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The S&P 500 Index (SPX) closed today at $2205, up two points. But a glance at the price chart is rather shocking. SPX has rocketed higher since November 4th, up $120 or 5.8%. This incredible run has occurred over 13 trading sessions or less than three weeks! By contrast, S&P 500 was up less than 3% over all of 2015, and that was only if you included the stock dividends.
Let's take a look at the small cap stocks, as represented by the Russell 2000 Index (RUT). These are the high beta stocks that move faster than the blue chips, whether the overall market is trading higher or lower. These are the classic "risk on" stocks. RUT closed today at $1342, up $8. Since November 4th, RUT has gained $179 or 15.4%. Wow! A broad market index is up over 15% in less than three weeks. That must have set a record. RUT broke its old all-time high on November 11th, and proceeded to set eight new all-time highs out of nine trading sessions since November 11th. RUT makes SPX look like an old man trying to keep up with the kids in a hundred yard dash.
Can this incredible rally be sustained? History and simple probabilities would say no. But the statisticians will tell us that the probabilities of any stock making a three standard deviation move is infinitesimally small. But those of us in the market every day find that five and six standard deviation moves are not that unusual. This strong market rally was not a highly probable event, but it happened.
What is driving this rally? Regardless of your politics, one has to give the election of Donald Trump the credit. Market analysts believe that the proposed economic plans, especially corporate and individual tax reforms, will stimulate economic growth. Hence, the financial stocks have been on fire. Take a look at the price chart for Goldman Sachs (GS). Analysts are expecting another booming economic era on Wall Street similar to the mid to late 1980s.
The minutes from the last FOMC meeting were released today, and portions of those minutes appear to make an interest rate hike at the December meeting a near certainty. In the past, even a hint of a rate hike sent the traders scrambling for the exits. The rate hike last December resulted in a 12% correction in the first quarter of this year. Will this rate hike be different?
If traders remain convinced that "happy days are here again", we may easily survive a 25 basis point rate hike. But we have another powerful force that may at least temporarily temper this bull market. As fund managers look at the nice gains that have piled up over the past few weeks and contemplate year end bonuses, the temptation to sell and take profits will be growing. The rate hike coming out of the next Fed meeting on December 14th may be the trigger for that profit-taking. Don't be caught unaware.
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All anyone on the financial networks could talk about last week was the strength of the "Trump rally". Perhaps we are getting ahead of ourselves. The Standard and Poors 500 Index (SPX) closed today at $2164, unchanged. This is the fourth day that SPX has essentially traded sideways. By contrast, the Russell 2000 index (RUT) closed at 1299, up $16, and set a new all-time high. RUT set its previous high at $1296 on June 23, 2015. Both SPX and NASDAQ have set new highs this year, but RUT stubbornly lagged behind.
From the market lows on 11/4, SPX has gained 3.8% through today's close, but RUT is up 11.7% - wow! The smaller companies, represented by RUT, are largely the high beta stocks, the stocks whose prices tend to outperform the market both in bullish rallies as well as bearish corrections. These are the classic "risk on" stocks. The fact that RUT finally woke up and is now leading this market is very bullish. But can this rally continue?
SPX is looking pretty tepid at this point. SPX traded strongly higher through Wednesday of last week, but has traded sideways since then. Whether one looks at price to earnings ratios of the broad market indices, average dividend yields of the S&P 500 or many other metrics, the answer is the same. The market is at a minimum, somewhat overvalued and perhaps significantly overvalued. After all, corporate earnings are weak, GDP growth is anemic and business capital investment is near historic lows. And don't forget the Fed; an interest rate hike is almost certain next month.
Don't mistake me for one of the perennial bears. But I don't own any rose colored glasses either. I think Trump's economic plan has merit and will drive an economic revival, if it gets implemented. But that may be a large "if".
Non-directional trades are well suited to this market. I opened a large number of SPX Jan 2017 iron condors at 1960/1970 and 2280/2290 today. I am also looking at diagonal call spreads on the financials, like GS and JPM. The beauty of these trades is that they allow for a little slowing or even some pull backs as the market contemplates a new administration taking office. Don't get caught up in the euphoria. As always, manage your risk.
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For the last several years, we have become accustomed to the market slowing and treading water as traders anticipate the upcoming FOMC meeting. But today is different. The Fed is meeting today and tomorrow, but no one is paying attention. All eyes are on the election next week and the latest scandals to erupt. My friends in Europe tell me that the everyone is glued to this Peyton Place saga (if you are old enough to remember Peyton Place).
Market behavior yesterday was unusual. Volatility rose, with the VIX moving over 17%, but the broad market averages were also rising most of the day - an unusual divergence. Normally we see volatility rise as the market declines. How should we interpret this anomaly?
Markets hate uncertainty, although options traders enjoy higher volatility, especially if you are selling premium. Many institutional traders are moving larger proportions of their portfolios to cash and are buying protection, as evidenced by the rising VIX. What should we lowly retail traders do? Personally, I am pursuing three lines of action:
1) A larger proportion of my accounts and client accounts are in cash. As profitable positions were closed, we didn't enter new positions.
2) I am selling weekly options in my more conservative accounts. As I close those positions this Friday, I will stay in cash until after the election.
3) I will be closing my November iron condors on the broad market indices if the spreads are less than two standard deviations out of the money.
I expect the market will be quite volatile after the election, but I think it will settle reasonably quickly. The model in my mind is the reaction to Brexit - surprise followed by the sentiment, "maybe the sky isn't falling after all".
As I write this article, the market futures are mildly positive, looking much like yesterday when the market stayed in positive territory most of the day, but then slowly lost ground to close unchanged. The sideways, choppy price action of the past several weeks may continue to be the norm as we move closer to this election. The sky isn't falling, but it may be quite stormy before it clears.
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I expected this market to be volatile and choppy leading up the election. But the weakness in the markets over the past two weeks has surprised me. Is this a harbinger of even more bearishness next week? Or will the market “get over this” and settle down quickly after the election?
I wouldn’t have predicted the wild market reaction to BREXIT or its rapid recovery just a couple of days later. The market’s reaction to the election results can’t be predicted either, although I am sure many will try. The key isn't predicting the move. Success in trading comes from managing the risk.
SPX closed today at $2085, down $3 and RUT closed at $1163, up $7. But the larger picture is much more dire. Since the most recent market peak on October 24th, SPX has declined 3%, while RUT and the NASDAQ Composite have dropped almost 5%. Will these declines continue or even accelerate next week?
If we draw the Bollinger bands on the SPX price chart, we will see that today’s close was the fourth successive close below the lower edge of the Bollinger bands. The Bollinger bands are drawn at two standard deviations around the 20 dma. We would expect about 95% of the data to be contained within the bands, and that generally holds true. It is common to watch stock or index prices oscillate within the bands, but when prices move outside the bands, they are usually pulled back within the bands in short order. The number of closes below the lower edge of the Bollinger bands during a correction is usually pretty small, typically three or four. The fact that we have already observed four lower closes this week might tempt us to think that we are close to “hitting bottom”. But this market perturbation may be unusual. We are setting every other record with this election. Why not in the market as well?
Stock market risk is very high as we go into this election. We can't predict who will win the election and we certainly can't predict the market's reaction to the election results. What we can do is manage the risk. I closed all of the positions in my Conservative Income service today. As my most conservative trading service, it makes sense to go entirely to cash in advance of the election. In my No Hype Zone newsletter, we closed our TSLA iron condor a couple of weeks ago for a nice 26% gain, but I have been reluctant to add any new positions in this market environment. My November iron condors in the Flying With The Condor™ service are over two standard deviations out of the money, so I may leave them open, but that judgment may change on Monday or Tuesday. The feared "black swan" moves of three and four standard deviations may be a very real possibility next week.
The easiest way to control your market risk is to simply go to cash. But you may have a large stock portfolio that would have significant tax liabilities triggered by selling. Hedging the portfolio with a few out of the money index put options is the answer. Use the option price calculator on your broker's web site to estimate the gains of those put options under a couple of "what if" scenarios. Based on the gains you project for the puts, you may estimate how many puts will be required to hold the losses in your portfolio to a reasonable level. Whatever you do, don't just sit and hope for the best. Take control. Manage the risk.
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The Standard and Poors 500 Index (SPX) closed today at $2133, unchanged after a wild ride higher in the morning; but all of those gains were lost by the close this afternoon. SPX opened the week at $2160, so the net price action was lower on the week. SPX flirted with the lows from early September yesterday, but recovered to close at $2133. The September low at $2120 is the new lower edge of the sideways trading channel, with an upper edge at $2195, set back in August.
The markets have been characterized by this sideways churning since mid-July. Market analysts are unanimous in one aspect – they are all nervous. Some blame the Fed and their concern about the prospect of higher interest rates. Some blame the presidential election, and one can easily find traders who are concerned about the prospects of either candidate winning. A Wall Street Journal survey of economists was published today, and gave a 60% probability of a recession within the next four years. That report was featured on all of the financial networks. What all of these analysts have in common is a high level of anxiety, and the looming specter of another market crash is always on traders minds during the month of October. We are seeing the net effects of all of these worries in the churning, directionless market.
The Russell 2000 Index (RUT) closed today at $1212, down $3 today and down about $27 or 2% for the week. RUT’s close today is essentially at its low when the market traded lower in early September. The question is whether RUT will break down through $1210 next week or continue to trade within the channel of $1210 to $1265. Russell has traded more weakly than SPX and the NASDAQ Composite all year. RUT has not even approached its high from 2015 at $1296. RUT’s price action continues to communicate a bearish signal.
I summarized the market last week as:
Nothing much has changed in this market for several months now. The GDP growth rate is minimal, corporate earnings are mediocre and the forward guidance has been bleak. The uncertainties surrounding the presidential election are piled on top to collectively hold the bulls in check. But the near zero interest rates are holding the bears in check. The result is a choppy, nervous, sideways market.
Nothing has really changed. If anything, traders are even more nervous. Be careful. This may be a good time to take a break if you can’t watch this market closely.
