foxex: Optimistic Rebound

Chart Advisor | Focus on the Price

Wednesday, September 09, 2020 Headlines

1. Investors' buying dampens the risk premium (even further)
2. Clean energy ETF shows power of diversification
3. Subtle warning signs in market breadth

Market Moves

Stocks rebounded strongly today after yesterday closed off a three-day slide that left the Nasdaq 100 (NDX) ten percent lower from its high. The rebound showed that at least some investors still have enthusiasm for buying stocks. Surprisingly, professional option sellers, whose decisions weigh heavily on the price action of the CBOE Volatility Index (VIX), may be starting to agree with those who are buying the stocks.

The chart below compares the S&P 500 index (SPX) in the upper left panel with the VIX in the upper right panel. The annotated arrows mark the difference between the SPX pricing and the VIX volatility. Since the VIX tends to move inversely correlated with SPX, we could have expected the VIX to have gone higher over the past three days, but it did not. Instead, a rough comparison of the position of closing prices relative to previous days shows that the VIX is pricing its risk much lower than one would expect (see note in chart below).

It is also interesting that SPX shows how prices rebounded within the linear regression channel articulated a few days ago, suggesting that this is a useful approximation of investor thinking. At least for now.

Clean Energy ETF Shows Power of Diversification

One ETF currently is making a nice case for the benefits of diversification. Investors who buy individual stocks may often have to ride through the vicissitudes inherent in price fluctuation. This can be emotionally trying if you happen to buy a stock just before a big drop.

With condolences to those who bought Tesla (TSLA) shares last week, one possible alternative is to consider investing in an ETF that selects its investments within a given sector or industry group. The chart below compares iShares Clean Energy ETF (ICLN), which invests in so-called green-technology companies. While Tesla shares are not in its top 15 holdings, it does hold stocks which have had a similarly wild ride along the way. The ETF holds many of these so that it dampens the fluctuations that individual stocks can have.

Notably, it is also strongly outperforming the broad market indexes. This chart provides another bit of evidence that investors are eager to put their money in places they believe in. The market appears to have more participants who want to buy and own stocks than those who want to sell.

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Markets Tend to Fall After Huge ETF Buying

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Subtle Warning Signs in Market Breadth

Today's third chart offers a bit of balance to the previous one. Although investors do seem enthused about buying and holding stock, the choices they make may be concentrating into a dangerous few stocks. Three breadth indicators are shown in the chart below: DITW (Dow stocks above their 20-day moving average), DIFI (Dow stocks above their 50-day moving average), and DIOH (Dow stocks above their 100-day moving average). Below them is State Street's Dow Jones Industrial Average ETF (DIA).

The main point here is that over the past three months this ETF has been trending higher, but in the past two months, two of the three indexes have made lower peaks along the way. This suggests that fewer stocks are hitting new highs. It further implies that investors may be slowing or reducing their rate of buying. Though this is not evidence of an imminent correction in the indexes, it is something to keep an eye on for the next two- or three-month time frame.

The Bottom Line

Stocks rebounded strongly off support and gave investors hope that the summer rally might resume and continue into fall. The VIX and the clean energy sector also show that this may be so. However, the breadth trends in the Dow components suggest that the upside may be short lived.