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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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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.
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The British vote took the bookies and the market pundits by surprise. The bookies lost a bundle and now it's our turn. SPX lost $76 Friday and then gapped open lower this morning and dove to $2001, down $37 on the day. On Friday SPX broke down through the 50 dma and then broke a strong support level at $2040. Today SPX broke the 200 dma.
What about the small caps? The Russell 2000 (RUT) has fared even more poorly than SPX. That fact alone is a bearish signal. Small caps always lead, whether in a bullish trend or a bearish trend. RUT broke its 50 dma Friday and broke down through the 200 dma today, closing at $1090, down $38. But today's price action on RUT broke the August flash crash low. By contrast, SPX remains about $130 above its flash crash lows.
The question on many traders' minds is simple. Is there hard economic justification for this sudden plummet? My answer is no. The bulk of the analysis I am reading addresses the huge uncertainties and uncertain time frames for the effects to be known, much less work through the global markets. Certainly, financial stocks are taking it on the chin because of their currency exchange positions and the huge moves in the Euro and the dollar. But are all of the S&P 500 stocks suddenly worth 5% less? I don't think so. When traders are unsure of the risk and are hearing talk of the sky falling, their first reaction is to sell, watch and wait.
So how should we handle this situation? Even though I don't see the justification, I can't ignore price action. Many trailing stops are being hit. I closed the put spreads in my July and August iron condors today. When I see signs of stabilization, I will replace those spreads. Some have suggested selling call spreads above this market, but I think that is risky. Go back and study the corrections of October 2014, August 2015 and during the first quarter this year. In all three cases, the snap back rally was quick and steep. You don't want to find yourself in front of that train.
One of the things I watch is the long lower shadow on the candlesticks. That suggests many traders are buying the lows of the day and driving the price higher. But don't jump too quickly. Look back at January 20th. That was tempting, but it was a fake out. February 11th was the low. Then March was a strong month. You want to be a little late to this party. Today's lower shadow on SPX was pretty anemic. We may be in for an extended period of pain before the market calms.
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The BREXIT vote surprised the markets last Friday and SPX plunged $76 or 3.6% from Thursday's close to Friday's close. But the markets didn't calm over the weekend. SPX gapped open lower on Monday to close down at $2001. But the last four days have been truly straight up! Today SPX closed at $2103, almost back where it closed on June 23rd before the BREXIT vote was in. We have seen a lot of price volatility in the markets over the past 2-3 years and the so-called V-bottom has become a familiar phenomenon. But I think this V-bottom set records - down nearly 4% in 2 days and essentially fully recovered in 4 days. We went from speculating about global recession to an aggressive bull market in record time.
The Chicago PMI jumped to 56.8 for June, up from 49.3 in May. The ISM manufacturing index increased again in June, up to 53.2 from May's 51.3. But construction spending remains weak, declining 0.8% in May; but that was an improvement over the 2.0% decline in April. Today's economic news was reasonably strong, but I don't think this huge turnaround is fully based on economic data. I think it has been a classic example of traders simply freaking themselves out. They panicked and sold, and just as quickly, decided it was overdone and bought back in with both hands. Volatility came in another point with VIX closing at 14.7%. This isn't the kind of price action that investors find comforting.
Many market participants left early for the long holiday weekend; trading volume was down 25% on the NYSE and down 19% on NASDAQ.
Another record turnaround came from Investors Business Daily this week. Their market assessment went from Confirmed Uptrend to Market in Correction and back to Confirmed Uptrend in just 3 days. That's a V-bottom.
Have a great Fourth of July Weekend. Fly the flag and eat a hot dog! We are fortunate to be Americans.
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In my last blog, I outlined the trade that I had developed over the past week, the iron condor on SPX with the weekly options that expired today, the 2030/2040 put spreads and the 2130/2140 call spreads. I sold the 2030/2040 put spreads on Thursday of last week, based on the strong bounce off of $2050 that day. Earlier this week, that position looked very solid and I added the 2130/2140 call spreads. I was patting myself on the back. I was confident my put spreads were "money in the bank" and the 2130/2140 calls were far enough OTM to be quite safe.
But then the Brits surprised us and the markets went crazy. When I checked the S&P futures early this morning, they were around $2025. This was after a close at $2113 yesterday - wow! SPX opened this morning and traded down to $2056 in the first ten minutes of trading and the VIX spiked as high as 26% intraday and closed at 25.8%. But intraday trading in SPX was pretty steady and calm throughout the day. This was even more surprising when considering the huge volume spike, up over 100% on the NYSE and NASDAQ. If today had been a normal trading day, I could have easily closed those 2030/2040 put spreads this afternoon for a modest debit. But not today, the market makers didn't want to let me out for a reasonable debit. I would have closed at a loss.
My credit was $325 per contract, so breakeven for the entire position was $2036.75. At that price, my 2040 calls would lose $325 per contract and the position would break-even. About 2-3 minutes before the close of trading today, SPX was above $2040 and I was poised to achieve my maximum gain. I felt like Charlie Brown as Lucy pulled the ball away, and SPX traded down to $2037.41. My 2040 puts expired ITM by $2.59, thus leaving me with a gain of $66 per contract or +10%. That was frustrating, but on a day like today, a 10% gain is blissful.
The iron condor positions in my Flying With The Condor™ service were actually helped by today's pullback; both the July and August positions are up several percent. There is a lot to be said for trading far OTM iron condor positions with 60+ days to expiration.
Where do we go from here? I don't claim to be a global economist, but I don't see what substantially changed today. By Euro Zone rules, this British exit will take many months if not a couple of years. Maybe I am missing something, but I think it was the surprise that spooked the markets. If I'm right, we will see some buying opportunities over the next few weeks. But then, maybe the sky is indeed falling...
