foxex: Quadruple Witching & Freaky Friday

Focus on the Price

Friday, December 21, 2018

1. Washington fights over a shutdown

2. Emerging Markets stocks continue to surprise

3. Is "quadruple witching" a leading indicator?

Major Moves

Investors are heading into the holiday week without a lot to be merry about. At one point today the Russell 2000 small-cap stock index was down almost 25%. A "bear market" is technically triggered once stocks are down 20% or more. In this case, small-cap stocks have been in a bear market since Monday when they crossed the 20% threshold.

Many analysts are blaming the fight in Washington over the spending bill/government shutdown for the volatility today even though, as I have previously pointed out, there aren't very many historical examples of government shutdowns that resulted in losses in the market.

It isn't that uncommon for investors to do some selling before a holiday week. Volume is normally very low in the trading sessions between Christmas and New Year's Day. It can be difficult (or at least more expensive) for investors who may need to make several changes to a portfolio to do so during the holiday week, which can motivate selling before the weekend.

Emerging Markets

Amongst all the bad news this week, there was a very interesting shift in investor behavior towards emerging markets stocks. While investors weren't necessarily bullish about emerging markets it was one of the few asset classes that did not reach new lows this week.

In fact, among the largest ETF's in the market, one of those with the greatest amount of fund inflows (new money invested in the fund) was the iShares Core Emerging Markets ETF (IEMG) that received $872 million in additional assets under management. As you can see in the chart below, even though this emerging market fund has been falling in value with the rest of the market, the assets under management (AUM) have recently been growing.

This particular fund has 28% exposure to China, 14% exposure to Korea, and 12% exposure to Taiwan. It's rare for stock funds like this to have a rising AUM while the price falls. The last time we saw this kind of bullish divergence was just before the big breakout in 2016. The opposite (falling AUM while the prices rising) is not as unusual and can be a good early warning sign that investors are becoming more bearish.

This doesn't change the fact that the market was overwhelmingly bearish this week, but it is an interesting development for us to monitor next week. On a related note, some of the other ETF's with the largest fund inflows this week included the iShares S&P 500 growth fund (IVW), iShares S&P 500 value fund (IVE), and the Vanguard value fund (VTV). Those fund flows could be seen a hint that bargain hunters are making an early move back into the market.

Read more:
60% of Stocks Now in a Bear Market

Dow Reaches a "Death Cross"
Understanding Assets Under Management (AUM)

Risk Indicators

To add a little insult injury, traders also had to deal with "quadruple witching" today which occurs on the third Friday (AKA "Freaky Friday") of the month that ends a calendar quarter. The quadruple witching expression refers to the day when four different types of stock related derivatives are expiring and settled.

1. Stock index futures

2. Single stock futures

3. Stock index options

4. Individual stock options

The market does not close higher or lower on quadruple witching days at a greater rate than any other day. However, the few days following quarter-end expiration does have an interesting relationship with short-term pivots and breakouts. As you can see on the following chart the correlation between quadruple witching and a few important reversals/breakouts has been fairly tight over the last 18 months.

I am not ready to suggest that this means the market is absolutely going to pivot higher over the next week or two. However, if I were trying to plan ahead, I would pay close attention to market activity in the week after quarterly expiration and settlement.

Read more:
What is Quadruple Witching?

Understanding Single Stock Futures (SSF)
Three Emerging Market ETFs with Relative Strength

Bottom line: Low Volume Next Week

The stock market will close early at 1 PM Eastern time on Monday and it will be closed all day on Tuesday for the Christmas holiday. Volume should be very light for the entire week; however investors should be on guard for big moves once traders come back to work following the New Year. Keep in mind that the giant 2013 rally was kicked off with a 4.5% gain on the S&P 500 that occurred between the half session on New Year's Eve (2012) and the full session on January 2, 2013. Assuming government shutdown news has not worsened during the holiday week, investors may be willing to move back into cheap stocks ahead of January's earnings reports.

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