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Volatility Continues on Trade War Escalation

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

With 480 companies (96%) of the S&P 500 reporting, below are the aggregate results for Q2 relative to recent quarters.

Quarter EPS beats        Rev beats

Q2 ‘19              77%                  56%

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%

Below are some of the higher-profile companies that reported Q2 earnings this week.  

Earnings Recap

Symbol            Actual  Estimate

EL                    0.64      0.53

KSS                 1.55      1.53

TJX                  0.62      0.62     

HD                   3.17      3.08

KSS                 1.55      1.53

TJX                  0.62      0.62

LOW                 2.15      2.01

TGT                  1.82      1.62

SPLK                0.30      0.12

JWN                 0.91      0.75

LB                    0.24      0.20

DKS                 1.26      1.20

INTU               -0.09     -0.15

ROST               1.14      1.12

CRM                 0.66      0.47

HPQ                 0.58      0.55

VMW                1.60      1.55

GPS                 0.63      0.53

FL                    0.65      0.67

Economics Recap

Better (or higher) than expected:

  • Existing Home Sales for Jul: 5.42M vs. 5.35M est
  • Initial (weekly) Jobless Claims: 209k vs. 216k est
  • Index of Leading Economic Indicators for Jul: +0.5% vs. +0.3% est

On Target:

  • None

Worse (or lower) than expected:

  • Markit Manufacturing Purchasing Managers Index (PMI) for Aug (Prelim): 49.9 vs. 50.5 est
  • Markit Services PMI for Aug (Prelim): 50.9 vs. 52.8 est
  • New Home Sales for Jul: 635k vs. 647k est

This was a fairly light week for economic data and this week I want to highlight the weekly jobless claims again. Despite talk of an economic slowdown or recession, the labor market still shows no signs of weakness.

Separately, the August Preliminary PMI reports on Manufacturing and Services were both very disappointing. In fact, the Manufacturing sector is indicating a contraction (<50.0) for the first time since these reports began in August 2016. This surprise not only roiled the equity markets (see Technicals section below), it also caused the 10/2 yield curve to invert again (see Interest Rates section below).

Initial Jobless Claims

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 8/22/19):

  1. Info Tech                      +28.4%
  2. Real Estate                   +25.4%
  3. Consumer Disc             +20.6%
  4. Communications Svc  +19.2%
  5. Cons Staples                +19.1%
  6. Utilities                         +16.8%
  7. Industrials                     +16.4%
  8. Financials                     +11.9%
  9. Materials                       +11.2%
  10. Healthcare                     +4.9%
  11. Energy                            +0.2%

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 8/22/19):

  • S&P 500 (SPX)                           +16.6%
  • Nasdaq Composite (COMPX)    +20.4%
  • Dow Industrials (DJI)                 +12.5%
  • Russell 2000 (RUT)                    +11.7%

Technicals

As I mentioned in the Economics Recap section above, the Manufacturing sector is indicating a contraction (<50.0) for the first time since Markit began releasing their PMI reports in August 2016. This surprisingly weak report not only shocked the bond markets (see Interest Rates section below) but also caused a quick (though short-lived) downside reversal in equities. This is a significant development because while the manufacturing sector in Germany has been in contraction since January, this may be an early signal that global recession fears are starting to show up in the U.S. too.

While equities have stabilized somewhat this week, the 7/26 SPX high of 3,025 remains as longer-term upside technical resistance. And while the SPX seems to be battling with the 100-day Simple Moving Average (SMA) at the moment, the 50-day (SMA) is still creating headwinds, possibly because it is getting close to the previous 2,954 resistance level. On the downside, technical traders should continue to watch the 200-day SMA of 2,802 (-4.1% below the current level) as the last support before the -10% correction level of 2,722 is reached.

SPX Chart

Source: StreetSmart Edge®

Past performance is no guarantee of future results.

Bear Market Trends

As I mentioned last week, it’s far too early to declare that a bear market has started, but if the SPX declines 20% before it reaches another new high (whether that takes a few weeks or a few years) the bear market will be declared as having started on 7/26/19. We never know whether a bear market (or bull market either) has begun until well after the start date. Since it still doesn’t appear that a new high will be reached any time soon, below is an update of my historical bear markets table. As you can see, if the current pullback reaches correction levels (down more than 10%) and then becomes a bear market (down more than 20%), at this point it will have been going on for 27 days and the total decline will have been -3.4% so far. If the current downtrend continues, I’ll update this table every few weeks.

Bear Market Table

Past performance is no guarantee of future results.

Option Volumes:

Prior to this week, higher volatility had been driving much higher volumes in August. At mid-month, aggregate option industry volume is averaging 22.6M contracts per day. That is well above the July level of 18.3M contracts per day and also well above the August 2018 level of 18.8M 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 -30.3%              
  • VIX put OI was -31.6%              

These declines are due to the August monthly contract expiration on 8/21 and are therefore N/A this week. As a result I viewed only the changes since 8/22 and observed the following:

  • VIX call OI was +4.6%              
  • VIX put OI was +5.1%               

These changes show almost no bias to the call or put side, so I see them as neutral for equities.

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

  • SPX call OI was -5.4%  
  • SPX put OI was -4.0%              

These declines are due to the August monthly contract expiration on 8/16 and are therefore N/A this week. As a result I viewed only the changes since 8/19 and observed the following:

  • SPX call OI was +2.5%
  • SPX put OI was +4.1%             

These changes show a very 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 -9.6%              
  • SPY put OI was -7.8%              

These declines are due to the August monthly contract expiration on 8/16 and are therefore N/A this week. As a result I viewed only the changes since 8/19 and observed the following:

  • SPY call OI was +3.8%             
  • SPY put OI was +3.1%             

These changes show almost no bias to the call or put 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 -15.5%           
  • QQQ put OI was -14.3%            

These declines are due to the August monthly contract expiration on 8/16 and are therefore N/A this week. As a result I viewed only the changes since 8/19 and observed the following:

  • QQQ call OI was +4.6%            
  • QQQ put OI was +5.9%

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

Combining VIX, SPX, SPY & QQQ data this week, I see the Index OI Change overall as moderately bearish in the near-term. The Equity OI Change shows a very small bias to the call side this week, so I see it as moderately bullish in the near-term.

OI Participation:

Index OI Participation is currently +18.5% versus 2018 levels, so I see it as bullish in the long-term.

Equity OI Participation is currently -1.0% versus 2018 levels, so I see it as neutral in the long-term.

Open Interest Put/Call Ratios (OIPCR):

The VIX OIPCR is down 1 tick at 0.36 versus 0.37 last week. At this time, VIX options traders are holding (long or short) 36 puts for every 100 calls. At this level, this ratio remains above the 200-day SMA (simple moving average) of 0.32, and it is just 1 tick below its YTD high. Since this ratio usually moves up with the VIX index, this is not a huge surprise given that the VIX is -1.79 points (-9.7%) this week through the close on Thursday (8/22). This very small decrease likely implies that VIX option traders are relatively comfortable with the current level of the VIX in the near-term. Therefore, I see the VIX OIPCR as neutral in the very near-term for the markets. Since this ratio has been generally rising for the past 6 weeks, I see it as still moderately bullish in the long-term.

This week the SPX OIPCR is up 6 ticks to 2.13 versus 2.07 last week. At this level this ratio remains well above the 200-day SMA (Simple Moving Average) of 1.79. It is now back to its YTD high. Most of the time, this ratio tends to move in the same direction as the index, and while the SPX has risen more than 34 points (+1.2%) this week, this outsized move is probably being exaggerated by the August contract expiration on Friday (8/16). Either way, it implies that SPX option traders (who are almost entirely institutional) remain heavily hedged on the SPX and are still positioned for a downside move. 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.

The normally stable Equity OIPCR is up 3 ticks to 1.04 versus 1.01 last week. Like the SPX ratio, this large move is probably being exaggerated by the August contract expiration on Friday (8/16). While this ratio includes a large retail component and it tends to be a contrarian indicator, it is also very common to see an upside move near the monthly expiration dates. Therefore at the risk of overstating the expiration effect, I see the Equity OIPCR as still neutral in the near-term for the market. I also see it as neutral in the long-term.

CBOE Volume Put/Call Ratios (VPCR):

The CBOE VIX VPCR has been moderately bearish most of the week. The 0.18 reading on Thursday (8/22) was bearish but the current reading of 0.51 as I’m writing this (mid-day Friday 8/23) is neutral. Therefore I see it as volatile in the very near-term.

The CBOE SPX VPCR has been bearish all week. The 2.04 reading on Thursday (8/22) was bearish, and the current reading of 1.92 as I’m writing this (mid-day Friday 8/23) is also bearish. While intraday levels tend to decline as the day goes on, I see this ratio as bearish in the very near-term. With a 5-day average of 2.33 versus 2.27 last week, it is bearish in the long-term.

The CBOE Equity VPCR has moved from moderately bullish earlier in the week to moderately bearish later in the week. The 0.74 reading on Thursday (8/22) was moderately bearish and the current reading of 0.96 as I’m writing this (mid-day Friday 8/23) is bearish. Since intraday levels tend to fall throughout the day, I see it as moderately bearish in the very near-term. With a 5-day moving average of 0.65 versus 0.79 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 well below 100 every day this week again. 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 51, I see the ISEE as bearish in the near-term. Since this ratio has now closed (mostly modestly) below 100 in 22 of the last 22 sessions, I see the ISEE as moderately bearish in the long-term.

OCC Volume Put/Call Ratios (VPCR):

The OCC Index VPCR has been all over the map this week, so I see it as volatile in the near-term. However, it has been bearish or moderately bearish in 13 of the last 17 sessions, so I see it as moderately bearish in the long-term.

The OCC Equity VPCR has been bearish this week, so I see it as bearish in the near-term. It has also been bearish or moderately bearish in 17 of the last 18 sessions, so I see it as moderately bearish in the long-term.

Volatility:

As I mentioned in the OIPCR section above, the VIX is -1.79 points (-9.7%) this week through the close on Thursday (8/22). However, the VIX has been elevated for most of the month of August so the 20-day historical volatility has jumped to 232% this week versus 224% last week.

Cboe Volatility Index (VIX)

After being elevated for 3 weeks, this week the VIX had been settling down a bit until President Trump’s tweets on Friday morning, at which point it jumped nearly 4 points immediately. As I’m writing this (mid-day Friday 8/23), the VIX is up more than 3 points (around 20.16). This is well above its long-term statistical mode of 12.42 (which I consider “normal” volatility) and even above the long-term statistical mean of 19.20. At this level, I see the VIX as bearish in the very near-term for the equity markets. It is moderately bearish in the long-term.

On a week-over-week basis, VIX call prices have fallen and VIX put prices have risen. At -53 versus +49 last week, the VIX IV Gap (the average IV of VIX calls less the average IV of VIX puts) is lower and when it is negative, it is bullish in the very near-term. It is neutral in the long-term. Keep in mind, this is not only a contrarian indicator, it tends to be one of the earliest indicators I discuss in this report, 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 -0.05 versus -0.10 last week. This small change is mostly due to the fact that prices on both near-term expirations and later expirations have fallen about the same amount this week.         

As of this writing (mid-day Friday 8/23), the nearest VIX futures contract (which expires on 8/28) was trading at 18.75, more than 1½ points below the spot VIX level of 20.33. Adjusting this price for the risk premium factor (which takes into account the time until expiration), the Risk Premium Adjusted Price (RPAP) is 18.39; nearly 2 points below the spot price.

With an adjusted level that is nearly 2 points below the spot price of the VIX, futures traders are indicating that they believe the VIX will clearly come down in the near-term. Therefore I see VIX futures as bullish in the near-term for the market. The RPAPs of the next two closest monthly futures contracts are 17.94 and 16.86 respectively. With the RPAPs of the further-dated contracts close to, and modestly below the spot price, I see VIX futures as moderately bullish 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 still somewhat elevated this week, the VIX Hedging Effectiveness is now Good in the near-term. At the moment, this means that options on the VIX (and possibly other volatility-related products) are showing decent sensitivity to market volatility, and could be effective as hedging tools in the very near-term. VIX Hedging Effectiveness is also Good 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 President Trump announced that the U.S. will delay applying additional tariffs on some Chinese imports until December 15. While the exempted items include Cell phones, video game consoles, toys and some footwear, other items such as clothing, groceries, diapers, soap, and sporting goods will be taxed beginning September 1st. Some analysts estimate that the new tariffs could increase Christmas shopping costs by an average of about $1000 per household; 40% more than the estimate provided when the May tariffs were added. And of course a fixed price increase always impacts lower income households the most, since it represents a larger portion of overall expenses. Since current store inventories will be replaced with more expensive inventories post-tariff, the uptick we’ve already seen in retail sales and consumer spending is likely to continue for at least the next month.

Separately on Friday (8/23) President Trump’s tweets sent equities into a late morning nosedive when he escalated his attacks on Jay Powell and China, and said he was ordering all package carriers to halt all shipments of Fentanyl from China. Following these tweets the SPX dropped about -1.8% in only 10 minutes.

Asia

As protests in Hong Kong continue, employees of US businesses with Hong Kong offices, are being asked to lay low. This seems like a wise course of action as Hong Kong based Cathay Pacific Airlines, has been under fire recently from the Chinese government for publicly supporting the Hong Kong protests, resulting in the ouster of CEO, Rupert Hogg and the resignation of 3 pilots. Apparently Hogg had been asked by Chinese aviation officials to supply a list of names of Cathay employees who had participated in the protests. News reports say Hogg resigned after submitting a list on which he had written only his own name. 

Separately, responding to the aforementioned tariffs due to take effect on September 1st, China announced on Friday (8/23) that it would levy retaliatory tariffs on $75B of U.S. imports. While this move should not have surprised anyone, premarket equity futures immediately dropped -1.0% on the news.  

Europe

This week in Brexit news, U.K. Prime Minister, Boris Johnson, met on Thursday (8/22) with French President, Emmanuel Macron to discuss the critical Brexit issue known as the Irish backstop, which prohibits a hard border between Ireland and Northern Ireland. The backstop would allow Northern Ireland to remain linked to the European Union, in the event of a hard Brexit. Johnson opposes the backstop because he sees it leading to a no-deal (hard) Brexit. By contrast, Macron describes the backstop, which was negotiated by former Prime Minister Theresa May, as non-negotiable. Yet despite this stumbling block, Macron expressed confidence that a solution that all sides could support, could be found within the next 30 days.    

Economic reports for next week:

Mon 8/26

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

Tue 8/27

Case-Shiller Home Price Index for Jun – 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 Aug – 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.  

Wed 8/28

None

Thu 8/29

GDP for Q2 – This is the second estimate (Preliminary) for Q2 and the consensus seems to be that GDP will be downgraded to +2.0%. You’ll recall that the first (Advance) report in Q2 showed +2.1%. 

Weekly Jobless Claims - For the week ending 8/17/19, claims were down 11k to 209k after being up 9k the prior week. The 4-week moving average now stands at 214k, unchanged from the prior week. With no change, the 4-week moving average is now 12k above the 48-year low set on 4/13/19.

Pending Home Sales Index for Jul – 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.

Fri 8/30

Personal Income & Spending for JulThese 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 Jul – 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.

Chicago PMI for AugThis 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.

University of Michigan Consumer Sentiment for Aug – This is the Final report for Aug. At 92.1, the mid-month report was down from 98.4 the prior month.

Interest Rates:

As I mentioned in the Economics Recap section above, the Manufacturing sector is indicating a contraction (<50.0) for the first time since Markit began releasing their PMI reports in August 2016. This surprisingly weak report not only shocked equity markets (see Technicals section above) but also immediately resulted in another brief 10y/2y yield curve inversion (yellow arrows), which had been positive since last week Thursday (8/15). As I discussed last week, an extended 10y/2y inversion has historically been seen as an early recession warning, though there have been some false signals, and the lead times have varied widely.

10/2 Yield Curve

 Source: StreetSmart Edge®

Past performance is no guarantee of future results.

On Wednesday (8/21) the Fed released the minutes of its late-July meeting, and they showed that “most participants” identified the 25 bps cut “as part of a recalibration of the stance of policy, or mid-cycle adjustment”, not the start of a long-term easing cycle. While the markets reacted negatively during the 7/31 press conference, this week’s minutes were pretty much met with only a yawn. The minutes also indicated that some members favored a 50 bps cut on 7/31, and most supported the plan that the Fed should not disclosure or imply anything about future rate setting plans.

Even prior to the official beginning of the Jackson Hole Wyoming summit on Friday (8/23), in response to seemingly hawkish media interviews with some FOMC members, the Fed Funds Futures probability of another 25 bps rate cut on 9/18 shot all the way back up to about 90% (green box), from about 67% last week. As a result, the probability of a 50 bps rate cut has fallen from about 36% last week to only about 10% this week (yellow box). This is a bit of a surprise given the surprisingly weak PMI reports, China’s announcement of retaliatory tariffs, and President Trump’s negative tweets on Friday.

WIRP

Source: Bloomberg L.P.

Past performance is no guarantee of future results.

Outlook:

With earnings season over and the economic calendar relatively light, it’s safe to say that government by Twitter will continue to be the main driver of markets again next week.

Bottom Line:

Early in the week it looked like the markets were finally calming down a bit after 3 rather volatile weeks, but then on Friday that all changed. While earnings season is over and the economic calendar is relatively light next week, it is safe to say the President’s Twitter feed will be up and running, so don’t get too complacent.

As you can see below, there were a few changes in the indicators this week and mostly they resulted in more disagreement. As a result, the consensus outlook for next week is Volatile, and picking an overall net direction is probably a futile effort. For now, Trump’s tweets trump everything else.  

Composite Market Sentiment

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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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.

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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.

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