Monday Morning Outlook: DJIA Makes It Two in a Row; Gold Soars to Record High
Have we put correction in rear-view mirror?
by Todd Salamone 6/19/2010 11:19 AM
schaeffersresearch.com
Another weekly win -- the second in a row for the Dow Jones Industrial Average (DJIA). The Dow made a strong push above 10,400 on Tuesday, and managed to hold that gain through the end of the week. Moreover, the S&P 500 Index (SPX) finished the week above 1,100 for the first time since mid-May. Looking ahead, Todd Salamone, Senior Vice President of Research, compares June 2009, which kicked off a summer slump, with June 2010. Todd concludes options traders were more optimistic in June 2009, and less so now. From a contrarian point of view, that's a bullish indicator. Next, Senior Quantitative Analyst Rocky White takes a look at the VIX premium, the relationship between the CBOE Market Volatility Index (VIX) and actual historical volatility. The VIX typically trades above actual volatility, but last week it fell well below it. Rocky considers what that might mean. Finally, we wrap up with a look at some key economic and earnings reports slated for release this week.
Recap of the Previous Week: A Firm Foothold Above 10,400
By Joseph Hargett, Senior Equities Analyst
The bulls proved their resilience this week. Despite a downgrade of Greece's debt to junk status, the steepest monthly drop in home construction in decades, yet another disappointing jobs report, sluggish manufacturing data, and another week of BP plc (BP) serving as a punching bag, the Dow Jones Industrial Average recorded its second straight weekly win, thanks largely to Tuesday's 214-point rally. (The other news this week, which may or may not have affected the market, was the World Cup, the big tournament for what the rest of the world calls football.)
The bulls tried their best to kick off the week on a high note. Stocks spent much of Monday in the black, thanks to an encouraging report on euro-zone industrial output. But Moody's Investors Service dampened the cheery mood by slashing its credit rating on debt-riddled Greece. By the end of the day, the Dow slipped 0.20%.
Europe again set the tone Tuesday, with positive debt offerings in Spain and Ireland. On the home front, the New York Fed's Empire State manufacturing index rose to 19.6 in June, pointing to improving business conditions in the region. The bulls took it from there, with the Dow rallying 214 points, or 2.10%.
There wasn't much to like on Wednesday on the economic front. Single-family home construction fell 17% in May, the government reported, while applications for building permits dropped 5.9%. Meanwhile, BP took center stage by suspending its dividend and setting aside $20 billion for victims of the Gulf of Mexico oil slick. (Truth to tell, BP never left the stage all week. President Obama addressed the nation about the oil spill on Tuesday night, and met with BP execs on Wednesday. BP CEO Tony Hayward then spent a very uncomfortable Thursday being mauled by congressmen during testimony before the House Energy and Commerce Committee.) Although the Dow spent much of Wednesday in the red, by the close it managed to eke out a 0.05% gain.
On Thursday, traders considered a drumbeat of reports that underscored the sluggish pace of the economic recovery. The Labor Department reported an increase in weekly jobless claims, defying expectations for a decline. The Conference Board's index of leading economic indicators inched ahead, as did manufacturing activity in the Philadelphia region, but both reports came in below expectations. However, a successful Spanish bond auction helped to offset some of the gloom and doom. Once again, despite spending much of the day in the red, the Dow managed a 0.24% gain.
Friday was another day-long battle with the breakeven line. An absence of earnings reports and a barren economic landscape threw Wall Street into the doldrums of Friday's triple expiration, but traders held their ground heading into the weekend. While the end of the week was as exciting as watching paint dry, the Dow recorded its second consecutive weekly gain of more than 2%, as the venerable average vaulted 2.3% higher. Elsewhere, the S&P 500 Index gained 2.4% for the week, and the Nasdaq Composite left the competition in the dust with a 3% advance.
And let's not overlook gold. Gold futures skyrocketed to a record-high closing price of $1,258.30 an ounce on Friday. For the week, gold advanced 2.3%, marking the commodity's fourth straight week-over-week advance.
What the Trader Is Expecting in the Coming Week: SPX 1,125 Could Pose Challenge
Todd Salamone, Senior Vice President of Research
"The sentiment landscape has taken a drastic turn since April, implying that we have moved into a low-expectation environment, which can be viewed as a positive... The technical backdrop, however, remains mixed... The SPX remains above its February and May lows in the 1,040 area, but comes into the week trading below the 1,100 century mark and its 200-day moving average, currently situated at 1,108."
Monday Morning Outlook, June 12, 2010
The S&P 500 Index (SPX) gained 2.4% last week, following the script of bullish tendencies during triple-witching expiration weeks, but deviating from the negative returns during June expiration week that we experienced in the last decade.
The low-expectation investing environment alluded to above was confirmed in last week's trading, as jobless claims and housing starts data came in weaker than expected, in addition to a softer-than-expected report from the Philadelphia Federal Reserve. However, the stock market did not react negatively to the poor economic news, as it would when investor expectations are high. Meanwhile, well-received debt offerings in Spain and Ireland sparked a Tuesday rally that defined last week's gain.
Tuesday's rally was so powerful that the SPX closed back above its 200-day moving average for the first time since May 19, 2010. So, for the second time in two years, the index moved above this trendline in the month of June. The crossover above this popular moving average in June 2009 was nothing more than a short-term sell signal, but the jury is still out as to whether or not June 2010's breakout is the real thing, or simply a "fakeout" in the short term.
With the SPX coming into the week at 1,117.51 and above its 200-day trendline, the 1,120-1,125 area could be the next challenge from a technical perspective. For example, the 160-day moving average is sitting at 1,126.10 – note on the chart below that this moving average marked the February 2010 low. Therefore, the risk to the bulls is that this trendline becomes resistance on the rally. Moreover, the 1,120 area marked resistance in November and December 2009 during a narrow trading range.
There are a couple of notable differences between June 2009 and June 2010 that bulls should view positively. First, in June 2009, customer-only, equity option buyers on the International Securities Exchange and Chicago Board Options Exchange were more optimistic than they had been all year, whereas sentiment among this group now is at a pessimistic extreme for 2010. Our data shows that when this crowd is at an optimistic extreme relative to prior months, the market is most vulnerable to a short-term decline. The market is more apt to surge higher when a pessimistic extreme is identified.
Moreover, our analysis of option activity on exchange-traded funds such as the iShares Russell 2000 Index Fund (IWM), PowerShares QQQ Trust (QQQQ) and S&P Depositary Receipts (SPY) suggests that institutional players are in the early stages of accumulation, whereas in June 2009 the same analysis suggested these players no longer saw value in the market.
Finally, where is volatility, as measured by the CBOE Market Volatility Index (VIX), headed?
Last week, I said,
"The VIX closed below 30 last week, the first weekly close below this level since the meteoric rise above 30 last month. Moreover, the VIX is below the SPX's 20-day historical volatility of 30.48, suggesting volatility is headed lower."
Indeed, the VIX declined during the past week, from 28.79 to 23.95 by Friday's close. With SPX 20-day historical volatility at 26.96, this would suggest volatility is still headed lower.
There is one risk in this conclusion. If volatility is trending higher from a longer-term perspective, the current "pullback" in volatility could end here. This is because the VIX is now trading just above its closing "half-high" of 46.00 in mid-May, which is also around its upward-sloping 200-day moving average. I point out the "half-high," because the pop in the VIX that began in January 2009 that lasted into March 2009 was from the 40 area, which was half the 80.08 closing high in November 2008.
The good news is that the cost of portfolio protection has been cut in half since this time last month. Use this plunge in the price of portfolio protection to your advantage, as June expiration may be an opportunity for you to replace expired put hedges at a cheaper cost than last month.
Are you interested in options trading but not confident about your skills? Let Ryan Detrick, Schaeffer's Senior Technical Strategist, help you. Ryan will present a free webinar called "5 Mistakes to Avoid When Trading Options" on June 22, 2010, at 1 p.m. In "5 Mistakes," Ryan talks about the common errors that rookie options traders (OK, veterans too) often make. These errors range from the inability to accept a losing streak to putting too much money into a single trade. Sign up here for this free webinar.
Prepare for the investing week ahead. Every week, Bernie Schaeffer and his staff provide you with their insight about what has happened and, more importantly, what will happen in the market. We dig deep and show you what's happening behind the scenes, and tell you which indicators are predicting major market moves. If you enjoyed this week's edition of Monday Morning Outlook, sign up here for free weekly delivery straight to your inbox.
Indicator of the Week: VIX Premium to Historical Volatility
By Rocky White, Senior Quantitative Analyst
Foreword: The CBOE Market Volatility Index, or VIX, is a commonly used measurement of market volatility. It uses prices on S&P 500 Index (SPX) options to measure the volatility that the market is expecting over the next 30 days. The VIX typically trades above the actual volatility of the SPX, but last week the VIX fell well below the actual volatility figure. The graph below shows the VIX and 20-day volatility of the market over the last year. As the market was pulling back over the last couple of months, actual volatility was rising along with the VIX. Now the VIX has come down well below actual volatility.
Daily chart of SPX 20-day historical volatility and VIX
VIX premium: We keep an eye on what we call the VIX premium. It shows where the VIX is in relation to actual volatility. A positive VIX premium means that the VIX is higher than actual volatility, and a negative VIX premium means that it is lower. Below is a chart of the VIX premium along with the SPX. I marked the spots on the SPX where the VIX premium fell below -10%, as it did last week (Note: I considered only one signal in any given 21-day period.)
Daily VIX premium versus SPX
Looking at the chart since 2008, those signals have been bullish at times and bearish at times, but the previous three occurrences happened at pretty momentous turning points for the market.
Quantifying the Signals: Going back to 2005, there have been nine signals prior to the most recent one. You can see in the tables below that those have been very good times to buy in the short term. Look at the returns one month later. All nine times the SPX was up in that time frame, averaging a return of 3.4%. We know from the chart above that those signals can come before a huge drop in the market, but in the very short term they have been solid and safe buy signals.
SPX returns following a signal
This Week's Key Events: The Fed and GDP
By Joseph Hargett, Senior Equities Analyst
Here is a brief list of some of the key events for the upcoming week. All earnings dates listed below are tentative and subject to change. Please check with each company's respective website for official reporting dates.
Monday
* There are no major economic reports scheduled for Monday release, and earnings season continues to contract. Sonic Corp. (SONC) and Steelcase Inc. (SCS) will step into the earnings spotlight.
Tuesday
* May's existing home sales will arrive on Tuesday. Meanwhile, Carnival Corp. (CCL), Walgreen Co. (WAG), Adobe Systems Inc. (ADBE), Jabil Circuit Inc. (JBL), and Red Hat Inc. (RHT) will post their quarterly results.
Wednesday
* Weekly U.S. petroleum supplies will be overshadowed on Wednesday by the Federal Open Market Committee's interest rate decision. Turning to earnings, Canadian Solar Inc. (CSIQ), CarMax Inc. (KMX), Rite Aid Corp. (RAD), Bed Bath & Beyond Inc. (BBBY), Darden Restaurants Inc. (DRI), and NIKE Inc. (NKE) will announce their results.
Thursday
* Thursday brings the usual weekly initial jobless claims, as well as May's durable goods orders. Lining up for the earnings confessional, we find Discover Financial Services (DFS), Lennar Corp. (LEN), H&R Block Inc. (HRB), Oracle Corp. (ORCL), and Research In Motion Limited (RIMM).
Friday
* We round out the week with the initial third-quarter gross domestic product reading and June's final University of Michigan consumer sentiment index. Finally, KB Home (KBH) is slated to pony up its quarterly earnings figures. |
