A Week in Review: Volatility, Momentum, Breadth, Sectors, Sentiment, Bonds, & Consumer Spending 11/13/17

Market & Volatility Overview
U.S. markets saw a slight dip in equities last week, something that we haven’t seen very often in 2017. The S&P 500 finished 0.21% lower, the Dow fell 0.5%, Small Caps declined 1.37%, and EAFE closed lower by 0.74%. While stocks were in the red for the week, the large cap indices remain above key support levels. In last week’s note I shared my Volatility Index model, noting that it was calling for a rise in the $VIX, which did end up rising nearly 27% to an intra-week high of 12.19, still well below its historical average but a few points off its recent all-time low that was set just two weeks ago. While spikes in spot $VIX have been fairly rare in the last ten months, I have shared my model a few times this year on the blog, in January before $VIX rose 26% in two days and in June nine days before the massive 50% intraday spike in volatility.

Below are some of the charts, stories, and pieces of data I found of interest over the last week…..

S&P 500 Daily
While it seems we get an overreach on social media and financial news outlets on any kind of weakness in stocks since markets have been so strong this year, even if it’s just lasted two days (so far). The S&P 500 has dipped down to its 20-day Moving Average, which is normal price action and not something to cause severe panic. We’ve seen several moves to at least the 50-day Moving Average earlier this year, and the index is still well above that intermediate-term support level. Looking at volume of the two-day dip it was well below the high we’ve seen in November alone, much less YTD. Focusing on daily momentum with the Relative Strength Index (RSI) in the top panel of the chart we saw a lower high but the RSI still is coming off of being ‘overbought’ which in my opinion disqualifies the labeling of a bearish divergence. In my opinion, a bearish momentum divergence holds more significance when the lower high occurs under 70. Could stocks go lower? Of Course. There’s plenty of things the equity bears could point to that could be catalysts for equities to continue lower, but as of Friday’s close we have just a short-term two-day dip that’s hardly fear-inducing.

Short-Term Bullish Price Pattern
According to Larry William’s book, Long-Term Secrets to Short-Term Trading, the last two days in the S&P 500 have set up a pattern to send the index higher. This chart, shared by @Time-Price-Research, shows the outside price bar followed by an inside day, meaning two days ago price trade above the prior day’s high and below the prior day’s low followed by Friday’s move of having its high and low inside the trading range of Thursday. Williams notes an 85% chance of price moving higher following this pattern according to his research.

Volatility Advances Higher
According to the CBOE, a majority of the Volatility measures moved higher last week. Four exceptions include the VIX for Apple and Amazon as well as the VIX for the Euro and Interest Rate Swaps. The largest percent change of the VIX measurements was the short-term and EFA Indices, rising 31.5% and 24.6%, respectively.

Performance Regimes for Short-Volatility ETNs
The one trade that’s received probably the most attention this year has been short volatility, often through the XIV ETN. Brent Osachoff of The Volatility Advisor, broke down the performance of XIV since its inception based on VIX percentile, noting “The 20-40% quintile and the 40-60% quintile are by far and away the best sub sections of the volatility market when it comes to the inverse volatility ETPs.” This shows that the absolute level of the Volatility Index is less important as a factor for volatility investing than many would have you believe – something I’ve been pounding the table about on this blog and social media.

Deteriorating Market Breadth
Market breadth has often been dismissed this year as equity markets have remained resilient in their advance. However, I still believe that breadth, a measure of broad market trend participation, is important to keep an eye on. We’ve seen several divergences in 2017 that have led to either minor declines that have quickly reversed or have just been straight out ignored. Below is a chart of the S&P 500 in the top panel and the 5-day average of new highs minus new lows on the NYSE. By looking at the one week average of this indicator we’re able to see a more smoothed version that is less volatile to single day swings. Over the last twelve months there’s been a series of higher highs as well as lower highs in this data set. Most recently we saw a peak in October of highs minus lows as fewer stocks were hitting new highs compared to the number hitting new lows in price – all while the S&P 500 marched higher, relying on just a few select stocks to continue to propel its advance. I believe this type of information is important but less so on its own and more so in concert with other pieces of market-related data.

As I noted earlier, momentum has not diverged – if it had, then the combination of diverging breadth and momentum would be more significant of a warning sign than breadth alone.

Stock Gains Since the Election
Last week saw the one year mark since the 2016 election, with many stocks seeing solid gains over the last twelve months. Bespoke Investment Group put together a great table showing the largest market gap gainers, noting that six companies alone added more than $100 billion in market cap to the S&P 500. Apple, Microsoft, Google, Amazon, and Facebook make the top five with the largest increase in their respective market caps.

More Gains Could be In Store For Stocks
Each Saturday Callum Thomas does an excellent job curating ten charts. One that stood out to me this week was this chart showing the average market performance before and after a market peaks. If the ‘market crash’ bears are right, and we do see a market peak within the next twelve months then history shows we could see some solid gains between now and then.

High Yield Divergence
One concern some traders have about the market recently has been the divergence between equities and high yield bonds. Steve Deppe put together a table showing previous instances where the S&P 500 was at an all-time high while the High Yield ETF (HYG) closed under its 50-day Moving Average. Historically the S&P has struggled when this divergence has occurred with average negative returns up to 20-days later.

5-year Treasury COT
Commercial Traders have been aggressively buying up 5-year Treasury bonds. The net-position of Commercial Traders has been hitting highs for the last couple of weeks as the 5-year bonds remain relatively flat in trading over the previous three weeks.

Sector Relative Rotation
The energy sector continues to make improvement in its trend of relative performance, just a few points shy of moving into the ‘leading’ category. The four sectors in the ‘lagging’ category (XLP, XLY, VNQ, XLU) pushed deeper into the red with the remaining defensive sector, health care, working its way closer from ‘weakening’ towards ‘lagging’ as investors risk appetite remains with the higher beta sectors.

Sector Correlation
The top two sectors most highly correlated over the last 20 days to the S&P 500 remain Technology and Utilities. REITs moved to being positively correlated as Industrials shifted to negative, joining Health Care and Consumer Staples.

Equity Outflows
One odd event that’s been taking place recently has been the outflows from the S&P 500 ETF (SPY) while equities continue to hit new highs. This great chart from SentimentTrader shows the number of days SPY saw outflows while the ETF was at a 1-year high over the previous 50 days. We’ve now seen 11 days of outflows, Jason Goepfert notes “Over the past 20 years, this now ranks as the 2nd largest cluster of new highs with an outflow, next to the largest cluster from February 2011. There have been a handful of other times when it reached 10 days, most of them since the 2009 low. Prior to 2007, it was even more rare, likely because there were fewer competitors to SPY compared to what we see today.”

A 700 Study Forecasts Higher Interest Rates
One research from the Bank of England and Harvard University produced a study looking at interest rates going back to 1311. Paul Schmelzing  notes that the current down trend is the second longest in the last 700 years. Most notable in his research as cited by Bloomberg is the potential for a quick reversal; “Be prepared though. The data show most reversals of real-rate stagnation periods have been rapid and non-linear. Within 24-months after hitting their troughs in the cycle, rates gained on average 315 basis points, with two occasions showing appreciations of more than 600 basis points, Schmelzing says”

High Yield is no longer that ‘high of a Yield in Europe
As government bonds continue to trade with negative yields throughout large parts of Europe, high yield debt has also been experiencing a decline as investors chase after anything that at least is above zero. Using the CS High Yield Index, the yield on European junk debt is now just 1.95%, hardly what many bond investors would label as ‘high yield.’

And it’s not just the (believed to be) secure debt in Europe that’s experienced a large drop in yield. Greece, who just a few years ago was on the brink of bankruptcy and has required several bailouts has seen its 10-year Yield decline as well – falling from over 18% in 2015 to barely above 5% today.

Christmas Shopping Expectations 
Based on a recent poll conducted by Gallup, American consumers are expecting to spend more this holiday season than previous years, surpassing the prior spending average high set in before the financial crisis. Gallup notes, ” That represents one of the biggest year-over-year increases in Gallup’s trend, pushing the spending projection to its highest level in a decade.”
Gallup also found that for the first time in over twenty years, a record low 16% of American shoppers plan to spend less this year than last, the first time since 190 that more consumers planned to up their spending than lower it.

Google Will Be Watching Where you Eat!
If the major tech companies didn’t already have enough personal information of its users, Google will now be able to estimate wait times at restaurants based on user data. (Gizmodo)

Have Bitcoins become an alternative energy source?
CNBC reports that two Russians have begun to rely on their bitcoin servers in order to provide heat for their house. (CNBC)

Isaac Newton learned a financial lesson like many investors after him – the hard way
Jason Zweig wrote a great piece spotlighting the history of the South Sea Bubble and Isaac Newton’s involvement in investing in the stock that ultimately lead to a 70+% loss. (Wall Street Journal)

A $25 Billion Day for Alibaba
This past Saturday was Singles Day in China, similar to American Black Friday and Cyber Monday shopping days. The online retailer hit a new record in gross revenue, making a reported $1 billion in its first two minutes. (The Street)

Rome turns to tourist attractions for revenue
As the struggling Italian city tries to scrape as much revenue together as possible, the Roman city will potentially turn to the Trevi Fountain as a cash source. Previously the coins tossed in the fountain by locals and tourists were given to charities, but as hard times continue to hit Italy that may change, with the fountain collecting millions of euros each year. (The Local)

Millennials prefer bitcoins to stocks
According to a survey conducted by a bitcoin firm, millennials may have a preference for the cryptocurrency over traditional investment holdings. The survey found that 30% of respondents would rather own bitcoins than stocks or bonds (Bloomberg)

Money lessons from a wealthy man you’ve probably never heard of
Do you know who Jacob Fugger is? Me either. But he’s apparently was a German banker and the wealthiest man to have ever lived, with a $400 billion net worth. This article shares seven of the lessons learned from his time.(MarketWatch)

Off-Topic

Champagne taste-tester
If the whole trading thing doesn’t work out, I don’t think I’d mind be a champagne taste-tester. Moet & Chandon’s wine quality manager tastes up to 50 wines each day. (Southern China Morning Post)

Voice-enabled speakers will be in half of households by 2022
In the next five years, according to a report from Jupiter Research, 70 million households will have a voice-enabled speaker like Google Home and Amazon’s Echo. (Techcrunch)

All-electric super car
If this is where all-electric vehicles are headed, then I’m going to be a big fan. This is Lamborghini’s latest prototype, the terzo-millennio.

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.

Why August Could be One Bear of a Month

Since my last blog post, titled “What I’m Seeing That Has Me Concerned About the Volatility Index” we saw a near 50% rise in the Volatility Index ($VIX) intraday nine days later on June 29th, which caught quite a few traders off-guard. I shared my insight that day in a piece for CNBC, saying the spike in volatility would likely be short-lived. Since then, volatility has resumed its downward path, hitting levels that have rarely, if ever, been seen (depending on which measure of volatility you use). In my VIX post I shared a chart of volatility seasonality, which showed that historically the VIX has put in a low around July/August. To expand on the topic of seasonality I want to dive into equity seasonality for August.

Below we take a look at different viewpoints on market seasonality as well as declining market momentum that could pose as a headwind for U.S. equities.

Seasonality
First up is this monthly seasonal chart by Jon Krinsky, CMT of MKM Partners, as shared by Josh Brown over at The Reformed Broker. Krinsky notes August has averaged a negative decline over the last 30 years but also points out that not every August has been bearish – ’06, ’09, and ’14 were notable exceptions.

Next is a chart I shared on Twitter which is from Tom Thornton’s daily note, Hedge Fund Telemetry. Tom does an excellent job sharing his insights each day in is letter. This chart looks at the decennial pattern of the Dow Jones Industrial Average going back to the early 1900s for years ending in “7”. As you can see, August has been an interesting turning point…. on average for the seventh year of the last 11 decades.

Jeff Hirsch, editor of The Stock Trader’s Almanac, notes that August in a post-election year has not been great for stocks. In fact, it’s the worst month for the Dow and the second worst month for the S&P 500, Nasdaq and Russell 1000 with average declines ranging from -18% to -15%, respective of the index.

Momentum
While discussing U.S. equities we often focus on just the indices themselves, but it’s important to remember that the stock market truly is a market of individual stocks. How those stocks trade is what ultimately impacts the indices themselves. I believe momentum is a powerful tool in stock analysis and can tell us quite a bit on the chart of individual stocks and markets. One such measurement of momentum is the Relative Strength Index (RSI). The chart below shows the average 14-day RSI for each of the stocks that make up the S&P 500. Since March this figure has been in a steady decline of lower highs while the index itself has been grinding higher. What I find really interesting is that we saw something very similar happen during the same time frame last year. In March 2016, the average RSI peaked and began to diverge through August – just before we saw the largest drawdown for that year. Will the same type of price action also follow 2017’s momentum divergence? We’ll see.

Another way to look at momentum is from a lens of being ‘overbought’ or ‘oversold.’ While on a short-term basis being ‘overbought’ can act as a headwind for stocks, it’s often a longer-term bullish sign of strong interest in the stock as buyers push momentum to high levels. By looking at the number of stocks that are seeing a high level of momentum via the RSI indicator we can get a different view of the health of momentum for the overall S&P 500 index. Similar to the chart above, we saw a peak in the percentage of S&P 500 stocks with their respective RSI above 70 (a commonly used level to denote ‘overbought’ status) just above 24%. As the index headed higher fewer and fewer stocks have been able to push their momentum readings above this threshold, with just 6.15% of the S&P 500 stocks getting ‘overbought.’

So there we have it. When looking at the S&P 500, the 50-day Moving Average seems to have become a favorite level of dip-buyers to step up their activity. As of this writing, we are still well above the 50-day as well as the shorter-term, 20-day with the index just a few points off its all-time high. If we do see weakness in equities I’ll be watching the prior June high as well as the 50-day MA as potential support levels. We are still in a well-defined up trend and that shouldn’t be discounted too quickly. There are plenty of catalysts that could keep prices buoyed, but it’s also important to understand the historical market implications and patterns that we also are facing. This should make for an interesting August for sure!

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.

Complacency in the Volatility Market

I was away from the office for a few days but upon returning it’s nice to see that trades have pushed equities higher as some of the major indices approach their prior highs. However, this has caused volatility to get back under 14 and the level of compression within the $VIX has hit such a level that causes me to give pause.

Volatility of volatility (as measured by VVIX) has fallen back to a level that for the last year and half has marked several low points for the $VIX.

VVIX

This, along with several other indicators that I closely monitor, has me watching volatility right now. While we head into a long holiday weekend, Jason Goepfert of SentimenTrader notes that since 2010 seasonality after Memorial Day hasn’t been extremely bullish for stocks, “Since 2010, the week of the holiday (next week) was positive only once (+1.2% in 2014). The other five years averaged a loss of 1.9%. None of the six years saw the S&P rally any more than 1.5% at its best point during the week.” Not that markets must follow their past playbook, but this negative slant of seasonality paired with what I’m seeing in volatility markets could play out in the bears favor in the coming weeks with a pop in the $VIX. We’ll see what happens.

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.

Expecting A Bounce In Volatility

The S&P 500 has rallied over 10% since the February low, push the index up to its 50-week Moving Average. Meanwhile the Volatility Index ($VIX) has declined approx. 47%, sending the ‘fear index’ to its lowest level so far this year.

One way to use Moving Averages besides in terms of trend identification and areas of support and resistance is measuring how far a security or market is from its specified average price. Currently the $VIX is the furthest it’s been from its 50-day MA since the prior lower high in the S&P 500 back in October 2015. As the chart below shows, it’s now more than one standard deviation below the mean based on the distance Volatility historically travels away from its 50-day.

Previous instances of the VIX falling this quickly has led to tough market conditions in the short-term for equities. As I mentioned on Twitter yesterday, the $VIX is also near its 200-week Moving Average, which has been an important level in the past. Steve Deppe also shared on Twitter that when the VIX that since 1990 when the index’s 20-day return is less than -30%, the average forward return for the S&P 500 over the next 5, 10, 20, and 40 days has been negative.

It’s important to remember that there are two ways that Volatility can correct it’s current stretched condition – time and price. We could see VIX move sideways and remain near 15, allowing its 50-day MA to ‘catch up’ or we could see a bounce sending Volatility higher. We obviously can’t know which option will occur, but it does seem that some form of mean-reversion needs to occur – whether it be via time or a large price movement.

sp500-vs-vix-50d-rsma-params-5y-red-x-x

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.

Are We About to See An Increase in Volatility?

One of the many tools in technical analysis are Bollinger Bands, which measure a set standard deviation price has traveled from a defined Simple Moving Average, in a way it’s measuring the volatility of a price move. Many traders often use Bollinger Bands as levels of potential support and/or resistance. However, I’m much more concerned with the distance between the bands themselves. Which, when applied to the Volatility Index, is showing signs of a potential rise in the $VIX.

When the upper and lower Bollinger Bands compress, it’s a result of a lack of change as measured by standard deviation, in this case, over the last 20 trading days. History has shown us that when this compression in the width of the Bollinger Bands for Volatility gets low enough, it has preceded spikes. Below is a chart of the $VIX over the last three years, with the width of the Bollinger Bands shown in the top panel. I’ve put blue dots on the VIX when the width has fallen below 20. While the $VIX hasn’t spiked immediately following every instance of this occurring, many large moves in volatility have followed such a compression in the Bands.

VIX

To shine a little more light on this topic, below is a list of times we’ve seen the bands width fall below 20 for the first time in two weeks and the $VIX itself was below 25. While the percentage of the time volatility was higher the next 1, 2, 3, 5, 10, 15, and 20 days ranges from 43% to 65%, what stands out to me is the minimum and maximum changes. Typically the minimum move over the shown periods of time is less than 10%, the maximum advances in volatility have been quite large – the mid-double digits.

Even though the number of instances the $VIX has risen has been low (typically less than 50% depending on the time period), when it does go higher we have seen some very strong moves to the upside in volatility. With the width of the bands now sitting under 20, it’s possible we see volatility pick up over the coming two weeks, if not sooner.

Understanding the probabilities and potential outcomes of historical market data is an important tool to being a successful trader.

VIX compression table

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.