Monday Morning Outlook: DJIA Nears 2010 Highs, SPX Hits a Golden Cross
Wall Street extends fall rally, but G-20 anxiety holds stocks in check
by Todd Salamone 10/23/2010 11:50 AM
schaeffersresearch.com
The Dow Jones Industrial Average (DJIA) briefly flirted with its 2010 highs last week, but Wall Street grew skittish ahead of the Group of 20 (G-20) meeting. Still, the bulls maintained their fall rally in style, sending the Dow to its first weekly close above 11,100 since April 23. Looking ahead, Todd Salamone, Senior Vice President of Research, discusses the concept of the "new normal," despite 85% of companies beating Wall Street's earnings forecasts. He also zeroes in on the lack of participation by retail investors in the current market rally, and the sentiment implications of this phenomenon. Next, Senior Quantitative Analyst Rocky White takes a closer look at last week's golden cross of the S&P 500 Index's (SPX) 50-day and 200-day moving averages, and ponders why the financial media gave more attention to the ominous "death cross" that occurred back in July. Finally, we wrap up with a look at some key economic and earnings reports slated for release this week.
Recap of the Previous Week: G-20 Steals Wall Street's Earnings Thunder
Schaeffer's Editorial Staff
It wasn't easy, but the Dow Jones Industrial Average (DJIA) extended its fall rally to three weeks in a row. In fact, the Dow pressed higher despite tight trading late in the week ahead of the Group of 20 (G-20) financial ministers meeting in Seoul, South Korea. Ultimately, a strong and steady barrage of better-than-expected quarterly earnings reports helped Wall Street shrug off those concerns -- as well as anxiety over the looming midterm elections, and the potential for quantitative easing from the Federal Reserve.
Surprisingly, Dow banking giant Citigroup Inc. (C) set the bullish tone for the week on Monday by not only topping consensus third-quarter earnings expectations, but also reporting fewer loan defaults during the quarter. C's unexpectedly solid performance threw off the specter of "foreclosure-gate" just in time for the National Association of Home Builders to report that its housing market index rose for the first time in four months in October, much to the surprise of economists, who were looking for a decline. The end result was a jump of nearly 81 points for the Dow by the close.
Unfortunately, Monday proved to be a false start. An unexpected interest rate hike from the People's Bank of China sent traders scrambling for the exits, while Apple Inc. (AAPL) - which usually leaves rainbows, butterflies, and a market rally in the wake of its quarterly earnings report - failed to live up to elevated investor expectations. The final nail in the coffin for stocks, however, was Bank of America Corp.'s (BAC) wider quarterly loss, and news that major bondholders are looking to force B of A to repurchase nearly $47 million in mortgages that were originally sold by Countrywide Financial. Licking its wounds, the DJIA rebounded from its lows of the day, but still finished with a loss of roughly 165 points, or 1.5%.
But B of A was just one of many companies in the earnings flood, and the market soon shrugged off the banking concern, along with its overreaction to China's interest-rate hike. In fact, strong quarterly results from Boeing (BA) and Wells Fargo (WFC), among others, provided an upward bias early on Wednesday. The bullish mood solidified late in the session, after lingering employment concerns detailed in the Fed's latest Beige Book essentially cemented the market's expectations for another round of quantitative easing. For the day, the DJIA gained 1.18%, erasing much of Tuesday's losses.
Despite a veritable flood of better-than-expected earnings from blue-chip companies, and a brief trip above 11,200 by the DJIA, Wall Street turned its attention toward the weekend on Thursday. The G-20 meeting on currency and interest rate policy loomed large, and traders were loath to take up firm positions ahead of the group's weekend statement. Investors largely overlooked quarterly reports from McDonald's Corp. (MCD), Travelers Companies Inc. (TRV), and Caterpillar Inc. (CAT), especially after an upward revision to the previous week's jobless claims drew more bears to the table. Still, the DJIA finished with modest gains, adding 0.35%.
The DJIA was constrained to a 50-point trading range on Friday, and G-20 anxiety held the Street captive for the duration of the session. Lackluster earnings reports from blue chips American Express Co. (AXP) and Verizon Communications Inc. (VZ) were mostly offset by solid numbers from tech giants Amazon.com Inc. (AMZN) and Baidu Inc. (BIDU). In the end, however, it was a wash for the DJIA, which ended roughly 14 points below where it began the day. For the week, the Dow recorded a solid gain of 3.2%, but was overshadowed by the S&P 500 Index's 3.7% advance and the Nasdaq Composite's impressive 4.7% rally.
What the Trading Desk Is Expecting: Why a Lack of Retail Investor Participation May be Bullish for the Market
By Todd Salamone, Senior Vice President of Research
"Signs Point to Swing and Miss on Earnings"
-The Wall Street Journal, Sept. 27, 2010
"Third-quarter earnings begin soon, and the primary mood on most trading desks is one of skepticism about the recent rally."
-Barron's, Sept. 27, 2010
"S&P 500 Profits Cut for First Time in Year by Analysts"
-Bloomberg, Oct. 4, 2010
The Group of 20 (G-20) talks are behind us and earnings season is accelerating, with midterm elections and a key Federal Open Market Committee (FOMC) meeting just around the corner in early November. Economic reports will dominate morning headlines throughout the upcoming week, as reports on existing and new home sales, durable goods orders, jobless claims and the third-quarter advanced gross domestic product (GDP) reading will be released.
Earnings will also be in focus, with heavyweights such as U.S. Steel Corp. (X), 3M Company (MMM), Exxon Mobil Corp. (XOM), Merck & Co. (MRK), Procter & Gamble Co. (PG), and Microsoft Corp. (MSFT) scheduled to report quarterly earnings. Traders will also get a glimpse into the state of the consumer via earnings reports from Sherwin-Williams Company (SHW), RadioShack Corp. (RSH), Coach Inc. (COH), Buffalo Wild Wings (BWLD), Panera Bread Company (PNRA), and P.F. Chang's China Bistro (PFCB).
I found a compelling headline on Bloomberg.com on Friday that read, "Boeing Sales Beat 'New Normal' Pessimism as Fed May Act." The "new normal" term has been tossed around quite a bit by various market commentators and analysts, with the implication that we should prepare ourselves for a long period of slower growth. Moreover, as the lead quotes suggest, there was not a lot of enthusiasm heading into earnings season, creating a lower bar for companies to hurdle. But 85% of companies reporting so far have beaten forecasts, helping support a market that has rallied strongly off the August lows.
Who is buying stocks? It certainly is not the retail investor -- not U.S. stocks, anyway -- which from a contrarian perspective is bullish. The Investment Company Institute reported this week that the consecutive weekly streak of net fund outflows in place since late April finally ended the week of Oct. 13th. But the streak ended because inflows into foreign equity funds were higher than the sharp decrease in net outflows from domestic equity funds.
It appears from our analysis of option activity that a strong bid for U.S. equities is still coming from hedge funds, who will buy index or exchanged-traded fund (ETF) put options to hedge long positions that they are accumulating. A clue as to when some hedge funds are in accumulation phase is when the ratio of bought-to-open puts versus bought-to-open calls increases on major exchange-traded funds, such as the SPDR S&P 500 ETF Trust (SPY), PowerShares QQQ Trust (QQQQ) and iShares Russell 2000 Index Fund (IWM).
The below graph, which you may be familiar with by now, continues to display a 20-day put/call volume ratio on the rise. The significance of who is buying is that when hedged hands are accumulating stocks, rallies tend to occur, and any sell-offs tend to be modest given they have put protection in place.
Daily SPX chart with 20-day BTO put/call volume ratio for the SPY, QQQQ, and IWM
On the technical front, a bullish "golden cross" occurred on the S&P 500 Index (SPX) Friday, in which the 50-day moving average rose above the 200-day moving average. Rocky White, our Senior Quantitative Analyst, will take you through the historical facts surrounding this development and present you with his interesting take in the "Indicator of the Week" section that follows.
We continue to view the 1,200 level on the SPX as a potential resistance area. Not only is it a round number, but it is the site of the 80-month moving average and the April 2010 peak. Moreover, the SPX danced around 1,200 for several months in late 2004 and most of 2005. We view support in the 1,150 area, site of the January 2010 peak. The 1,150 level on the SPX also corresponds to the 115 level on the SPY, site of peak put open interest in the November option series.
Keep your long exposure, as continued hedge fund buying and potential money moving from the sidelines can keep this bull trend intact. With the CBOE Market Volatility Index (VIX – 18.78) below 20 and around five-month lows, now is an opportune time to hedge your long portfolio with short-term, out-of-the-money index or ETF put options. Potential technical resistance lies just overhead and there are several possible market-moving catalysts on the immediate horizon, suggesting the purchase of portfolio protection is prudent at this time.
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Indicator of the Week: The S&P 500 Index's Golden Cross
By Rocky White, Senior Quantitative Analyst
Foreword: Last July I wrote about the "death cross" on the S&P 500 Index (SPX). That's when the 50-day moving average crosses below the 200-day moving average. This is often portrayed as a bearish signal for the market. Nevertheless, the market has rallied since then and we just had a "golden cross." That, as you may have guessed, is the opposite of a death cross. It's when the 50-day crosses above the 200-day. The chart below shows the golden and death crosses on the S&P 500 since 2000. While some of the death crosses marked a mere pullback, all the golden crosses have been bullish for the market. However, history is not always a good predictor for the market and there is a more important aspect of this that I'll talk about next.
Daily SPX chart with death crosses and golden crosses
Media Attention: I, like everyone else in the media, wrote about the death cross in July when it happened. This is from my Monday Morning Outlook article in early July:
"One thing to keep in mind is that these technical levels can garner some media attention. We have seen a few articles about the death cross. Too much media attention can cause a contrarian affect of the indicator. For example, if media attention in the death cross strikes enough fear into traders then they will sell before it happens or put on hedges that prevent them from being forced to liquidate losing positions. In this situation the selling pressure is exhausted by the time the death cross occurs and now the sideline money and unwind from the hedges can actually instigate a rally."
The rally happened, as the market is up almost 15% since the death cross. Now the 50-day moving average has overtaken the 200-day to complete the golden cross. Unlike the July death cross, which everyone was talking about by the time it happened, I've hardly seen anything discussing the impending golden cross. Look at the chart below using data from Google Trends. It measures the interest in the United States of the terms "golden cross" and "death cross" by comparing the number of Google searches for those words. Look at the huge spike just before July in searches for "death cross." Compare that to the number of searches for "golden cross" happening now.
Google trends for SPX death cross and golden cross
Historical Data: I've already noted that the most important takeaway from the golden cross is the media's lack of coverage, given the mass coverage of the death cross less than four months earlier. However, let's look at the historical data following these events. Since the early 1970s, there have been 18 golden crosses and 19 death crosses (including the most recent one). The table below shows that the market is usually pretty strong after a golden cross. In the four months following a golden cross the S&P 500 increases an average of 4.22% while the market has usually only gained 1.87% over the same period. Note there is outperformance in all time frames below.
The death cross signals are mixed compared to the typical S&P 500 returns. There is outperformance after a death cross at three- and six-month time frames but underperformance at one and 12 months.
SPX returns following death and golden crosses
Finally, below is another way to assess the returns. It looks at how often the returns are positive following a golden cross and death cross. The conclusions are the same as the table above. The golden cross is bullish while a death cross is more mixed.
SPX percent positive following death and golden crosses
Wrapping Up: The golden cross typically signals good returns in the near future. More importantly, this bullish phenomenon is being completely ignored. Four months ago, when the death cross occurred, there was a barrage of articles asserting it confirmed a looming market crash. I haven't heard a peep about the golden cross happening right now. It seems no one is pointing to this bullish news because no one believes a rally is imminent. This lack of belief has bullish implications for the market. It suggests bad news is priced into the market already so there are a lot of people standing on the sidelines. As this market continues to rally investors will come to believe or have no choice but to submit and begin buying. The inflow of sideline money can sustain this rally for a long time. Don't be late getting in.
This Week's Key Events: Ready or Not, Here Comes Third-Quarter GDP
Schaeffer's Editorial Staff
Here is a brief list of some of the key events this 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
* The National Association of Realtors will report on existing home sales for September. M/I Homes Inc. (MHO), RadioShack Corp. (RSH), Sohu.com Inc. (SOHU), Atheros Communications Inc. (ATHR), SL Green Realty Corp. (SLG), and Texas Instruments Inc. (TXN) will report earnings.
Tuesday
* The Case-Shiller home price index for August and October's consumer confidence index are on tap for Tuesday. AK Steel (AKS), ArcelorMittal (MT), Biogen Idec Inc. (BIIB), Bristol-Myers Squibb Co. (BMY), DuPont (DD), Johnson Controls Inc. (JCI), Kimberly-Clark Corp. (KMB), Lexmark International Inc. (LXK), U.S. Steel Corp. (X), Under Armour Inc. (UA), Valero Energy Corp. (VLO), Broadcom Corp. (BRCM), Massey Energy Co., (MEE), NetGear Inc. (NTGR), and Novellus Systems Inc. (NVLS) are scheduled to issue their quarterly reports.
Wednesday
* On Wednesday, September's durable goods orders, September's new home sales, and the weekly report on U.S. petroleum supplies are slated for release. Scheduled to report earnings are Brinker International Inc. (EAT), ConocoPhillips (COP), The Procter & Gamble Co. (PG), P.F. Chang's China Bistro (PFCB), Sprint Nextel Corp. (S), Goldcorp Inc. (GG), and Visa Inc. (V).
Thursday
* The Labor Department will release the weekly new jobless claims figures. Meanwhile, 3M Company (MMM), Avon Products Inc. (AVP), Colgate-Palmolive Co. (CL), Exxon Mobil Corp. (XOM), Motorola Inc. (MOT), Potash Corp. of Saskatchewan Inc. (POT), and Microsoft Corp. (MSFT) will report earnings.
Friday
* We round out the week with an advance look at third-quarter gross domestic product, October's Chicago purchasing managers' index, and the final reading for the October University of Michigan consumer sentiment index. Arch Coal Inc. (ACI), Chevron Corp. (CVX), The Estee Lauder Companies Inc. (EL), Merck & Co. Inc. (MRK), and Sony Corp. (SNE) will report earnings. |
