After Friday's huge move higher, it was natural to expect a little bit of a slowdown today. SPX lost $2 to close at $2181 and RUT was down a dollar to close at $1230. Volatility was essentially unchanged with the VIX at 11.5%. Trading volume slowed with 1.9 billion shares of the S&P 500 companies trading. Trading volume declined 10% on the NYSE and dropped 20% on NASDAQ.
Many of the big names have already made their earnings announcements for this cycle. We have NVIDIA Corporation (NASDAQ:NVDA) later this week and Cisco Systems Inc (NASDAQ:CSCO) and Wal-Mart Stores Inc (NYSE:WMT) next week. 86% of the S&P 500 have already reported and 69% beat analyst estimates, but that ignores the fact that earnings continue to decline on a year over year basis. According to FACTSET, the current earnings decline for the second quarter is -3.5%. If that number holds, it will be the fifth consecutive quarter of earnings declines. That has not happened since 2008-2009. In addition, guidance for the third quarter has been largely negative with 67% of companies offering lower guidance. FACTSET reports that the price to earnings ratio (P/E) of the S&P 500 now equals 17.0 on an 12 month forward looking basis. The five year average P/E is 14.7 and the ten year average P/E is 14.3. These data offer a quantitative basis for the commonly heard opinion that this market is overbought. However, overbought markets may remain overbought longer than I have funds to short the market.
But we are left with the question: What is driving this market higher? As we have seen above, the run higher certainly isn't based on stronger earnings streams. Maybe traders are buying with renewed confidence that the Fed won't raise interest rates before the end of the year. Another possibility is that we are seeing the effects of global cash flows into our stock market, i.e., the "best house in the bad neighborhood" theory. Our economic data are mediocre at best, but the U.S. stock market looks better than many other global markets.
So we are left with a quandary. The market's most probable direction is to continue higher, but a pull back or correction is overdue. We just don't know what may trigger the sell off or when that might occur.
I am continuing to trade bullish positions in this market, but I am favoring diagonal bull call spreads because those positions offer some downside protection if the stock or index pulls back. I am also positioning my non-directional trades with additional safety margin on the upside. And my stops are on a hair trigger.