Trading | January 14, 2022

Weekly Trader’s Outlook

Fed policy, interest rates and inflation metrics keep equity markets on edge.

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

Weekly Market Review:

Earnings Summary

The regular Q4 earnings season begins to really ramp up next week. This week, 5 S&P 500 companies reported Q4 earnings and 4 of them beat consensus EPS expectations. A detailed earnings calendar can be found by logging into Schwab.com and selecting Research>Calendar>Earnings.

Overall, 26 (5%) of the companies in the S&P 500 have reported Q4 results. Below are the aggregate beat rates relative to the final results from recent quarters.

Quarter       EPS beats      Rev beats

Q4 ’21           81%                  73%

Q3 ‘21              82%                  68%

Q2 ‘21              86%                  83%

Q1 ‘21              87%                  72%

Q4 ’20              78%                  69%     

Q3 ‘20              84%                  74%

Q2 ‘20              85%                  65%

Q1 ‘20              65%                  59%

Q4 ’19              74%                  64%     

Q3 ‘19              78%                  58%

Q2 ‘19              76%                  56%

Q1 ‘19              77%                  57%

Q4 ’18              73%                  60%     

Q3 ’18              82%                  61%     

Q2 ‘18              84%                  72%

Q1 ‘18              81%                  74%

Average          79%                  66%

From a growth standpoint, Q4 earnings are +17.9% y/o/y so far versus the +21% estimate when the quarter ended. Q4 revenue is +12.8% y/o/y so far versus the +13% estimate when the quarter ended. This compares to actual growth of +39.1% and +17.4% respectively in all of Q3.

Economics Recap

Better (or higher) than expected:

  • Wholesale Inventories for Nov: +1.4% vs. +1.2% est
  • NFIB Small Business Optimism Index for Dec: 98.9 vs. 98.7 est
  • Producer Price Index (PPI) for Dec: +0.2% vs. +0.4% est

On Target:

  • Core PPI for Dec: +0.5% vs. +0.5% est
  • Business Inventories for Nov: +1.3% vs. +1.3% est

Worse (or lower) than expected:

  • Treasury Budget for Dec: -$21.3B v. -$5.0B est
  • Consumer Price Index (CPI) for Dec: +0.5% vs. +0.4% est
  • Core CPI for Dec: +0.6% vs. +0.5% est
  • Initial (weekly) Jobless Claims: 230k vs. 200k est
  • Retail Sales for Dec: -1.9% vs. -0.1% est
  • Import Prices for Dec: -0.2% vs. +0.2% est
  • Export Prices for Dec: -1.8% vs. +0.3% est
  • Industrial Production for Dec: -0.1% vs. +0.2% est
  • Capacity Utilization for Dec: 76.5% vs. 77.0% est
  • University of Michigan Consumer Sentiment for Jan: 68.8 vs. 70.0 est

This was a busy week for economic data, and there were plenty of disappointments across the board. The headline CPI (+7.0% y/o/y) was the highest since June 1982. It is also well above the 4.7% y/o/y increase in earnings reported last week. However, as we’ve seen throughout most of 2021, the y/o/y change is being exaggerated by abnormally low comparison numbers. In December 2020 the economy was not yet fully open. As shown below (yellow line), at +5.5%, the y/o/y change in core inflation (ex-food and energy) was definitely higher, but if you remove the 2020 dip and follow the longer-term trend, it is a somewhat more gradual increase from 2019 (red line). If you extrapolate the pre-pandemic trend, the increase from the December 2020 theoretical level (if there had been no pandemic) would be about +3.6%. But even that is a 10-year high and well above the Fed’s 2% target.

CPI

Source: Bloomberg L.P.

Past performance is no guarantee of future results.

Also notable this week was the headline PPI (+9.7% y/o/y) which was one tick below the November level, but November was a multi-decade high so the decrease is negligible. Since the PPI measures the price of raw materials before they become consumer goods, this modest decrease could imply that inflation has peaked and that could mean a slightly lower CPI next month. I emphasize the word “could”, because one data point does not make a trend.

Finally, retail sales were also very weak in December. While this implies not only that consumers probably shopped early for Christmas because they were worried about inventory shortages, it also likely means that Inflation has finally reached a point where it is impacting consumer behavior, not just consumer sentiment.

Market Performance YTD

Here is the 2022 YTD (versus 2021 full-year) performance of the market broken down by the 11 market sectors (as of the close on 1/13/22):

                                      2022 YTD                     2021 Final                 Category

  1. Energy                         +13.6%                         +47.7%                         Defensive
  2. Financials                     +5.5%                           +32.5%                         Cyclical
  3. Industrials                     +0.6%                           +19.4%                         Cyclical
  4. Cons Staples                -0.2%                            +15.6%                         Defensive
  5. Materials                       -1.2%                            +25.0%                         Cyclical
  6. Utilities                         -2.4%                            +14.0%                         Defensive
  7. Communications Svc  -2.7%                            +20.5%                         Defensive
  8. Consumer Disc             -3.6%                            +23.7%                         Cyclical
  9. Healthcare                    -4.8%                            +24.2%                         Defensive
  10. Info Tech                       -5.6%                            +33.4%                         Cyclical
  11. Real Estate                   -5.7%                            +42.5%                         Cyclical

Source: Bloomberg L.P.

Past performance is no guarantee of future results.

Here is the 2022 YTD (versus 2021 full-year) performance of the major U.S. equity indices (as of the close on 1/13/22):       

                                                       2022 YTD      2021 Final     Forward P/E Ratio     

  • S&P 500 (SPX)                             -2.2%                +26.9%                         21.2                 
  • Nasdaq Composite (COMPX)   -5.3%                +21.4%                         30.1
  • Dow Industrials (DJI)                 -0.6%                +18.7%                         19.0
  • Russell 2000 (RUT)                    -3.8%                +13.7%                         24.2

 

Technicals

The SPX was down about 18 points through Thursday (1/13) and another 20 points or so as I’m writing this (mid-day Friday 1/14). With the VIX up nearly 2 full points in the same timeframe, I think it’s safe to say that last week’s outlook of Moderately Bearish and more Volatile, was on the mark. That’s especially true given that the top-to-bottom intraday range in the SPX was more than 160 points overall, as reflected by the long candles (and long wicks) shown in the chart below.

As you can see, the SPX has been both above and below the 50-day SMA (currently 4,680) this week, and there isn’t much technical support until it falls back down to the 100-day SMA (4,574). That would represent a -4.6% move from the top. And while it may not come into play anytime soon, the January 3rd record close (4,796) remains as the upside resistance level.

SPX

Source: StreetSmart Edge®

Past performance is no guarantee of future results.

Option Volumes:

After 2 weeks of trading, January option volume is averaging 40.7M contracts per day. That is above the final December level of 38.7M, but below the January 2021 level of 44.4M contracts per day. As a reminder, November’s 45.2M level set a new record as the busiest month of trading in the history of the options industry.

Open Interest:

OI Change:

The following data comes from the Chicago Board Options Exchange (Cboe) where about 98% of all index options, about 20% of all Exchange Traded Product (ETP) options, and about 15% of all equity options are traded:

In reviewing the VIX OI Change for the past week I observed the following:

  • VIX call OI was +4.9%              
  • VIX put OI was +4.3%              

Historically, the daily change in the VIX and the SPX have been opposite each other about 80% of the time. These changes reflect a very small bias toward the call side, so I see the VIX OI Change as moderately bearish for the market in the near-term.   

In reviewing the SPX OI Change for the past week I observed the following:

  • SPX call OI was +2.5%
  • SPX put OI was +1.5%             

While SPX volume tends to be mostly institutional hedging, these changes reflect a small bias toward the call side, so I see the SPX OI Change as moderately bullish for the market in the near-term. 

In reviewing the ETP OI change (which includes SPY, QQQ, DIA & IWM) for the past week I observed the following:

  • ETP call OI was+3.5%              
  • ETP put OI was +2.9%            

The aggregate changes in Exchange Traded Products reflect a very small bias toward the call side, so I see the ETP OI Change as moderately bullish for the market in the near-term.

In reviewing the Equity OI Change for the past week I observed the following:

  • Equity call OI was +2.1%                      
  • Equity put OI was +2.1%                       

Equity volume tends to have a large retail component to it. These changes reflect no bias toward the call or put side, so I see the Equity OI Change as neutral for the market in the near-term.

OI Participation

Index OI Participation is +2.2% versus 2021 levels, so I see it as moderately bullish in the long-term.

Equity/ETF OI Participation is +10.8% versus 2021 levels, so I see it as bullish in the long-term.

Open Interest Put/Call Ratios (OIPCR):

The VIX OIPCR is down 2 ticks to 0.53 versus 0.55 last week. This ratio tends to move in the same direction as the VIX index, so this move is quite inconsistent with the VIX, which was +1.55 (+8.3%) over the last 4 sessions. This downtick likely implies that participants may be expecting the VIX to continue to trend higher over the next few days. As a result, I see the VIX OIPCR as moderately bearish in the very near-term for the markets. This ratio is now down 27 ticks in the last 5 weeks and is also well below the 200-day SMA of 0.64. As a result, I see it as moderately bearish in the long-term for the markets.

The SPX OIPCR is up 2 ticks to 2.19 versus 2.17 last week. This ratio also tends to move in the same direction as the SPX, so this uptick is also inconsistent with the SPX, which has fallen 18.00 points (-0.4%) over the last 4 sessions. As a result, it likely indicates that SPX option traders (who are almost entirely institutional) could be expecting more modest declines in the SPX next week. Therefore, I see the SPX OIPCR as moderately bearish in the near-term for the market. This ratio is now 23 ticks below its mid-September high and just below the 200-day SMA of 2.21. I see it as neutral in the long-term.

The normally very stable Equity OIPCR is unchanged again at 0.78 versus 0.78 last week. This ratio remains 2 ticks above its lowest level since mid-July. At this level it implies that equity option traders (which includes a lot of retail traders) remain about as bullish as they have been for the past 3 weeks, though less bullish than in Q1 of last year. I see the Equity OIPCR as moderately bullish in the near-term for the market. This ratio remains very close to the 200-day SMA (currently 0.77), so I see it as neutral in the long-term.

Cboe Volume Put/Call Ratios (VPCR):

The Cboe VIX VPCR has been mostly neutral this week. The 0.74 reading on Thursday (1/13) was neutral but the current reading of 0.77 as I’m writing this (mid-day Friday 1/14) is neutral. While this ratio tends to decline as the day goes on, I see it as neutral in the very near-term.

The Cboe SPX VPCR has moved from neutral to moderately bearish this week. The 1.85 reading on Thursday (1/13) was moderately bearish, and the current reading of 1.92 as I’m writing this (mid-day Friday 1/14) is moderately bearish. While intraday levels tend to decline as the day goes on, I see it as moderately bearish in the very near-term. With a 5-day moving average of 1.67 versus 1.90 last week, I see it as moderately bearish in the long-term too.

The Cboe Equity VPCR has been moderately bullish (<0.63) most of the week. The 0.60 reading on Thursday (1/13) was moderately bullish, but the current reading of 0.82 as I’m writing this is moderately bearish. While this ratio tends to decline as the day goes on, this is quite a swing, so I see it as volatile in the very near-term. With a 5-day moving average of 0.54 versus 0.53 last week, I see it as moderately bullish in the long-term too. As noted below, long-term for this ratio is about a week or two.

Since volume based put/call ratios are very reactive and very short-term in nature, near-term usually means just a day or two, while long-term is more like a week or two.

OCC Volume Put/Call Ratios (VPCR):

The OCC Index VPCR has moved from moderately bearish (>1.10) to bearish (>1.40) this week. As a result, I see it as bearish in the near-term. It has been bearish in 7 of the last 9 sessions, so I see it as bearish in the long-term.

The OCC Equity VPCR has been moderately bullish (<0.80) for most of the week. Therefore, I see it as moderately bullish in the near-term. With a 5-day average of 0.66 versus 0.64 last week, it is now moderately bullish in the long-term.

Volatility:

Cboe Volatility Index (VIX)

At the time of this writing (mid-day Friday 1/14), the VIX is +0.62 to 20.93. At its current level, the VIX is implying intraday moves in the SPX of about 51 points per day (this was 48 last week). The 20-day historical volatility is 109% this week versus 123% last week. The VIX is just above its long-term average (19.54) and well above its long-term mode (12.42) which I consider to be “normal” volatility. At this level I see the VIX as moderately bearish in the very near-term for the equity markets. While the VIX is 14 points below its December intraday high, it is well above its 12-month low, which occurred about 9 weeks ago. I see it as neutral in the long-term for now.

On a week-over-week basis, VIX call prices have fallen while VIX put prices have risen sharply. At +7 versus +125 last week, the VIX IV Gap (the average IV of VIX calls less the average IV of VIX puts) is sharply lower. At this level it is bullish in the very near-term. Until just the past 3 days, the VIX IV Gap has been mostly stable over the past 5 weeks, so I see it as neutral in the long-term.

Keep in mind, this is not only a contrarian indicator most of the time, it tends to be one of the earliest and shortest-term indicators I discuss in this report, so it can also change directions very quickly.

VIX Futures

As of this writing (mid-day Friday 1/14) the nearest VIX futures contract (which expires on 1/19) was trading at 20.85; very close to the spot VIX level of 20.93. Adjusting this price for the risk premium factor (which takes into account the time until expiration), the Risk Premium Adjusted Price (RPAP) is 20.51; still rather close to the spot price.

With an adjusted level that is fairly close to the spot price, futures traders are indicating that they believe the VIX is likely to remain about where it is over the next few days. Therefore, I see VIX futures as neutral in the near-term for the market. The RPAPs of the next two closest monthly futures contracts are 20.71 and 20.81 respectively. With the RPAPs of the further-dated contracts both very close to the spot price, I see VIX futures as neutral in the long-term for the SPX.

Since VIX futures are typically much less reactive to current market conditions than the VIX index, near-term for VIX futures usually means a few days, while long-term means a couple of weeks.

With the VIX up more than 2 points this week, VIX Hedging Effectiveness has risen to Moderate in the near-term. At the moment, this means that options on the VIX (and possibly other volatility-related products) are showing at least some sensitivity to market volatility, and maybe at least moderately effective as hedging tools in the very near-term. VIX Hedging Effectiveness is now also Moderate in the long-term.

VIX Hedging Effectiveness is a manner of measuring the magnitude of VIX moves relative to the magnitude of SPX moves in the opposite direction. When the VIX is highly reactive, VIX related products can serve as potentially effective hedging tools, when the VIX is not very reactive, traditional hedging techniques may be a better choice.

Global News:

Cryptocurrencies

In November of last year, the National Bureau of Economic Research (NBER) published a paper titled, “Blockchain Analysis of the Bitcoin Market”. This wide-ranging report explored such topics as transaction volumes, network structures, mining, immutability and ownership concentration. It is not my intention to make a case for or against Bitcoin (or any cryptocurrency for that matter) but some of the statistical discoveries shared in the report, that I found most interesting were as follows:

  • 90% of transaction volume in Bitcoin is not tied to economically meaningful activities, i.e. not used to pay for a product or service.
  • In aggregate, illegal transactions, scams and gambling make up less than 3% of total Bitcoin market volume.
  • As a result, the demand from illegal transactions is largely not responsible for the high valuation of cryptocurrencies; rather high valuations are driven primarily by speculative trading activity.
  • However, even where firms subject to Securities and Exchange Commission (SEC) Know-your-customer (KYC) rules deal exclusively with other firms subject to KYC rules, preventing inflows of tainted funds (i.e. money-laundering) is nearly impossible.
  • Privacy coins such as Monero and the increasing popularity of Decentralized Finance (DeFi) platforms further facilitate money laundering activities.
  • The top 10% of all Bitcoin miners control nearly 90% of the mining capacity, and the top 0.1% (about 50 miners) control close to 50% of all Bitcoin mining capacity.
  • The Bitcoin eco-system is mostly dominated by a few institutional and very concentrated players.
  • Estimates indicate that up to 95% of all Bitcoin is owned by only 2% of all crypto account holders.
  • Such concentration makes Bitcoin inherently susceptible to systemic risk.

For Schwab’s perspective on cryptocurrencies, please visit: www.schwab.com/cryptocurrency

Economic reports for next week:

Mon 1/17

MLK Day - Market Holiday – No reports

Tue 1/18

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

Wed 1/19

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

Thu 1/20

Initial Jobless Claims - For the week ending 1/8/22, claims were up 23k after being up 7k the prior week. The 4-week moving average now stands at 211k, up 6k from the prior week.

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

Fri 1/21

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

Interest Rates:

During his Senate confirmation hearing on Tuesday (1/11), Fed Chair Jay Powell called high inflation a “severe threat” to the economic recovery. He affirmed that the Fed was preparing to raise interest rates because the economy no longer needed emergency support. However, he also expects inflation to fall on its own as supply-chain bottlenecks subside. He did not deny the fed funds futures market’s expectations that interest rates would likely begin to increase in March. On that note, the Fed Funds Futures probability of an interest rate hike in March has risen to 94% from 78% only a week ago. Interest rates on the 10-year treasury ($TNX) have fallen a bit this week after last week’s sharp rise; from 1.80% on Monday to 1.75% at the time of this writing (mid-day Friday 1/14).

Outlook:

High inflation is finally impacting consumer behavior, and traders are contemplating the lesser of two evils; high inflation or higher interest rates. Volatility is likely to persist as this debate will not be resolved next week.  

Bottom Line:

As you can see below, there were only a few changes this week and most of them were upgrades, which moves the balance of the indicators very close to neutral. However, the VIX is elevated, the VIX IV Gap is pointing to a possible bounce on Tuesday, and the short-term column includes Bullish, Bearish and Volatile indications. Under these circumstances, determining the ultimate direction is nearly impossible so the most logical outlook for next week is just Volatile. Be on the lookout for a possible bounce higher on Tuesday, followed by potentially more large intraday swings throughout the week.

Composite

Past performance is no guarantee of future results.

Key:

OI = Open Interest

OIPCR = Open Interest Put/Call Ratio

VPCR = Volume Put/Call Ratio

IV = Implied Volatility

+ means this indicator has changed in a bullish direction from the prior posting.

– means this indicator has changed in a bearish direction from the prior posting.

+/ – means this indicator has changed bi-directionally; i.e. last week was either Volatile, N/A or Breakout.

^ means this indicator is at a historical extreme that has often (though not always) preceded a market reversal.

What You Can Do Next

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