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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.
A couple of weeks ago, I offered two possible driving forces behind the bullish post-BREXIT market:
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.
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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.
So what should we be doing in this market? I don't presume to have all the answers, but my trading boils down to a few bullet points:
- 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.
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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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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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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.
