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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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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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October is well known for its large number of severe market crashes, from the famous crash of 1929 that ushered in the great depression to the financial meltdown of 2008. Maybe the hobgoblin of market crashes has the bulls pulling in their horns (too many metaphors). SPX closed today at $2154, down $7, and ending the week down ten dollars. RUT didn't fare any better, closing down at $1237, losing $14 for the week. Volatility rose a bit today, with the VIX rising about seven tenths of a point to close at 13.5%.
SPX has traded sideways for about three months now, with a brief pullback on September 9th, followed by a quick recovery. But now we are firmly back in the sideways trading channel. If you plot the Bollinger bands on the SPX, you will see that the price has stayed close to the center of the bands for over two weeks.
Whereas SPX and the NASDAQ Composite indices have set new all-time highs this year, the Russell 2000 Index (RUT) has failed to reach the high it set at $1296 in the summer of 2015. This is a bearish sign because the high beta stocks of the Russell have normally led bull markets higher.
It is interesting that the jobs report this morning didn't move this market much either way. I thought a weak report, which we received, would enthuse the bulls since they would expect weak jobs numbers to hold the Fed's interest rate hikes at bay for a while longer.
This sideways market is ideal for our iron condor positions in the Flying With The Condor™ service. Our October iron condor on SPX is up 23% and the November position stands at a net gain of 9%. I will probably close the October position next week and open December.
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. We may be stuck here for a while.
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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.
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SPX opened this morning at $2162, traded down to $2152, but then rebounded to close at $2171, up $11 on the day. Candlestick enthusiasts will note this as a long lower shadow, a classic clue that the bulls are strong, i.e., they saw that intraday low on SPX as a bargain and starting buying, driving the price higher. And this was on higher trading volume, with 2.2 billion shares of the S&P 500 trading today. Trading volume was up 16% on the NYSE and was 4% higher on NASDAQ.
But there was another significant clue of bullish strength today. The durable goods orders report came out today for August and was dead flat, 0.0% change. July was up 3.6%. The durable goods report is one of the fundamental measures of U.S. economic strength, and this was a terrible report. But the market shrugged it off and traded higher. Strong bull markets ignore bad news... until they don't.
Tomorrow brings the final estimate of the second quarter GDP growth rate. The last estimate was a paltry +1%, annualized. If the report tomorrow continues on that weak line, it will be a another test for the bulls.
In the meantime, the recent market behavior has been nearly ideal for delta neutral traders. My September SPX iron condor closed at a 16% gain. The SPX condor for October is up 21% and the November position is already up 6%, even though it has only been open for a couple of weeks.
The market clearly has a bullish bias, but be careful. It remains a nervous market.
