Monday Morning Outlook: Why Bulls Need the VIX to Stay South of 50
Surveying the technical outlook in the wake of a wildly volatile week for stocks
by Todd Salamone 8/13/2011 1:11 PM
It was an appropriately tumultuous week on Wall Street, as traders around the globe reacted to S&P's U.S. debt downgrade. If any additional evidence was needed to prove that the global financial system had shifted on its axis, Tuesday's Fed statement sealed the deal. Much to their presumable chagrin, the generally hawkish trio of Fisher, Plosser, and Kocherlakota emerged as the unlikely -- and unsuccessful -- defenders of the Fed's famous "extended period" language, which was discarded this past week as the relic of a more optimistic time. Stocks spent the week bouncing between dramatic gains and stomach-churning losses, with the Dow Jones Industrial Average pinballing through its most volatile four-day streak since 2008. By the time Friday's closing bell sounded, the major market indexes were a little worse for the wear, but key support levels remained firmly intact.
This week, Todd Salamone steps back from the fray to offer some calm, rational technical analysis. Encouraging signs of stability are starting to develop, but Todd warns that the bulls can't relax just yet -- especially as the VIX lingers within striking distance of a historically significant round-number level. Meanwhile, Rocky White casts a contrarian eye on the latest Investors Intelligence survey, which revealed a somewhat unlikely increase in optimism. Finally, we wrap up with a preview of this week's major economic and earnings events, as well as a few sectors of note.
Notes from the Trading Desk: Starting to Stabilize, But Still Not Out of the Woods
By Todd Salamone, Senior VP of Research
"The key 1,200 century mark on the SPX is also the approximate site of its 80-week moving average (1,206.10), which caught the lows at the July/August 2010 bottom. The index's weekly close below this trendline and the 1,200 century mark is a cause for concern heading into this week's trading. "...The 900 level on the MID acted as resistance in 2007-2008 prior to a brutal pullback in this index. The decline back below this former resistance level puts the bears in control, and thus a move down to the index's 80-month moving average, at 764, could be in the offing. The 80-month moving average acted as support at the 2002 bottom and at the July/August 2010 bottom, while a move below this trendline in October 2008 was a precursor of more damage to come.
"...The RUT broke below its 80-week moving average last week, which is currently sitting at 729.54. For what it's worth, the 80-month moving average on the RUT is sitting at 686.91. This trendline was supportive during pullbacks in 1998 and 2001, but when broken to the downside, is predictive of more selling."
-- Monday Morning Outlook, August 6, 2011
Last week, on the heels of the Standard & Poor's downgrade of U.S. debt, and in anticipation of a wild week with potential downside repercussions, we gave you some longer-term levels to focus on with respect to the key indexes that we track. The goal was to give you a road map for the volatile week that was about to be.
Indeed, there was nothing good about the S&P 500 Index's (SPX - 1,178.81) close below the 1,200 level and its 80-week moving average, as these developments foreshadowed immediate weakness. But what intrigues us about last week's trading is the low at the 1,100 century mark, which also coincides with the index's 40-month moving average. This trendline covers approximately three years, incorporating monthly closing prices going back to a few months before Lehman Brothers went under, and it capped a rally ahead of May 2010's "flash crash." For Fibonacci players, the pullback to 1,100 represents a 38.2% retracement of the March 2009 low and last May's peak. Additionally, as of the end of August, the 10-year breakeven price on the SPX is located at 1,133,58, which the index was able to rally above by week's end.
The Russell 2000 Index (RUT - 697.50) hit a low in the 650 area, and quickly recovered to close the week above its 80-month moving average, which we mentioned as having significance last week. The 650 level marked a major speed bump in 2005 on the index's way to its peak in 2007, and then briefly acted as support in 2008, before the Lehman situation eventually pushed the RUT back below 650. The RUT finally closed the week at 697.50, which means it remains above a double of its March 2009 low of 342.59.
Turning to the S&P 400 MidCap Index (MID - 843.08), Tuesday and Wednesday's lows in the 770 area were slightly above its 80-month moving average at 764.78, and nearly a 25% haircut from its 1,015 peak. Moreover, with the index rallying late in the week, it closed back above the 800 century mark, which is approximately double its 2009 low.
"...the jury is out as to whether or not the VIX has indeed peaked, but from this perspective, there is certainly room for the VIX to move higher and challenge its May 2010 high in the 48 area."
-- Monday Morning Outlook, August 6, 2011 By Monday's close, the CBOE Market Volatility Index (VIX - 36.36) indeed challenged the 48 area, as realized volatility on the SPX surged as a result of the day's sell-off. The VIX then retreated the rest of the week, after "realized" volatility finally caught up with "implied volatility." For bulls, the pop in the VIX may be very encouraging. As you can see on the chart below, dating back to the "Asian Contagion" worries in 1997, the VIX has peaked five times on its six previous trips to the upper 40s. The exception was the financial crisis in 2008, when credit markets essentially stopped functioning, unlike today.
That said, if you were to look at a daily chart of the VIX in 2008, you'll see that it took about a week for the index to finally take out 50 after its initial run at this level. If the VIX can stay below 50 in the upcoming week, a case can be made for another VIX peak, which would be music to the bulls' ears.
The market showed a little bit of stability late last week that could extend into this week, potentially keeping the VIX below this key round-number level. The SPX, for example, finally managed to advance above key intraday trendlines that had continuously capped rally attempts during the sell-off from 1,340, as we noted last week.
Some of the selling during the past couple of weeks could have been related to, and exaggerated by, big put strikes on index and exchange-traded fund (ETF) options getting breached to the downside. The implications are that sellers of this portfolio insurance (i.e., put sellers) take on additional risk when these breakdowns occur, and they manage this additional risk by shorting more and more equity futures. Once this "delta hedge" selling process ends, equities can begin to regain their footing, as we saw late last week. If such stability continues, the opposite mechanics could occur, as put sellers that are short futures cover their positions, due to the expiration of the remaining out-of-the-money puts that are outstanding.
What does this all add up to? The VIX spike to an area that has historically marked buying opportunities, coincident with various indexes finding support at intriguing levels this past week, suggests you can begin accumulating equities in the small- and mid-cap spaces -- but do so on a smaller scale than normal. The equity market is not out of the woods, despite some initial signs of stability. For example, the RUT is still below 750, and the MID remains below 900. Plus, there are no visible signs in the options market that hedge-fund managers are increasing their long equity positions. Maintain exposure to gold and Treasurys, and continue to avoid the big-cap financials.
Indicator of the Week: A Surprise Bullish Rise in the Investors Intelligence Sentiment Poll
By Rocky White, Senior Quantitative Analyst
Foreword: With rampant volatility triggering the market's biggest three-week drop in over two years, you might expect to see a lot of fear on Wall Street. That's exactly why we were so surprised to see the results of the latest Investors Intelligence (II) sentiment poll. Every week, II surveys financial advisors and reports the percentages that are bullish and bearish on the market (they have a third designation for those on the fence). In the latest weekly survey, the percentage of bulls actually increased, while bears decreased.
Below is a chart showing the percentage of bulls in the weekly II survey alongside the performance of the S&P 500 Index (SPX). (Note: The poll is released on Wednesdays, but the poll is taken the Friday before. So, to match up the price action with the poll results, the chart is only updated through Friday, Aug. 5.) You'll notice the recent uptick in the "bulls" line, despite the index's hard fall. At that point, the market had suffered its biggest two-week slide in more than two years, so we had expected the percentage of bulls to decrease -- signaling pessimism. Over that two-week time frame, the bulls only fell from about 50% to 47%, which is actually a higher percentage than a couple of months ago, when the market was above 1,300.
Bulls Gain Ground in a Down Week: Below is a table showing all weeks where the SPX fell at least 5%, while the percentage of bulls in the II survey actually increased. The last time this happened was late 2008. You'll see the market's weekly return, along with the percentage of II bulls in the week prior to the drop, the week of the drop, and finally the week after the drop (to see if panic set in a week later). However, there were only a handful of occasions where the percentage of bulls declined the next week following a market pullback. It's also worth noting that this latest reading had a relatively high percentage of bulls compared to most other occurrences, coming in second only to the 2001 incident.
Below is a table showing those same dates as above, along with the SPX returns out to a three-month time frame following those dates. As contrarians, we were put off by the bullish increase in the latest II poll, as well as the fact that the market showed some weakness following the last occurrence in 2008. However, after considering the other occasions when the number of bulls increased amid a big weekly drop, the returns were generally pretty bullish.
Of course, we look at many different indicators to gauge investor sentiment and market conditions. For this particular indicator, it makes us feel better that the stubbornness of II bulls does not historically have the bearish implications that we might have expected.
This Week's Key Events: Retail Earnings, Inflation Data on Deck
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 economic calendar kicks off Monday with the Empire State manufacturing index for August. On the earnings front, we'll hear from Lowe's (LOW), Urban Outfitters (URBN), Zagg (ZAGG), Agilent Technologies (A), Estee Lauder (EL), and Harmony Gold Mining (HMY).
Tuesday
- Tuesday's docket includes July's housing starts, import/export prices, industrial production, and capacity utilization. Scheduled to report earnings are Home Depot (HD), Wal-Mart Stores (WMT), Saks (SKS), Dick's Sporting Goods (DKS), Dell (DELL), Analog Devices (ADI), and JinkoSolar (JKS).
Wednesday
- Inflation data starts to hit the Street on Wednesday, with the release of the producer price index (PPI) and core PPI for July. Also due out is the regularly scheduled report on weekly petroleum supplies. Among the companies expected to share the earnings stage are Target (TGT), Abercrombie & Fitch (ANF), BJ's Wholesale Club (BJ), Staples (SPLS), Hot Topic (HOTT), Deere & Co. (DE), JDS Uniphase (JDSU), NetApp (NTAP), and Canadian Solar (CSIQ).
Thursday
- Initial and continuing jobless claims are on the calendar for Thursday, along with the consumer price index (CPI) and core CPI for July. Traders will also hear about existing home sales and the Conference Board's index of leading economic indicators for July, as well as the August Philadelphia Fed index. Meanwhile, notable earnings reporters include Hewlett-Packard (HPQ), Salesforce.com (CRM), Autodesk (ADSK), Marvell Technology (MRVL), Aeropostale (ARO), Dollar Tree (DLTR), GameStop (GME), Foot Locker (FL), JA Solar (JASO), and J.M. Smucker (SJM).
Friday
- There are no major economic reports on Friday. Ann Inc. (ANN), China Sunergy (CSUN), and Yingli Green Energy (YGE) round out the week's slate of earnings reports.
schaeffersresearch.com |
