (FOMC), or as we usually say, "the Fed". Fed watchers are rather confident we will see another rate increase on Wednesday. As always, the question is whether this interest rate increase is already baked into current market prices, or whether the market pulls back in response. The huge bullish run we have enjoyed since the election last year seems to have flattened out after the Standard and Poors 500 Index (SPX) hit a high of $2396 on March 1st, slowly declining and closing at $2373 yesterday. Trading volume has also dropped off since March 1st, closing at 1.9 billion shares yesterday, well below the 50 day moving average (dma).
The market futures are suggesting a lower open this morning, so it appears this waiting game will continue today, and probably through tomorrow afternoon.
Economic data have been strengthening recently, but the bulk of the market gains are based on expectations of gains yet to be realized: tax reform and trimming of bureaucratic regulations, to name a couple. Will an interest rate hike dampen that enthusiasm?
I was invited to write a chapter on the diagonal spread for a new e-book that was just published. That will make for good reading while we wait on the Fed.
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The markets are up over 14% since the election, and that's a huge run in anyone's book. So it isn't surprising that concern has been growing that this rally has run too far, too quickly. We begin to think that there must be a correction lurking around the corner. Yesterday's strong decline across all of the major market indices brought out the "sky is falling" folks. SPX did decline $29 or 1.2%, so it wasn't a trivial down day. More troubling to me was the fact that the sell-off strengthened into the market close. There was no market rally to end an otherwise dismal day and give traders hope.
But today was a different day for traders. SPX opened at $2348, and closed at $2348, up $4 on the day. The small cap stocks, as represented by the Russell 2000 Index, didn't fare quite as well, but today's trading didn't extend yesterday's losses. RUT was essentially unchanged at $1346, down less than a dollar.
Both SPX and RUT have been trading in a sideways channel for about three weeks. Today's little mini-rally almost pulled SPX back to its support level at $2355. RUT was more successful, essentially closing at the support level held for the last few weeks.
Was today just a temporary pause before we go over the cliff? That is hard to answer with much certainty, but let's consider the evidence:
The trailing 12 month price to earning ratio for the S&P 500 is at record levels. We have to go back to 2009 to find higher numbers.
The CBOE SKEW ratio measures the demand for far out of the money put options. The thinking is that the large institutional traders will see the storm coming and buy protection. SKEW did reach very high levels this past Friday, at 153, higher than the first quarter correction of 2016 or the correction in the fall of 2014. But SKEW declined to 136 today, still moderately high, but not quite as scary.
I follow the volatility index for the S&P 500 (the ticker symbol is VIX). Normally we see VIX tracking steadily higher in the days just before a correction, but VIX has been pretty quiet. Even during the scary decline yesterday, the high of VIX was 12.9%, and VIX closed at 12.8% today. These remain historically low levels of volatility. During the market decline preceding the election last year, VIX hit a high of 23%. The big players aren't panicking just yet.
Where does that leave us? I think today's price action shows that the bulls remain firmly in control of this market. Traders remain optimistic about the future of our economy. Don't get me wrong. We should be cautious, but it would be premature to move largely to cash. It does raise an interesting question. Do you have trailing stops entered to protect those gains you have enjoyed since the election?
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The S&P 500 roared higher this week, closing yesterday at a new all-time high of $2351. I must say this has caught me by surprise. Conventional wisdom believes this strong bullish run has arisen from the prospects of individual tax reform, lower corporate taxes, and a reduction in the regulatory burden on business. Each day brings news reports of political resistance to many of these campaign proposals. I think the market has gotten ahead of itself, but the price is the price. My rationale one way or the other isn’t relevant.
The forward-looking P/E for the S&P 500 is now 17.6, the highest level since June 2004. The five-year average P/E is 15.2 and the ten-year average is 14.4. Higher stock prices have been driving this ratio higher because forward estimates for earnings are not growing as rapidly as prices. This suggests that the market’s exuberance since the election may be a bit overdone. In my opinion, there is substantial evidence for a bullish market outlook; I don’t disagree with that assessment. But the prospects of a pull back or correction appear to be increasingly probable.
The S&P 500 volatility index (VIX) rose on Wednesday this past week, but then declined to close on Friday at 11.5%. Wednesday presented a classic VIX divergence, i.e., when the market index and index volatility are running in the same direction. In this case, VIX ran from 10.8% to 12% on Wednesday, while The S&P 500 traded higher by $13, closing at $2349, a new all-time high (until Friday). VIX divergences are high probability indicators. In this case, with a rising VIX in a rising market, a pull back is highly probable, and in fact, did occur on Thursday. The S&P 500 followed through with a lower open on Friday, but then the bulls reasserted themselves and pushed the index higher.
More and more overbought signals are appearing, but markets can and have continued to rise in overbought conditions before. This is where the market adage originated, “Markets climb a wall of worry.” Trades positioned with a bullish posture make the most sense in this environment, but keep your stops tight. The probability of a pull back or correction is increasing, but that may be well into the future.
