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Trader’s Outlook for December 15, 2017: Optimism rises as tax bill looms

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

Starting on 11/29/2017, my tweets will also cover option block trades and other unusual option activity.

Weekly Market Review:

Earnings Summary

Q3 earnings season is essentially over now, and below are the final aggregate results relative to recent quarters.

Quarter            EPS beats        Rev beats

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%

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

Earnings Recap

Symbol        Actual  Estimate

CASY               1.28      1.40

PAY                 0.44      0.43

ORCL               0.70      0.68

ADBE               1.26      1.16

COST               1.36      1.34     

Economics Recap

Better than expected:

  • NFIB Small Business Optimism Index for Nov: 107.5 vs. 104 est
  • Core PPI for Nov:+0.3% vs. +0.2% est
  • Retail Sales for Nov: +0.8% vs. +0.3% est
  • Weekly Jobless Claims: +225k vs. 239k est

On Target:

  • PPI for Nov: +0.4% vs. +0.4% est
  • CPI for Nov: +0.4% vs. +0.4%
  • FOMC Rate Decision for Dec: +0.25% vs. +0.25% est
  • Business Inventories for Oct: -0.1% vs. -0.1% est

Worse than expected:

  • JOLTS for Oct: 5996K vs. 6135K est
  • Core CPI for Nov: +0.1% vs. +0.2% est
  • Industrial Production for Nov: +0.2% vs. +0.3% est
  • Capacity Utilization for Nov: 77.1% vs. 77.2% est

It was a heavy week for economic data and as you can see above, the results were somewhat mixed. Of particular note this week was the weekly jobless claims, which (as shown in the chart below) were so low that we’re now only 1000 jobs away from the best labor market since 1973. 

Source: Schwab Center for Financial Research

Past performance is no guarantee of future results.

Technicals

After a few days of weakness last week following the Mike Flynn downturn, equity markets have regained positive momentum this week on continued strong economic data and tax reform optimism. As shown below, after hitting another record high on Tuesday 12/12, the market has been consolidating, possibly waiting for the passage (or failure) of the congressional tax bill.

Source: StreetSmart Edge®

Past performance is no guarantee of future results.

Option Volumes:

Midway through December and option volumes are averaging a healthy 19.0M contracts per day. This is just above the November level of 18.9M contracts per day and well above the December 2016 level of 16.0M 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 +6.2%
  • VIX put OI was +8.8%

These increases show a modest put-bias, so I see them as moderately bullish this week.  

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

  • SPX call OI was +6.6%
  • SPX put OI was +4.3%

These increases show a modest call-bias, so I see them as moderately bullish this week. 

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

  • SPY call OI was -7.3%
  • SPY put OI was +2.8%

These changes show an unusual decline in calls outstanding, before expiration, which also indicates a fairly high put-bias, so I see them as bearish this week. 

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 modest bias to the put side this week, so I see it as also moderately bearish in the near-term.

OI Participation:

Index OI Participation is currently +30.2% versus 2016 levels, so I see it as bullish in the long-term.

Equity OI Participation is currently +8.7% 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 up one tick to .29 versus .28 last week. At this time, VIX options traders are holding (long or short) only 29 puts for every 100 calls on the VIX. This ratio is only 1 tick below the 200-day SMA (simple moving average) of .30. This small uptick is somewhat surprising given that the VIX has been below 11 all week, so this likely implies that participants expect volatility to remain low. Additionally, at this level it is 5 ticks above its YTD low of .24, which it hit on October 18th, so concern of a sharp spike in the VIX is still low. At this level I see the VIX OIPCR as neutral in the very near-term for the markets. Since this ratio has been generally rising for about 4 weeks now, I see it as still moderately bullish in the long-term.

The SPX OIPCR is down 2 ticks to 2.01 versus 2.03 last week. At this level this ratio is very close to the 200-day SMA (simple moving average) of 2.02. This downtick is a bit surprising given the SPX is back at record highs again, since it indicates a decrease in concern of a pullback. Since it is now only a tick above its lowest level in 4½ months, I see the SPX OIPCR as bullish in the near-term for the market. Since it has been moving mostly lower for about 4 weeks now, I see it as moderately bullish in the long-term.

The normally very stable Equity OIPCR is down 1 tick to 1.00 versus 1.01 last week, so I see the Equity OIPCR as moderately bullish in the near-term for the market. This ratio is down several ticks from its YTD average high, so I see it as moderately bullish in the long-term.

CBOE Volume Put/Call Ratios (VPCR):

The normally volatile CBOE VIX VPCR has moved from neutral to moderately bearish this week. The .28 reading on Thursday (12/14) was moderately bearish, but the current reading of .62 as I’m writing this (mid-day Friday 12/15) is neutral. Therefore I see it as neutral in the very near-term.

The CBOE SPX VPCR has been neutral all week. The 1.46 reading on Thursday (12/14) was neutral, and the current reading of 1.49 as I’m writing this (mid-day Friday 12/15) is also neutral. While this ratio tends to fall as the day progresses, I see it as neutral in the very near-term. With a 5-day average of 1.44 versus 1.66 last week, it is neutral in the long-term.

The CBOE Equity VPCR has been mostly moderately bullish this week. The .60 reading on Thursday (12/14) was moderately bullish but the current reading of .97 as I’m writing this (mid-day Friday 12/15) is bearish. Since intraday levels on equity options tend to decline as the day progresses, I see it as moderately bearish in the very near-term. With a 5-day moving average of .58 versus .60 last week, it is 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 week the ISEE had been modestly bullish by closing just above the 100 mark for the past 3 sessions. Since this gauge measures only retail opening activity and it is actually a call/put indicator, a level above 100 means that retail option traders on the ISE are trading more calls than puts. While the intraday level at the time of this writing is 65, I see the ISEE as moderately bullish in the near-term. Having closed above 100 in 13 of the last 18 sessions, I see the ISEE as moderately bullish in the long-term.

OCC Volume Put/Call Ratios (VPCR)

The OCC Index VPCR has been mostly on the negative side this week. Therefore I see it as moderately bearish in the near-term. However, it has closed in moderately bearish, neutral and moderately bullish territory over the past 3 weeks, so I see it as neutral 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. It has also been in neutral or moderately bullish territory in 16 of the last 19 sessions, so I see it as moderately bullish in the long-term too.

Volatility:

CBOE Volatility Index (VIX)

For the most part, the VIX had been rising modestly this week, until news on Friday began to point to likely passage of the tax bill, at which point it began to decline back towards record low levels.

This week the 20-day historical volatility average on the VIX is 80% versus 96% last week. As of this writing (mid-day Friday 12/15) the VIX is down almost a full point around 9.56. As soon as the news indicated that the votes needed for passage of the tax bill were in place, equities began to rally, leaving little doubt whether the market sees the tax plan and bullish or bearish. With a close below 10.00 very likely, and a record SPX close likely, on Friday (12/15) I see the VIX as bullish in the very near-term for the market. Down about 2 points in the past 2 weeks, I see it as moderately bullish in the long-term.

On a week-over-week basis, VIX call prices are down and put prices are mostly flat, which implies that participants do not expect a volatility spike any time soon. At +125 versus +167 last week, the VIX IV Gap (the average IV of VIX calls less the average IV of VIX puts) is neutral in the very near-term. Since the gap had been widening last week before narrowing this week, I see it as 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 4.57 versus 3.94 last week. This small increase is mostly due to a larger downtick in the near-term futures versus the longer-term futures.                        

As of this writing (mid-day Friday 12/15), the nearest VIX futures contract (which expires on 12/20) was trading at 9.85, just above the spot VIX level of 9.52. Adjusting this price for the risk premium factor (which takes into account the time until expiration), the Risk Premium Adjusted Price (RPAP) is 9.69, very close to the spot price.

With an adjusted level that is close to the spot price of the VIX, futures traders are indicating that they believe the VIX is fairly valued 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 10.60 and 10.98 respectively. With the RPAPs of the further dated contracts more than a point above the spot VIX, 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.

With the pre-tax vote uptick in the VIX this week, the VIX Hedging Effectiveness is 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 some sensitivity to market volatility, and may be moderately effective as hedging tools in the very near-term. VIX Hedging Effectiveness is 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 the European Central Bank (ECB) held interest rates steady, but sharply increased its Eurozone growth forecasts for 2018 from +2.2% to +2.4%.

Asia

After the US Fed hiked interest rates by 0.25% on Wednesday (12/13) the People’s Bank of China (PBOC) quickly followed suit with a very modest 0.05% rate hike. Some saw the move as both symbolic and also small enough to have virtually no impact on Chines GDP growth levels.

Economic reports for next week:

Mon 12/18

NAHB Homebuilder Index for Dec – This is a composite index (ranging from 0 – 100) comprised of Single-family home sales, Future sales expectations, and Buyer traffic, and is viewed as an indicator of new home sales trends. Collectively, the components are intended to provide a gauge of overall conditions in the market for selling new homes.

Tue 12/19

Housing Starts and Building Permits for Nov – 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.

Wed 12/20

Existing Home Sales for Nov – This is a good measure of overall demand in the housing market, because it aggregates completed closings on all single family dwellings, which comprise the largest portion of the housing market. Home buying can imply economic stability, since it is often the largest single investment for any family. It can also lead trends in future durable goods purchases.

Thu 12/21

GDP for Q3 – This is the third estimate (Final) for Q3 and since this data is now 3 months old, any revision is likely to be ignored by the markets. You’ll recall that the second (Preliminary) report in Q3 showed +3.3%. 

Weekly Jobless Claims - For the week ending 12/9/17, claims were down 11k to 225k after being down 2k the prior week. The 4-week moving average now stands at 235k, down 7k from the prior week. With this change, the 4-week moving average is now just 1k above the 44-year low hit in late February.

Fri 12/22

Personal Income & Spending for NovThese 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.

Personal Consumption Expenditures (Core PCE) for Nov – PCE includes durable goods and nondurable goods which are directly influenced by the retail sales reports and services. This is the Fed’s preferred inflation gauge.

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

New Home Sales for Nov – 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.

University of Michigan Consumer Sentiment for Dec – This is the Final report for Dec. At 96.8, the mid-month report was slightly lower from the prior month.

Interest Rates

As expected, at the conclusion of the FOMC’s last 2-day policy meeting of 2017 on Wednesday (12/13), the Fed announced a 0.25% increase in the Fed Funds rate. With the likely confirmation of Jerome Powell as the next Fed head, this was Janet Yellen’s final press conference in that role before her term ends on 2/3/2018. As you can see below, while there is barely more than a 0% chance of another rate hike in January, the March 2018 meeting (the next one with a scheduled press conference) has a very high 76% probability for another hike.

Source: Bloomberg L.P.

Past performance is no guarantee of future results.

Outlook:

Since the Government shutdown that was scheduled to occur on Saturday (12/9) was narrowly averted by a 2-week continuing resolution bill passed on 12/7, we find ourselves in a similar situation again this week, as the next potential shutdown could be on Saturday (12/23). While it seems unlikely Congress would allow that to happen just before the Christmas holiday, history tells us it probably would not impact the market much. Not only is the week of Christmas typically a very light week for trading volumes, but as you can see below, while past performance is no guarantee of future results, the market actually rose during the last 3 shutdowns.

Source: Schwab Center for Financial Research

Past performance is no guarantee of future results.

Late Friday (12/15) last minute holdout Marco Rubio (Senator from FL) is reportedly ready to vote for the newly modified tax bill, and Congressional leaders are saying they have the necessary votes needed for passage. While I wouldn’t call it a done deal just yet, optimism by market participants has pushed indices to record levels in anticipation. If there was any doubt how the market feels about the tax plan, this action should put that to rest.

Bottom Line:

With a light economic calendar and very few earnings reports to focus on, market action next week is likely to be dominated entirely by activity in Washington DC regarding the tax bill. If the bill passes, equities will likely move higher and it would not be surprising to see the VIX index hit an all-time closing low (below 9.14).

As you can see below, the indicators are fairly mixed this week, but with the market seeing the congressional tax bill as bullish in the near-term, and fundamentals still driving the long-term, the outlook for next week is Moderately Bullish.

The one caveat of course is what happens if the tax bill is defeated? No one knows for sure, but one way to answer this question is that the house bill was passed on 11/16 and the SPX jumped about 21 points (+0.8%) that day. As of this writing (mid-day Friday 12/15) with the SPX around 2678, it has risen a total of about 114 points (+4.4%) since then. It seems very reasonable that most, if not all of the gain since 11/16 would be at risk in the event the bill fails. While a 114 point drop in the SPX may not sound catastrophic (and it really isn’t), it would be the largest point and percentage drop of 2017.

Given recent past patterns, I also think the immediate reaction to the "surprise" failure might result in a decline as much as -188 SPX points (-7%) immediately, before quickly recovering to a more modest -4.4% decline within a few days. Lately most surprises have resulted in overly exaggerated market pullbacks followed by a quick recovery of at least half the initial decline. Additionally, those specific sectors with the highest effective tax rates that have benefitted recently would likely pullback even further. I believe the odds of passage are fairly high.

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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