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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.
Be safe out there.
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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.
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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.
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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.
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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.
