Options Trading Insights: S&P Surges Most Since 2004 11-13-23

S&P surges the most in one move since 2004 but overall market breadth remains a problem. 

The S&P surged all week (+1.31%) with the exception of Thursday due to a poor treasury auction, which was immediately shrugged off and followed by a spectacular rally on Friday. The price action caught many off guard including myself as I expected there to be a price correction sometime last week.

A price correction is typical after a multi-day rally particularly off of a low that we saw in early November. It is important to realize that there are two types of “corrections.” Price corrections which are more typical (see below), and time corrections (same chart below), which actually show a lot more relative strength. 

Time corrections show lack of any willing sellers even when there is some buyer exhaustion.   That is exactly what happened with the S&P 500 this week: no sellers but most of the week also had no buyers. 

With this change in sentiment we can probably expect a couple of things going into the end of the year. The first is that all the money managers sitting on the sidelines could feel forced to pile in due to year-end “performance chasing”. Bonuses are coming up, and bills have to get paid! 

This will happen particularly if the 10-year Treasury remains subdued into the end of the year.  With yields of their peak (see Index below), it will push more buyers into equities searching for returns. If this uptrend continues, however, the breakout we saw on Friday could lack follow-through.

The other thing that we could probably expect going into the end of the year if we do get a Santa Claus rally are popular stocks that have led the markets this year will continue to lead due to the same phenomenon of performance chasing. 

If you are a money lagging manager and do not have the top performers in your portfolio, investors will question your competence. It is an extremely competitive business, one that I’m both grateful to have experienced, BUT happy to be no longer in!

This leads me to my concept of overall market breadth. Although markets look like they’re going to rally, the strength of the rally seems limited to only a chosen few. See breadth/heat map below:

Based on this map I think you and I can both pick them out by now.   Even as all stocks were up on Friday, these “usual suspects” are likely the names that will outperform going into the end of the year, and these are the names I will stick with because that’s what the market is telling me to do. The breadth is still lacking despite Friday’s rally.

Next year will perhaps be a different story when the “January effect” potentially takes hold and sector rotation becomes more of a popular thing. For now, my theme going into the end of the year is fairly simple and that is to continue to do what’s working and not try to get too creative.

This week we have the all important CPI data coming out on Tuesday. The numbers are largely expected to remain “sticky” as the Fed wrestles with the conundrum of inflation, resilient consumers, falling oil, and mild upticks in jobless rates (see below). Any changes to the job market out on Thursday and retail sales Wednesday can turn things over to the other side pretty quickly.

I’ll be watching cautiously but like many of the institutions out there that are performance chasing into the end of the year,  I will be adding bullish exposure as well. On Friday I added (ASML) to my options basket (see below) and I removed a bearish trade (EW) at the same time that was working out well (see below).   

Although I’m still bearish on (EW), I wanted to tilt my portfolio more bullish than bearish. Focusing on the “basket” and not any single trade is very important, especially during a sentiment shift.

Bullish entry:

Bearish exit:

As far as sectors go, one interesting thing that I’ve noticed is the dispersion between some of them. It’s rare that you get several major sectors on one side of the spectrum while others are on the other side. 

For instance, healthcare is probably one of the poorest sectors (see below) and has missed most of this rally. Technology is on the other side of things (see below) where they have consistently outperformed.  

As you can see this week, it is all going back to what groups have worked, verses which ones have not for most of the year:

In the interests of keeping a balanced portfolio like I always do, I will look to healthcare mostly for one or two bearish ideas. One that particularly caught my eye is (SNY), which I will likely enter on any bear rally I see. This stock got crushed on earnings, and has not even made an attempt to fill in the gap, showing true relative weakness. (see below)

I generally don’t always trade household names or mega caps because I do like to do my homework and run through my screening, but when my bullish ideas from my screen happen to coincide with these household names it forces me to buy them. 

One name I’ll be looking at this week is (META), which is outperforming substantially in the last couple of weeks (see below).

I’m a lot more bullish than a week ago,  not because I want to be but because that’s what the markets are telling me to do. It is always important as a trader to put away your feelings and to do the homework necessary for success. 

This week’s price action was a very strong reminder to follow this discipline and to take advantage of the opportunities that the market presents.