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Sunday, March 20, 2011

The March cycle is complete and the MCTO team brought in just under 8% on our recommended March trades.  The auto-trade accounts brought in 5.5%, which takes into account reserve and idle cash.  (we're a touch more conservative in the auto-trade accounts so we tend to overweight on the less aggressive trades and underweight on the more aggressive trades, thus the difference in returns)  Because the markets were choppy and accompanied by sharp fear-based selloffs, we were able to invest most of our cash this month.  We felt comfortable to continue to open bull put spreads this month because the US macroeconomic indicators and corporate earnings continue to impress, telling us that there was a high probability that certain major support levels would hold even with the sharp DOWN days.  In contrast, however, if we saw a deterioration in the US economy via earnings and the macroeconomic indicators, we would have been much more careful to open the bottom bull put spreads, and we probably would have avoided the bull put spreads all together.  For more on the March trades please visit the ROI Page.  It's time to move on to April.

Here are some of the themes and views of guest speakers on the financial news channels over the last week.  We monitor this chatter because it provides deeper insight into the economy, the bond market and the stock market, even though there will be conflicting viewpoints: 

On the positive:  Federal regulators have been restricting banks to pay and/or increase dividends since the financial meltdown in late 2008, but last week after the Fed ran another round of bank stress tests on 19 banks, they lifted some of these restrictions and JP Morgan, AMEX and Wells Fargo, among a few others announced increases in their dividend payments sending the signal that banks are mending;  G7 central banks agreed to intervene to stop the rapid appreciation of the Japanese Yen, which was causing some stress in the markets;  officials have successfully connected power to Japan reactor #1 and #2 to help reactivate the cooling systems - there is a good chance that power will be restored to all of the reactors within the next few days;  one money manager believes that the market was due for a correction and a period of consolidation, and we are seeing a setup for the next bull run - he believes that global economy is still on track, especially emerging markets;  another money manager thinks US equities are undervalued, that the expansionary period for the US economy is in the 4th or 5th inning so there is more room for stocks to run, CEO's of US companies are buying their stock back at a rapid clip, and he thinks that this recent pull back is providing a buying opportunity for US stocks;  one money manager noted that as long as oil stays below $125 per barrel they will not need to adjust their economic outlook, which currently is positive.

On the negative:  Japan's nuclear threat is not yet over and any surprises could move the markets to the downside;  Gadaffi of Libya (multiple spellings exist) is threatening to fight a "long and bloody war", and until these activities in Libya settle down oil prices most likely will stay above $100/barrel;  unrest in Yemen and Bahrain is also heating up and many civilians are being killed by pro government security forces - until this settles down oil prices will stay elevated;  the markets are currently headline driven, which is keeping many investors on the sidelines and keeping the traders active with very short horizons; China increased bank reserve requirements again for the 3rd time in 3 months to cool inflation and to slow the Chinese economy;  an oil analyst believes that the situation in Japan will not impact oil prices one way or the other globally, and that the unrest in the middle East and Northern Africa are the main activities that will impact oil prices;  technology stocks have been hit hard in the last week due to supply chain fears from the slowdown and/or shutdown of many companies in Japan - e.g. Apple is down 6% for the week;  one money manager believes that global growth will come in a little lower than what many economists are predicting (i.e. GDP will probably be no higher than 3.5% by the end of 2011) due to increases in energy costs, which translates into an unexpected tax;  one pundit used the example of Nike and how they disappointed last week and stated that their margins are under pressure from large increases in input costs for cotton, oil and freight - he believes that we are seeing a fundamental problem and other companies are going to disappoint when Q111 earnings start to come in during the 2nd week of April.

Let's look at the charts.  Below are the daily & weekly Dow Industrials charts showing that the Dow continues to correct, it dropped below the 50 day simple moving average (SMA), and bounced off of the 11,600 level near the 100 day SMA and the bottom of the 2 std. deviation linear regression channel.  The A/D Line and On Balance Volume indicators have pulled back as expected, but continue to show reasonable strength telling us that institutional investors are not interested in selling too much of their stock.  The 8 day exponential moving average (EMA) is below the 22 day EMA, telling us that the Dow is in a DOWN trend.  The 8/22 day EMA does a good job of providing short term trend trading signals.  This DOWN trend is also now confirmed because the Dow has closed below the 50 day SMA for several consecutive days.  On the potential downside, if the DOW continues to pull back there is a reasonable probability that the Dow will continue to find support at its 100 day SMA and the bottom of the 2 std. deviation linear regression channel near 11,600.  If the Dow pulls back farther there is a high probability that the Dow will find support at its April high and 62% Fibonacci level near 11,200.  Worst case the Dow will find support at its most recent Nov low, major psychological level, and its 200 day SMA at 11,000.  The 3rd chart down shows the weekly chart with Fibonacci retracements to provide a big-picture perspective;  we can see that 11,200 (62% Fibonacci level) will be the potential major support level if the Dow has a severe pullback.

Below are the daily & weekly charts for the SPY, and ETF that tracks at 1/10th the value of the S&P 500 index, SPX.  The 2nd chart down is a weekly chart providing a big-picture view of the SPY showing Fibonacci Retracements with probable support and resistance levels. The 3rd chart down is the VIX Index representing the implied volatility of the S&P 500 index.  For more on how the American style options trade on the SPY please go here.  We can see that the SPY continues to selloff and it has now closed below the 50 day SMA and the Aug 2008 high.  The A/D Line continues to show reasonable strength, but the On Balance Volume indicators is telling us a different story where institutions are selling some of their holdings, which is bearish.  Along with the SPY now trading below the 50 day SMA, the 8 day exponential moving average (EMA) is below the 22 day EMA, telling us that the SPY is in a confirmed DOWN trend.  There is still a reasonable probability that the SPY will find support at its 100 day SMA and the bottom of its 2 std. deviation linear regression channel near 126.  If the SPY pulls back farther, there is a high probability that it will find support at its 62% Fibonacci level and April/Nov high near 123.  If the market has a severe correction from a new, negative event there is a very high probability that the SPY will find support at its most recent Nov low and its 200 day SMA at 118.  Looking at the 2nd chart down with the Fibonacci Retracements, the SPY has pierced down through 130, and the next target is the 62% Fibonacci level at 123.  Looking at the implied volatility via the VIX (3rd chart shown) it continued to climb and if it remains elevated it tells us that investors will sell some of their holdings quickly if they deem it necessary, which will accelerate downside movement; thus, the market will continue to have larger swings over the next few weeks. (which is also good for us credit spread writers as we can bring in higher levels of premium for the spreads that we sell)

Below is the daily MNX, a mini index that tracks at 1/10th of the NASDAQ 100 Index - NDX, representing 100 of the largest non-financial companies, many in the technology sector.  We can see that the MNX has been pulling back hard, it pierced down through its 50 day SMA, which is bearish, but it is attempting to find support at its pre-recession high, 100 day SMA and bottom of its 2 std. deviation linear regression channel near 222.  The MNX is in a confirmed DOWN trend.  However, if investors hold the MNX above 222, this will be a long term bullish signal and the market will most likely power higher once the correction is over.  If the correction is severe from a new negative event, there is a very high probability that the MNX will find support at 210 near its Nov low, or 205.5 near the April high and the 200 day SMA.

Below is the daily IWM, an ETF that tracks at 1/10th the value of the Russell 2000 small cap index, RUT.  We can see that the IWM continues to pull back and is attempting to find support near 79.  Because the the 8 day EMA is below the 22 day EMA (for more info see 8/22 day EMA) and because the IWM has closed below its 50 day SMA for several consecutive days, the IWM is in a confirmed DOWN trend.  Per potential downside, there is reasonable probability that the IWM will still find support at 79 representing its 50 day SMA, the last area of consolidation in Dec and Jan, and past resistance levels in Dec '07 and Oct '08.  If IWM continues to pull back there is better probability that it will find support at its January low of 77, which adds in the 100 day SMA and the bottom of its 2 std. deviation channel.  If the correction is deeper there is a very high probability that the IWM will find support at 74 representing its 78% Fibonacci level and April high.  If the correction is severe from a new negative event, there is an extremely high probability that the IWM will find support at 70 representing a major psychological level, the consolidation period in October, and the 200 day SMA.  The 2nd chart down is a weekly view of the IWM showing Fibonacci Retracements and it shows that the RUT consolidated near 79 for 6 weeks, it rallied again, and then had 2 consolidation weeks, but so far it's been holding near 79.  The 3rd chart down shows that the implied volatility (aka "fear") for the RUT remains elevated, but not too elevated, telling us that volatility will be higher (which is good for us credit spread writers) and more cash will probably flow out of small caps and out of the overall market over the next few weeks.

Macro-Level, Fundamental View of US Economy's Underlying Health

Below are a selection of macroeconomic indicators to give us a big-picture, fundamental view of the health of the US economy.  If/when the US economy begins to weaken, as we will monitor via gradually deteriorating macroeconomic indicators and estimated corporate earnings, this information will help us:  1) reduce our downside exposure by opening fewer bull put spreads, and being ultra-careful when we do open some; 2) trigger us to open a long term hedge to protect some/all of our bull put spreads; 3) alert us to possibly start opening bearish directional, speculative trades; and 4) tell us when it's time to move to the sidelines. 

Initial Unemployment Claims decreased from 401k to 385k, which was a good reading. As long as the new claims number remains below 400k the US economy will most likely add at least 100k jobs monthly. Economists usually monitor the 4 week moving average, the orange line, since the weekly reading is volatile. The 2nd chart down is the 4 week average going back to 1992 showing how this indicator behaves during good times and bad.  Note that when the economy is expanding new claims are usually between 300k to 350k, and when it drops below 300k the economy is most likely overheating and the Fed is probably jacking up interest rates to slow things down.

The Conference Board Leading Economic Indicator (LEI) -  The Conference Board is a highly respected independent economic research house.  One of their closely watched indicators is the Leading Economic Indicator, or LEI, which comprises 10 economic components.  For more on this indicator please visit the Learning Center.

Conclusion for LEI Index:  The LEI for the U.S. increased 0.8 percent in February to 113.4, following a 0.1 percent increase in January, and a 1.0 percent increase in December.  According to Ataman Ozyildirim, economist at The Conference Board, "With February’s large gain, the U.S. LEI returned to the strengthening upward trend that began last September. The LEI is pointing to an economic expansion that should gain more momentum in the coming months. In February, improvements in labor markets, financial components, and consumer expectations more than offset falling housing permits."  According to Ken Goldstein, economist at The Conference Board, "This is the latest data point to an improving economy, one that will continue to gain strength through the summer. The economy continues to encounter strong headwinds. One headwind is the sharp rise in food and energy prices. Still, the way inflation will move is unclear, given the degree of slack in the overall economy, and especially in the labor market."

The Empire State Manufacturing Survey that measures the level of business activity in the State of New York continued to climb, coming in with solid results.

The Philly Fed Manufacturing Index that measures business activity in Pennsylvania, Northern New Jersey and Delaware rocketed from 35.9 in February to 43.4 in March.  The main index, along with its sub-indexes show that manufacturing activity within this region is expanding rapidly.

Housing Starts tumbled in February falling from 618,000 to 479,000, the lowest level since April 2009.  It's going to take many more quarters if not years to see an improvement in this sector, and it will continue to put a drag on the overall economy.

The Consumer Price Index is a measure of the price level of a fixed market basket of goods and services purchased by consumers, and is the most widely cited inflation indicator.  Excluding volatile food and energy costs, core prices increased a modest 0.2%.  (orange line)  This is a good reading telling us that general inflation is very low and deflation is also not a problem, which allows the Fed to keep short term interest rates near zero.  Food and energy inflation is high, but so far it's not affecting core inflation.

Federal Reserve Beige Book - Excerpt from the March 2, 2011 report - "The twelve Federal Reserve Districts indicated that overall economic activity continued to expand at a modest to moderate pace in January and early February. Both Kansas City and San Francisco noted that their economies expanded further. Boston and Philadelphia cited conditions as improving. New York, Cleveland, Richmond, Atlanta, and St. Louis described activity as modestly improving, while Minneapolis and Dallas experienced moderate growth. Chicago reported that although there was an increase in activity, it was at a pace not quite as strong as during the previous reporting period."

Corporate Earnings - (Text last Updated on March 6th; chart updated on March 20th) Q410 earnings season is wrapping up and 71% of the S&P500 companies beat analyst's consensus estimates, 9% met, and 20% missed.  The long-term average % of companies beating analyst's estimates is 62%, so Q410 earnings were very good.  One analyst noted that top line revenue growth was strong, which is great news as top line revenue was a point of concern.  However, another analyst noted that higher energy and commodity prices will eat into margins, and he believes that the current 2011 aggregate, estimated S&P 500 earnings of $93 to $100/share will probably be cut as 2011 progresses.  (if this is true the stock market will not be happy and will need to moderate to reflect the new level of earnings)  Analysts are expecting earnings to come in 36.3% higher than a year earlier, which is up from 31% at the start of Q410.  The currently estimated Q111 earnings growth rate for the S&P 500 companies is 13.2%.  Below is the weekly chart of the S&P 500 index, the same chart shown at the top of this advisory, and it shows analyst's projected 2011 aggregated S&P 500 earnings between $93 and $100/share, with a projected P/E ratio of 14 to 15, which would put the S&P 500 index between 1300 and 1500 by the end of 2011.  The S&P 500 is currently trading at a P/E multiple of 14.2 times a conservative, forward looking aggregate of $93/share.  (Data supplied by Thomson Reuters)

Conclusion from the Macro-level Fundamental View of US Economy's Health - The US economy continues to expand where GDP growth is approximately 2.8%.  Some economists believe that GDP growth will accelerate mid-year and be as high as 4.0% by the end of 2011. The macroeconomic indicators and corporate earnings are pointing to continued growth through the end of 2011 supporting the notion that GDP could be 4.0% by year end.  Moreover, we're at an inflection point where the US economy is now adding a larger number of jobs each month since the initial unemployment claims number is now coming in under 400k.  (e.g. in February the economy added 222k private sector jobs)  When the new claims number is under 400k the economy will usually add 150k or more jobs monthly. 

Short-term to Intermediate-term (1 to 3 weeks) Sentiment and Volume Flow Analysis:  Below are a selection of Volume, Advance/Decline and other sentiment and breadth based indicators to help us gauge the strength of the prevailing trend and to predict the timing of a trend reversal.

Implied Volatility on the S&P 500 Index (VIX) -  We watch implied volatility (IV), also known as the "fear index", on the S&P 500 Index to help us gauge investor sentiment and to give us insight into the strength of the prevailing trend, if there is one, and the probability that the market will make big moves UP or DOWN. 

Conclusion for IV on the S&P 500 Index:  Implied volatility (i.e. fear) popped up over the last few weeks from an increase in unrest in the Middle East, fear that higher oil prices could derail a fragile US economy, and then the disaster in Japan with the threat of a nuclear meltdown in one of their power plants.  As long as the VIX remains elevated, we could have more selling and large swings in the market.  Overall, we credit spread writers like higher volatility because the market will provide us more strong UP and DOWN days, so this is good for us.

The Big Picture from Investors Business Daily (IBD) -  IBD's outlook shows the market "in a correction".  It usually takes five distribution days, i.e. DOWN days on high volume, on three or more indexes for them to show that the market as in a correction.  During a correction, once the market has one or more follow-through days, i.e. an UP day on strong volume, they will change their outlook from "market in correction" back to "market in confirmed up-trend".

Market Action - Friday's trade was the second UP day in a row on higher volume, which conveys some newfound confidence in the market and that some institutional money was participating in the buying.  However, it's too early to tell and we need to see how the market behaves over the next week.

Investor's Intelligence Bull/Bear Spread -  The B/B Spread is a well respected gauge of overall investor sentiment.  For more information on the B/B Spread please go here.

Conclusion for B/B Spread Indicator:   As of last Tuesday, March 15th, there were 29.9% more bulls than bears, telling us that even though we are experiencing more geopolitical risk lately, such as the horrible situation in Japan and the new war in Libya, more money will most likely flow into stocks than flow out of stocks once we see some closure on some of these situations.  Note how the market usually corrects when this indicator hits 40%, representing too much positive sentiment and usually a very overbought market.

Advance Decline Volume Line on the NYSE Composite -  The volume behind the number of advancing stocks less the volume behind the number of declining stocks provides  broad insight into the strength of a developing trend or prevailing trend, and provides insightful prediction into the timing of a trend reversal. This indicator is traditionally classified as a breadth-based indicator. We monitor the 13 day SMA (blue line) on the A/D Volume Line looking for a positive slope (bullish) or negative slope (bearish), we monitor the blue MACD histogram, and look at the intermediate-term of the trend via the red MACD line crossing above or below the zero line. 

Conclusion from the A/D Volume Line:  The blue 13 day SMA line is sloping down and volatility has increased where we are seeing larger swings on the A/D volume line.  The MACD has been mostly bearish as the blue histogram is choppy to negative, and the red line on the MACD chart is negative.  Overall, this chart is not providing us much predictive guidance on future direction of the market, other than that volatility will be higher on the major indexes for the next 1 to 2 weeks.  What we are watching for is "positive divergence" where the A/D Volume Line starts to show some "hidden" bullish energy as the market continues to trend DOWN, which will be an early sign of an upcoming trend reversal. (and again we are not seeing this yet)

NYSE New Highs-New Lows Index -  This broad-based breadth indicator shows the daily new highs less the daily new lows on the NYSE, and it continues to slope downward, which is bearish for the market.  This tells us that the market most likely will continue to pull back and/or consolidate in choppy fashion for the next 1 to 2 weeks.  Similar to what we are looking for above in the advance/decline volume line, we are waiting to see some positive divergence where the new high/new lows line starts to show some "hidden" bullish energy, which will be an early sign of an upcoming trend reversal.

Below is a relative strength comparison of the Russell 2000 index versus the S&P 500 index (SPX).  We care about this because if the small cap stocks increase faster than the big caps, investors are feeling more comfortable with risk and more money will flow into all equities pushing up the entire market.  We can see that the speed at which the RUT moves as compared to the S&P 500 index is slowing down and most likely the market will continue to consolidate, be choppy and/or pull back for the next few weeks.

Below is the daily chart of the Consumer Discretionary Select ETF - symbol XLY.  This fund comprises companies that make products that are not absolutely required to live, and are discretionary items such as high-end clothing, fast food, automobiles, and media types of products.  This sector tends to do well during the middle to late of an upswing in the economy, and gets crushed when the economy starts to sputter. We can see that this index was creating a wedge in a tight trading range, and up until a few days ago it was somewhat steady and holding above its 50 day SMA.  However, it recently pierced down through its 50 day line and it closed below the Oct 2007 high for 3 consecutive days.  Some professional traders will be going short on this index, and probably the market as a whole as this doesn't look healthy.

Below is the daily chart of the Select Industrials ETF - symbol XLI.  This fund comprises industrial conglomerates within aerospace & defense, machinery, air freight & logistics, road & rail, commercial services & supplies, electrical equipment, construction & engineering, building products, airlines and trading companies & distributors.  This sector is holding somewhat steady and closed on Friday still above the 36 level, which is a sign that the market is trying to stabilize.

Below is the daily chart of SOX Semiconductor Index. We watch the SOX because it's a broad-based indicator for the health of the US economy because a very large % of products that can be purchased by consumers have some form of electronics in them.  Additionally, when high tech stocks/indexes lead the rally, the rally will most likely continue.  Alternatively, when tech stocks suddenly stop leading the rally, the broad market will eventually pull back.  This index is a little concerning where it pulled back harder than the other indexes and already pierced down through the 50 day SMA.  However, the good news so far is that it's holding above the March 2008 high and the 100 day SMA near 423, and if the SOX holds above this level it will send a bullish signal to the market.  (i.e. once the correction is over this market is most likely heading higher)

Below is the XLF, Financial Sector ETF.   We watch the XLF because it's a broad based measure of the health of the US banking and financial sector; and usually, an economy will not self-sustainably expand unless its banking and financial systems are healthy.  We can see that it's pulling back like the broad market and so far it's attempting to hold above its 50 day SMA, which is good, and provides us some confidence that the broad US market will probably hold above certain key support levels...at least so far.

Volume Flow Indicators -  Below are the shorter term 30 day charts using 30 minute volume bars on the S&P 500 index and the Russell 2000 index.  The 30 day chart provides 1 to 2 days of predictive visibility.  We look at volume flow because it's one of the few ways to predict the strength of a developing trend, gauge the strength of an existing trend, and predict the timing of a trend reversal.

Conclusion for the Volume Flow Indicators:  The primary SBV Oscillator for S&P 500 and Russell 2000 indexes show to either "stay in cash but we are seeing bullish energy so get ready to go long", or  "go long".  (again using 30 day chart with 1 to 2 days of predictive visibility)  Note the RUT green volume bars at the top of the RUT chart noted with an arrow - this "end of day buying on high volume" tells us that investors are still interested in buying small cap stocks, so most likely after things in the Middle East and Japan settle down, money will most likely move back into the market.  For more on how to read these volume-based indicators please visit Primer on Trend and Trend Reversal Analysis using Volume Based Indicators.

Conclusion from the short-term to intermediate-term technical volume, advance/decline volume and sentiment based analysis:   As long as the Middle East tensions don't spread to Saudi Arabia and oil stays below $125/barrel, this market will probably shake off this correction and power higher, but this correction/consolidation period could last for many more weeks.

Below is the economic calendar for the next 4 weeks:

The Week of Mar 21st:  The economic announcements that are closely followed are Durable Orders on Thur the 24th and GDP on Fri the 25th.  For more information on this economic calendar please go to: http://www.briefing.com/Investor/Public/Calendars/EconomicCalendar.htm.

The Week of Mar 28th:   This is a big week and just about all of the data can move the markets, especially the jobs report that comes out on Friday the 1st.

The Week of April 4th:   This is a quiet week so the market will be looking elsewhere for clues about where to go next with stock prices.

The Week of April 11th:   This week takes us to the end of our April options.  The big one this week is Retail Sales on Wed the 13th. 

Overall prediction of where the market is heading in the next 2 to 3 weeks from all of the data analyzed above - updated on March 20th:   The market is in a confirmed DOWN trend because the 8/22 EMAs had a bearish crossover (i.e. the 8 day EMA crossed below the 22 day EMA) and the major indexes are below their respective 50 day SMAs. If oil stays below $125/barrel and the unrest stays out of Saudi Arabia we believe the pullback will hold at these levels and be short lived because most economic and earnings data coming from the US have been strong.  If the correction continues and becomes more severe there is a high probability that the major indices will find support at their respective April highs.  Once the correction is over, the market will most likely resume its UP trend and take out new highs through May.  Here is what we see that guides us to these predictions:  1) Q410 S&P 500 corporate earnings came in strong and are estimated to hit an aggregate $93 to $100 of earnings in 2011, which will put the S&P 500 index between 1300 and 1500 by the end of 2011, using the projected P/E ratio of 14 to 15;  2) Half of the S&P 500 companies are expected to raise their dividends in 2011, and some of the major banks just upped their dividends sending the "all clear" signal for the financial sector;  3) All US macroeconomic indicators, other than housing related, are trending UP, and job creation is now finally accelerating;  4) The FED continues to commit to follow through on QE2 (quantitative easing II) to buy $600B in US Treasuries and this will help keep the value of the US Dollar low, which will help grow exports and the overall US GDP - additionally it will help keep interest rates low and help instill investor confidence, which will help drive up stock prices; 5) Q410 top line revenue growth came in strong;  6) at the technical level, the major indexes are finding support at their respective 100 day SMAs, which so far looks bullish.

We recommend the following trades:

Let's watch the market for a day or so before jumping in.  Most likely we will be opening some spreads this week.

RUT Bear Call Credit Spread
on hold

RUT Bull Put Credit Spread
on hold

SPY Bear Call Credit Spread
on hold

SPY Bull Put Credit Spread
on hold

MNX Bear Call Credit Spread
on hold

MNX Bull Put Credit Spread
on hold

Note:  If you are an auto-trade subscriber no action is required. 

Sunday, March 13, 2011

Our prayers, solace and sympathies go out to the Japanese people as they've just endured one of the most powerful earthquakes ever recorded, along with the resulting tsunamis that destroyed several of their costal cities.

We are down to the last week for our March spreads and everything is currently safe.  We're hopeful that the disaster in Japan won't impact the US markets too much.  If at anytime any of our spreads get under pressure we'll send out instructions via email.  To play it safe, it's recommended to check your accounts to make sure you have sufficient reserve cash.  For example, let's say you have 20 RUT bull put spreads in one of your accounts; because we open 10 point wide spreads on the RUT each spread requires $1k of maintenance, so in this case you've invested about $20k and you should have at least $5k in reserve cash (about 25%) sitting in the account.  This reserve cash will be needed just in case we need to make some adjustments to our existing bull put spreads.

Here are some of the themes and views of guest speakers on the financial news channels over the last week.  We monitor this chatter because it provides deeper insight into the economy, the bond market and the stock market, even though there will be conflicting viewpoints: 

On the positive:  One money manager believes that the market wants to go higher because valuations are not stretched, the Fed continues to hold interest rates low and inflation is low - thus, investors should buy on the dips and take advantage of the current correction;  Another guest speaker believes that the earthquake and tsunami damage in Japan most likely will not impact the global economic rebound;  An oil analyst believes that the situation in Japan will not impact oil prices one way or the other globally, and that the unrest in the middle East and Northern Africa are the main activities that will impact oil prices;  If all of Libya's oil production is taken off line, a Saudi Arabian Prince claims that they'll be able to ramp up production within a few days and they will cover this shortfall in supply - this same Prince also said $100 oil is not justified;  One money manager predicts that the US market will start rallying again in short order since he's seeing lower highs in volatility (VIX);  one analyst noted that retail sales came in strong and this is just one more data point showing that the US economy will continue to expand.

On the negative:  Until the potential civil war activities in Libya settle down, oil prices most likely will stay above $100/barrel.

Let's look at the charts.  Below are the daily & weekly Dow Industrials charts showing that the Dow is pulling back and so far is holding above its 50 day SMA, which is good news.  The A/D Line and On Balance Volume indicators have pulled back as expected, but continue to show reasonable strength telling us that institutions are not interested in selling too much of their stock.  The 8 day exponential moving average (EMA) has now crossed below the 22 day EMA, telling us that the Dow is in a DOWN trend.  The 8/22 day EMA does a good job of providing short term trend trading signals.  This DOWN trend won't be confirmed until we see the Dow close below the 50 day SMA for a two consecutive days;  when it does, the selling will probably accelerate as this bearish crossover will trigger a certain amount of selling.  On the potential downside if the DOW continues to pull back, there continues to be a reasonable probability that the Dow will find support at its 50 day SMA and major psychological level of 12,000, as long as the Middle East crises doesn't spread much farther and that oil doesn't go much higher than $120/barrel.  If the Dow pulls back farther, there is a high probability that it will find support at its 100 day SMA and bottom of its 2 std. deviation channel near 11,600.  If the correction is severe from a new negative event, such as a spread of contagion to Saudi Arabia, there is a very high probability that it will find support at its April high and 62% Fibonacci level near 11,200;  and worst case the Dow will find support at its most recent Nov low, major psychological level, and its 200 day SMA at 11,000.  The 3rd chart down shows the Fibonacci retracements that provide a big-picture perspective and we can see that 11,200 (62% Fibonacci level) will be the potential major support level if the Dow has a severe pullback.

Below are the daily & weekly charts for the SPY, and ETF that tracks at 1/10th the value of the S&P 500 index, SPX.  The 2nd chart down is a weekly chart providing a big-picture view of the SPY showing Fibonacci Retracements with probable support and resistance levels. The 3rd chart down is the VIX Index representing the implied volatility of the S&P 500 index.  For more on how the American style options trade on the SPY please go here.  We can see that the SPY is pulling back like the other major indexes, but so far is holding above its 50 day SMA and the Aug 2008 high near 130.5.  Like the Dow, the A/D Line and On Balance Volume indicators have pulled back, but continue to show reasonable strength during this correction telling us that institutions are not interested in selling too much of their stock.  The 8 day exponential moving average (EMA) has now crossed below the 22 day EMA, telling us that the SPY is in a DOWN trend.  This DOWN trend won't be confirmed until we see the SPY close below its 50 day SMA for a two consecutive days.  There is still a reasonable probability that the SPY will find support at its 50 day SMA near 130, as long as the Middle East crises doesn't spread much farther and that oil doesn't go much higher than $120/barrel.  If the SPY pulls back farther, there is a high probability that it will find support at its 62% Fibonacci level and April/Nov high near 123.  If the market has a severe correction from a new, negative event there is a very high probability that the SPY will find support at its most recent Nov low and its 200 day SMA at 118.  Looking at the 2nd chart down with the Fibonacci Retracements, the SPY so far has held above 130, the Aug 2008 high, which is long term bullish.  Looking at the implied volatility via the VIX (3rd chart shown) it remains elevated from the conflict in the Middle East and fear that higher oil prices could derail a fragile US economy.  If the VIX remains elevated it tells us that investors will sell some of their holdings quickly if they deem it necessary, which will accelerate downside movement; thus, the market will continue to have larger swings over the next few weeks. (which is also good for us credit spread writers as we can bring in higher levels of premium for the spreads that we sell)

Below is the daily MNX, an mini index that tracks at 1/10th of the NASDAQ 100 Index - NDX, representing 100 of the largest non-financial companies, many in the technology sector.  We can see that the MNX has been pulling back like the other indexes.  So far, the MNX has been attempting to hold above the 50 day SMA but it closed below the 50 day line on Friday.  If it closes below the 50 day SMA for two consecutive days, then most likely this index is heading toward its 100 day SMA and pre-recession high near 224.  However, if investors hold the MNX above 224, the Oct 2007 pre-recession high, this will be a long term bullish signal and the market will power higher once the correction is over.  If the correction is severe from a new negative event, there is a very high probability that the MNX will find support at 210 near its Nov low, or 205.5 at the April high and the 200 day SMA.

Below is the daily S&P 100 large-cap index, OEX.  For more on how the American style options trade on the OEX please go here.  We can see that the OEX is pulling back and so far is closing above its 50 day SMA.  The 8 day EMA crossed below the 22 day EMA telling us that the OEX is now in a DOWN trend.  This DOWN trend will not be confirmed until the OEX closes below the 50 day SMA for two consecutive days.  If the OEX continues to pull back, there is a reasonable probability that it will find support at 575 representing the 62% Fibonacci level.  If the pullback is deeper there is a high probability that it will find support at 553.5 representing the April and Nov highs, the 100 day SMA and the bottom of its 2 std. deviation channel.  If the correction is severe from a new negative event, there is a very high probability that the OEX will find support at its most recent Nov low and 200 day SMA near 530. 

Below is the daily IWM, an ETF that tracks at 1/10th the value of the Russell 2000 small cap index, RUT.  We can see that the IWM has been pulling back while trading choppy.  The 8/22 day EMA had a bearish crossover telling us that the IWM is now in a DOWN trend.  It has been closing above the 50 day SMA, which so far is positive, and the DOWN trend won't be confirmed until the IWM closes below its 50 day SMA for 2 consecutive days.  Per potential downside, there is reasonable probability that the IWM will still find support at 79 representing its 50 day SMA, the last area of consolidation in Dec and Jan, and past resistance levels in Dec '07 and Oct '08.  If IWM continues to pull back there is better probability that it will find support at its January low of 77, which adds in the 100 day SMA and the bottom of its 2 std. deviation channel.  If the correction is deeper there is a very high probability that the IWM will find support at 74 representing its 78% Fibonacci level and April high.  If the correction is severe from a new negative event, there is an extremely high probability that the IWM will find support at 70 representing a major psychological level, the consolidation period in October, and the 200 day SMA.  The 2nd chart down is a weekly view of the IWM showing Fibonacci Retracements and it shows that the RUT consolidated near 79 for 6 weeks, it rallied again, and then had 2 consolidation weeks, but so far it's been holding above 79. The 3rd chart down shows that the implied volatility (aka "fear") for the RUT remains elevated, but not too elevated, telling us that volatility will be higher (which is good for us credit spread writers) and more cash will probably flow out of small caps and out of the overall market over the next few weeks.

Macro-Level, Fundamental View of US Economy's Underlying Health

Below are a selection of macroeconomic indicators to give us a big-picture, fundamental view of the health of the US economy.  If/when the US economy begins to weaken (we also will be watching corporate earnings) we'll be able to monitor the gradual deterioration of the economy and this information will help us  1) reduce our downside exposure by opening fewer bull put spreads, and being ultra-careful when we do open some; 2) trigger us to open a long term hedge to protect some/all of our bull put spreads; 3) alert us to possibly start opening bearish directional, speculative trades; and 4) tell us when it's time to move to the sidelines. 

Initial Unemployment Claims increased from 371k to 397k. This increase is nothing to be concerned with, at least for now, because new claims are still below 400k and this is known as the "recovery zone".  As long as the new claims number remains below 400k the US economy will most likely add at least 100k jobs monthly. Economists usually monitor the 4 week moving average, the orange line, since the weekly reading is volatile. The 2nd chart down is the 4 week average going back to 1992 showing how this indicator behaves during good times and bad.  Note that when the economy is expanding new claims are usually between 300k to 350k, and when it drops below 300k the economy is most likely overheating and the Fed is probably jacking up interest rates to slow things down.

Retail Sales rose 1.0% in January meeting consensus expectations.  Core retail sales (2nd chart), that exclude volatile sales from auto & parts dealers, gasoline stations and building material suppliers grew 0.7% in January slightly beating expectations.  Overall, the results were good and tell us that consumers continue to open their wallets;  this is important because consumer spending represents 2/3rds of the US economy.

Consumer credit came in positive for the 4th consecutive month, the first time we've seen positive numbers since Jan 2008, which is excellent news for the US economy.  Because this number is revised often and by a large %, it's not terribly accurate from month to month, so it's best to just monitor the trend and we can see that it's finally in positive territory.  In general, the more credit that consumers have, the main form as credit cards that are classified as revolving credit, the more that they'll spend so consumer credit is important to follow.  Since 2008 we've seen a huge and unprecedented "deleveraging" of the US consumer where they have been paying down their credit cards, credit limits have been reduced by the banks, and their equity line of credit on their homes have evaporated.  The 2nd chart down shows year over year available consumer credit going back to 1995 and we can see that it's now starting to trend UP again.

Economic Cycle Research Institute (ECRI) Leading Indicators -  ECRI is a highly respected independent economic research house that has one of the best track records in predicting when recessions start and end.  Two of their key leading economic indicators, which comprise a dozen economic variables, are the Weekly Leading Index (WLI) and the Weekly Growth Index (WGI).  For the WGI, any reading above zero predicts that the US economy will continue to expand for the following 2 to 3 months. For more on these indicators please visit the Learning Center.

Conclusion for WLI & WGI:  Both indicators continue to trend higher and are looking strong.  According to Lakshman Achuthan, ECRI's Managing Director,  "The forward-looking WLI predicts that the US economy will continue to expand at least through the summer of 2011". 

Corporate Earnings - (Text last Updated on March 6th; chart updated on March 11th) Q410 earnings season is wrapping up and 71% of the S&P500 companies beat analyst's consensus estimates, 9% met, and 20% missed.  The long-term average % of companies beating analyst's estimates is 62%, so Q410 earnings were very good.  One analyst noted that top line revenue growth was strong, which is great news as top line revenue was a point of concern.  However, another analyst noted that higher energy and commodity prices will eat into margins, and he believes that the current 2011 aggregate, estimated S&P 500 earnings of $93 to $100/share will probably be cut as 2011 progresses.  (if this is true the stock market will not be happy and will need to moderate to reflect the new level of earnings)  Analysts are expecting earnings to come in 36.3% higher than a year earlier, which is up from 31% at the start of Q410.  The currently estimated Q111 earnings growth rate for the S&P 500 companies is 13.2%.  Below is the weekly chart of the S&P 500 index, the same chart shown at the top of this advisory, and it shows analyst's projected 2011 aggregated S&P 500 earnings between $93 and $100/share, with a projected P/E ratio of 14 to 15, which would put the S&P 500 index between 1300 and 1500 by the end of 2011.  The S&P 500 is currently trading at a P/E multiple of 14.2 times a conservative, forward looking aggregate of $93/share.  (Data supplied by Thomson Reuters)

Conclusion from the Macro-level Fundamental View of US Economy's Health - The US economy continues to expand where GDP growth is approximately 2.8%.  Some economists believe that GDP growth will accelerate mid-year and be as high as 4.0% by the end of 2011. The macroeconomic indicators and corporate earnings are pointing to continued growth through the end of 2011 supporting the notion that GDP could be 4.0% by year end.  Moreover, we're at an inflection point where the US economy is now adding a larger number of jobs each month since the initial unemployment claims number is now coming in under 400k.  (e.g. in Feb the economy added 222k private sector jobs)  When the new claims number is under 400k the economy will usually add 150k or more jobs monthly. 

Short-term to Intermediate-term (1 to 3 weeks) Sentiment and Volume Flow Analysis:  Below are a selection of Volume, Advance/Decline and other sentiment and breadth based indicators to help us gauge the strength of the prevailing trend and to predict the timing of a trend reversal.

Implied Volatility on the S&P 500 Index (VIX) -  We watch implied volatility (IV), also known as the "fear index", on the S&P 500 Index to help us gauge investor sentiment and to give us insight into the strength of the prevailing trend, if there is one, and the probability that the market will make big moves UP or DOWN. 

Conclusion for IV on the S&P 500 Index:  Implied volatility (i.e. fear) popped up over the last few weeks from an increase in unrest in the Middle East and fear that higher oil prices could derail a fragile US economy.  The market was also technically overbought and was in need of a pullback, so some of this increase in the VIX was due to a fear that the pullback could be deep.  As long as the VIX remains elevated, we could have more selling.  Overall, we credit spread writers like higher volatility because the market will provide us more strong UP and DOWN days, so this is good for us.

The Big Picture from Investors Business Daily (IBD) -  IBD's outlook shows the market "in a correction".  It usually takes five distribution days, i.e. DOWN days on high volume, on three or more indexes for them to show that the market as in a correction.  During a correction, once the market has one or more follow-through days, i.e. an UP day on strong volume, they will change their outlook from "market in correction" back to "market in confirmed up-trend".

Seasonality Influences -  The “Best 6 months” of the year effect runs from Nov through April.  If the market does well during the traditionally volatile September & October time frame, which it did, then the "best six months" seasonal effect is even more pronounced where the market will continue the UP trend through April. (this happened 85% of the time since 1920)

Market Action - Friday's trade was an UP day on low volume, which does not yet convey confidence in the market as most institutional money was sitting on the sidelines and not buying.  However, one bright spot was that Investors Business Daily's top 50 stocks rallied on a ratio of 6 winners to every 1 loser, which was very impressive;  this tells us that investors so far still have confidence at the market's current levels and are buying into the highly rated stocks. 

Advance Decline Volume Line on the NYSE Composite -  The volume behind the number of advancing stocks less the volume behind the number of declining stocks provides  broad insight into the strength of a developing trend or prevailing trend, and provides insightful prediction into the timing of a trend reversal. This indicator is traditionally classified as a breadth-based indicator. We monitor the 13 day SMA (blue line) on the A/D Volume Line looking for a positive slope (bullish) or negative slope (bearish), we monitor the blue MACD histogram, and look at the intermediate-term of the trend via the red MACD line crossing above or below the zero line. 

Conclusion from the A/D Volume Line:  The blue 13 day SMA line is sloping down and volatility has increased where we are seeing larger swings on the A/D volume line.  The MACD is bearish as the blue histogram is choppy to negative, and the red line on the MACD chart is negative.  Overall, this chart is not providing us much predictive guidance on future direction of the market, other than that volatility will be higher on the major indexes for the next 1 to 2 weeks.  What we are watching for is "positive divergence" where the A/D Volume Line starts to show some "hidden" bullish energy as the market is still selling off, which will be an early sign of an upcoming trend reversal. (and again we are not seeing this yet)

NYSE New Highs-New Lows Index -  This broad-based breadth indicator shows the daily new highs less the daily new lows on the NYSE, and it continues to slope downward, which is bearish for the market.  This tells us that the market most likely will continue to pull back and/or consolidate in choppy fashion for the next 1 to 2 weeks.  Similar to what we are looking for above, we are waiting to see some positive divergence where the new high/new lows line starts to show some "hidden" bullish energy, which will be an early sign of an upcoming trend reversal.

Below is a relative strength comparison of the Russell 2000 index versus the S&P 500 index (SPX).  We care about this because if the small cap stocks increase faster than the big caps, investors are feeling more comfortable with risk and more money will flow into all equities pushing up the entire market.  We can see that the speed at which the RUT moves as compared to the S&P 500 index is slowing down and most likely the market will continue to consolidate, be choppy and/or pull back for the next few weeks.

Below is the daily chart of the Consumer Discretionary Select ETF - symbol XLY.  This fund comprises companies that make products that are not absolutely required to live, and are discretionary items such as high-end clothing, fast food, automobiles, and media types of products.  This sector tends to do well during the middle to late of an upswing in the economy, and gets crushed when the economy starts to sputter. We can see that this index is creating a wedge in a tight trading range, and what's interesting is that it's also holding somewhat steady and above its 50 day SMA.  This tells us that investors are still confident in the strength of the US economy and believe that the economy will continue to expand even if we have higher oil prices, which is a long-term bullish sign for the overall market.

Below is the daily chart of the Select Industrials ETF - symbol XLI.  This fund comprises industrial conglomerates within aerospace & defense, machinery, air freight & logistics, road & rail, commercial services & supplies, electrical equipment, construction & engineering, building products, airlines and trading companies & distributors.  This sector is also holding somewhat steady and closed on Friday still above its 50 day SMA, which is a sign that the market probably won't melt down from unrest in the middle East and the earthquake in Japan.

Below is the daily chart of SOX Semiconductor Index. We watch the SOX because it's a broad-based indicator for the health of the US economy because a very large % of products that can be purchased by consumers have some form of electronics in them.  Additionally, when high tech stocks/indexes lead the rally, the rally will most likely continue.  Alternatively, when tech stocks suddenly stop leading the rally, the broad market will eventually pull back.  This index is a little concerning where it pulled back harder than the other indexes and already pierced down through the 50 day SMA.  However, the good news so far is that it's holding above the March 2008 high and the 100 day SMA near 423, and if the SOX holds above this level it will send a bullish signal to the market.  (i.e. once the correction is over this market is heading higher)

Below is the XLF, Financial Sector ETF.   We watch the XLF because it's a broad based measure of the health of the US banking and financial sector; and usually, an economy will not self-sustainably expand unless its banking and financial systems are healthy.  We can see that it's pulling back like the broad market and so far it's attempting to hold above its 50 day SMA, which is good, and provides us some confidence that the broad US market will probably hold above certain key support levels...at least so far.

Volume Flow Indicators -  Below is the 1.5 year chart using 1 day volume bars on the S&P 500 index and the Russell 2000 index.  The 1.5 year chart provides 3 to 4 weeks of predictive visibility.  We look at volume flow because it's one of the few ways to predict the strength of a developing trend, gauge the strength of an existing trend, and predict the timing of a trend reversal.

Conclusion for the Volume Flow Indicators:  The primary SBV Oscillator for S&P 500 and Russell 2000 indexes remain as "stay in cash".  For both indexes the sub-indexes are holding reasonably steady providing us confidence that certain major support levels will hold as this correction unfolds.  This also tells us that once the unrest in the Middle East settles down a little, and assuming that oil doesn't go much higher than $120/barrel, this market is most likely going to power higher.  For more on how to read these volume-based indicators please visit Primer on Trend and Trend Reversal Analysis using Volume Based Indicators.

Conclusion from the short-term to intermediate-term technical volume, advance/decline volume and sentiment based analysis:   As long as the Middle East tensions don't spread to Saudi Arabia and oil stays below $120/barrel, this market will probably shake off this correction and power higher, but this correction/consolidation could last for many more weeks.

Below is the economic calendar for the next 1 week:

The Week of Mar 14th:   This week takes us to the end of our March options.  The results from the Fed's meeting on Tues the 15th is closely followed and can move the markets, along with the Philly Fed number on Thur the 17th. For more information on this economic calendar please go to: http://www.briefing.com/Investor/Public/Calendars/EconomicCalendar.htm.

Overall prediction of where the market is heading in the next 2 to 3 weeks from all of the data analyzed above - updated on March 14th:   The market is now in a DOWN trend because the 8/22 EMAs recently had a bearish crossover. (i.e. the 8 day EMA crossed below the 22 day EMA), but the DOWN trend will not be confirmed until a few of the major indexes close below their respective 50 day SMAs for two or more consecutive days.  If oil stays below $120/barrel and the unrest stays out of Saudi Arabia we believe the pullback will be relatively shallow because most economic and earnings data coming from the US have been strong.  So far most of the indexes have held above their respective 50 day SMAs, which is long term bullish.  If the correction continues and becomes more severe there is a high probability that the major indices will find support at their respective April highs.  Once the correction is over, the market will most likely resume its UP trend and take out new highs through May.  Here is what we see that guides us to these predictions:  1) Q410 S&P 500 corporate earnings came in strong and are estimated to hit an aggregate $93 to $100 of earnings in 2011, which will put the S&P 500 index between 1300 and 1500 by the end of 2011, using the projected P/E ratio of 14 to 15;  2) Half of the S&P 500 companies are expected to raise their dividends in 2011;  3) All US macroeconomic indicators, other than housing related, are trending UP, and job creation is now finally accelerating;  4) The seasonal "market has its best 6 months between Nov and April" is in full swing, and it does even better when the market does well in Sep and Oct, as it did;   5) The FED continues to commit to follow through on QE2 (quantitative easing II) to buy $600B in US Treasuries and this will help keep the value of the US Dollar low, which will help grow exports and the overall US GDP - additionally it will help keep interest rates low and help instill investor confidence, which will help drive up stock prices; 6) Q410 top line revenue growth came in strong; 7) So far the XLI Industrial select ETF, XLF Financial Select ETF, and XLY consumer Discretionary ETF are all holding above their respective 50 day SMAs, which is long term bullish. 

We recommend the following trades:

We are down to the last week for our March spreads and everything is currently safe.  We're hopeful that the disaster in Japan won't impact the US markets too much.  If at anytime any of our spreads get under pressure we'll send out instructions via email.  To play it safe, it's recommended to check your accounts to make sure you have sufficient reserve cash.  For example, let's say you have 20 RUT bull put spreads in one of your accounts; because we open 10 point wide spreads on the RUT each spread requires $1k of maintenance, so in this case you've invested about $20k and you should have at least $5k in reserve cash (about 25%) sitting in the account.  This reserve cash will be needed just in case we need to make some adjustments to our existing bull put spreads.

Normally we don't collect premium during expiration week, which is this week;  however, because volatility is elevated and the markets could bounce around a lot, we might have the opportunity to bring in a little more premium on the top spreads, so we'll continue to show these trades.  However, most likely these trades will not fill this week. 

RUT Bear Call Credit Spread
BTO '11 RUT Mar18 880 call
STO '11 RUT Mar18 870 call - for a credit of 30 to 47 cents.  If this spread starts to fill for more than 47 cents credit, suspend any further fills on it and click-UP a strike to keep your credit between 30 and 47 cents.  We will hold onto all existing spreads if we're forced to click UP.  It will take an UP day before this spread will fill for at least 30 cents credit, so please be patient; let's wait for the market to come to us.

RUT Bull Put Credit Spread
we're done collecting premium this month for the bottom spreads.

OEX Bear Call Credit Spread
BTO '11 OEX Mar18 615 call
STO '11 OEX Mar18 610 call - for a credit of 20 to 30 cents.  If this spread starts to fill for more than 30 cents credit, suspend any further fills on it and click-UP a strike to keep your credit between 20 and 30 cents.

OEX Bull Put Credit Spread
we're done collecting premium this month for the bottom spreads.

SPY Bear Call Credit Spread
on hold

SPY Bull Put Credit Spread
we're done collecting premium this month for the bottom spreads.

MNX Bear Call Credit Spread
on hold

MNX Bull Put Credit Spread
we're done collecting premium this month for the bottom spreads.

Note:  If you are an auto-trade subscriber no action is required.  We'll be watching the bottom spreads closely and if at anytime they get under pressure we'll take the necessary action.

Sunday, March 6, 2011

The market rallied strongly on Thursday as the ADP Employment Report and the initial claims report each came in with strong results.  We decided to not jump into our top bear call spreads because the US government's jobs report was coming out on Friday, and if good, the markets could have rallied farther.  Friday's jobs report did impress with excellent results, as shown below, but instead of rallying the markets sold off.  Regardless, we should continue to have higher volatility this week to allow us to finish off collecting premium on our desired bull put spreads; then if we can get a few more UP days we might have a chance to open our yet to be set top spreads to complete the iron condors.

Let's look at the charts.  Below are the daily & weekly Dow Industrials charts showing that the Dow is starting to trade sideways and choppy. (2nd chart down is the same daily chart but zoomed in so we can see the candlesticks in more detail)  The A/D Line and On Balance Volume indicators have pulled back a little, but continue to show reasonable strength.  The 8 day exponential moving average (EMA) remains above the 22 day EMA, telling us that the Dow is still in a confirmed UP trend, but the UP trend is under pressure.  The 8/22 day EMA does a good job of providing short term trend trading signals.  On the potential downside if the DOW continues to pull back, there is a reasonable probability that the Dow will find support at its 50 day SMA near 11,900, as long as the Middle East crises doesn't spread much farther and that oil doesn't go much higher than $110/barrel.  If the Dow pulls back farther, there is a high probability that it will find support at its April high, 62% Fibonacci level, and below its 100 day SMA and bottom of its 2 std. deviation channel near 11,250.  If the correction is severe from a new negative event, such as a spread of contagion to Saudi Arabia, there is a very high probability that the Dow will find support at 11,000 that represents a major psychological level, its most recent Nov low, and its 200 day SMA.  The 3rd chart down shows the Fibonacci retracements that provide a big-picture perspective and we can see that 11,250 will be the potential major support level if the Dow has a severe pullback.

Below are the daily & weekly charts for the SPY, and ETF that tracks at 1/10th the value of the S&P 500 index, SPX.  The 2nd chart down is a weekly chart providing a big-picture view of the SPY showing Fibonacci Retracements with probable support and resistance levels. The 3rd chart down is the VIX Index representing the implied volatility of the S&P 500 index.  For more on how the American style options trade on the SPY please go here.  We can see that the SPY is now trading sideways and choppy.  The A/D Line and  On Balance Volume indicators did pull back some telling us that higher volume selling occurred over the last 2 weeks. (i.e. institutions were selling some of their holdings, which is bearish), but they don't look that bad.  The 8/22 day EMA tells us that the SPY is still in a confirmed UP trend because the 8 day EMA remains above the 22 day EMA.  If the SPY continues to pull back there is a reasonable probability that the SPY will find support at its 50 day SMA near 129, as long as the Middle East crises doesn't spread much farther and that oil doesn't go much higher than $110/barrel.  If the SPY pulls back farther, there is a high probability that it will find support at its 62% Fibonacci level and April/Nov high near 123.  If the market has a severe correction from a new, negative event there is a very high probability that the SPY will find support at its most recent Nov low and near its 200 day SMA at 118.  Looking at the 2nd chart down with the Fibonacci Retracements, the SPY so far has held above 130, the Aug 2008 high, which is long term bullish.  Looking at the implied volatility via the VIX (3rd chart shown) it remains elevated from the conflict in the Middle East and fear that higher oil prices could derail a fragile US economy.  If the VIX remains elevated it tells us that investors are ready to sell some of their holdings quickly if they deem it necessary, which will accelerate downside movement, and that the market will continue to have larger swings.

Below is the daily QQQ, an ETF that tracks at 1/40th of the NASDAQ 100 Index - NDX, representing 100 of the largest non-financial companies, many in the technology sector.  We can see that the Q's have been pulling back and trading sideways and choppy like the other indexes.  So far, the Q's have been holding above the 50 day SMA, which is rather impressive and sending a long term bullish signal.  More importantly is if investors hold the Q's above 55, the Oct 2007 high; if they do, this will definitely be a long term bullish signal.  If the correction is deeper, there is a high probability that the Q's will find support at 52 near its most recent Nov low.  If the market and the Q's have a severe correction from a new negative event, there is a very high probability that it will find support at 50.5 representing the April high and the 200 day SMA.

Below is the daily S&P 100 large-cap index, OEX.  For more on how the American style options trade on the OEX please go here.  We can see that the OEX is now trading sideways and choppy like the other major indexes. Because the 8 day EMA remains above the 22 day EMA it tells us that the OEX is still in a confirmed UP trend.  The OEX is also holding above its 50 day SMA which is long term bullish.  If the OEX continues to pull back, there is a reasonable probability that it will find support at 575 representing the 62% Fibonacci level and just below its 50 day SMA.  If the pullback is deeper there is a high probability that it will find support at 553.5 representing the April and Nov highs, the 100 day SMA and the bottom of its 2 std. deviation channel.  If the correction is severe from a new negative event, there is a very high probability that the OEX will find support at its most recent Nov low and 200 day SMA near 530. 

Below is the daily IWM, an ETF that tracks at 1/10th the value of the Russell 2000 small cap index, RUT.  We can see that the IWM has now been trading sideways and choppy.  The 8/22 day EMA tells us that the IWM is still in a confirmed UP trend because the 8 day EMA remains above the 22 day EMA.  It's also holding above the 50 day SMA, which so far is sending a long term bullish signal.  Per potential downside, there is reasonable probability that the IWM will find support at 79 representing its 50 day SMA, the last area of consolidation, and past resistance levels in Dec '07 and Oct '08.  If IWM continues to pull back there is better probability that it will find support at its January low of 77, as long as oil doesn't climb much higher than $110/barrel and the unrest doesn't spread to Saudi Arabia.  If the correction is deeper there is a very high probability that the IWM will find support at 74 representing its 78% Fibonacci level and April high.  If the correction is severe from a new negative event, there is an extremely high probability that the IWM will find support at 70 representing a major psychological level, the consolidation period in October, and the 200 day SMA.  The 2nd chart down is a weekly view of the IWM showing Fibonacci Retracements and it shows that the RUT consolidated near 79 for 6 weeks, it rallied again, and then had 2 consolidation weeks, but so far it's held above 79. The 3rd chart down shows that the implied volatility (aka "fear") for the RUT remains elevated telling us that volatility will be higher (which is good for us credit spread writers) and more cash could flow out of small caps and the overall market over the next few weeks.

Macro-Level, Fundamental View of US Economy's Underlying Health

Below are a selection of macroeconomic indicators to give us a big-picture, fundamental view of the health of the US economy.  If/when the US economy begins to weaken (we also will be watching corporate earnings) we'll be able to monitor the gradual deterioration of the economy and this information will help us  1) reduce our downside exposure by opening fewer bull put spreads, and being ultra-careful when we do open some; 2) trigger us to open a long term hedge to protect some/all of our bull put spreads; 3) alert us to possibly start opening bearish directional, speculative trades; and 4) tell us when it's time to move to the sidelines. 

The non-farm jobs number came in strong showing the US economy added 192,000 jobs coming in close expectations.  Moreover, the private sector added 222,000 jobs, beating consensus of 198,000 new jobs.  The unemployment rate also dropped from 9.1% to 8.9%.  The second chart shows the same non-farm payroll change going back to 1995 and we can see that a growing US economy usually adds between 150k to 250k monthly.  The 3rd chart shows that initial unemployment claims dropped to 368,000 in Feb from 388,000 in Jan, which was a huge decline. Overall, this was an excellent report.

The Chicago Purchasing Managers Report came in strong telling us that manufacturing activity in the Mid-West region is doing well. Any reading over 50 tells us that economic activity is expanding.

The ISM Index that measures manufacturing activity across the entire US increased from 60.8 in January to 61.4 in February, which was a strong reading and tells us that the economy continues to grow.  Any reading over 50 tells us that economic activity is expanding.  The 2nd chart is the same ISM index going back to 1995 showing that a "healthy" ISM index is between 51 and 60, so today's current reading is excellent and it's actually overshooting this level.  The 2nd chart also shows the new order sub-index (orange line), which is an important component of the ISM Index and we can see that it continues to climb and looks healthy.

Personal Income grew 1.0% in January, which is helping the US economy stay on an expansionary path. The more people make, the more that they'll spend.  Personal spending, shown in more detail on the 2nd chart remained somewhat flat growing 0.2%, which was disappointing, but at least it continues to move in the right direction.  Overall, it was a decent report.

The sales of auto and light trucks grew from 9.59 million units in January to 10.22 million units in February, which was the strongest reading since Aug 2008. (numbers are SAAR - seasonally adjusted annual rates)  This tells us that consumer's confidence continues to improve helping them to make large ticket purchases;  moreover, the briefing.com analyst noted that consumers are gaining access to more credit, which is also helping to increase car sales since consumers have easier access to car loans.  Overall, this was an excellent report and the results bode well for the broad economy.

Corporate Earnings - Q410 earnings season is wrapping up and 71% of the S&P500 companies beat analyst's consensus estimates, 9% met, and 20% missed.  The long-term average % of companies beating analyst's estimates is 62%, so Q410 earnings were very good.  One analyst noted that top line revenue growth was strong, which is great news as top line revenue was a point of concern.  However, another analyst noted that higher energy and commodity prices will eat into margins, and he believes that the current 2011 aggregate, estimated S&P 500 earnings of $93 to $100/share will probably be cut as 2011 progresses.  (if this is true the stock market will not be happy and will need to moderate to reflect the new level of earnings)  Analysts are expecting earnings to come in 36.3% higher than a year earlier, which is up from 31% at the start of Q410.  The currently estimated Q111 earnings growth rate for the S&P 500 companies is 13.2%.  Below is the weekly chart of the S&P 500 index, the same chart shown at the top of this advisory, and it shows analyst's projected 2011 aggregated S&P 500 earnings between $93 and $100/share, with a projected P/E ratio of 14 to 15, which would put the S&P 500 index between 1300 and 1500 by the end of 2011.  The S&P 500 is currently trading at a P/E multiple of 14.2 times a conservative, forward looking aggregate of $93/share.  (Data supplied by Thomson Reuters)

Conclusion from the Macro-level Fundamental View of US Economy's Health - The US economy's GDP is currently growing at the rate of 2.8%, and some economists believe that GDP growth will accelerate mid-year and be as high as 4.0% by the end of 2011. The macroeconomic indicators and corporate earnings are pointing to continued growth through the end of 2011 supporting the notion that GDP could be 4.0% by year end.  Moreover, we're at an inflection point where the US economy is now starting to add a larger number of jobs each month since the initial unemployment claims number is now coming in under 400k.  (case in point the Feb unemployment report showed that the economy added 192k jobs)  When the new claims number is under 400k the economy will usually add 150k or more jobs monthly. 

Short-term to Intermediate-term (1 to 3 weeks) Sentiment and Volume Flow Analysis:  Below are a selection of Volume, Advance/Decline and other sentiment and breadth based indicators to help us gauge the strength of the prevailing trend and to predict the timing of a trend reversal.

Implied Volatility on the S&P 500 Index (VIX) -  We watch implied volatility (IV), also known as the "fear index", on the S&P 500 Index to help us gauge investor sentiment and to give us insight into the strength of the prevailing trend, if there is one, and the probability that the market will make big moves UP or DOWN. 

Conclusion for IV on the S&P 500 Index:  Implied volatility (i.e. fear) popped up over the last few weeks from an increase in unrest in the Middle East and fear that higher oil prices could derail a fragile US economy.  The market was also technically overbought and was in need of a pullback, so some of this increase in the VIX was due to a fear that the pullback could be deep.  As long as the VIX remains elevated, we could have more selling.  Overall, we credit spread writers like higher volatility because the market will provide us more strong UP and DOWN days, so this is good for us.

The Big Picture from Investors Business Daily (IBD) -  IBD's outlook shows the market as "uptrend under pressure".  They've tallied 5 distribution days for the NASDAQ Composite, and 4 each for the NYSE composite and S&P 500 indexes.  It usually takes five distribution days, i.e. DOWN days on high volume, on three or more indexes for them to show that the market is in a correction.  During a correction, once the market has one or more follow-through days, i.e. UP days on strong volume, they will change their outlook from "market in correction" back to "market in confirmed up-trend".

Seasonality Influences -  The “Best 6 months” of the year effect runs from Nov through April.  If the market does well during the traditionally volatile September & October time frame, which it did, then the "best six months" seasonal effect is even more pronounced where the market will continue the UP trend through April. (this happened 85% of the time since 1920)

Market Action - In the last 9 trading days, Investors Business Daily's "highly rated stocks" that have had recent breakouts to the upside have failed.  (i.e. these particular, closely watched stocks hit a buy point and then rallied, but the rally quickly failed and the stock fell back to the technical buy point)  Additionally, some highly rated stocks are "stalling" where the stock doesn't move but the volume is 2x to 3x normal volume telling us that institutions are selling some of their holdings.  Finally, the DOWN days for the market as a whole are on higher volume and the UP days are on lower volume telling us that institutions have not been participating in the buying, but are selling some of their holdings on the DOWN days.  Overall, this type of market action is negative and could be signal that more DOWN days are coming.

Advance Decline Volume Line on the NYSE Composite -  The volume behind the number of advancing stocks less the volume behind the number of declining stocks provides  broad insight into the strength of a developing trend or prevailing trend, and provides insightful prediction into the timing of a trend reversal. This indicator is traditionally classified as a breadth-based indicator. We monitor the 13 day SMA (blue line) on the A/D Volume Line looking for a positive slope (bullish) or negative slope (bearish), we monitor the blue MACD histogram, and look at the intermediate-term of the trend via the red MACD line crossing above or below the zero line. 

Conclusion from the A/D Volume Line:  The blue 13 day SMA line is sloping down and volatility has increased where we are seeing larger swings on the A/D volume line.  We are seeing a glimmer of "higher lows" on the A/D volume line telling us that volatility is starting to decrease.  The MACD is showing a bearish reading as the blue histogram is choppy to negative, and the red line on the MACD chart is negative.  Overall, this chart is not providing us much predictive guidance on future direction of the market, other than that volatility is going to be higher on the major indexes for the next 1 to 2 weeks.

NYSE New Highs-New Lows Index -  This broad-based breadth indicator shows the daily new highs less the daily new lows on the NYSE, and it continues to slope downward, which is bearish for the market.  This tells us that the market most likely will continue to pull back and/or consolidate in choppy fashion for the next 1 to 2 weeks.

Below is a relative strength comparison of the Russell 2000 index versus the S&P 500 index (SPX).  We care about this because if the small cap stocks increase faster than the big caps, investors are feeling more comfortable with risk and more money will flow into all equities pushing up the entire market.  We can see that the speed at which the RUT moves as compared to the S&P 500 index is slowing down and most likely the market will continue to consolidate, be choppy and/or pull back for the next few weeks.

Below is the daily chart of the Consumer Discretionary Select ETF - symbol XLY.  This fund comprises companies that make products that are not absolutely required to live, and are discretionary items such as high-end clothing, fast food, automobiles, and media types of products.  This sector tends to do well during the middle to late of an upswing in the economy, and gets crushed when the economy starts to sputter. We can see that this index had a few strong DOWN days similar to the other indexes, but what's interesting is that it's also holding somewhat steady and well above its 50 day SMA.  This tells us that investors are still confident in the strength of the US economy and believe that the economy will continue to expand even if we have higher oil prices, which is a bullish sign for the overall market.

Volume Flow Indicators -  Below is the 1.5 year chart using 1 day volume bars on the S&P 500 index.  The 1.5 year chart provides 3 to 5 weeks of predictive visibility.  We look at volume flow because it's one of the few ways to predict the strength of a developing trend, gauge the strength of an existing trend, and predict the timing of a trend reversal. 

Conclusion for the Volume Flow Indicators:  The primary SBV Oscillator for S&P 500 triggered a few weeks ago telling us to go short or move into cash.  The primary SBV Oscillator for Russell 2000 Index also triggered a few weeks ago for us to go short or to move into cash.  However, for the RUT, the sub-indexes are not looking that weak and the MACD is actually going bullish again.  This tells us that once the unrest in the Middle East settles down a little, and assuming that oil doesn't go much higher than $110/barrel, this market is most likely going to power higher.  For more on how to read these volume-based indicators please visit Primer on Trend and Trend Reversal Analysis using Volume Based Indicators.

Conclusion from the short-term to intermediate-term technical volume, advance/decline volume and sentiment based analysis:   As long as the Middle East tensions don't spread to Saudi Arabia and oil stays below $110/barrel, this market will probably shake off this pullback and power higher, but this consolidation period could last for many more weeks.

Below is the economic calendar for the next 2 weeks:

The Week of Mar 7th:   Retail sales on Friday the 11th is closely followed and can move the markets.  For more information on this economic calendar please go to: http://www.briefing.com/Investor/Public/Calendars/EconomicCalendar.htm.

The Week of Mar 14th:   This week takes us to the end of our March options.  The results from the Fed's meeting on Tues the 15th is closely followed and can move the markets, along with the Philly Fed number on Thur the 17th.

Overall prediction of where the market is heading in the next 2 to 3 weeks from all of the data analyzed above - updated on March 6th:   The market remains in a confirmed UP trend as the 8/22 EMAs have not yet had a bearish crossover. (i.e. when the 8 day EMA crosses below the 22 day EMA), but the UP trend is under pressure and the indexes are now trading sideways and choppy in a consolidation pattern.  We have had a few strong DOWN days over the last 2 weeks from escalation of Middle East unrest, but if oil stays below $110/barrel, we believe the pullback will be shallow because most economic and earnings data coming from the US have been positive.  So far the indexes have held above their respective 50 day SMAs, which is long term bullish.  If the correction continues and becomes more severe caused by, e.g. unrest spreading to large oil producing countries such as Saudi Arabia, there is a high probability that the major indices will find support at their respective April highs.  Once the correction is over, the market will most likely resume its UP trend and take out new highs through May.  Here is what we see that guides us to these predictions:  1) Q410 S&P 500 corporate earnings came in strong and are estimated to hit an aggregate $93 to $100 of earnings in 2011, which will put the S&P 500 index between 1300 and 1500 by the end of 2011, using the projected P/E ratio of 14 to 15;  2) Half of the S&P 500 companies are expected to raise their dividends in 2011;  3) All US macroeconomic indicators, other than housing related, are trending UP, and job creation is now finally accelerating;  4) The seasonal "market has its best 6 months between Nov and April" is in full swing, and it does even better when the market does well in Sep and Oct, as it did;   5) The FED continues to commit to follow through on QE2 (quantitative easing II) to buy $600B in US Treasuries and this will help keep the value of the US Dollar low, which will help grow exports and the overall US GDP - additionally it will help keep interest rates low and help instill investor confidence, which will help drive up stock prices; 6) One analyst noted that Q410 top line revenue growth came in strong; 7) the XLI Industrial select ETF, XLF Financial Select ETF, and XLY consumer Discretionary ETF are all holding above their respective 50 day SMAs, which is long term bullish;  8) The small caps (RUT) and technology stocks (QQQ) are holding above key support levels.

We recommend the following trades:

For the trades shown below, we recommend to use about 15% to 20% of your cash, in total, on the days that our recommended spreads are filling within the recommended price range.  For more info on how much cash to use in a single day please visit the FAQ Page and read entry #45.

RUT Bear Call Credit Spread
on hold

RUT Bull Put Credit Spread (note that we moved up the strikes)
STO '11 RUT Mar18 740 put
BTO '11 RUT Mar18 730 put - for a credit of 45 to 80 cents credit.  If this spread starts to fill for more than 80 cents credit, suspend any further fills on it and click-DOWN a strike to keep your credit between 45 and 80 cents.  We will hold onto all existing spreads if we're forced to click down.  It will take a DOWN day before this spread will fill for at least 45 cents credit, so please be patient; let's wait for the market to come to us.  Make sure not to put spreads that have matching strike prices in the same account since the matching strikes will cancel each other out and you will end up with a 20 point wide spread.  (which is not the end of the world, but something we try to avoid since we want the flexibility to be able to open the top bear call spreads to complete the iron condor)  For more on this topic please visit the FAQ Page and read entry #26 - "Why do I need multiple accounts when trading the RUT?".  If you already have the RUT Mar 720/730 bull put spread in your account and you don't have cash ready to go in a different account, you can open the IWM Mar 72/74 bull put spread in the same account within the credit price range of 9 to 15 cents. Just remember that since this is a 2 point wide spread you'll be opening 5x the number of spreads as compared to opening a 10 point wide spread, so the commissions hit is substantially higher.

OEX Bear Call Credit Spread
on hold

OEX Bull Put Credit Spread (note that we moved up the strikes)
STO '11 OEX Mar18 550 put
BTO '11 OEX Mar18 545 put - for a credit of 25 to 40 cents.  If this spread starts to fill for more than 40 cents credit, suspend any further fills on it and click-DOWN a strike to keep your credit between 25 and 40 cents.  It will take a DOWN day before this spread will start to fill for at least 25 cents credit, so please be patient;  let's wait for the market to come to us.  Make sure not to put spreads that have matching strike prices in the same account since the matching strikes will cancel each other out and you will end up with a 10 point wide spread, and our goal is to keep all of our OEX spreads 5 points wide.

SPY Bear Call Credit Spread
on hold

SPY Bull Put Credit Spread (note that we moved up the strikes)
STO '11 SPY Mar18 123 put
BTO '11 SPY Mar18 121 put - for a credit of 10 to 15 cents credit.  If this spread starts to fill for more than 15 cents credit, suspend any further fills on it and click-DOWN a strike to keep your credit between 10 and 15 cents.  If we are forced to click-down we'll hold onto all existing spreads.  It will take a strong DOWN day before this spread will start to fill for at least 10 cents credit, so please be patient;  let's wait for the market to come to us.  Make sure not to put spreads that have matching strike prices in the same account since the matching strikes will cancel each other out and you will end up with a 4 point wide spread, and our goal is to keep all of our SPY spreads 2 points wide.

Note:  If you are an auto-trade subscriber no action is require.  We've opened 2 positions of the RUT Mar 720/730 bull put spread and 1 position of the SPY Mar 120/122 bull put spread in your account last week (i.e. 3 of the targeted 5 trades per month that require maintenance, so we have 2 trades to go); we hope to open the final 2 pull put spread positions this week where one will be on the OEX.

Sunday, February 27, 2011

We had a few solid DOWN days last week allowing us to open some of our recommended March bull put spreads.  We are hopeful that we'll have more volatility this week to allow us to finish off collecting premium on our desired bull put spreads.

Q410 earnings season is coming to a close and the results have been solid where 71% of the S&P 500 companies have beat earnings estimates.  The following companies report earnings this week that are closely followed by investors:

Tues the 1st:  Hovnanian
Wed the 2nd:  BJ's Wholesale, Costco, Staples
Thu the 3rd:  Big Lots, Novell, Marvell

Let's look at the charts.  Below are the daily & weekly Dow Industrials charts showing that the Dow had a few strong DOWN days last week and then had an UP day on Friday on lower volume.  The A/D Line and On Balance Volume indicators pulled back a little, but continue to show strength.  The 8 day exponential moving average (EMA) remains above the 22 day EMA, telling us that the Dow still is in a confirmed UP trend. The 8/22 day EMA does a good job of providing short term trend trading signals.  On the potential downside if the DOW continues to pull back, there is a reasonable probability that the Dow will find support at its 50 day SMA near 11,800, as long as the Middle East crises doesn't spread much farther and that oil doesn't go much higher than $100/barrel.  If the Dow pulls back farther, there is a high probability that it will find support at its April high, 62% Fibonacci level, and just below its 100 day SMA and bottom of its 2 std. deviation channel near 11,250.  If the correction is severe from a new negative event, such as a spread of contagion to Saudi Arabia, there is a very high probability that the Dow will find support at 11,000 that represents a major psychological level, its most recent Nov low, and its 200 day SMA.  The 2nd chart down shows the Fibonacci retracements that provide a big-picture perspective and we can see that so far the Dow has not made it up to its 78% Fibonacci level of 12,500.

Below are the daily & weekly charts for the SPY, and ETF that tracks at 1/10th the value of the S&P 500 index, SPX.  The 2nd chart down is a weekly chart providing a big-picture view of the SPY showing Fibonacci Retracements with probable support and resistance levels. The 3rd chart down is the VIX Index representing the implied volatility of the S&P 500 index.  For more on how the American style options trade on the SPY please go here.  We can see that the SPY pulled back last week and then rebounded on low volume on Friday.  The A/D Line and  On Balance Volume indicators did pull back a little telling us that higher volume selling occurred last week. (i.e. institutions were selling some of their holdings which is bearish)  The 8/22 day EMA tells us that the SPY is still in a confirmed UP trend because the 8 day EMA remains above the 22 day EMA. If the SPY continues to pull back there is a reasonable probability that the SPY will find support at its 50 day SMA near 128, as long as the Middle East crises doesn't spread much farther and that oil doesn't go much higher than $100/barrel.  If the SPY pulls back farther, there is a high probability that it will find support at its 62% Fibonacci level and April/Nov high near 123.  If the market has a severe correction from a new, negative event there is a very high probability that the SPY will find support at its most recent Nov low and near its 200 day SMA at 118.  Looking at the 2nd chart down with the Fibonacci Retracements, the SPY successfully held above 130, the Aug 2008 high, as the market sold off, which so far is very bullish.  Looking at the implied volatility via the VIX (3rd chart shown) it popped up last week from an increase in unrest in the Middle East and fear that higher oil prices could derail a fragile US economy.  The market is also technically overbought and was in need of a pullback so some of this increase in the VIX is due to a fear that the pullback could be deep; moreover, if the VIX remains elevated it tells us that investors will sell some of their holdings more quickly if they deem it necessary.

Below is the daily QQQ, an ETF that tracks at 1/40th of the NASDAQ 100 Index - NDX, representing 100 of the largest non-financial companies, many in the technology sector.  We can see that the Q's pulled back like the other indexes. The thing that we need to watch is if investors will hold the Q's above 55, the Oct 2007 high; if they do, this will be a bullish signal.  If the correction is deeper, there is a high probability that it will find support at 52 near its most recent Nov low.  If the market and the Q's have a severe correction from a new negative event, there is a very high probability that it will find support at 50 representing the April high and the 200 day SMA.

Below is the daily S&P 100 large-cap index, OEX.  For more on how the American style options trade on the OEX please go here.  We can see that the OEX pulled back and then rebounded some on Friday.  Because the 8 day EMA remains above the 22 day EMA it tells us that the OEX is still in a confirmed UP trend.  If the OEX continues to pull back, there is a reasonable probability that it will find support at 575 representing the 62% Fibonacci level and the 50 day SMA.  If the pullback is deeper there is a high probability that it will find support at 553.5 representing the April and Nov highs, the 100 day SMA and the bottom of its 2 std. deviation channel.  If the correction is severe from a new negative event, there is a very high probability that the OEX will find support at its most recent Nov low and 200 day SMA near 530. 

Below is the daily IWM, an ETF that tracks at 1/10th the value of the Russell 2000 small cap index, RUT.  We can see that the IWM had a few strong DOWN days last week and then had an UP day on Friday on normal volume.  The 8/22 day EMA tells us that the IWM is still in a confirmed UP trend because the 8 day EMA remains above the 22 day EMA.  Assuming that the unrest in the Middle East doesn't spread to more large oil producing nations, this UP day last Friday on normal volume tells us that investors are still willing to take on more risk and that they might shake off the Middle East problems and drive the US markets higher.  Per potential downside, there is reasonable probability that it will find support at 79 representing its 50 day SMA, the last area of consolidation, and past resistance levels in Dec '07 and Oct '08.  If IWM continues to pull back there is better probability that it will find support at its January low of 77, as long as oil doesn't climb much higher than $100/barrel and the unrest doesn't spread to Saudi Arabia or other large oil producers.  If the correction is deeper there is a very high probability that the IWM will find support at 74 representing its 78% Fibonacci level and April high.  If the correction is severe from a new negative event, there is an extremely high probability that the IWM will find support at 70 representing a major psychological level, the consolidation period in October, and the 200 day SMA.  The 2nd chart down is a weekly view of the IWM showing Fibonacci Retracements and it shows that the RUT consolidated near 79 for 6 weeks, it started to rally again, and then had a DOWN week, but so far it held above 79. The 3rd chart down shows that the implied volatility (aka "fear") for the RUT popped up and if it stays elevated more money could flow out of the small caps over the next week.

Macro-Level, Fundamental View of US Economy's Underlying Health

Below are a selection of macroeconomic indicators to give us a big-picture, fundamental view of the health of the US economy.  If/when the US economy begins to weaken (we also will be watching corporate earnings) we'll be able to monitor the gradual deterioration of the economy and this information will help us  1) reduce our downside exposure by opening fewer bull put spreads, and being ultra-careful when we do open some; 2) trigger us to open a long term hedge to protect some/all of our bull put spreads; 3) alert us to possibly start opening bearish directional, speculative trades; and 4) tell us when it's time to move to the sidelines. 

Aruoba-Diebold-Scotti Business Conditions Index (ADS) -  The ADS Index is a forward looking, high-frequency (i.e. it's updated weekly) macro-level business conditions index comprising a dozen economic indicators that track the health of the US economy.

Conclusion for ADS Index:  The ADS Index climbed back near zero in Aug 2009 and has continued to bounce between -0.25 and +0.5 since then.  We show the -/+ 0.25 band with the blue area and when the economy is deemed "healthy" it's usually within this band.  As we can see, the ADS Index has been inside this band since Aug 2009 telling us that the economy is relatively healthy and should continue to expand.

Initial Unemployment Claims broke below 400k for the 2nd time in three weeks and fell from 413,000 to 391,000.  We continue to cross our fingers that this DOWN trend in initial unemployment claims is real and represents a breakthrough for the US economy as new claims were stuck between 450k and 470k for almost a year.  When initial unemployment claims drop below 400k, the economy will usually start to add at least 150k jobs monthly.  Economists usually monitor the 4 week moving average, the orange line, since the weekly reading is volatile. The 2nd chart down is the 4 week average going back to 1993 and shows how this indicator behaves during good times and bad.  Note that when the economy is expanding new claims are usually near 325k per month, and when it drops to 275k the economy is overheating.

The headline number for Durable Goods came in strong with 2.7% month-over-month growth for January, which was a solid result.  However, after stripping out the volatile transportation industry the number disappointed dropping 3.6% for the month.  Overall, the Briefing.com analysts were not alarmed after watching monthly trend data and believe that Durable Goods orders will continue to expand.

New Home Sales (red line) continue to be depressed as low priced distressed and foreclosed homes continue to flood the market and compete directly with newly constructed homes.  On the positive, however, sales of existing homes (green line) is looking better and is gradually improving, albeit in choppy fashion. The housing market will continue to be a drag on the US economy for many more quarters, if not years.

The S&P/Case-Shiller Home Price Index, using data through Dec 2010, shows that housing prices are contracting again.  However, this is not that surprising as stocks/commodities/housing/economies don't go straight up and a pullback like this is expected as a rebounding market will usually move in an Elliott Wave type of fashion.  With this said, if the pullback is too deep then all bets are off and the market under question, in this case housing, could fall farther.  Based on the economic data that we've been monitoring over the last 6 months, and assuming oil stays below $140/barrel, there is a high probability that housing will continue to rebound once this pullback is over.

Fourth Quarter Gross Domestic Product was revised down to 2.8% from 3.2%, which was a little disappointing. The 2nd chart down shows personal consumption, an important component of GDP, and this number was also revised down during this 2nd estimate of Q4 GDP, but it is moving in the right direction as shown by the trend on the chart.  Overall, the US economy is growing almost in the 3.0% plus GDP rate, which is classified as a somewhat healthy economy.

Corporate Earnings - Just about all S&P 500 companies have release Q410 earnings and 71% have beat analyst's consensus estimates, 9% met, and 20% missed.  The long-term average % of companies beating analyst's estimates is 62%, so Q410 earnings were very good.  One analyst noted that top line revenue growth was also looking very strong, which is great news as top line revenue has always been a point of concern.  However, another analyst noted that higher energy and commodity prices will eat into margins, and he believes that the current 2011 aggregate, estimated S&P 500 earnings of $93 to $100/share will probably be cut as 2011 progresses.  (if this is true the stock market will not be happy about this)  Analysts are expecting earnings to come in 36.3% higher than a year earlier, which is up from 31% at the start of Q410.  The currently estimated Q111 earnings growth rate for the S&P 500 companies is 13.2%.  Below is the weekly chart of the S&P 500 index, the same chart shown at the top of this advisory, and it shows analyst's projected 2011 aggregated S&P 500 earnings between $93 and $100/share, with a projected P/E ratio of 14 to 15, which would put the S&P 500 index between 1300 and 1500 by the end of 2011.  The S&P 500 is currently trading at a P/E multiple of 14.2 times a conservative, forward looking aggregate of $93/share.  (Data supplied by Thomson Reuters)

Conclusion from the Macro-level Fundamental View of US Economy's Health - The US economy's GDP is currently growing at the rate of 2.8%, and some economists believe that GDP growth will accelerate mid-year and be as high as 4.0% by the end of 2011.  We're also probably at an inflection point where the US economy will start to add appreciable jobs since the initial unemployment claims number is bouncing around 400k, and it came in at 391k last week;  when the new claims numbers are under 400k the economy will usually start to add 150k or more jobs monthly. 

Short-term to Intermediate-term (1 to 3 weeks) Sentiment and Volume Flow Analysis:  Below are a selection of Volume, Advance/Decline and other sentiment and breadth based indicators to help us gauge the strength of the prevailing trend and to predict the timing of a trend reversal.

Implied Volatility on the S&P 500 Index (VIX) -  We watch implied volatility (IV), also known as the "fear index", on the S&P 500 Index to help us gauge investor sentiment and to give us insight into the strength of the prevailing trend, if there is one, and the probability that the market will make big moves UP or DOWN. 

Conclusion for IV on the S&P 500 Index:  Implied volatility (i.e. fear) popped up last week from an increase in unrest in the Middle East and fear that higher oil prices could derail a fragile US economy.  The market is also technically overbought and was in need of a pullback, so some of this increase in the VIX is due to a fear that the pullback could be deep.  As long as the VIX remains elevated, we could have more selling.

The Big Picture from Investors Business Daily (IBD) -  IBD's outlook shows the market as "uptrend under pressure".  They show 4 distribution days each for the NASDAQ Composite, NYSE composite, and S&P 500.  It usually takes five distribution days, i.e. DOWN days on high volume, on three or more indexes for them to show that the market is in a correction.  During a correction, once the market has one or more follow-through days, i.e. UP days on strong volume, they will change their outlook from "market in correction" back to "market in confirmed up-trend".

Seasonality Influences -  The “Best 6 months” of the year effect runs from Nov through April.  If the market does well during the traditionally volatile September & October time frame, which it did, then the "best six months" seasonal effect is even more pronounced where the market will continue the UP trend through April. (this happened 85% of the time since 1920)

Market Action - In the last 4 trading days highly rated stocks that are followed by Investors Business Daily are opening UP, but by the end of the day investors are selling into the strength where the stock closes DOWN for the day.  Additionally, some highly rated stocks are "stalling" where the stock doesn't move but the volume is 2x to 3x normal volume telling us that institutions are selling some of their holdings.  Finally, on Friday last week we had an UP day, but it was on very low volume telling us that institutions were not participating in the buying.  Overall, this type of market action is negative and could be signal that more DOWN days are coming.

Advance Decline Volume Line on the NYSE Composite -  The volume behind the number of advancing stocks less the volume behind the number of declining stocks provides  broad insight into the strength of a developing trend or prevailing trend, and provides insightful prediction into the timing of a trend reversal. This indicator is traditionally classified as a breadth-based indicator. We monitor the 13 day SMA (blue line) on the A/D Volume Line looking for a positive slope (bullish) or negative slope (bearish), we monitor the blue MACD histogram, and look at the intermediate-term of the trend via the red MACD line crossing above or below the zero line. 

Conclusion from the A/D Volume Line:  The blue 13 day SMA line is sloping down, volatility is increasing where we are seeing larger swings on the A/D volume line, and we are seeing lower lows on the strong DOWN days demonstrating negative divergence.  (i.e. the stock market keeps climbing, but this breadth-based indicator is deteriorating)  The MACD also is showing a stronger bearish reading.  However, this is not a typical negative divergence chart pattern and most likely without the negative catalyst from the Middle East, this UP trend probably would have continued.

NYSE New Highs-New Lows Index -  This broad-based breadth indicator shows the daily new highs less the daily new lows on the NYSE, and it finally pulled back with last week's selling.  Up until this point it was not providing us any early negative divergence readings, telling us that this UP trend probably would have continued without the negative Middle East catalyst.

Below is a relative strength comparison of the Russell 2000 index versus the S&P 500 index (SPX).  We care about this because if the small cap stocks increase faster than the big caps, investors are feeling more comfortable with risk and more money will flow into all equities pushing up the entire market.  We can see that the speed at which the RUT moves as compared to the S&P 500 index is slowing down and if this downward slope continues, as shown with the black trend lines, it tells us that the market's UP trend will most likely pause to consolidate its gains.

Below is the daily chart of the Consumer Discretionary Select ETF - symbol XLY.  This fund comprises companies that make products that are not absolutely required to live, and are discretionary items such as high-end clothing, fast food, automobiles, and media types of products.  This sector tends to do well during the middle to late of an upswing in the economy, and gets devastated when the economy starts to sputter. We can see that this index had a few strong DOWN days similar to the other indexes, but what's interesting is that it also rebounded on Friday.  This tells us that investors are still confident in the strength of the US economy and believe that the economy will continue to expand even if we have higher oil prices, which is a bullish sign for the overall market.

Volume Flow Indicators -  Below is the 1.5 year chart using 1 day volume bars on the S&P 500 index.  The 1.5 year chart provides 3 to 5 weeks of predictive visibility.  We look at volume flow because it's one of the few ways to predict the strength of a developing trend, gauge the strength of an existing trend, and predict the timing of a trend reversal. 

Conclusion for the Volume Flow Indicators:  The primary SBV Oscillator for S&P 500 index just triggered for us to go short, but just barely.  However, because the sub-indexes are not that weak, we need to watch this for a few more days to validate this trigger.  Note the arrow at the top pointing to the red volume bars.  These bars are not that high telling us that the DOWN days last week were not on high volume telling us that institutions were not participating that much in the selling.  At the moment, and as long as the price of oil doesn't go much higher than $100/barrel, this chart is telling us that the market is going to shake off this pull back and might attempt to power higher.  For more on how to read these volume-based indicators please visit Primer on Trend and Trend Reversal Analysis using Volume Based Indicators.

Conclusion from the short-term to intermediate-term technical volume, advance/decline volume and sentiment based analysis:   As long as the Middle East tensions don't spread much farther and that oil stays below $100/barrel, this market might attempt to shakeoff this pullback and power higher.

Below is the economic calendar for the next 3 weeks:

The Week of Feb 28th:   This is a big week where all of this data is closely followed and can move the markets, especially the jobs numbers on Friday the 4th.  For more information on this economic calendar please go to: http://www.briefing.com/Investor/Public/Calendars/EconomicCalendar.htm.

The Week of Mar 7th:   Retail sales on Friday the 11th is closely followed and can move the markets.

The Week of Mar 14th:   This week takes us to the end of our March options.  The results from the Fed's meeting on Tues the 15th is closely followed and can move the markets, along with the Philly Fed number on Thur the 17th.

Overall prediction of where the market is heading in the next 2 to 3 weeks from all of the data analyzed above - updated on Feb 28th:   The market remains in a confirmed UP trend as the 8/22 EMAs have not yet had a bearish crossover. (i.e. the 8 day EMA crosses below the 22 day EMA)  We had a few strong DOWN days last week from escalation of Middle East unrest, but if oil stays below $100/barrel, we believe the pullback will be shallow and short lived because most economic and earnings data coming from the US have been positive.  So far the indexes have held above their respective 50 day SMAs, which is bullish.  If the correction continues and becomes more severe caused by, e.g. unrest spreading to large oil producing countries such as Saudi Arabia, there is a high probability that the major indices will find support at their respective April highs.  Once the correction is over, the market will most likely resume its UP trend and take out new highs through May.  Here is what we see that guides us to these predictions:  1) Corporate earnings continue to be strong and are on track to grow 36.3% in Q410 and 13.2% in Q111, and the S&P 500 index is estimated to hit an aggregate $93 to $100 of earnings in 2011, which will put the S&P 500 index between 1300 and 1500 by the end of 2011, using the projected P/E ratio of 14 to 15;  2) Half of the S&P 500 companies are expected to raise their dividends in 2011;  3) Just about all of the US macroeconomic indicators are trending UP;  4) The seasonal "market has its best 6 months between Nov and April" is in full swing, and it does even better when the market does well in Sep and Oct, as it did;   5) The FED continues to commit to follow through on QE2 (quantitative easing II) to buy $600B in US Treasuries and this will help keep the value of the US Dollar low, which will help grow exports and the overall US GDP - additionally it will help keep interest rates low and help instill investor confidence, which will help drive up stock prices; 6) One analyst noted that top line revenue growth is looking strong as companies release earnings; 7) the XLI Industrial select ETF, XLF Financial Select ETF, and XLY consumer Discretionary ETF bounced back like the other indexes on Friday telling us that money continues to flow into the market; 8) the small caps (RUT) and technology stocks (QQQ) are holding above key support levels; 9) The breadth based indicators, like $NYUD and $NYHL shown above, are not showing any early signs of negative divergence, which is bullish.

We recommend the following trades:

For the trades shown below, we recommend to use about 15% of your cash, in total, on the days that our recommended spreads are filling for within the recommended price range.  For more info on how much cash to use in a single day please visit the FAQ Page and read entry #45.

RUT Bear Call Credit Spread
on hold

RUT Bull Put Credit Spread
STO '11 RUT Mar18 730 put
BTO '11 RUT Mar18 720 put - for a credit of 45 to 90 cents credit.  If this spread starts to fill for more than 90 cents credit, suspend any further fills on it and click-DOWN a strike to keep your credit between 45 and 90 cents.  We will hold onto all existing spreads if we are forced to click down.  It will take a DOWN day before this spread will fill for at least 45 cents credit, so please be patient; let's wait for the market to come to us.

OEX Bear Call Credit Spread
on hold

OEX Bull Put Credit Spread
STO '11 OEX Mar18 545 put
BTO '11 OEX Mar18 540 put - for a credit of 25 to 40 cents.  If this spread starts to fill for more than 40 cents credit, suspend any further fills on it and click-DOWN a strike to keep your credit between 25 and 40 cents.  It will take a DOWN day before this spread will start to fill for at least 25 cents credit, so please be patient;  let's wait for the market to come to us.

SPY Bear Call Credit Spread
on hold

SPY Bull Put Credit Spread
STO '11 SPY Mar18 121 put
BTO '11 SPY Mar18 119 put - for a credit of 10 to 17 cents credit.  If this spread starts to fill for more than 17 cents credit, suspend any further fills on it and click-DOWN a strike to keep your credit between 10 and 17 cents.  If we are forced to click-down we'll hold onto all existing spreads.  It will take a strong DOWN day before this spread will start to fill for at least 10 cents credit, so please be patient;  let's wait for the market to come to us.

Note:  If you are an auto-trade subscriber no action is require.  We've opened 2 positions of the RUT Mar 720/730 bull put spread in your account last week (2 of the targeted 5 trades per month that require maintenance, so we have 3 trades to go)  and we hope to open the OEX and SPY bull put spreads this week.

Monday, February 21, 2011

The Feb cycle is complete and for the iron condors that we were able to open they were 100% profitable and brought in about 10%.  However, February was a difficult cycle to invest all of our cash in our desired "able to sleep at night" spreads because the market was continuously trending higher on tight candlesticks, below average volume and on relatively low volatility.  For the auto-trade accounts, because we were able to invest only half of the available cash, i.e. a lot of the cash was sitting idle, when taking into account the idle and reserve cash the return was closer to 3.5%.  Regardless, we made some money this month and it's time to move on to March.

The market continues to trend higher and this UP trend is not yet over as we wait for a negative, external event to derail the UP trend.  As of this writing the DOW Futures is down over 120 points, so Monday most likely will be a strong DOWN day, and it will take a few days to see if it's the beginning of a long needed correction.

Q410 earnings season continues and the following companies report earnings this week that are closely followed by investors:

Tues the 22nd:  Barnes & Noble, Home Depot, Macy's, Office Depot, Wal-Mart, Hewlett Packard
Wed the 23rd:  Dollar Tree, TJX, Toll Brothers, Priceline.com
Thu the 24th:  General Motors, Kohl's, Olympic Steel, Sears Hldg., Target, Applied Materials, Autodesk, Salesforce.com
Fri the 25th:  JC Penney

Let's look at the charts.  Below are the daily & weekly Dow Industrials charts showing that the Dow continues to trend higher, and the pace of the uptrend recently accelerated.  The A/D Line and On Balance Volume indicators continue to show considerable strength.  The 8 day exponential moving average (EMA) remains above the 22 day EMA, telling us that the Dow still is in a confirmed UP trend. The 8/22 day EMA does a good job of providing short term trend trading signals.  Many traders will continue to "ride and drive the trend" and now have their sights set on 12,500 representing a psychological level and the 78% Fibonacci retracement level; once the Dow hits 12,500 many traders will take some or most of their profits.  On the potential downside when the DOW finally pulls back to take a breather, there is a reasonable probability that the Dow will find support at its 50 day SMA near 11,800, as long as minimal negative news surfaces about the US, Europe, Asia or the Middle East.  If the Dow pulls back farther, there is a high probability that it will find support at its April high, 62% Fibonacci level, 100 day SMA and the bottom of its 2 std. deviation channel near 11,250.  If the correction is severe from a new negative event, there is a very high probability that the Dow will find support at 11,000 that represents a major psychological level, its most recent Nov low, and it's near the 200 day SMA.  The 2nd chart down shows the Fibonacci retracements that provide a big-picture perspective and we can see how the Dow will now probably attempt to climb to its 78% Fibonacci level at 12,500.

Below are the daily & weekly charts for the SPY, and ETF that tracks at 1/10th the value of the S&P 500 index, SPX.  The 2nd chart down is a weekly chart providing a big-picture view of the SPY showing Fibonacci Retracements, probable support and resistance levels and projected price targets based on estimated 2011 aggregate earnings. The 3rd chart down is the VIX Index representing the implied volatility of the S&P 500 index.  For more on how the American style options trade on the SPY please go here.  We can see that the SPY continues to trend higher, it successfully broke above the Aug 2008 high of 130.5, and it's demonstrating a lot of strength.  The A/D Line and  On Balance Volume indicators continue to look strong. The 8/22 day EMA tells us that the SPY is still in a confirmed UP trend because the 8 day EMA remains above the 22 day EMA.  Traders now have the SPY at 138 in their sights as this represents the 78% Fibonacci level, and most likely traders will successfully drive the SPY up to this level.  Once the SPY pulls back to take a well needed rest, there is a reasonable probability that the SPY will find support at its 50 day SMA near 127, as long as minimal negative news surfaces about the US, Europe, Asia or the Middle East.  If the SPY pulls back farther, there is a high probability that it will find support at its 62% Fibonacci level and April/Nov high near 123.  If the market has a severe correction from a new, negative event there is a very high probability that the SPY will find support at its most recent low and near its 200 day SMA at 118.  Looking at the 2nd chart down with the Fibonacci Retracements, the SPY remains solidly above the 62% level of 123 so the SPY will most likely remain above this level now.  We show the estimated SPY price target range of 130 to 150 based on analyst earning's estimates for 2011.  Looking at the implied volatility via the VIX (3rd chart shown) it deflated back to 15.5 telling us that more cash will probably move into the markets.  However, the VIX is hitting support at 15.5, telling us that investors feel that the US stock market is probably overextended and a major selloff could hit at any time.

Below is the daily QQQ, an ETF that tracks at 1/40th of the NASDAQ 100 Index - NDX, representing 100 of the largest non-financial companies, many in the technology sector.  We can see that the Q's continue to trend higher, after pulling back and lagging the market in late January.  The thing that we'll watch when the market eventually pulls back is if investors hold the Q's above 55, the Oct 2007 high and just below the 50 day SMA;  if they do, this will be a very bullish signal.  If the correction is deeper, there is a high probability that it will find support at 52 near its most recent Nov low.  If the market and the Q's have a severe correction from a new negative event, there is a very high probability that it will find support at 50 at the April high and near its 200 day SMA.

Below is the daily S&P 100 large-cap index, OEX.  For more on how the American style options trade on the OEX please go here.  We can see that the OEX continues to trend higher and looks strong.  Because the 8 day EMA remains above the 22 day EMA it tells us that the OEX is still in a confirmed UP trend.  The next target for the OEX is 605 representing the Aug 2008 high, and there is a good chance that short term traders will "ride and drive" the OEX up to 605 before dumping some or most of their long holdings.  When the OEX eventually pulls back, there is a reasonable probability that it will find support at 575 representing the 62% Fibonacci level and the 50 day
SMA.  If the pullback is deeper there is a high probability that it will find support at 553.5 representing the April and Nov highs, the 100 day SMA and the bottom of its 2 std. deviation channel.  If the correction is severe from a new negative event, there is a very high probability that the OEX will find support at its most recent Nov low and 200 day SMA near 530. 

Below is the daily IWM, an ETF that tracks at 1/10th the value of the Russell 2000 small cap index, RUT.  We can see that the IWM was getting toppy & choppy and consolidating, but then it shook off the weakness and started to head higher again.  Assuming that the unrest in the Middle East doesn't derail the rally, traders will probably push the small caps up to the pre-recession high near 85 before taking some or most of their profits.  When the IWM eventually pulls back to take a rest there is a reasonable probability that it will find support at its January low, and just below its 50 day SMA near 77, as long as minimal negative news surfaces about the US, Europe and Asia economies or unrest in the Middle East.  If the correction is deeper there is a very high probability that the IWM will find support at 74 representing its 78% Fibonacci level, April high, 100 day SMA and the bottom of its 2 std. deviation channel.  If the correction is severe from a new negative event, there is an extremely high probability that the IWM will find support at 70 representing a major psychological level, the consolidation period in October, and the 200 day SMA.  The 2nd chart down is a weekly view of the IWM showing Fibonacci Retracements and it shows that the RUT consolidated near 79 for 6 weeks, and now is leading the market higher again. The 3rd chart down shows that the implied volatility (aka "fear") for the RUT has dropped back down to 22, but it's hitting support at this level and remaining slightly elevated telling us that investors are nervous that the market is overextended and that the small cap stocks have run too far.

Macro-Level, Fundamental View of US Economy's Underlying Health

Below are a selection of macroeconomic indicators to give us a big-picture, fundamental view of the health of the US economy.  If/when the US economy begins to weaken (we also will be watching corporate earnings) we'll be able to monitor the gradual deterioration of the economy and this information will help us  1) reduce our downside exposure by opening fewer bull put spreads, and being ultra-careful when we do open some; 2) trigger us to open a long term hedge to protect some/all of our bull put spreads; 3) alert us to possibly start opening bearish directional, speculative trades; and 4) tell us when it's time to move to the sidelines. 

Retail Sales rose a modest 0.3% in January.  Core retail sales (not shown) that exclude volatile sales from auto & parts dealers, gasoline stations and building material suppliers also grew 0.3% in January and came in slightly below expectations.  Overall, the results were good and tell us that consumers are continuing to open their wallets and this is important since consumer spending represents about 2/3rds of the US economy.

Initial Unemployment Claims increased from 385k to 410k.  Even though this number increased in January, there is still a good chance that this new DOWN trend in new jobless claims is real and represents a breakthrough for the US economy as new claims have been stuck between 450k and 470k for almost a year.  When initial unemployment claims drop below 400k, the economy will usually start to add at least 150k jobs monthly. Economists usually monitor the 4 week moving average, the orange line, since the weekly reading is volatile. The 2nd chart down is the 4 week average going back to 1992 showing how this indicator behaves during good times and bad.  Note that when the economy is expanding new claims are usually near 325k per month, and when it drops to 275k the economy is overheating.

The Philly Fed Manufacturing Index that measures business activity in Pennsylvania, Northern New Jersey and Delaware increased dramatically from 19.3 to 35.9.  This index, along with its sub-indexes show that manufacturing activity within this region is expanding nicely.

The Empire State Manufacturing Survey that measures the level of business activity in the State of New York continued to climb, coming in with solid results.

The Conference Board Leading Economic Indicator (LEI) -  The Conference Board is a highly respected independent economic research house.  One of their closely watched indicators is the Leading Economic Indicator, or LEI, which comprises 10 economic components.  For more on this indicator please visit the Learning Center.

Conclusion for LEI Index:  The LEI for the U.S. remained about flat from Dec to Jan coming in at 112.3.  According to Ataman Ozyildirim, economist at The Conference Board, "with January’s very slight increase, following two large gains in Nov and Dec, the U.S. LEI is still pointing to economic expansion in the coming months. Falling housing permits and weakening labor market indicators were barely offset by the continued positive contributions of the financial components. The LEI remains on a rising trend with its growth rate picking up in recent months. However, current economic conditions, as measured by the coincident economic index (CEI), while improving slowly, remains weak."   According to Ken Goldstein, economist at The Conference Board, "the economy gained some momentum in late fall, and the latest data suggest that trend will continue. The cumulative change in the U.S. LEI over the last six months is a sharp 3.0 percent, signaling continued expansion"

Business Inventories look good and continue to grow as manufacturers believe that demand for their products will continue to rise.  Moreover, the 2nd chart is Business inventories-to-Sales ratio and it shows that inventories are lean and manufacturers will have no choice but to increase manufacturing output as demand rises. (which is good)  The healthy range for the Business inventories-to-Sales ratio is any reading below 1.30 and the current reading is below this level.

Industrial Production, an index that measures the physical output of the nation's factories, mines and utilities declined 0.1% in January.  More importantly, however, the manufacturing component that strips out data from the mines and utilities increased by 0.3%, which was a solid number and tells us that manufacturing activity within the US continues to expand.  The 2nd chart down shows capacity utilization and it continues to move in the right direction staying relatively flat in January from the December reading of 76.1%.  Overall, it was a good report.

The Consumer Price Index is a measure of the price level of a fixed market basket of goods and services purchased by consumers, and is the most widely cited inflation indicator.  Excluding volatile food and energy costs, core prices increased a modest 0.2%.  This is a good reading telling us that general inflation is very low and deflation is also not a problem, which allows the Fed to keep short term interest rates near zero. (food inflation is another problem and not addressed here)

Housing Starts & Building Permits are still at historic low levels and this sector is still in a recession.  It's going to take many more quarters if not years to see an improvement in this sector, and it will continue to put a drag on the overall economy.

Corporate Earnings - As of Friday, Feb 18th, 417 S&P 500 companies have release Q410 earnings and 71% have beat analyst's consensus estimates and 20% have missed.  The long-term average % of companies beating analyst's estimates is 62%.  One analyst noted that top line revenue growth was also looking very strong, which is great news as top line revenue has always been a point of concern.  Analysts are now expecting earnings to come in 36.3% higher than a year earlier, which is up from 31% at the start of Q410.  The currently estimated Q111 earnings growth rate for the S&P 500 companies is 13.2%.  Below is the weekly chart of the S&P 500 index, the same chart shown at the top of this advisory, and it shows analyst's projected 2011 aggregated S&P 500 earnings between $93 and $100/share, with a projected P/E ratio of 14 to 15, which would put the S&P 500 index between 1300 and 1500 by the end of 2011.  The S&P 500 is currently trading at a P/E multiple of 14.2 times a conservative, forward looking aggregate of $93/share.  (Data supplied by Thomson Reuters)

Conclusion from the Macro-level Fundamental View of US Economy's Health - The US economy's GDP is currently growing at the rate of 3.2%, and many economists believe that growth will be closer to 3.7% by the end of 2011.  We're also probably at an inflection point where the US economy will start to add appreciable jobs since the initial unemployment claims number is bouncing around 400k, and it came in at 383k last week;  when the new claims numbers are under 400k the economy will usually start to add 150k or more jobs monthly. 

Short-term to Intermediate-term (1 to 3 weeks) Sentiment and Volume Flow Analysis:  Below are a selection of Volume, Advance/Decline and other sentiment and breadth based indicators to help us gauge the strength of the prevailing trend and to predict the timing of a trend reversal.

Implied Volatility on the S&P 500 Index (VIX) -  We watch implied volatility (IV), also known as the "fear index", on the S&P 500 Index to help us gauge investor sentiment and to give us insight into the strength of the prevailing trend, if there is one, and the probability that the market will make big moves UP or DOWN. 

Conclusion for IV on the S&P 500 Index:  Implied volatility (i.e. fear) has deflated in the last few weeks telling us that more money will probably continue to flow into stocks until a new negative new hit the newswire.  However, the VIX is hitting support at 15.5, telling us that investors feel that the US stock market is probably overextended and a major selloff could hit at any time.

The Big Picture from Investors Business Daily (IBD) -  IBD's outlook shows the market in a "confirmed uptrend".  They show 4 distribution days for the NASDAQ Composite Index, 3 distribution days for the NYSE composite index, and 2 distribution days for the S&P 500 index.  It usually takes five distribution days, i.e. DOWN days on high volume, on three or more indexes for them to show that the market is in a correction.  During a correction, once the market has one or more follow-through days, i.e. UP days on strong volume, they will change their outlook from "market in correction" back to "market in confirmed up-trend".

Seasonality Influences -  The “Best 6 months” of the year effect runs from Nov through April.  If the market does well during the traditionally volatile September & October time frame, which it did, then the "best six months" seasonal effect is even more pronounced where the market will continue the UP trend through April. (this happened 85% of the time since 1920)

Market Action - The market is opening each morning with a neutral to slightly positive Dow futures, but near the close of the trading day investors/traders are jumping in helping the major indices close near their respective highs of the day, which is bullish.

Advance Decline Volume Line on the NYSE Composite -  The volume behind the number of advancing stocks less the volume behind the number of declining stocks provides  broad insight into the strength of a developing trend or prevailing trend, and provides insightful prediction into the timing of a trend reversal. This indicator is traditionally classified as a breadth-based indicator. We monitor the 13 day SMA (blue line) on the A/D Volume Line looking for a positive slope (bullish) or negative slope (bearish), we monitor the blue MACD histogram, and look at the intermediate-term of the trend via the red MACD line crossing above or below the zero line. 

Conclusion from the A/D Volume Line:  The blue 13 day SMA line was "flat lined" for a few weeks telling us that the current UP trend was getting tired, but now it's finding energy again and is trending higher again.  We were also seeing larger swings on the A/D volume line (i.e. higher volatility) with lower highs and lower lows, demonstrating negative divergence.  (i.e. the stock market keeps climbing, but this breadth-based indicator is deteriorating)  But now the market is back to higher volume on advancing stocks as compared to declining stocks, which is bullish again. The MACD blue histogram is trending UP where it's slightly positive, telling us that the market is finding more bullish energy again.

NYSE New Highs-New Lows Index -  This broad-based breadth indicator shows the daily new highs less the daily new lows on the NYSE, and it's definitely showing strength again.  The MACD histogram is also bullish telling us that the market is still in a confirmed UP trend and more cash will most likely flow into the market driving stocks higher.

The McClellan Oscillator on the NYSE Composite, shown below, (middle chart) represents a broad-based advance/decline based indicator.  We can see that it is above the zero line, which is bullish for the overall market.  The Summation Index (bottom chart) represents the intermediate-term horizon and it's recently picked up some steam, telling us that the rally is still intact until it's derailed from an external negative event.

Below is a relative strength comparison of the Russell 2000 index versus the S&P 500 index (SPX).  We care about this because if the small cap stocks increase faster than the big caps, investors are feeling more comfortable with risk and more money will flow into all equities pushing up stocks.  The speed at which the RUT moves as compared to the S&P 500 index was slowing down, but recently investors shifted back to small caps and are pumping more money into small caps as compared to the big caps.  This tells us that this UP trend will continue a while longer.

Below is the XLF, Financial Sector ETF and we can see that it rallied in the last two weeks and has taken out a new high above the April 2010 high, which is very bullish.  This tells us that investor optimism continues to remain high on the financial and banking sector.  The recent broad-market rally has been boosted by this run-up in the financials.

Below is the daily chart of SOX Semiconductor Index and we can see that it continues to take out new highs.  We watch the SOX because it's a broad-based indicator for the health of the US economy because a very large % of products that can be purchased by consumers have some form of semiconductors in them.  Moreover, when high tech stocks/indexes lead the rally, the rally will most likely continue.  Alternatively, when tech stocks suddenly stop leading the rally, the broad market will eventually pull back.

Below is the daily chart of the Consumer Discretionary Select ETF - symbol XLY.  This fund comprises companies that make products that are not absolutely required to live, and are discretionary items such as high-end clothing, fast food, automobiles, and media types of products.  This sector tends to do well during the middle to late of an upswing in the economy, and gets devastated when the economy starts to sputter. We can see that this index was trading sideways and then recently shot up and and has been taking out new highs.  This tells us that the "risk trade" is "on" as investors are feeling comfortable to take-on more risk.

Below is the daily chart of the Select Industrials ETF - symbol XLI.  This fund comprises industrial conglomerates within aerospace & defense, machinery, air freight & logistics, road & rail, commercial services & supplies, electrical equipment, construction & engineering, building products, airlines and trading companies & distributors.  Because the industrial sector continues to show strength and that it's broad-based and is highly correlated to the overall health of the US economy, it tells us that this rally is going to last a little while longer.

Volume Flow Indicators -  Below are the 1.5 year charts using 1 day volume bars on the S&P 500 and Russell 2000 indexes.  The 1.5 year chart provides 3 to 5 weeks of predictive visibility.  We look at volume flow because it's one of the few ways to predict the strength of a developing trend, gauge the strength of an existing trend, and predict the timing of a trend reversal. 

Conclusion for the Volume Flow Indicators:  The primary SBV Oscillator for S&P 500 index is telling us to stay long and that it'll probably "grind higher" for a few more weeks.  The chart for the S&P 100 index (not shown) looks similar to the chart for the S&P 500 index and it's telling us to stay long.  The primary SBV Oscillator for the Russell 2000 triggered several weeks ago telling us to go to cash, or go short, but it recently moved back to "go long".  Usually when we see a chart like this where it didn't have a proper pullback, it's not advisable to go long until the SBV Oscillator is firmly back above the red trigger line and the sub-indexes also need to show reasonable strength, and right now we are seeing sufficient bullish triggers for the RUT to go long again...but we need to be careful as we didn't have a proper pullback.  For more on how to read these volume-based indicators please visit Primer on Trend and Trend Reversal Analysis using Volume Based Indicators.

Conclusion from the short-term to intermediate-term technical volume, advance/decline volume and sentiment based analysis:   The big cap stocks and small cap stocks are back in a confirmed UP trend.  This tells us that this rally will most likely run for at least a few more weeks, barring any new and unexpected negative news events. 

Below is the economic calendar for the next 4 weeks:

The Week of Feb 21st:   This week is somewhat quiet other than Durable Goods on Thur the 24th, which is closely followed and can move the markets.  However, if Initial claims come in below 400k, this will help fuel the market for further gains. For more information on this economic calendar please go to: http://www.briefing.com/Investor/Public/Calendars/EconomicCalendar.htm.

The Week of Feb 28th:   This is a big week where all of this data is closely followed and can move the markets, especially the jobs numbers on Friday the 4th.

The Week of Mar 7th:   Retail sales on Friday the 11th is closely followed and can move the markets.

The Week of Mar 14th:   This week takes us to the end of our March options.  The results from the Fed's meeting on Tues the 15th is closely followed and can move the markets, along with the Philly Fed number on Thur the 17th.

Overall prediction of where the market is heading in the next 2 to 3 weeks from all of the data analyzed above - updated on Feb 21st:   The market continues to remain in a confirmed UP trend and this UP trend will probably continue for several more weeks  until a negative catalyst derails it.  So far the unrest in the Middle East has been shrugged off by investors and most data coming from the US has been positive.  The market is in need of a pullback, which would be healthy, but it will be purely technical in nature.  When we finally have a correction there is a reasonable probability that the pull-back will be shallow and the major indexes will find support at their respective 50 day SMAs.  If the correction is more severe caused by a new and unexpected negative event, (e.g. democratic unrest/contagion spreading to large oil producing countries such as Saudi Arabia) there is a high probability that the major indices will find support at their respective April highs.  Once the correction is over, and it will probably be short lived, the market will most likely resume its UP trend and take out new highs through May.  Here is what we see that guides us to these predictions:  1) Corporate earnings continue to be strong and are on track to grow 36.3% in Q410 and 13.2% in Q111, and the S&P 500 index is estimated to hit an aggregate $93 to $100 of earnings in 2011, which will put the S&P 500 index between 1300 and 1500 by the end of 2011, using the projected P/E ratio of 14 to 15;  2) Half of the S&P 500 companies are expected to raise their dividends in 2011;  3) Just about all of the US macroeconomic indicators are trending UP;  4) The seasonal "market has its best 6 months between Nov and April" is in full swing, and it does even better when the market does well in Sep and Oct, as it did;   5) The FED continues to commit to follow through on QE2 (quantitative easing II) to buy $600B in US Treasuries and this will help keep the value of the US Dollar low, which will help grow exports and the overall US GDP - additionally it will help keep interest rates low and help instill investor confidence, which will help drive up stock prices; 6) One analyst noted that top line revenue growth is looking strong as companies release earnings; 7) the XLI Industrial select ETF, XLF Financial Select ETF, and XLY consumer Discretionary ETF are looking strong telling us that money continues to flow into the market and this rally is not yet over. 8) the small caps (RUT) and technology stocks (QQQ) suddenly regained strength and are leading the market again;  9) the market is very overextended and is in need of a technical correction.

We recommend the following trades:

RUT Bear Call Credit Spread
on hold

RUT Bull Put Credit Spread
STO '11 RUT Mar18 730 put
BTO '11 RUT Mar18 720 put - for a credit of 55 to 95 cents credit.  If this spread starts to fill for more than 95 cents credit, suspend any further fills on it and click-DOWN a strike to keep your credit between 55 and 95 cents.  We will hold onto all existing spreads if we are forced to click down.  It will take a stronger DOWN day before this spread will fill for at least 55 cents credit, so please be patient; let's wait for the market to come to us.

OEX Bear Call Credit Spread
on hold

OEX Bull Put Credit Spread
STO '11 OEX Mar18 545 put
BTO '11 OEX Mar18 540 put - for a credit of 25 to 40 cents.  If this spread starts to fill for more than 40 cents credit, suspend any further fills on it and click-DOWN a strike to keep your credit between 25 and 40 cents.  It will take a solid DOWN day before this spread will start to fill for at least 25 cents credit, so please be patient;  let's wait for the market to come to us.

SPY Bear Call Credit Spread
on hold

SPY Bull Put Credit Spread
STO '11 SPY Mar18 121 put
BTO '11 SPY Mar18 119 put - for a credit of 12 to 17 cents credit.  If this spread starts to fill for more than 17 cents credit, suspend any further fills on it and click-DOWN a strike to keep your credit between 12 and 17 cents.  If we are forced to click-down we'll hold onto all existing spreads.  It will take a strong DOWN day before this spread will start to fill for at least 12 cents credit, so please be patient;  let's wait for the market to come to us.

Note:  If you are an auto-trade subscriber no action is require

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