MarketWatch.com mentions how the stock market wrapped up a solid week on a down note as better-than-expected first-quarter earnings failed to stir buying appetite on Wall Street, underlining concerns about lofty quarterly expectations for American corporations, high valuations and geopolitical anxiety. For the week, the Dow Industrials moved up 1.79% while the benchmark S&P 500 Index rose 1.99%. The small cap Russell 2000 jumped 2.39% and the tech-heavy Nasdaq was the biggest winner up 2.77%.
A standard chart that we use to help confirm the overall market trend is the Momentum Factor ETF (MTUM) chart. Momentum Factor ETF is an investment that seeks to track the investment results of an index composed of U.S. large- and mid-capitalization stocks exhibiting relatively higher price momentum. This type of momentum fund is considered a reliable proxy for the overall stock market trend. We prefer to use the Heikin-Ashi format to display the Momentum Factor ETF. Heikin-Ashi candlestick charts are designed to filter out volatility in an effort to better capture the true trend. In the updated chart below the orange square highlights the MTUM consolidating into a trading range.
Another tool to help confirm the overall market trend is the Bullish Percent Index (BPI). The Bullish Index is a popular market “breadth” indicator used to gauge the internal strength/weakness of the market. Like many of the technical market internal indicators, it is used both to confirm a move in the market and as a non-confirmation and therefore divergence indication. We always point out how in recent years technology stocks have been a relatively reliable indicator of overall market direction. Last week we wrote “… the Nasdaq Index consolidating into a trading range…The next probable move is higher especially if upcoming quarterly earnings season produces favorable pronouncements…” In the updated chart the orange uptrend line confirms Nasdaq stock starting to move higher heading into quarterly earnings.
In the updated chart below, the Dollar touched a seven-week high and managed to eke out a small gain on the week, even as underlying geopolitical and trade fears persisted. Gold advanced as U.S. tensions with Russia and China fed the precious metal’s investment appeal, sending prices up for a second straight week. “Safe haven demand picks up with the situation in Syria coming to a decision point into the weekend for the Trump administration,” said Jeff Wright, chief investment officer at Wolfpack Capital. “The true anxiety is how to respond without escalation of crisis from Russia, who have their own troops embedded” alongside Syrian President Bashar al-Assad’s forces throughout the country. Treasury bonds were flat this week, as investors braced for higher interest rates from the Federal Reserve after an inflation report and minutes from the central bank’s last policy meeting. Geopolitical worries faded somewhat, sapping haven-related demand as investors piled back into stocks and other assets perceived as risky. Riskier assets were buoyed after President Donald Trump appeared to walk back the threat of an imminent military strike on Syria in response to an alleged chemical attack on the rebel-held town of Douma by Syrian President Bashar al-Asad’s forces. The potential for action, however, remains a factor for markets.
As reported by LPL Financial research, midterm election years tend to be relatively volatile period, with stocks historically seeing the largest intra-year pullbacks. One potential reason is that in the past the political party that has won the presidency has lost seats in the House and Senate during the midterm election, generating some uncertainty during these years. Examining the full four-year presidential cycle also shows that the second and third quarters of the president’s second year in office (so right now) can indeed leave bulls frustrated. “Going all the way back to the Dow’s inception in 1896 displays that this quarter and next quarter are quite weak historically. But the good news is we’ve seen big rallies after this weakness. However, this is something to be aware of as we move forward in this midterm year,” said Ryan Detrick, Senior Market Strategist. Although we expected more volatility this year, we are seeing some signs of better times ahead for equites.
In the updated graph below, gold as a safe haven is the top performing investment category this year. A positive sign is the Nasdaq starting to rise. Technology stocks have been market leaders and if there is follow through on the bullish move the overall market will probably follow.
The CBOE Volatility Index (VIX) is known as the market’s “fear gauge” because it tracks the expected volatility priced into short-term S&P 500 Index options. When stocks stumble, the uptick in volatility and the demand for index put options tends to drive up the price of options premiums and sends the VIX higher. In the chart below, the VIX fell 19% last week but is still is relatively high compared to what investors have come to expect. But traders probably need to adjust to the fact the current volatility level is more in line with the historical norm.
Robert W. Baird & Co. Willie Delwiche reports the historically sedate rally of 2017 continues to recede in the rear-view mirror. After seeing just eight daily price moves of 1% or more in 2017, the S&P 500 has now experienced 28 in 2018. All the more remarkable is that the first three weeks of the year fit the pattern of 2017 more than the experience of the past 20 years. The S&P 500 has experienced 28 moves of 1% or more over the past 51 trading days (or over the past ten weeks, we have averaged a 1% move every other trading day). The S&P 500 has already experienced as many 2% daily moves in 2018 as it did 1% moves in all of 2017. Increased volatility, however, doesn't mean the end of the bull market, but it is now a much more challenging environment to trade.
The American Association of Individual Investors (AAII) Sentiment Survey measures the percentage of individual investors who are bullish, bearish, and neutral on the stock market for the next six months; individuals are polled from the ranks of the AAII membership on a weekly basis. The current survey result is for the week ending 04/11/2018. Pessimism among individual investors about the short-term direction of the stock market is at its highest level in more than year. The latest AAII Sentiment Survey also shows declines in optimism and neutral sentiment.
• Bullish sentiment, expectations that stock prices will rise over the next six months, fell 5.8 percentage points to 26.1%. Optimism was last lower on August 31, 2017 (25.0%). Bullish sentiment is below its historical average of 38.5% for the seventh consecutive week and the eighth time in 10 weeks. Bullish sentiment, conversely, is now at an unusually low level. Unusually low levels of optimism have been historically followed by above-average and above-median six- and 12-month returns for the S&P 500 index.
• Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, declined 0.3 percentage points to 31.2%. This is a two-month low. Even with the decline, neutral sentiment remains above its historical average of 31.0% for the eighth consecutive week.
• Bearish sentiment, expectations that stock prices will fall over the next six months, jumped by 6.1 percentage points to 42.8%. Pessimism was last higher on March 9, 2017 (46.5%). Bearish sentiment is above its historical average of 30.5% for the third consecutive week. Bearish sentiment is now at an unusually high level (more than one standard deviation above average). Unusually high levels of pessimism have historically been followed by above-median, but not above-average, six- and 12-month returns for the S&P 500.
Many individual investors are anticipating continued volatility and/or think that the current political backdrop could have a further impact on the stock market. Trade policy is influencing some individual investors’ sentiment, but not all. While many individual investors either approve of the recent interest rate hike or don’t expect it to affect the stock market, some are concerned about the impact that rising rates will have. Also influencing sentiment are valuations, tax cuts, earnings and economic growth.
The National Association of Active Investment Managers (NAAIM) Exposure Index represents the average exposure to US Equity markets reported by NAAIM members. The blue bars depict a two-week moving average of the NAAIM managers’ responses. As the name indicates, the NAAIM Exposure Index provides insight into the actual adjustments active risk managers have made to client accounts over the past two weeks. The current survey result is for the week ending 04/11/2018. First-quarter NAAIM exposure index averaged 78.08%. Last week the NAAIM exposure index was 55.57 %, and the current week’s exposure is at 65.12%. Last week we wrote “…Equity exposure remains near the lows established last November but will probably trend higher heading into quarterly earnings season…” You can see the exposure index starting to edge higher. Big name tech stocks like Netflix report earnings next week. Technology stocks have been leading the market. If investors like what they hear and tech shares jump, the overall market will probably follow suit elevating equity exposure.
Trade talk and politics could hang over the market in the coming week, even with a blast of earnings news providing a bright spot. A handful of Dow components report in the week ahead, along with dozens of S&P 500 companies. Of particular focus, moving into the second quarter is the ability of companies to deliver on elevated earnings expectations. The consensus expectation is for earnings to rise between 15-20% in the first quarter. Recent economic data has struggled to match expectations but earnings estimates have remained high. The bottom line is that a high bar has been set and a failure to match elevated expectations could fuel more volatility.
As recently reported in the Almanac Trader, the upcoming April option expiration week is generally bullish across the board with solid gains on the last day of the week, the entire week and the week after. Since 1982, DJIA and S&P 500 have both advanced 23 times in 36 years on expiration day with an average gain of just under 0.2%. Expiration week as a whole has a slightly more bullish track record over the past 36 years to expiration day. Average weekly gains are 1% or better for S&P 500, DJIA and NASDAQ. The bullish bias of April expiration also persists during the week after. DJIA has posted a full-week gain in twelve of the last fourteen weeks following expiration.
The current range-bound trend is not expected to endure indefinitely. The best course of action is to trade in the direction of momentum behind any break outside of the current trading range. But, remain wary of a false breakout and maintain tight stops. Until the breakout happens high volatility provides an opportunity to generate premium from selling credit spreads.
Feel free to contact us with questions,
Senior Trading Strategist
The opinions and forecasts expressed herein are those of Mr. Gregory Clay and may not actually come to pass. Mr. Clay’s opinions and viewpoints regarding the future of the markets should not be construed as recommendations. The analysis and information in this report is for informational purposes only. No part of the material presented in this report is intended as an investment recommendation or investment advice. The analysis provided is based on both technical and fundamental research and is provided "as is" without warranty of any kind, either expressed or implied. Although the information contained is derived from sources which are believed to be reliable, they cannot be guaranteed.