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Trader’s Outlook for February 22, 2019: Correction recovery slows down

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

Q4 earnings season is nearly over now. With 445 companies (89%) of the S&P 500 reporting, below are the aggregate results relative to recent quarters.

Quarter        EPS beats        Rev beats

Q4 ’18               72%                  59%     

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%

Q4 ‘14               69%                  58%

Q3 ‘14               73%                  60%

Q2 ‘14               67%                  64%                 

Q1 ‘14               68%                  52%

Q4 ‘13               65%                  61%

Q3 ‘13               66%                  53%

Q2 ‘13               66%                  54%                 

Q1 ‘13               66%                  46%

Average            72%                  58%

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

Earnings Recap

Symbol       Actual  Estimate

WMT                 1.41      1.34

CVS                 2.14      2.08

CAR                 0.53      0.37

DPZ                 2.62      2.69

INTC                 1.00      0.86

ROKU               0.05      0.03

FSLR                0.60      0.63

KHC                 0.84      0.94

W                     -1.12     -1.30

Economics Recap

Better (or higher) than expected:

  • NAHB Housing Market Index for Feb: 62 vs. 59 est
  • Initial (weekly) Jobless Claims: 216k vs. 225k est

On Target:

  • None

Worse (or lower) than expected:

  • Durable Good Orders for Dec: +0.1% vs. +0.2% est
  • Philadelphia Fed Index for Jan: -4.1 vs. 12 est
  • Existing Home Sales for Jan: 4.94M vs. 5.05M est
  • Index of Leading Indicators for Jan: -0.1% vs. +0.1% est

It was a relatively light week for economic data and this week I’d like to highlight Initial Jobless Claims again. As I discussed 2 weeks ago, the recent government shutdown resulted in a (not unexpected) spike in weekly claims, which (as shown below) was pretty much in line with each of the previous shutdowns that lasted more than 2 weeks.

  • Sep 1978: +38k
  • Dec 1995: +82k
  • Oct 2013: +65k
  • Jan 2019: +53k

And while the 4-week moving average is still ticking higher, with a decline of 18k two weeks ago, and a decline of 23k this week, there is little doubt the impact of the shutdown is now gone, and the labor market remains historically strong.

Source: Schwab Center for Financial Research

Past performance is no guarantee of future results.

Technicals

Here is the 2019 YTD performance of the market broken down by the 11 market sectors (as of the close on 2/21/19):

  1. Industrials                     +17.4%
  2. Energy                          +14.5%
  3. Info Tech                      +13.1%
  4. Real Estate                   +12.1%
  5. Consumer Disc             +11.5%
  6. Financials                     +10.7%
  7. Materials                       +10.4%
  8. Communications Svc     +11.1%
  9. Staples                         +6.9%
  10. Healthcare                     +6.6%
  11. Utilities                         +6.2%

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 2/21/19):

  • S&P 500 (SPX)                         +10.7%
  • Nasdaq Composite (COMPX)    +12.4%
  • Dow Industrials (DJI)                 +10.8%
  • Russell 2000 (RUT)                    +16.8%

In this section last week, I stated, “I have often said that for traders, some of the best buying opportunities in the market occur when there is an emotional reaction that appears way too extreme. The downturn following the very weak December retail sales report was a great example of this.” As of the close on Thursday (2/21) the SPX is +42 points (+1.5%) from that time.

Perhaps more interesting though, is that with the strength of the correction recovery (as shown in the chart below), the SPX is now just 156 points (5.6%) away from the all-time high of 2,930 reached last October. With earnings season nearly over, estimates falling for Q1 earnings, lowered Q4 GDP estimates, and geopolitics still causing anxiety, I don’t expect the market to approach that level anytime soon. In the near-term I think the SPX will run into some fairly heavy technical resistance around 2,800 (red arrows) but I do think it could revisit those highs in the second half of the year if the both the trade war and the Brexit are resolved favorably.

Source: StreetSmart Edge®

Past performance is no guarantee of future results.

Option Volumes:

It is past the midway point in the month of February and aggregate option industry volume is averaging just 18.7M contracts per day. That is below the January level of 20.1M contracts per day and well below the February 2018 level of 25.1M 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:

  • VIX call OI was +13.1%             
  • VIX put OI was +7.6%               

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

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

  • SPX call OI was -6.6%  
  • SPX put OI was -10.0%            

These changes reflect the February monthly contract expiration on Friday (2/15) and are therefore N/A this week. 

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

  • SPY call OI was -19.8%                        
  • SPY put OI was -12.9%            

These changes reflect the February monthly contract expiration on Friday (2/15) and are therefore N/A this week. 

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

  • QQQ call OI was -8.5%
  • QQQ put OI was -12.4%            

These changes reflect the February monthly contract expiration on Friday (2/15) and are therefore N/A this week. 

Since the SPX, SPY & QQQ data are of no value this week, but the VIX reflects a small bearish bias overall, I see the Index OI Change as moderately bearish in the near-term. The Equity OI Change shows almost no 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 -21.2% versus 2018 levels, so I see it as moderately bearish in the long-term.

Equity OI Participation is currently -10.9% versus 2018 levels, so I see it as moderately bearish in the long-term.

Open Interest Put/Call Ratios (OIPCR):

The VIX OIPCR is down 2 ticks to 0.26 from 0.28 last week. At this time, VIX options traders are holding (long or short) 26 puts for every 100 calls. At this level, this ratio remains well below the 200-day SMA (simple moving average) of 0.35. This downtick may imply that VIX options traders are expecting the VIX to move slightly higher next week. As a result, I see the VIX OIPCR as moderately bearish in the very near-term for the markets. Given YTD trends, it remains neutral in the long-term.

This week the SPX OIPCR is down 1 tick to 1.68 versus 1.69 last week. At this level it remains well below the 200-day SMA (simple moving average) of 1.79. This ratio tends to move in the same direction as the index, so it is not surprising that it is little changed this week, given that the SPX is too. As a result, it implies that SPX option traders (who are almost entirely institutional) are reasonably comfortable with the index at its current level. Therefore I see the SPX OIPCR as neutral in the near-term for the market. For now it remains moderately bullish in the long-term.

The normally stable Equity OIPCR is down 1 tick to 1.02 versus 1.03 last week. Despite a gain of +10.7% YTD, this ratio remains near its highest level since mid-January 2018. At this level, it implies that equity option traders (which includes a substantial number of retail traders) are still skeptical regarding the sustainability of the post-correction recovery; a big contrast to the institutional activity. As a result I see the Equity OIPCR as still bearish in the near-term for the market. It is now moderately bearish in the long-term.

CBOE Volume Put/Call Ratios (VPCR):

The normally volatile CBOE VIX VPCR has been mostly moderately bearish this week. The 0.22 reading on Thursday (2/21) was bearish and the current reading of 0.12 as I’m writing this (mid-day Friday 2/15) is bearish. Therefore, I see it as bearish in the very near-term.

The CBOE SPX VPCR had been mostly neutral this week, but the 1.62 reading on Thursday (2/21) was moderately bearish, and the current reading of 1.90 as I’m writing this (mid-day Friday 2/15) is moderately bearish. While 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 1.49 versus 1.53 last week, it is neutral in the long-term.

The CBOE Equity VPCR has been mostly neutral this week. The 0.66 reading on Thursday (2/21) was neutral, and the current reading of 0.68 as I’m writing this (mid-day Friday 2/15) is neutral. While intraday levels tend to decline as the day goes on, I see it as neutral in the very near-term. With a 5-day moving average of 0.58 versus 0.57 last week, it remains moderately bullish 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 ISEE has been below 100 all week. 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. While Thursday’s close was below 100, the intraday level at the time of this writing is 161, but I see the ISEE as neutral in the near-term. Since this ratio has closed below 100 in 20 of the last 27 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 this week. Therefore I see it as moderately bearish in the near-term. This ratio has been bearish or moderately bearish in 10 of the past 12 sessions, so I see it as also moderately bearish in the long-term too.

By contrast, the OCC Equity VPCR has been all over the map again this week, so I see it as volatile in the near-term. It is still volatile in the long-term too.

Volatility:

Volatility has fallen steadily for the past 8 weeks now. The 20-day historical volatility of the VIX is 76% this week versus 97% last week.

Cboe Volatility Index (VIX)

As I’m writing this (mid-day Friday 2/22), at current levels (just below 14) the VIX is implying only 20-point daily moves in the SPX. At its current level, which is a YTD low, the VIX remains slightly above its long-term statistical mode of 12.42 (which I consider “normal” volatility) and well below its long-term statistical average of 19.28. Given its low level, the VIX is down less than a point this week overall, but I see it as moderately bullish in the very near-term for the equity markets. Additionally, the VIX has fallen more than 21 points (-60%) since 12/24, and at its current level is moderately bullish in the long-term too.

On a week-over-week basis, VIX call prices are virtually unchanged while VIX put prices are modestly lower. At +111 versus +96 last week, the VIX IV Gap (the average IV of VIX calls less the average IV of VIX puts) is slightly higher but at this level remains neutral in the very near-term. It is neutral in the long-term too. 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 +1.40 versus +1.18 last week. This increase is modest but it mostly reflects falling prices in the near-term expirations, while the longer-term contracts have fallen less.                                

As of this writing (mid-day Friday 2/15), the nearest VIX futures contract (which expires on 2/27) was trading at 15.00, more than a point above the spot VIX level of 13.93. Adjusting this price for the risk premium factor (which takes into account the time until expiration), the Risk Premium Adjusted Price (RPAP) is 14.71, more than a half point above the spot price.

With an adjusted level that is more than a half point above the spot price of the VIX, futures traders are indicating that they believe the VIX will likely uptick slightly in the early part of next week. Therefore I see VIX futures as moderately bearish in the near-term for the market. The RPAPs of the next two closest monthly futures contracts are 14.32 and 14.06 respectively. With the RPAPs of the further-dated contracts both very close to the spot price, I see VIX futures as also 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.

With the VIX ticking modestly lower this week, the VIX Hedging Effectiveness remains in the Moderate category in the near-term. At the moment, this means that options on the VIX (and possibly other volatility-related products) are showing only a small amount of sensitivity to market volatility, and may not be very effective as hedging tools in the very near-term. VIX Hedging Effectiveness is also 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

In response to President Trump’s emergency declaration last week to fund the southern border wall, California and several other states have sued to block his action, citing a violation of the separation of powers doctrine in the Constitution. Basically, opponents say only Congress has the “power of the purse” to allocate funds for such discretionary purposes.

Europe

This week in Brexit news: Prime Minister Theresa May was in Brussels still trying to negotiate a better exit deal, despite European Commission President Jean-Claude Juncker’s assertion that further negotiations are a waste of time. Key among the issues still being discussed is the new border with Ireland. Time is running out with the 3/29 deadline a mere 5 weeks away and the number of companies that have threatened to shut down UK operations is growing rapidly. Motor vehicle production, for example, is a major industry in the UK with over 180,000 employees. Below is a list of some of the jobs cuts that have already been announced or could be at risk in the automobile sector alone:

Company                       UK jobs potentially threatened

BMW                              8,000

Rolls Royce                    5,000

Jaguar                            4,500

Honda                            3,500

Nissan                            740

Vauxhall                         650

Ford                               ?

Toyota                           ?

Source: Politico, Yahoo Finance, Huffington Post, The Chronicle

Asia

President Trump indicates that he is still considering an extension of the “tariff-truce” deadline set for March 1. Mid-level and cabinet-level negotiations are going on this week, and as long as progress is being made, President Trump seems willing to maintain the current pause until he and President Xi can meet in a few weeks. I say “apparently”, because as is so often the case, Trump added his usual, “We’ll see what happens” to keep the suspense alive.

Economic reports for next week:

Mon 2/25

Wholesale Inventories for Dec – This report covers manufacturing inventory data, so it is not a good indicator of consumer activity, but it may have ramifications on future GDP levels.

Tue 2/26

Case-Shiller Home Price Index for Dec – This index measures the change in the average prices of single-family, residential real estate across a broad section of 20 major cities in the US.

Conference Board Consumer Confidence for Feb – There are several other confidence measures, such as the University of Michigan Consumer Sentiment, and they don’t always agree. Gasoline prices and stock market performance tend to have the biggest impact on these measures.  

New Home Sales for Jan – 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.

Wed 2/27

Durable Goods Orders for Jan – This is a key measure of consumer and industrial spending trends and often causes market swings if it misses estimates. This one is likely to be watched more closely than usual, given the especially weak December report.

Factory Orders for Dec – This report includes both durable and non-durable goods orders, as well as wholesale and retail inventories. Like the construction report, it usually doesn’t impact the market much.

Pending Home Sales Index for Jan – 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 equity markets adversely if it comes in very low.

Thu 2/28

GDP for Q4 – This is the first estimate (Advance) for Q4 and the consensus seems to be in the range of +2.5%, which would be a decrease from +3.4% in Q3.

International Trade (Trade Balance) for JanThis report tracks trends in the export and import of goods and services. Exports can indicate economic expansion both in the U.S. and abroad. Imports can indicate growing domestic demand. However, this is a lagging report which rarely has any impact on the market.

Wholesale Inventories for Jan – This report covers manufacturing inventory data, so it is not a good indicator of consumer activity, but it may have ramifications on future GDP levels.

Chicago PMI for FebThis report is a gauge of business conditions within manufacturing and service firms in the Chicago area. A reading above 50 indicates expansion and a reading below 50 indicates contraction.

Weekly Jobless Claims - For the week ending 2/16/19, claims were down 23k to 216k after being up 4k the prior week. The 4-week moving average now stands at 236k, up 4k from the prior week. With this change, the 4-week moving average is now 30k above the 48-year low set on 9/15/18.

Fri 3/1

Personal Income & Spending for JanThese reports use data from the monthly employment report to gauge income from wages and salaries. Personal income is also sometimes used to forecast future consumer spending.

Construction Spending for Jan– Construction spending measures new overall construction activity. This report can predict future activity in housing and commodities, which can be a sign of economic growth.

ISM Manufacturing Index for Feb - The Institute of Supply Management (ISM) Manufacturing Index tracks economic data from companies in the manufacturing sector. An increasing value is usually perceived as bullish for equities because it implies that profits in the manufacturing sector are on the rise.  

University of Michigan Consumer Sentiment for Feb – This is the Final report for Feb. At 95.5, the mid-month report was up from the prior month.

Interest Rates

On Wednesday (2/20) the FOMC released the minutes of their January 30th meeting which seemed to indicate that they are done raising rates for now. If the futures market is any indication, the next move in rates is more likely to be down than up. As you can see below, the probability of another interest rate hike decreased this week. In fact, the Fed Funds Futures probability of a rate hike any time in 2019 is now less than 2% (red box) down from 4% last week, and down sharply from about 25% four weeks ago. On the other side, the probability of a rate cut in 2019 is now about 10% (green box), down from 13% last week and nearly 24% two weeks ago. As a reminder, there have been 9 rates hikes since 2015, and the Fed has never hiked rates when the Fed Funds Futures probability was less than 68%.

Source: Bloomberg L.P.

Past performance is no guarantee of future results.

Outlook:

A heavy economic calendar, technical resistance and festering geopolitical issues setup a potentially lower and more volatile week ahead; possibly the first negative week of the year.

Bottom Line:

Next week there will be far fewer earnings announcements but the economic calendar is much busier, including a few potentially market-moving reports such as: January Durable Goods, the first look at Q4 GDP, and February ISM Manufacturing. Additionally, the deadline on the tariff truce with China occurs on Friday (3/1), and while I fully expect this to be extended, the markets probably do too, so it may be enough to offset the other catalysts. It could be a “buy-the-rumor; sell-the-news” event.

As you can see below, most of the changes in the indicators this week were negative, and given that the SPX is approaching technical resistance, (see the Technicals section above) the immediate upside is pretty limited at the moment. Therefore the consensus outlook for next week is Moderately Bearish and given how far the VIX has fallen recently, also likely more Volatile.

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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Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

(0219-9ZV4)

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