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Trader’s Outlook for October 20, 2017: "Melt up" keeps on melting

Follow me on Twitter @RandyAFrederick. I’ll tweet interesting observations about volatility, equities, put/call ratios, technical signals, economics etc. as I see them.

Weekly Market Review:

Earnings Summary

Earnings season accelerated this week with several high profile names reporting. So far 88 companies (17%) of the S&P 500 have reported, and below are the aggregate results relative to recent quarters.

Quarter            EPS beats        Rev beats

Q3 ’17              81%                 75%    

Q2 ‘17              77%                 69%

Q1 ’17              78%                 63%

Q4 ’16              73%                 53%

Q3 ‘16              72%                 55%

Q2 ‘16              72%                 53%

Q1 ’16              72%                 52%

Q4 ’15              68%                 46%

Q3 ’15              68%                 43%

Q2 ‘15              70%                 48%

Q1 ‘15              68%                 43%

Q4 ‘14              69%                 58%

Q3 ‘14              73%                 60%

Q2 ‘14              67%                 64%                

Q1 ‘14              68%                 52%

Below are some of the higher profile companies that reported this past week.  

Earnings Recap

Symbol        Actual  Estimate

NFLX                0.29      0.32

UNH                 2.66      2.57

JNJ                  1.90      1.80

MS                   0.88      0.81

HOG                0.40      0.39

GS                   5.02      4.25

CSX                 0.51      0.51     

IBM                  3.30      3.28

AXP                 1.62      1.48

EBAY               0.48      0.48

UAL                  2.22      2.19

VZ                    0.98      0.98

GE                   0.29      0.50

PG                   1.09      1.08

Economics Recap

Better than expected:

  • Empire Manufacturing for Oct: 30.2 vs. 21 est
  • Export Prices for Sep: +0.8% vs. +0.6% est
  • Import Prices for Sep: +0.7% vs. +0.6% est
  • Industrial Production for Sep: +0.3% vs. +0.2% est
  • NAHB Housing market Index for Oct: 68 vs. 64 est
  • Weekly Jobless Claims: 222k vs. 236k est
  • Existing Home Sales for Sep: 5.39M vs. 5.29M est

On Target:

  • None

Worse than expected:

  • Capacity Utilization for Sep: 76.0% vs. 76.1% est
  • Housing Starts for Sep: 1127k vs. 1160k est
  • Building Permits for Sep: 1215k vs. 1224k est
  • Index of Leading Indicators for Sep: -0.2% vs. +0.1% est

It was a fairly busy week for economic data and as you can see above, there were more upside surprises than downside surprises. Initial jobless claims for the week ending 10/14/17 were the lowest single reading since early 1973! Also worth noting (as shown in the chart below) is that the spike in weekly jobless claims that appeared in September as a result of the hurricane in Houston, has now been completely reversed. Not unlike Hurricane Sandy in 2012, this further illustrates not only the strength, but also the resilience of the labor market.     

Source: Schwab Center for Financial Research

Past performance is no guarantee of future results.

Technicals

Despite plenty of indications last week that the market was overdue for at least a modest pullback, the only downside occurred on Thursday morning (10/19) and by mid-day it was already gone. While that weak opening was attributed to a few downside earnings surprises initially, it could just as easily have been unease related to the anniversary of black Monday (October 19, 1987) since it lasted less than 2 hours. On that fateful day 30 years ago, the SPX dropped a whopping 57.86 points (-20.47%). An equivalent decline at today’s levels would be -525 points, which would put the SPX back to around 2042; reversing the last 20 months of gains.  

Despite the $SPX closing at 4 successive record highs this week, (and likely 5 by the time you read this) the $VIX closing above 10 for the past 3 sessions indicates that concerns of a larger pullback are rising just slightly; the question remains when it might occur.

Source: StreetSmart Edge®

Past performance is no guarantee of future results.

Also worth noting is that with multiple new highs this week, the bull market is still very much alive. As a result, below is an update on its strength and duration. Now +8.3% in its eighth year (since 3/10/17) and more than +278% overall, it is still second strongest and second longest since WW II.

Source: StreetSmart Edge®

Past performance is no guarantee of future results.

Option Volumes:

As the regular monthly option expiration approaches (Friday 10/20) volumes have picked up modestly, now averaging 16.2M contracts per day. This is just below the September level of 16.8M contracts per day but just above the September 2016 level of 15.1M contracts per day.

Open Interest:

OI Change:

In reviewing CBOE open interest (OI) data (where >90% of the index activity occurs), I observed the following changes over the past week:

  • VIX call OI was -27.6%
  • VIX put OI was -31.3%

These declines are due to the October VIX option contract expiration on Wednesday (10/18) and are therefore N/A this week.  

In reviewing SPX data for the past week I observed the following:

  • SPX call OI was +5.5%
  • SPX put OI was +5.2%

These changes show very little bias at all this week, so I see them as neutral in the near-term.

In reviewing SPY data for the past week I observed the following:

  • SPY call OI was +2.0%
  • SPY put OI was +8.3%

These changes show a bias to the put side, so I see them as moderately bearish in the near-term. 

Combining the VIX, SPX and SPY data, I see the Index OI Change as moderately bearish in the near-term. The Equity OI Change shows a very slight bias to the put side this week, so I see it as moderately bearish in the near-term.

OI Participation:

Index OI Participation is currently +19.6% versus 2016 levels, so I see it as bullish in the long-term.

Equity OI Participation is currently +6.8% versus 2016 levels, so I see it as moderately bullish in the long-term.

Open Interest Put/Call Ratios (OIPCR):

This week the VIX OIPCR is down 1 tick to .25 versus .26 last week. At this time, VIX options traders are holding (long or short) only 25 puts for every 100 calls on the VIX. This ratio is 7 ticks below the 200-day SMA (simple moving average) of .32. This downtick combined with a modest uptick in the VIX implies a slightly elevated level of concern of an uptick in the VIX. At this level however, this ratio is only one tick above its YTD low of .24, which it hit on Wednesday (10/18). When this ratio last hit .24 in late June, the VIX did experience a modest rise (into the 11-12 range) a week or two later. I see the VIX OIPCR as bearish in the very near-term for the markets. Since this ratio has been falling for 5 weeks now, I see it as still moderately bearish in the long-term.

The SPX OIPCR is up 4 ticks to 2.19 versus 2.15 last week. At this level this ratio remains well above the 200-day SMA (simple moving average) of 1.96. This uptick is not at all surprising given the SPX has hit record highs for the first 4 sessions this week. While this uptick does show growing concern of a pullback, since it is well below this YTD high of 2.28 hit in late September, I see the SPX OIPCR as moderately bearish in the near-term for the market. Since it has been moving mostly sideways for 3 weeks now, I see it as neutral in the long-term.

The normally very stable Equity OIPCR is up one tick to 1.07 versus 1.06 last week. This ratio is pretty close to its YTD average high, but it is also very common to see an uptick a few days before the monthly option expiration. As a result, I see the Equity OIPCR as neutral in the near-term for the market. However, given that this ratio is still relatively high from a historical perspective, I see it as moderately bearish in the long-term.

CBOE Volume Put/Call Ratios (VPCR):

The normally volatile CBOE VIX VPCR had been neutral earlier in the week. But the .40 reading on Thursday (10/19) was moderately bearish, and the current reading of .26 as I’m writing this (mid-day Friday 10/20) is moderately bearish. Therefore I see it as moderately bearish in the very near-term.

The CBOE SPX VPCR has also been mostly moderately bearish this week. The 1.62 reading on Thursday (10/19) was moderately bearish, but the current reading of 1.57 as I’m writing this (mid-day Friday 10/20) is neutral. Since this ratio does tend to fall as the day progresses, I see it as neutral in the very near-term. With a 5-day average of 1.74 versus 2.00 last week, it is moderately bearish in the long-term.

The CBOE Equity VPCR has been neutral this week. The .70 reading on Thursday (10/19) was neutral and the current reading of .66 as I’m writing this (mid-day Friday 10/20) is neutral. While intraday levels on equity options tend to decline as the day progresses, this is unlikely to drop enough so I see it as neutral in the very near-term. With a 5-day moving average of .69 versus .65 last week, it remains neutral in the long-term.

Since volume based put/call ratios are very reactive and very short-term in nature, near-term usually means just a day or two, while long-term is more like a week.

ISE Retail Sentiment Index (ISEE):

This week the ISEE had been mostly neutral until Thursday (10/19) when it closed in bearish territory with a level of 59. Since this gauge measures only retail opening activity and it is actually a call/put indicator, a level below 100 means that retail option traders on the ISE are trading fewer calls than puts, and on Thursday, that means only 59 calls for every 100 puts. However, given the intraday level at the time of this writing is 178, I see the ISEE as neutral in the near-term. Given recent trends, I see the ISEE as still neutral in the long-term.

OCC Volume Put/Call Ratios (VPCR)

The OCC Index VPCR has been mostly in or around neutral territory this week. Therefore I see it as neutral in the near-term. Additionally, it has been all over the place over the past few weeks and like last week, in a higher volatility environment I would see that as volatile. Instead, since volatility has been so low recently, I see it as neutral in the long-term.

Similarly, the OCC Equity VPCR has also moved from moderately bearish to neutral this week. Therefore I see it as neutral in the near-term. Also like the index ratio, it has been all over the place over the past few weeks, so I see it as neutral in the long-term.

Volatility:

CBOE Volatility Index (VIX)

With its most recent close of 9.91 on Monday (10/16) the VIX has now closed below ten 33 times this year. However, as mentioned in the Technicals section above, it has closed above 10 for the past 3 sessions, despite the SPX closing at new record highs all 3 of those days.  

This week the 20-day historical volatility average on the VIX is just 53% versus 51% last week. As of this writing (mid-day Friday 10/20) the VIX is down fractionally, just below 10.00. At its current level, while still quite low from a historical perspective, the VIX is indicating just a very slight increase in downside worry. Still at these levels, I view the VIX as moderately bullish in the very near-term for the market. I see it as also moderately bullish in the long-term.

On a week-over-week basis, VIX call prices are down slightly and put prices fairly flat. At +129 versus +149 last week, the VIX IV Gap (the average IV of VIX calls less the average IV of VIX puts) is lower, but at this level is still in the range of neutral in the very near-term. Since this gap has been pretty steady over the past 6 weeks, it is neutral in the long-term. Keep in mind, this tends to be one of the earliest indicators I discuss in this blog, and it can also change directions very quickly.

VIX Futures

At the moment, the difference between the sum of the 3rd and 4th month futures and the 1st and 2nd month futures is 3.99 versus 4.07 last week. This small decrease is mostly due to the expiration of the October monthly futures contracts on 10/18.                       

As of this writing (mid-day Friday 10/20), the nearest VIX futures contract (which expires on 10/25) was trading at 10.15, less than ½ a point above the spot VIX level of 9.78. Adjusting this price for the risk premium factor (which takes into account the time until expiration), the Risk Premium Adjusted Price (RPAP) is 9.96, barely above the spot price.

With an adjusted level that is very close to the spot price of the VIX, futures traders are indicating that they believe the VIX is just about right at the moment. Therefore I see VIX futures as neutral in the near-term for the market. The RPAPs of the next two closest monthly futures contracts are 10.51 and 10.34 respectively. With the RPAPs of the further dated contracts both less than ¾ of a point above the spot VIX, I see VIX futures as neutral in the long-term for the SPX.

Since VIX futures are typically much less reactive to current market conditions than the VIX index, near-term for VIX futures usually means a few days, while long-term means a couple of weeks.

Despite the VIX closing above 10 for most of the week, VIX Hedging Effectiveness remains Poor in the near-term. At the moment, this means that options on the VIX (and possibly other volatility-related products) are showing very little sensitivity to market volatility, and may not be effective as hedging tools in the very near-term. VIX Hedging Effectiveness is also now Poor in the long-term.

VIX Hedging Effectiveness is a manner of measuring the magnitude of VIX moves relative to the magnitude of SPX moves in the opposite direction. When the VIX is highly reactive, VIX related products can serve as potentially effective hedging tools, when the VIX is not very reactive, traditional hedging techniques may be a better choice.

Global Review/Outlook

Europe

This week French President Emmanuel Macron called a proposed Brexit deal from UK Prime Minister Theresa May, “a long way off”, implying that there is still much work to do to reach consensus. German Chancellor Angela Merkel added, “There has been progress, but it’s not yet sufficient to begin a second phase”. Both leaders want a larger financial commitment from May before discussing potential trade deals.

Asia

As part of a very long speech this week, Chinese President Xi Jinping presented a confident vision for a more prosperous future for China and its role in the world. He affirmed the need for a "still stronger" Communist Party, and said it was important to continue to wipe out corruption, curb industrial overcapacity, income inequality and pollution.

Economic reports for next week:

Mon 10/23

None

Tue 10/24

None

Wed 10/25

Durable Goods Orders for Sep – This is a key measure of consumer and industrial spending trends and often causes market swings if it misses estimates.

New Home Sales for Sep – This report measures sales activity of newly constructed homes and other single family dwellings, and is generally considered less important than building permits since it is more of a trailing report.

Thu 10/26

Weekly Jobless Claims - For the week ending 10/14/17, claims were down 22k to 222k after being down 14k the prior week. The 4-week moving average now stands at 249k, down 10k from the prior week. With this change, the 4-week moving average is now 15k above the 44-year low hit in late February.

Pending Home Sales Index for Sep – This report measures actual contracts signed, whereas existing sales (reported last week) measures actual closings, so this one is slightly more forward looking. This one will usually only affect the market adversely if it comes in very low, relative to estimates.

Fri 10/27

GDP for Q3 – This is the first estimate (Advance) for Q3 and the consensus seems to be in the range of +2.5%, which would follow the final level of +3.1% from Q2.

University of Michigan Consumer Sentiment for Oct – This is the Final report for Oct. At 101.1, the mid-month report was up from the prior month.

Interest Rates

Now at 83%, the probability of a Fed rate hike in December is at its highest level this year. This represents about a 10 percentage point gain over last week.

Source: Bloomberg L.P.

Past performance is no guarantee of future results.

Outlook:

A “melt up” is a bull market driven by the “FOMO” (fear of missing out) syndrome, rather than by economic fundamentals. The danger in a melt up is the subsequent melt down that can occur once everyone is in. While the current market has been described as such, I would argue that is a misnomer; this bull market is being driven by very strong fundamentals; thus its continued resilience.

Bottom Line:

Last week the indicators were nearly unanimous that a modest pullback was in the offing, and yet this week’s action was anything but. I think it is worth reminding all readers that what the indicators actually show is not what the market will do, but what the majority of market participants are doing. In other words, market participants may be preparing for a downside or an upside move, but that doesn’t mean it will always happen; just that if it does, they are in a position to capitalize on it.

The overall economic backdrop (especially the labor market) remains quite strong, and earnings season has been quite good so far, so continued low volatility is likely next week. Additionally, as you can see below, most of the changes were in a positive direction this week, so despite multiple new record highs in the SPX, participants are generally expecting no worse than a sideways week of consolidation. Therefore the outlook for next week is Neutral.

Past performance is no guarantee of future results.

Key:

OI = Open Interest

OIPCR = Open Interest Put/Call Ratio

VPCR = Volume Put/Call Ratio

IV = Implied Volatility

+ means this indicator has changed in a bullish direction from the prior posting.

– means this indicator has changed in a bearish direction from the prior posting.

+/ – means this indicator has changed bi-directionally; i.e. last week was either Volatile, N/A or Breakout.

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