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Schwab Live: Trader’s Outlook for July 12, 2019

Equities Rally on Rate Cut Optimism

Follow me on Twitter @RandyAFrederick. I’ll tweet interesting observations about volatility, put/call ratios, technical signals, economics, option block trades and other unusual activity.

Weekly Market Review:

Earnings Summary

Now that Q2 is over, earnings season is just beginning. Wall Street consensus expectations are calling for earnings to be 0.0% versus Q2 2018. You may recall back in Q1, the expectations were for -1.5% but the actual result was +1.3%.

With only 22 companies (4%) of the S&P 500 reporting, below are the aggregate results for Q2 relative to recent quarters. Don’t read too much into these numbers as it is very early in the season.

Quarter EPS beats        Rev beats

Q2 ‘19              82%                  73%

Q1 ‘19               77%                  57%

Q4 ’18               73%                  60%     

Q3 ’18               82%                  61%     

Q2 ‘18               84%                  72%

Q1 ‘18               81%                  74%

Q4 ’17               78%                  76%     

Q3 ’17               78%                  68%     

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%

Average            75%                  58%

Q2 earnings season is just now starting but not all companies follow a regular calendar quarter. Below are some of the higher-profile companies that reported this week.  

Earnings Recap

Symbol            Actual  Estimate

PEP                 1.54      1.50

LNN                  0.50      0.79

LEVI                 0.17      0.13

BBBY               0.12      0.08

FAST                0.36      0.37

DAL                  2.35      2.29     

Economics Recap

Better (or higher) than expected:

  • NFIB Small Business Optimism Index for Jun: 103.3 vs. 103.1 est
  • Consumer Price Index (CPI) for Jun: +0.1% vs. 0.0% est
  • Core CPI for Jun: +0.3% vs. +0.2% est
  • Initial (weekly) Jobless Claims: 209k vs. 222k est
  • Producer Price Index (PPI) for Jun: +0.1% vs. 0.0% est
  • Core PPI for Jun: +0.3% vs. +0.2% est

On Target:

  • Wholesale Inventories for May: +0.4% vs. +0.4% est

Worse (or lower) than expected:

  • Consumer Credit for May: $17.1B vs. 17.7B est
  • Job Openings and Labor Turnover Survey (JOLTS) for May: 7.32M vs. 7.47M est

This was a relatively light week for economic data and I would like to highlight that there were several upside surprises. In addition to the NFIB Small Business Optimism Index, the CPI and the PPI, Initial Jobless Claims have fallen for the past 2 weeks. This leaves the 4-week moving average just 17k above its lowest level since December 1969.

Source: Schwab Center for Financial Research

Past performance is no guarantee of future results.

Market Performance

Here is the 2019 YTD performance of the market broken down by the 11 market sectors (as of the close on 7/11/19):

  1. Info Tech                      +29.9%
  2. Consumer Disc             +23.9%
  3. Communications Svc     +23.2%
  4. Real Estate                   +21.8%
  5. Industrials                     +19.6%
  6. Financials                     +18.1%
  7. Cons Staples                +17.5%
  8. Utilities                         +15.3%
  9. Materials                       +14.4%
  10. Energy                          +11.9%
  11. Healthcare                     +8.1%

Source: Bloomberg L.P.

Past performance is no guarantee of future results.

Here is the 2019 YTD performance of the major U.S. equity indices (as of the close on 7/11/19):

  • S&P 500 (SPX)                         +19.7%
  • Nasdaq Composite (COMPX)    +23.5%
  • Dow Industrials (DJI)                 +16.1%
  • Russell 2000 (RUT)                    +15.5%

Technicals

Following the release of Fed Chair Jay Powell’s prepared remarks on Wednesday morning (7/10), the SPX rallied to an intraday high of 3,002, briefly exceeding its first 1,000-point benchmark since surpassing 2,000 for the first time back in August 2014. But the technical resistance level at the previous high of 2,995 showed up late in the day and prevented the index from closing at a new high. Then on Thursday (7/11), following Powell’s testimony in front of the Senate Banking Committee, another intraday rally above 3,000 eased just enough for the SPX to close at a new high just below that level.

While the new 2,999 high could become the new upside technical resistance, the SPX looks like it may close above this level on Friday (7/12) pushing it even higher. Either way, the existing downside support level of 2,954 remains, and as a result of the 2,999 high, the -10% downside correction level has moved up to 2,699 (yellow line).

Source: StreetSmart Edge®

Past performance is no guarantee of future results.

Option Volumes:

With less than 2 weeks complete in July, relatively calm markets have resulted in less trading activity. Aggregate option industry volume in July is averaging just 16.9M contracts per day. That is well below the June level of 19.1M contracts per day and even below the July 2018 level of 17.8M contracts per day.

Open Interest:

OI Change:

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

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

  • VIX call OI was +7.1%              
  • VIX put OI was +23.3%             

These changes show a large bias to the put side, so I see them as bullish for equities.

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

  • SPX call OI was +0.9%
  • SPX put OI was +4.3%             

These changes show a modest bias to the put side, so I see them as moderately bearish for equities.

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

  • SPY call OI was +3.2%             
  • SPY put OI was +2.4%             

These changes show an insignificant bias to the call side, so I see them as neutral for equities.

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

  • QQQ call OI was -2.5%
  • QQQ put OI was +3.7%

These changes show a modest bias to the put side, so I see them as moderately bearish for equities.

Combining VIX, SPX, SPY & QQQ data this week, there is a wide range of sentiment reflected, so I see the Index OI Change overall as volatile in the near-term. The Equity OI Change shows very little bias to the call or put side this week, so I see it as neutral in the near-term.

OI Participation:

Index OI Participation is currently +16.9% versus 2018 levels, so I see it as moderately bullish in the long-term.

Equity OI Participation is currently -4.4% versus 2018 levels, so I see it as neutral in the long-term.

Open Interest Put/Call Ratios (OIPCR):

The VIX OIPCR is up 5 ticks at 0.34 versus 0.29 last week. At this time, VIX options traders are holding (long or short) 34 puts for every 100 calls. At this level, this ratio is now above the 200-day SMA (simple moving average) of 0.32, but still well above the YTD low of 0.20 reached in late-April. As the SPX crept further into record territory this week, the VIX has fallen only fractionally through the close on Thursday (7/11). However, this sharp increase implies that VIX option traders expect the VIX to potentially fall even further in the near term, which is very surprising given that it is less than a point above its YTD low. At this level, I see the VIX OIPCR as moderately bullish in the very near-term for the markets. I see it as moderately bullish in the long-term too.

This week the SPX OIPCR is up 6 points at 2.01 versus 1.95 last week. At this level this ratio is well above the 200-day SMA (Simple Moving Average) of 1.77. It is now also at its highest level since October of last year. Most of the time, this ratio tends to move in the same direction as the index, but this uptick is fairly sizable given the SPX has risen less than 10 points (+0.3%) this week. As a result, it implies that SPX option traders (who are almost entirely institutional) appear to be increasing their hedges as the SPX creeps into record territory. At this level I see the SPX OIPCR as moderately bearish in the near-term for the market. It remains moderately bearish in the long-term too.

The normally stable Equity OIPCR is down 1 tick to 1.01 versus 1.02 last week. While this ratio includes a large retail component and it tends to be a contrarian indicator, it is very balanced. Therefore I see the Equity OIPCR as neutral in the near-term for the market. I see it as neutral in the long-term.

CBOE Volume Put/Call Ratios (VPCR):

The normally volatile CBOE VIX VPCR has been mostly neutral this week. The 0.49 reading on Thursday (7/11) was neutral but the current reading of 0.30 as I’m writing this (mid-day Friday 7/12) is moderately bearish. Therefore I see it as neutral in the very near-term.

The CBOE SPX VPCR has been moderately bearish all week. The 1.82 reading on Thursday (7/11) was moderately bearish, and the current reading of 1.81 as I’m writing this (mid-day Friday 7/12) is moderately bearish. Since intraday levels tend to decline as the day goes on, I see this ratio as moderately bearish in the very near-term. With a 5-day average of 1.79 versus 1.43 last week, it is moderately bearish in the long-term.

The CBOE Equity VPCR has been fairly neutral this week. The 0.61 level on Thursday (7/11) was neutral, but the current reading of 0.72 as I’m writing this (mid-day Friday 7/12) is neutral. Since intraday levels tend to fall throughout the day, I see it as neutral in the very near-term. With a 5-day moving average of 0.59 versus 0.62 last week, it is 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):

The ISEE has closed below 100 in 3 of this week’s 4 sessions. 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 more puts than calls. Since the intraday level at the time of this writing is 79, I see the ISEE as moderately bearish in the near-term. Since this ratio has closed below 100 in 7 of the last 9 sessions, I see the ISEE as moderately bearish in the long-term.

OCC Volume Put/Call Ratios (VPCR)

The OCC Index VPCR has been moderately bearish all week. Therefore I see it as moderately bearish in the near-term. However, over the past 3 weeks, it has been moderately bearish, neutral and moderately bullish multiple times, so I see it as still volatile in the long-term.

By contrast, the OCC Equity VPCR has been moderately bullish all week. Therefore, I see it as moderately bullish in the near-term. Additionally, this one has been moderately bullish in 11 of the past 15 sessions, so I see it as also moderately bullish in the long-term.

Volatility:

As I mentioned in the OIPCR section above, as the SPX edged into record territory this week, the VIX has fallen only fractionally through the close on Thursday (7/11). I continue to find it rather surprising that markets keep hitting new highs given the U.S. and China still do not have a new trade agreement, current tariffs have not been lifted, and the USMCA has not yet been passed. The market’s complacency is assuming optimal outcomes on all of these things, which is not a foregone conclusion. The 20-day historical volatility of the VIX is 71% this week versus 63% last week.

Cboe Volatility Index (VIX)

While this VIX is little changed for the week, as I’m writing this (mid-day Friday 7/12), it is down about a quarter point (around 12.65); less than a point above its YTD low. This is just above its long-term statistical mode of 12.42 (which I consider “normal” volatility) but well below its long-term statistical mean of 19.23. At this level, I see the VIX as moderately bullish in the very near-term for the equity markets. It is moderately bullish in the long-term too.

On a week-over-week basis, VIX call prices have risen while VIX put prices have fallen modestly. At +148 versus +107 last week, the VIX IV Gap (the average IV of VIX calls less the average IV of VIX puts) is higher but at this level is still neutral in the very near-term. It is also neutral in the long-term. Keep in mind, this tends to be one of the earliest contrarian 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 +3.39 versus +2.48 last week. This increase mostly reflects solidly lower prices in the near-term expirations, while the longer-term contracts have fallen only slightly.            

As of this writing (mid-day Friday 7/12), the nearest VIX futures contract (which expires on 7/17) was trading at 13.45, less than a point above the spot VIX level of 12.65. Adjusting this price for the risk premium factor (which takes into account the time until expiration), the Risk Premium Adjusted Price (RPAP) is 13.23; only about a ½ point above the spot price.

With an adjusted level that is just about a half point above spot price of the VIX, futures traders are indicating that they believe the VIX level will remain fairly steady in the near-term. 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 13.99 and 13.97 respectively. With the RPAPs of the further-dated contracts both slightly more than a point above the spot price, I see VIX futures as moderately bearish 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 falling just slightly this week, the VIX Hedging Effectiveness remains Moderate in the near-term. At the moment, this means that options on the VIX (and possibly other volatility-related products) are showing at least a little sensitivity to market volatility, and may be at least somewhat effective as hedging tools in the very near-term. VIX Hedging Effectiveness is Moderate 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

North America

Last week, according to economic advisor Larry Kudlow, the U.S. and Chinese trade officials held constructive phone conversations about trade. However, China maintained that for negotiations to make progress, the U.S. must remove all existing tariffs. A few days later, President Trump tweeted that “Mexico was doing a great job at the border, but China is letting us down by not buying enough farm products from the U.S.”

Asia

As mentioned above, and perhaps related to the farm products issue, on Friday (7/12) China reported that its $29.9B trade surplus with the U.S. was the largest amount YTD. Chinese trade officials maintain that the purchase of agricultural products was not a precursor to a trade deal, but rather a part of the more comprehensive deal under discussion. To that point, data indicate an actual reduction is purchases since the 6/21 meeting in Osaka, and statements from China indicate no plans for increases anytime soon.

Europe

The UK’s U.S. Ambassador, Kim Darroch resigned this week following the public exposure of his private memos which described the Trump administration as “uniquely dysfunctional and inept”. While President Trump responded to the comments by calling Daroch a “pompous fool and a very stupid guy”, it was the risk the exchange posed to U.S./UK relations, and his lack of support from the likely next Prime Minister, Boris Johnson, that ultimately led to his resignation.

Separately, International Monetary Fund (IMF) Chief, Christine Lagarde has been nominated to succeed Mario Draghi as the next leader of the European Central Bank (ECB). If she is confirmed by the ECB’s governing council, her term will begin in November.

Economic reports for next week:

Mon 7/15

None

Tue 7/16

International Trade (Import & Export Prices) for Jun – This report tracks the prices of goods bought in the US but produced abroad and the prices of goods sold abroad but produced in the US, respectively. Price changes are impacted by inflationary pressures and currency exchange rates.

Retail Sales for Jun – This report is a widely watched gauge of consumer sentiment and spending habits.

Industrial Production & Capacity Utilization for JunIndustrial production measures industrial output as a percentage, relative to output from 2007. Capacity Utilization measures output potential as a percentage, relative to the actual output from 2007. 

Business Inventories for May – This is a lagging indicator since all of the components have been previously released.

Wed 7/17

Housing Starts and Building Permits for Jun – Housing starts measure the beginning of the excavation of the land on which a new single or multi-family residence will be built, and is used as a gauge of housing demand and strength in the construction industry. Building permits are required before excavation can begin, and any changes in permits are often reflected in starts in subsequent months.

Weekly Jobless Claims - For the week ending 7/6/19, claims were down 13k to 209k after being down 7k the prior week. The 4-week moving average now stands at 219k, down 4k from the prior week. With this change, the 4-week moving average is now 17k above the 48-year low set on 4/13/19.

Thu 7/18

Leading Economic Indicators for Jun – As you probably know, this is more of a trailing than a leading report since the 10 components have already been released. As a result, the market reaction is usually fairly muted.

Fri 7/19

University of Michigan Consumer Sentiment for Jul – This is the first report for July. The final report for June declined to 98.2 from 100.0 previously.

Interest Rates

As I mentioned last week, while the interest rate on the 10-year Treasury briefly dipped below the technical support level of 2.00% back on 7/3, it has rallied sharply ever since. With a rate cut virtually certain on 7/31, this will steepen the yield curve somewhat, which should help allay near-term recession fears.

Source: StreetSmart Edge®

Past performance is no guarantee of future results.

Fed Chairman Jay Powell’s monetary policy testimony on Wednesday (7/10) and Thursday (7/11) mostly reiterated what he said after the last FOMC meeting on June 19; essentially that the economy did reasonably well during the first 6 months of 2019, but that he is concerned inflation is running below their 2% objective. He also highlighted concerns about trade tensions and global growth. And while not directly stating a rate cut is coming, he did say that the committee will “act as appropriate to sustain the expansion” and may have to cut rates soon, as several FOMC members feel a somewhat more accommodative monetary policy is warranted. On the plus side, he noted the recent rebound in consumer spending, continued strength in the labor market, and expectations for a pickup in inflation.

Following Fed Chair Jay Powell’s remarks on Wednesday and Thursday, the Fed Funds Futures probability of a rate cut on 7/31 remains solidly at 100% (green box). Yet despite some solid economic data this week, the odds of that cut being 50 bps instead of 25 bps has actually increased from 0% to 16.5% (red box). As I mentioned last week, many economists and market analysts have argued that a 25 bps cut is needed to reverse the last 25 bps hike in Dec ’18, which they believe should not have happened.

Source: Bloomberg L.P.

Past performance is no guarantee of future results.

Outlook:

With still no resolution on trade/tariffs in sight, equities continue to press further into record territory due to monetary policy optimism. Apparently “Don’t fight the Fed” is still sound advice.

Bottom Line:

President Trump has stated that he wants the Fed to lower interest rates, while Fed Chair Powell has stated that the Fed should remain independent and free from political influence. It appears that President Trump has devised the perfect plan where both of these seemingly opposing issues can coexist; maintain trade uncertainty at a level that is just enough to necessitate rate cuts, but not quite enough to adversely impact the markets.

Some of the short-term indicators moved up and some of them moved down this week. I believe this speaks to the significant amount of disagreement among the different market participants. The start of earnings season next week will likely be the biggest driver of individual stocks, but not enough of them will be reporting to drive the broader market very much. Given that the 7/31 rate cut is essentially baked into the market, and the current low level of volatility, the consensus of the indicators appear to offset each other and point to Neutral again for next week.  

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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Important Disclosures:

Options carry a high level of risk and are not suitable for all investors. Certain requirements must be met to trade options through Schwab. With long options, investors may lose 100% of funds invested. Multiple leg options strategies will involve multiple commissions. Protective puts increase your cost basis in the underlying security. Please read the options disclosure document titled "Characteristics and Risks of Standardized Options."

All stock and option symbols and market data shown above are for illustrative purposes only and are not a recommendation, offer to sell, or a solicitation of an offer to buy any security. Past performance should not be construed as indicative of future results.

Multi-leg options strategies will involve multiple commissions. Spread trading must be done in a margin account. Covered calls provide downside protection only to the extent of the premium received and limit upside potential to the strike price plus premium received. Commissions, taxes and transaction costs are not included in the examples used in this discussion, but can affect final outcome and should be considered. Please contact a tax advisor for the tax implications involved in these strategies.

Schwab does not recommend the use of technical analysis as a sole means of investment research. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed. The information presented does not consider your particular investment objectives or financial situation (including taxes), and does not make personalized recommendations.

Please note that this content was created as of the specific date indicated and reflects the author’s views as of that date. It will be kept solely for historical purposes, and the author's opinions may change, without notice, in reaction to shifting economic, business, and other conditions. Indexes are unmanaged, do not incur management fees, costs and expenses, and cannot be invested in directly.

The information presented does not consider your particular investment objectives or financial situation, and does not make personalized recommendations. Any opinions expressed herein are subject to change without notice. 

Please contact a tax advisor for the tax implications involved in the strategies referenced in this article. Supporting documentation for any claims or statistical information is available upon request. Futures trading carries a high level of risk and is not suitable for all investors. Past performance is no guarantee of future results.

Investing involves risks, including loss of principal. Hedging and protective strategies generally involve additional costs and do not assure a profit or guarantee against loss. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

All references to subjects (securities, indexes, futures contracts, and options contracts) were derived based on screens conducted by the writer for certain anomalous activity such as volumes, volatility and other related market data. As needed for brevity, the writer may have applied discretion when choosing among screen outputs for inclusion. Such discretion may have been based on news reports or other considerations of public interest. The views or opinions are those of the writer, and are subject to change without notice. All referenced subjects were chosen for illustrative purposes only and should not be considered recommendations, offers to sell, or solicitations of offers to purchase.

The information provided here is for general informational purposes only. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

The Global Industry Classification Standard (GICS) was developed by and is the exclusive property of Morgan Stanley Capital International Inc. (MSCI) and Standard & Poor's. GICS is a service mark of MSCI and S&P and has been licensed for use by Charles Schwab & Co., Inc. Index used for the 11 market sectors. 

The S&P 500 Index is a market-capitalization-weighted index comprising 500 widely traded stocks chosen for market size, liquidity and industry group representation. The NASDAQ Composite Index is a broad-based market-capitalization weighted index of 2,630 stocks in all three NASDAQ tiers: Global Select, Global Market and Capital Market. The Dow Jones Industrial Average is a price-weighted index of 30 stocks compiled by Dow Jones as a way to gauge the performance of the industrial component of America’s stock markets. The Russell 2000 Index is a market-capitalization-weighted index comprised of the smallest 2000 companies in the Russell 3000 Index, representing approximately 8% of the Russell 3000 total market capitalization.

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