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Pundits of every stripe have been predicting correction for several weeks, if not months. So the market action yesterday and today shouldn't have been too surprising. The S&P 500 Index (SPX) has now lost 61 points since January 15th, constituting a pullback of 3.3%. And most of that was accomplished over just two days! Technical analysts will tell us that a market correction can't really be called a correction unless it exceeds 7%, so we aren't there yet, but we are nearly half way. In 2013, we had several pull backs of the 4-5% variety, and the brave souls who bought the dips were well rewarded. I have already drawn the 4% and 5% lines on my SPX chart at $1776 and $1758, respectively. Maybe I should add $1721 (7%). My analysis of this market boils down to three principal alternatives:
1) Just another 4-5% pull back, or
2) An authentic correction of 7-10%, or
3) The beginning of a full fledged bear market.
I haven't been shy about my conservative outlook. Government ineptitude and antagonism toward business are strangling private enterprise, so it isn't surprising that this is the slowest economic recovery in history. But the economy is muddling along in spite of all of the road blocks and hindrances. So the third alternative seems unlikely to me, especially with a Federal Reserve that is willing to do anything to prop up the markets. That leaves me expecting a pull back of some kind, but unsure of the magnitude. I think the current pull back could get uglier and move into the full correction mode, given some significant stimulus - something like the downgrade of our treasury debt that occurred in 2011. If we just continue to receive mediocre economic data, I am inclined toward the 4-5% pull back scenario. But that doesn't mean I am loading up on SPX calls. I remain cautious.
SPX closed at $1790, down $38. RUT closed at $1144 for a loss of $28. VIX spiked up to 18.4% - and didn't pull back toward the end of trading. Hmmm. As you might expect, trading volume spiked upward with 3.1 billion shares of the S&P 500 stocks exchanging hands. Trading jumped 15% on the NYSE and was up 16% on NASDAQ.
This week was almost devoid of economic data. But next week will offer many possible market moving events:
Monday: New Home Sales and AAPL earnings
Thursday: 4th Qtr GDP and GOOG earnings
Friday: Chicago PMI and University of Michigan Consumer Sentiment
I closed the 1110/1120 put spreads in my RUT Feb iron condor today. That leaves me with a current P/L of +3% and a maximum potential gain of +8%, assuming scenario three plays out and the call spreads expire worthless. That adjustment will allow me to enjoy my weekend. I hope you can as well.
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SPX challenged its resistance level at $1850, but pulled back to close at $1844, up $5 on the day. But RUT broke out to a new all-time high at $1176, up $7. Trading volume is down a bit from Friday, but remains above the 50 dma with 2.5 billion shares of the S&P 500 trading today. Trading volume dropped 12% on the NYSE and decreased 8% on NASDAQ. Volatility remains low with the VIX at 12.9%, although the VIX spiked up to 13.4% this morning and then pulled back.
OTM index put volume is increasing, suggesting some institutional hedging of their portfolios just in case the often predicted correction actually occurs. If the markets continue to trade sideways, we may successfully blow off some of the excess without a lot of damage. RUT's strong push higher today was certainly a sign of bullish strength.
Today was a light day for economic data, and the balance of the week doesn't have any significant reports scheduled, unless you count the weekly unemployment claims. But those weekly reports don't often move the market.
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The S&P 500 Index is coming very close to breaking out and setting a new all-time high. SPX gapped upward at the open this morning and traded as high as $1851 before pulling back to close at $1848, up $10. The previous closing high is $1848 from December 31. RUT gained $8 to close at $1171, a new all-time high. Volatility remained unchanged with VIX at 12.3%. Trading volume rose with 2.6 billion shares of the S&P 500 stocks changing hands. Trading volume increased 13% on the NYSE and increased 4% on NASDAQ.
The Beige Book, the minutes from the last FOMC meeting, was released today and appeared to fuel the market's advances. More Fed districts reported moderate economic growth in November and December than previously reported. Plus, eight out of the twelve districts reported higher hiring rates. The Empire State manufacturing report jumped to 12.2 in January from December's 2.2. PPI increased 0.4% in December and increased 1.2% for the entire year of 2013.
This market's strength continues unabated. One can argue all day long that the underlying economic numbers don't support such exuberance, but one has to trade what he sees, not what he thinks makes sense. Today's increase on RUT makes it virtually certain that the put spreads from my January condor will expire worthless. Unfortunately, that starts the new year with a loss of $1,100 on 20 contracts. or -9.6%. The original iron condor was adjusted twice and both spreads were rolled higher. If I had not closed the call spreads Friday, I could have closed on Monday for a small gain, but that's the old 20:20 hindsight thing.
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The Russell 2000 Index (RUT) made consecutive all-time highs Wednesday and Thursday, but retreated $5 today to close at $1168. SPX lost $7, closing at $1839. Volatility remained unchanged with the VIX at 12.4%. As one might expect on an options expiration Friday, trading volume was up with 2.6 billion shares of the S&P 500 trading. Trading on the NYSE rose 28% and volume rose 11% on NASDAQ.
SPX is now down about $9 or -0.5% since the first of the year. The stock almanac's January barometer is looking pretty weak at the halfway point. SPX appears unable to generate sufficient momentum to break out to new highs above $1850. On the other hand, it remains pretty strong, not really giving up much ground. Next week looks to be slow in terms of economic data, so the most likely market moving events may be the continuing stream of earnings announcements. But so far, those announcements haven't built much excitement. The bears haven't been able to generate any momentum when the market has appeared weakest so far this year. Today was good example; as the markets pulled back, volatility remained flat. The bulls are reserved, but confident.
We had several economic reports today: housing starts came in at an annualized rate of 999k in December, down from 1107k; building permits followed that trend with 986k in December, down form 1017k. Industrial production dropped in December to +0.3%, down from +1.0%; capacity utilization was flat at 79.2%. The University of Michigan consumer sentiment survey declined in January to 80.4 from December's 82.5. Maybe this mediocre data contributed to the markets trading weakly sideways today. The losses accelerated in the last hour of trading, but the markets bounced back in the last few minutes so the closes came in above the day's lows.
SPX settled today for the January options at $1846.06. As I write this blog, the RUT settlement value has not yet been released. You may check this link to see it posted later today on the CBOE web site.
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We observed severe market drops repeatedly last year that proved, in retrospect, to be excellent buying opportunities. The last two days of trading provide one more example. SPX closed down $23 yesterday but gained $20 today to close at $1839. RUT also recovered almost all of yesterday's losses, gaining $16 to close at $1163. VIX declined a full point to 12.3%. So the bulls have done it once again. Perhaps the market gods are training us to "go all in" on the next dip and then surprise us with a severe correction (I don't have a better theory).
Trading volume fell off today as the markets rebounded with 2.2 billion shares of the S&P 500 trading. Trading volume declined by 12% on both the NYSE and NASDAQ.
SPX now has a pretty well defined sideways trading channel from a low of $1810 set in late November to the high of $1850 defined in late December. I think using those two levels as triggers for one's trading posture makes sense. In my opinion, the most difficult aspect of last year's trading was handling the frequent price whipsaws, similar to what we saw yesterday and today. The worst whipsaw of last year was a $46 swing on SPX in only four days! Why is this market so volatile? I am sure there are many viable answers. I am inclined to think that the "great experiment" by the Fed in supporting this market has made seasoned traders nervous. They have never experienced a market with FOMC intervention of this type and aren't sure what to expect. As a result, their fingers are quick to hit the exit button and then jump back in at the slightest of signs. They don't want to miss such a huge bull market, but they also worry that the "great experiment" could end badly.
I think the lesson for us small fry trying to survive in this market of charging elephants is to be cautious and stay hedged; don't be afraid to exit early. I closed my RUT Jan call spreads in the market rally Friday afternoon; if I had waited, I could have done much better on Monday. But I don't think you can afford to take that chance. You might get stepped on by an elephant.
