Monday Morning Outlook: Are Hedge Funds Coming Back to the Market?
Put volume spiked on QQQ last week, hinting at equity accumulation
by Todd Salamone 3/26/2011 12:00 PM
The major market indexes cruised past key technical milestones last week, even though the headlines offered up plenty of cause for concern. Over the course of the past five sessions, traders essentially shrugged off a U.N. no-fly operation over Libya, rising violence in Syria and Yemen, the ongoing crisis in Japan, and hot-and-cold U.S. economic data. Oh -- and the increasingly likely prospect of a bailout for Portugal. But in hindsight, it seems safe to surmise there was plenty of panic priced into the equities market already.
In fact, Todd Salamone cites several indicators to support the bullish case going forward. Along with the recent dip in the CBOE Market Volatility Index (VIX), Todd also points to evidence of renewed hedge fund interest in equities. Meanwhile, Rocky White crunches the numbers to find the most foolproof technical analysis indicator of 2011. Finally, we wrap up with a preview of the week ahead -- including the payrolls report for March -- as well as a few sectors of note.
Notes from the Trading Desk: Carving Out a Bull-Market Bottom
By Todd Salamone, Senior Vice President of Research
"To the extent that some of last week's selling was driven by hedging activity related to the huge put open interest on expiring index and ETF options, it would favor the bulls, as investor anxiety climbed amid the selling. For example, the latest survey from the American Association of Individual Investors (AAII) revealed only 28% of those surveyed were bullish -- the lowest percentage of bulls since late August 2010, which was a buying opportunity.
"Despite the rising fears, the SPX managed to close the week above its 80-day moving average, which we identified as a potential support area in the event of a decisive break below 1,300... Moreover, we found it interesting that the SPX, Dow Jones Industrial Average (DJIA -- 11,858.52) and Russell 2000 Index (RUT -- 794.66) pulled back to their respective breakevens for the year, and closed the week in positive territory.
"While the VIX peaked in the 30 area around mid-week, we won't have confirmation that a top has been reached until we see a decline below these long-term trendlines and the 20 level... Another concern is that our analysis of activity in the options market indicates that hedge funds are still not showing interest in accumulating equities."
-- Monday Morning Outlook, March 19, 2011
One week ago in this space, we noted a spike in fear among traders and investors, sparked by a developing nuclear crisis in Japan and continued tensions in the Middle East and North Africa. Our thought was that the selling related to these headlines could have been exaggerated by expiration-week action, and this was supported by a convincing equity market rebound from support during the past five days' worth of trading.
The Dow Jones Industrial Average (DJIA -- 12,220.59), S&P 500 Index (SPX -- 1,313.80) and Russell 2000 Index (RUT -- 823.85) rallied back above their key respective round-number levels of 12,000, 1,300 and 800. Moreover, the S&P 400 Midcap Index (MID -- 970.43) rallied from a perfect test of its 80-day moving average at its lows two week ago, and ended this past week's trading just 11 points below its record closing high at 980.49 in February. Finally, the CBOE Market Volatility Index (VIX -- 17.91) confirmed the peak at its double low in the 30 area, as it did a round-trip back below a few key long-term moving averages and the 20 level.
A few indicators caught our attention this past week which could align nicely for the bulls. For instance, evidence in the options market suggests some hedge funds may be in the early stages of accumulation again.
Specifically, the combined International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX) 20-day buy-to-open put/call volume ratio on the PowerShares QQQ Trust (QQQ -- 56.84), SPDR S&P 500 ETF Trust (SPY – 131.30) and iShares Russell 2000 Index (IWM – 82.22) finally turned higher after declining for several weeks. When this ratio peaked at a high level and turned lower several weeks ago, we cautioned that the market could run into headwinds, as it signaled hedge funds were no longer in buying mode. For new readers, hedge fund managers will usually buy ETF puts as protection against equities they are accumulating. When put demand slows, it suggests many of these managers are not in buying mode, but as put demand grows, it implies they are buying.
Much of the put activity last week took place on the QQQ. In fact, Wednesday's QQQ put buying was so substantial that the QQQ's cumulative 50-day buy-to-open (BTO) put/call volume ratio popped from 2.39 to 2.72 in only one day – the ratio's largest daily percentage increase since we have been tracking the data.
This prompted us to research past instances when the QQQ's 50-day put/call volume ratio was below 2.50 and increased by more than 5 percent in one day. The parameters of this study would suggest a sudden interest in QQQ-related equities following a period in which hedged players were ignoring this group. As you can see below, since 2007, our research shows that the QQQ tends to take on a bullish pattern subsequent to such signals.
Along the same lines, fear among equity option players hit a six-month high, as you can see in the equity-only, customer-only buy-to-open put/call ratio graph below, which combines data from the ISE, CBOE, and PHLX. Sharp increases in this ratio tend to mark significant bottoms. Fear levels among this segment of the market have not yet hit an "off-the-chart" level, as in 2008 and 2009. But then again, it takes lower levels of fear to carve out a short-term bottom in a bull-market environment relative to a bear-market environment.
Finally, last week's sharp VIX decline amid a steady rise in SPX historical volatility since the beginning of the year has culminated in a situation in which the VIX is trading at a very small premium relative to SPX historical volatility. As you can see on the chart below, when the VIX reading and SPX historical volatility converge following a period of weakness, such situations usually mark bottoms and precede a period of bullish price action.
Resistance for the SPX is in the 1,333 area, which is around the March 2011 high and marks a double of the SPX's March 2009 low. Support is in the 1,280 area, which acted as resistance for a brief period in early January and support later that month. Since mid-February, there have been only three closes below 1,280, and the rising 80-day moving average is in this area, too.
Indicator of the Week: Comparing Technical Analysis Indicators
By Rocky White, Senior Quantitative Analyst
Foreword: Believe it or not, there are many traders out there who buy and sell stocks based only on price action. All of their decisions are based off of a chart. Sometimes they cannot even tell you what the company does, or even what sector of the economy it's in. The method of forecasting stock prices based on prior price action is called technical analysis. There are many technical analysis indicators that most traders have heard of, or at least seen included on a price chart. Moving averages are often considered important to technical analysis. This week, I'll take a look at some of the more popular indicators to see which has performed the best over the last several years.
Indicators: First, I'll briefly describe the indicators that I evaluated.
* RSI: The RSI (Relative Strength Indicator) is an oscillator that ranges from zero to 100. A low number reading suggests a stock is oversold and ready to bounce. A typical "buy" level for this indicator is 30.
* MACD: The MACD (Moving Average Convergence/Divergence) is calculated using the difference between two moving averages for a stock. A moving average of that difference is then used, and called the signal line. A common "buy" signal is generated when the MACD crosses above that signal line.
* Golden Cross: A golden cross occurs when a shorter-term moving average crosses above a longer-term moving average. In the analysis below I used 50-day and 80-day moving averages.
* Moving Average Crossover: Here, we're simply looking at the stock price crossing above a certain moving average. I compared returns after the stock's price crossed above its 20-, 50-, and 80-day moving averages.
Below is a table with each of the signals discussed above and stock return data over the next month of trading after a buy signal was generated. Keep in mind, this is a very simple way of looking at these signals. Technical analysts generally consider more than just one single "buy" signal on one indicator.
That being said, the MACD has clearly been the best indicator of the ones I considered. It's the only one that outperformed all stocks in general. The worst-performing signal is the golden cross, which actually shows an average negative return after a "buy" signal.
Technical indicators track record since 2005
This Year: The table above goes back to 2005, but I also wondered how these signals had performed in 2011 specifically. The table below shows the results. Again, the golden cross is the worst-performing signal by far. The MACD again outperforms all stocks, but just slightly.
One difference is the simple moving average crossovers. The best-performing technical indicator so far this year has been a crossover of the 20-day moving average. The second best is a cross above the 80-day moving average.
Technical indicators track record in 2011
This Week's Key Events: Bracing for March Payrolls
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
* We hit the ground running with economic news this week, as Monday brings us the latest word on personal incomes and spending, pending home sales for February, and the Dallas Fed manufacturing index for March. Cal-Maine Foods (CALM) and Phillips-Van Heusen (PVH) are scheduled to report earnings.
Tuesday
* The pace stays busy on Tuesday. On the economic front, we've got weekly chain store sales, the S&P/Case-Shiller home price index for January, and the Conference Board's consumer confidence index for March. Meanwhile, the earnings calendar includes Lennar (LEN), A-Power Energy (APWR), Apollo Group (APOL), and Sealy (ZZ).
Wednesday
* Wednesday features the regularly scheduled update on crude inventories, as well as ADP's employment report for March -- which will be eyed as a potential preview of Friday's closely watched jobs number. Family Dollar (FDO) is slated to announce its quarterly results ahead of the open, with Mosaic (MOS) reporting after the close.
Thursday
* On Thursday, we'll hear reports on weekly jobless claims, the Chicago purchasing managers index (PMI) for March, and factory orders for February. Lawson Software (LWSN), CarMax (KMX), Robbins & Myers (RBN), and Krispy Kreme (KKD) headline a mixed bag of earnings announcements.
Friday
* The Labor Department will take center stage ahead of Friday's open with its March nonfarm payrolls report. Consensus estimates are calling for an increase of 192,000, according to Dow Jones. Also on tap are construction spending for February, the ISM's manufacturing index, and domestic auto sales data for March. No notable earnings reports are on the calendar. |
