Are Investors Over-extended?

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Markets set new highs last week and overall conditions feel sturdy, but as our technical experts, John Jagerson and Wade Hansen, write below…

Over the long term, though, we need to keep an eye on a few issues to ensure a more significant shift in sentiment doesn’t catch us off guard.

What are those issues?

That’s what John and Wade detailed in their Strategic Trader update from last week, which we feature below.

For newer Digest readers, Strategic Trader is InvestorPlace’s premier trading service. It combines options, insightful technical and fundamental analysis, and market history to trade the markets, whether they’re up, down, or sideways.

Returning to markets today, traders are bullish and fundamentals are improving, but there are some signs that investors could be over-extended.

Let’s find out what they are – and more importantly – if John and Wade believe these signs warrant a change in your market-approach today.

Have a good weekend,

Jeff Remsburg

 

Risk Indicators Favor Large-Caps and Income

By John Jagerson and Wade Hansen

The Federal Reserve’s meeting minutes from its last meeting were released today (Wednesday).

In short, policymakers believe it will be a long time before they end the asset purchase program (quantitative easing).

Furthermore, the Fed is trying to make it clear that it will communicate any change in monetary policy very far in advance of any adjustments. We take that to mean the Fed will not take away the monetary-stimulus “punchbowl” this year.

That’s good news from the Fed, which sustains our bullish outlook.

However, almost everything the Fed released in the minutes matched what traders had already learned from the last meeting on March 17. Without any surprises, the minutes shouldn’t have much of an impact on the market this week.

What Risk Indicators are Telling Us

There are a few risk indicators that are looking a little weak currently.

In the short term, ironically, this could work out in our favor for our bullish trades.

Over the long term, though, we need to keep an eye on a few issues to ensure a more significant shift in sentiment doesn’t catch us off guard.

In the short term, the soft spots in the market should keep rates from continuing higher. If traders are pricing in a little less growth and inflation, capital flows will favor the tech sector and other large-caps.

This is one reason we have been increasing our exposure in those areas with new trades on Apple (AAPL) and Micron (MU).

You can easily see what we mean in the following chart where the SPDR Technology ETF (XLK) has been rising again as long-term yields (TNX) flattened out and declined slightly.

Fig. 1 — Comparison Chart of SPDR Technology ETF (XLK) & 10-Year Treasury Note Yield (TNX) — Chart Source: TradingView

Besides falling yields, there is more evidence that traders may be cooling their growth expectations a little.

In the following chart, you can see both the China Hang Seng 50 Index and the iShares High Yield bond indexed ETF (HYG) have failed to get anywhere near new highs, as the S&P 500 has done.

When indexes like these lag, it’s not a signal for a bear market or anything particularly dire, but it often accompanies an increase in volatility and a preference for larger, stable, more liquid stocks.

As option-sellers, this is in our favor because it makes it easier to open and close trades as needed.

If the market does get a little more volatile, it should make it easier for us to compound our covered call income when stocks drop to short-term support.

Fig. 2 — Comparison Chart of China Hang Seng 50 Index & iShares High Yield Corp. Bond ETF (HYG) — Chart Source: TradingView

Other high-risk assets are showing the same mild weakness we see in the previous image.

The Russell 2000 small-cap index has finally paused its run and is stuck at resistance. Emerging Markets (excluding China) have been stuck in a channel since January. And the CBOE’s SKEW risk index has been channeling near its highs since December.

For now, we don’t expect to make many adjustments to our strategy. We have already focused on stable, large-cap stocks, tech and retail for new positions.

Starting next week, earnings data will be released for the first quarter, which could refresh investor appetite for riskier assets if they are as surprisingly good as the last rounds in January and February.

 

The Bottom Line

We are seeing in the market right now another perspective on what margin debt was telling us last week.

Traders are bullish, and the fundamentals are improving, but there are some signs that investors could be over-extended.

In the past, that setup has increased the potential for volatility but rarely a significant pullback or bear market.

Sincerely,

John Jagerson and Wade Hansen


Article printed from InvestorPlace Media, https://investorplace.com/2021/04/are-investors-over-extended/.

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