Equity Market Outlook By Market-Makers

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Includes: SPY
by: Peter F. Way, CFA

Summary

Concerned that stock prices are too high and bound to come back down?

Because there are better prospects for some other form of investments?

Or because investors have run out of uncommitted cash?

Here’s what firing-line professionals see their big-money fund clients trying to do.

Looking forward in time, not back

Adjusting holdings of multi-billion dollar funds can only be accomplished by block trades where hundreds of thousands of shares are exchanged in one transaction at one point in time, at one per-share price. That usually only happens when a Market-Maker [MM] firm takes a position in the trade, balancing buyers with sellers.

Their capital can only be used that way when the price-change market risk involved is neutralized by hedging. Then that capital is freed up for similar re-use. The extent of likely price changes seen likely in the stock or ETF involved in the block trade is revealed in negotiations over the price and structure terms of the hedge.

The negotiators in the hedging protection deals, on both buyer and seller sides, have extensive world-wide information-gathering systems and personnel, and trained and experienced evaluative staffs to back up their bargaining postures. Substantial real-money bets about the future are being made in the hedging process.

A multitude of such block trades are in negotiation every market day, providing price range forecasts for thousands of equities. Comparisons of the upper and lower extremes of those price ranges with their current market quote provide upside and downside price change prospects for each security. Those dimensions are directly comparable across all stocks.

Today, Monday March 27, 2017, over 2,500 stocks and ETFs averaged upside price expectations of +12.2% and downside prospects of -4.3%. On Friday those averages were +12.4% and -4.5%.

Perhaps more significant than the forecast population's averages are its composition.

On Friday, 5.3% of the population had larger downside prospects than upside ones. Today that proportion was reduced slightly to 4.7%.

The average downside expectation of those issues with greater downsides remained the same today as they had been on Friday, -9.6%. The upside average prospect improved a bit, from 6.7% to +6.8%, not significantly.

In order to foster comparability of the price range forecast dimensions, a metric called the Range Index [RI] was created. Its numeric value tells what percentage of the whole forecast price range is found below the current market quote at the time of the forecast.

So small RIs suggest disproportionately large upsides (cheapness) and large RIs suggest large downside price change exposure (expensiveness). It is possible for prices to occur outside the forecast range, with RIs of over 100 at the upper end, and more commonly, negative RIs at the lower end.

Figure 1 displays the "Market Profile" distribution of Range Indexes at today's market close.

Figure 1

(used with permission)

The skew of RI values toward perceptions of issues being cheap is evident. As previously indicated, less than 5% of the population have RIs above 50 (more downside than upside.)

Additionally, the ~3 dozen issues off the negative end of the RI scale are an impressive portion of the 7.2% of the forecast population now priced below the levels believed to be reasonable for them (a zero RI) in coming weeks and months. This is a slightly larger proportion than seen on Friday.

The typical upside potential price gain for these extremely depressed issues now is +15.2%, in contrast to the population average's +12.2%, and the logically over-priced set (above a 50 RI) at an upside of +6.8%.

What does an overpriced market look like?

(used with permission)

Here is the October 2007 peak of the market, when SPDR S&P500 Index ETF (NYSEARCA:SPY) was at $156 on its way down ultimately in March 2009 to $68. Its average RI was over 50 and 48% of the population had RIs of 50 or more.

A Range Index of 50 indicates as much downside prospect as upside. How likely are you to buy the bridge that guy is offering when its potential toll revenue is only what he wants you to pay for it?

Today's RI of just under 25 suggests an average market prospect with three times as much upside potential as downside exposure. In that distribution there are some 180 stocks or ETFs priced below where well-informed market professionals think they ought to be priced under their worst appearance in the next few months.

In October, 2007 out of the same size population, there were only two.

Conclusion

If a market correction is coming, so is Christmas.

Both are beyond the horizon of MMs at this date, but I'll still bet on Christmas.

Additional disclosure: Peter Way and generations of the Way Family are long-term providers of perspective information, earlier helping professional investors and now individual investors, discriminate between wealth-building opportunities in individual stocks and ETFs. We do not manage money for others outside of the family but do provide pro bono consulting for a limited number of not-for-profit organizations.

We firmly believe investors need to maintain skin in their game by actively initiating commitment choices of capital and time investments in their personal portfolios. So our information presents for D-I-Y investor guidance what the arguably best-informed professional investors are thinking. Their insights, revealed through their own self-protective hedging actions, tell what they believe is most likely to happen to the prices of specific issues in coming weeks and months. Evidences of how such prior forecasts have worked out are routinely provided. Our website, blockdesk.com has further information.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.