The market remains in a full-blown bullish trend as traders are discounting negative data and celebrating positive news. The market is always somewhat disconnected from Main Street and usually the market gets it right when reflecting future political and economic events in current prices. Investors don't believe that the people who sit in the White House and Congress are stupid enough to really create another recession. The market for now is telling us that employment is growing at a decent pace in the private sector and the economy is actually improving. The market told us politicians would not let us fall over the cliff at the beginning of the year and it didn't happen. The market is saying the upcoming sequestration and debt ceiling negotiation will be resolved. The market could be totally too optimistic and get it all wrong, but for now we are trading at multi-year highs with the bears totally muzzled.
The 7% rally since the end of last year has some traders concerned that a pullback is eminent, but as we go into the month of February keep in mind the mantra "how January goes, so does the entire year." Approximately 90% of stocks in the S&P closed up on the month and the Dow had its best January since 1989. As recently pointed out by media pundits, the year has moved in the same direction as January results in 61 of the last 84 years, or 72.6% of the time. The effect is even more pronounced in years when the markets rise in January. Of the 54 times that January has been up since 1929, the year has ended higher 43 times, or 79.6% of the time.
Many traders believe the markets are overextended, but the biggest change over the past few years is positive equity inflows. It has been reported in the media how many of the big investment managers are starting to see inflows into their equity mutual fund products spreading beyond fixed income and ETFs of the past few years. These inflows helped the S&P close up 5.13% on the month, for its best January since its 6.13% gain in January 1998. Just like last year when the stock market started out on fire, it is highly doubtful stocks will keep up the current pace.
One of the primary reasons for the rush into the stock market is underinvestment. Many of the big institutional investment funds pulled back during the credit crisis. JP Morgan reported the primary reasons the stock market sees further gains are: 1) investors remain underweight equities and 2) corporate credit continues to act well, particularly HY spreads, which have improved since the start of the year, but they also say we are watching for a notable change in trend; they think the risk/reward in equities will likely be less attractive. The new month means new inflows and it also means a letup in the some of the selling tied to the January month-end rebalance. While inflows have been a positive for the stock market this year, they do not always mean the markets will continue higher. Underscoring that idea is the fact that the past four years of outflow did not hold the S&P back from doubling in price.
The January 27th Couch Potato opined "...note in the chart below is that the S&P 500 index is flashing extremely overbought signals from the Relative Strength Indicator (RSI) and momentum oscillator (MACD). As highlighted in the chart, the last time the index was at its current overbought level was the end of last summer right before stock prices flattened out and led to a correction. Similar to price action this year, in January of 2012, stocks flew out of the gate and rose over 12% in the first quarter. But the market gave back most of its gains before closing up 13.4% on the year. The quandary for investors who now want to jump in the market is itâ€™s expensive to initiate new long positions at these price levels, but that doesnâ€™t mean the time is right for bearish trades...Without a doubt stocks current bullish move is getting overextended, but similar to what happened last fall the most probable reaction is that stocks will trade range-bound before any significant pullback or move higher..." You can see in the updated chart below how the S&P 500 index price flattened out last week up until Friday. However, stock prices spurted on Friday probably mostly due to additional equity fund inflows on the first day of the month. Sellers are still on sidelines and with limited selling going on the additional equity inflows catapulted stocks higher.
As discussed above, January market action this year was similar to January 2012 when stocks came out firing like gangbusters. The weekly S&P 500 index chart below suggest that from a technical perspective it might be difficult for stocks to go much higher without some sort of pullback. Prices can maintain an overbought level on a daily chart for a while before reacting, but when the overbought condition catches up with longer term charts that is considered a very strong signal. Also notice the chart below is displaying the 'Hanging Man' candlestick chart formation. This is considered a sign of the end of a bullish move.
SPY Position Update ---------------------------------------------------------------
SPY closed at $151.24 on Friday â€“ the February position is approx. $2,000 in the red
The January 16th Couch Potato published a February expiration SPY bear call spread
The call spread is approx. $2,000 in the red (see tables below)
$150 strike price short call delta is .6757 (33% probability this position will be profitable)
SPY Risk Analysis
Friday's stock market surge pushed the S&P 500 index higher and triggered our SPY ETF $150 strike price short call exit rule. Fortunately, there is plenty of time to adjust this trade over the next few days.
TLT Position Update ---------------------------------------------------------------
TLT closed at $115.54 on Friday â€“ the February position is approx. $1,000 in the red
The January 9th Couch Potato set up a February expiration TLT bull put spread
The put spread is approx. $1,000 in the red (see tables below)
$116 strike price short put delta is -.5505 (45% probability this position will be profitable)
TLT Risk Analysis
As equity prices jumped higher on Friday as treasuries crashed. The treasury bond ETF closed below our $116 strike price TLT short put. Unless the ETF price recovers over the next few days we expect to adjust this trade.
GLD Position Update --------------------------------------------------------------
GLD closed at $161.45 on Friday â€“ the February position is approx. $1,400 in the black
The January 15th Couch Potato published a February expiration GLD call spread
The call spread is approx. $900 in the black (see tables below)
$167 strike price short call delta is .0791 (92% probability this position will be profitable)
The January 15th Couch Potato published a February expiration GLD put spread (see table below)
The put spread is approx. $500 in the black (see tables below)
$158 strike price short put delta is -.1904 (81% probability this position will be profitable)
GLD Risk Analysis
Basically, since the end of last year gold has remained in a trading range. Investors are abandoning bonds and precious metal in favor of equities. If the current trend continues the most probable risk is to our $158 strike price GLD short put.
As mentioned above, the SPY call spread exit rule is triggered and over the next few days we expect to do a trade adjustment. Also, if treasury bonds don't recover from being oversold we will need to make a decision on adjusting our TLT put spread position.
Couch Potato Trader Disclaimer
All results reported in this section are hypothetical. While the numbers represented here may have been achieved or beaten by our readers, we make no representation that any individual investor achieved these exact results. The tracking for the plays listed in this section uses closing prices for the day the newsletter is published and it is not meant to imply that any reader actually received those prices (though many often do) or participated in these recommendations (even though many do). The portfolio represented here is hypothetical and for investment education purposes only. It is only an illustration of what type of gains a knowledgeable trader might receive utilizing these strategies. If you don't get close to these results, guess what. It isn't the fault of the strategies.