Signs We May Have Reached a Market Bottom
Sentiment and technical indicators may point to more upside
by Todd Salamone 6/16/2012 9:35:11 AM
After a week of intraday swings and the occasional triple-digit move, the Dow Jones Industrial Average (DJI - 12,767.17) settled the week 1.7% higher than where it began. Stocks continue to experience daily volatility within the larger context of a range-bound market, but Friday's defeat of significant technical resistance could be the beginning of a positive shift for the bulls. Heading into a critical week that includes Greece's election results and the outcome of the latest Fed meeting, Todd Salamone reviews important sites of both resistance and support and surveys the current sentiment landscape, which is consistent with market bottoms. Rocky White then provides a list of potentially bullish picks for the second half of the year, generated by a screen that features analysts' ratings as a contrarian indicator. Finally, we wrap up with a look at this week's notable earnings and economic events and review a few sectors of note.
Notes from the Trading Desk: Two Resistance Levels Down, One to Go?
By Todd Salamone, Senior VP of Research
"The technical backdrop improved last week, but the bulls are not out of the woods ... the VIX enters the week trading at potential support 50% above its March lows. This area has contained three separate pullbacks since late May, which have coincided with weakness in the equity market. Meanwhile, the SPX faces resistance at several key levels, including: - 1,320 -- A pivot point on several occasions during the 2000s
- 1,333 -- Double the March 2009 low
- 1,340-1,360 -- Site of the 2011 highs
... The current open interest configuration on the SPDR S&P 500 ETF (SPY - 133.10) is very put-heavy, setting up the potential for short-covering related to the expiring put open interest at strikes immediately below the current SPY price. The odds are in the bulls' favor, absent a negative outcome with respect to Spain over the weekend ... On the upside, a move into heavy call strikes at 134 and 135 would be a possibility in the event of a short-covering rally. These areas correspond to SPX 1,340 and 1,350, respectively, which we cited above as potential chart resistance."
- Monday Morning Outlook, June 9, 2012 Following a weak start to expiration week last Monday, the market rallied into the weekend, catalyzed primarily by rumors of coordinated worldwide central bank actions in the event of negative fallout from the Greek elections this weekend. This catalyst created an apparent short-covering rally -- a possibility we alluded to last week -- due to the expiration of heavy put open interest on major exchange-traded funds (ETFs), such as the SPDR S&P 500 ETF (SPY – 134.14).
The rally from Monday's low pushed the SPY into the 134.00 area, which corresponds with 1,340 on the S&P 500 Index (SPX – 1,342.84), home of potential resistance due to heavy call open interest at the SPY 134 and 135 strikes in the (now-expired) June series. This region also marked the site of three highs in 2011 and multiple peaks this year dating back to the end of last month. Encouraging for the bulls is the SPX's move further above the 1,320 area late in the week, a level that proved pivotal on multiple occasions going back to 2000, and a magnet in recent days, as the index traded six consecutive days above and below this level, up through Friday. Moreover, the SPX closed back above its March 2009 double-low at 1,333.58 on Friday, after this level had acted as intraday resistance the previous trading day.
So, while two of three major resistance levels were taken out this past week, resistance from last year's highs remains overhead, particularly near the 1,340 area. Whether you are a bull or bear, there are potentially market-moving events immediately ahead (Greek elections, Fed and G-20 meetings next week) and 1,340 may act like a brick wall once again or be decisively breached to the upside, should stocks muscle higher.
The CBOE Market Volatility Index (VIX – 21.11) has remained stubbornly high, with the SPX rallying about 25 points since June 6 and the VIX remaining flat over this period. Per the chart below, note how VIX drops continue to be contained in the area that is 50% above the March intraday and closing lows. The obvious conclusion is we get a huge bounce from this area on Monday morning, but then again, it will likely take a gap below this area in order for the VIX to make a sustained move south of this support, which has been in place since mid-May.
Also of interest for bulls is the potential for a bearish, or inverse, "head and shoulder" pattern on the VIX to develop, as displayed in the 30-minute intraday chart below. A break below the neckline in the 20.00-20.50 area would target a VIX move to 12.00 in relatively short order, which is likely unimaginable to many market participants, given the negative headlines and uncertainty both here and overseas. An imploding VIX would likely be coincident with an explosive rally in stocks. Should the VIX explode higher from this recent support zone, the 27.50-29.00 area -- site of this month's high and double the March low -- would be an important area to watch.
As we have been saying for weeks, the present sentiment backdrop is consistent with major bottoms during the past few years, suggesting there is enough short-covering potential and sideline money to sustain a sharp rally over a brief period. This in turn would likely then spark a volatility implosion, as discussed above. Consider:
- Total short interest on U.S. equities is at 2012 highs.
- There are more bears than bulls in the American Association of Individual Investors.
- Hedge funds have extremely light exposure to S&P and small-cap stocks, as evidenced by the low buy (to open) put/call volume ratios on the SPY and iShares Russell 2000 Index ETF (IWM – 77.22) during the past 50 days. In fact, the IWM's 50-day buy (to open) put/call volume ratio is near the levels of 2009, which marked a decisive bottom in the index. Low put/call ratios indicate lighter-than-normal hedging activity, which typically occurs when long exposure is relatively light.
- Per the chart immediately below, the 10-day, all-equity, buy (to open) put/call volume ratio is now at its highest level since March 2009, a sign of a potential extreme in pessimism, even as major U.S. equity benchmarks remain in the green this year. Rollovers from high levels in this ratio (which we have yet to see presently) have been consistent with major rallies.
With the SPX coming into the week in a resistance zone from last year's highs in the 1,340-1,360 area, but above potential support (first in the 1,320-1,333 region and then at 1,290), we thought it would be fitting to conclude with a quick review of potential support and resistance areas on the S&P 400 Midcap Index (MID – 920.26) and Russell 2000 Index (RUT – 771.32).
For the MID, resistance could emerge at the year-over-year (52-week) breakeven point, which will range between 930 and 940 during next week's trading. This is also the area of the MID's 2007 peak. We see support at 905, which marked a couple of pivot points in May and June.
For the RUT, resistance could emerge at its respective one-year breakeven that ranges between 780 and 805 next week. The 20-month moving average is located at the bottom of the 780-805 range; this trendline has had some proven significance in the past. Support is at 750, site of the index's peaks prior to Lehman going under in September 2008 and the flash crash of 2010.
Indicator of the Week: Analyst Rankings and Second-Half Stock Returns
By Rocky White, Senior Quantitative Analyst
Foreword: Analysts on Wall Street provide a lot of great information for those looking for fundamental data on a specific company. They are also a valuable source for stock traders, acting as a great contrarian signal (though I'm not sure they are especially proud of that). When everyone expects a stock to move higher, all good news is priced in, and buying power gets exhausted, leaving the stock with nowhere to go but down.
The opposite tends to happen for stocks that everyone hates. "Everyone" includes analysts, by the way. If the analyst community is universally bullish on a company, that may be a warning for that stock. If they are all advocating to "sell," then the selling could be close to over. As we prepare for the second half of 2012, I decided to go back and see how stocks did in the second part of the year, depending on analysts' "buy" recommendations.
Analyst Performance: Using buy/hold/sell data from Zacks Investment Research, I looked at stock returns in the second half of each year since 2000 (Note: I only considered stocks with a minimum of 10 analyst recommendations and 5,000 contracts in open interest). For every year, I placed the stocks into three groups depending on the percentage of buy recommendations. The table below illustrates that stocks with the most bearish analysts' sentiment (the fewest percentage of buy recommendations) had easily the best returns. Those stocks averaged a 5.70% return for the second half of the year. Other stocks averaged between 2.62% and 2.70%.
The next table shows data since 2008. The results are similar and the conclusions are the same. Do not count on analysts to predict the direction of stock prices.
Analysts by Year: The table below shows how the analysts did in each individual year since 2000. Maybe they're getting better? In 2011, there was pretty much no difference between the stocks on which analysts were most bearish and on those toward which they were most bullish. In 2010, stocks seeing the most bullish opinion among analysts outperformed the other groups. So going against the analysts is not a slam dunk, but over the longer term, it has paid to be a contrarian.
Underloved Outperformers: The sentiment toward a certain stock is most significant when it is running counter to price action. When a stock is moving higher in the face of negative sentiment, it means there are a lot of people unconvinced of the rally. That's a sign there is a lot of sideline money that can pour into that stock when the negative sentiment capitulates and turns bullish. This is a recipe for a fast-and-furious rise and/or a long, sustained rally.
If you're looking for stocks to trade in the second half of this year, the list below may be a good place to start your research. These are stocks that would fall into the "bearish" analyst bucket in the tables above, are positive on the year, and have been trading above their 200-day moving average for the most consecutive days. I would say that fits the bill for negative sentiment in the face of positive price action.
This Week's Key Events: Home Sales, Tech Earnings, and a Big Fed Meeting
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 week begins with the National Association of Home Builders (NAHB) housing market index. There are no major earnings reports scheduled for release.
Tuesday
- Tuesday's docket brings the latest data for housing starts and building permits. Plus, the Federal Open Market Committee's (FOMC) begins its two-day meeting to assess interest-rate policy. On the earnings front, we'll hear from Adobe Systems (ADBE), Barnes & Noble (BKS), Discover Financial Services (DFS), FedEx (FDX), and Jabil Circuit (JBL).
Wednesday
- Wednesday's economic calendar features the regularly scheduled crude inventories and an assessment from the Federal Open Market Committee (FOMC) regarding interest-rate policy. Just after 2 p.m. ET, Federal Reserve Chairman Ben Bernanke will hold a press conference to discuss the FOMC's latest position. Bed Bath & Beyond (BBY), Micron Technology (MU), and Red Hat (RHT) are all slated to step into the earnings confessional.
Thursday
- Weekly jobless claims, existing home sales, the Philadelphia Fed's manufacturing index, and the Conference Board's index of leading economic indicators hit the Street on Thursday. Carmax (KMX), ConAgra Foods (CAG), and Oracle (ORCL) will take turns releasing their earnings reports.
Friday
- The week ends on a quiet note as there are no major economic reports and Darden Restaurants (DRI) is alone on the earnings landscape.
And now a few sectors of note...
Dissecting The Sectors
| | Sector | Leisure/Retail
Bullish |
Outlook: Consumer spending remains relatively healthy, with a 2.9% uptick in this metric during the first quarter contributing two percentage points to the gross domestic product (GDP). Also encouraging is the historically low 30-year mortgage rate, as potential refinancing activity could mean U.S. consumers are left with more discretionary income. That said, same-store sales for May were a mixed bag; the collective number slightly outpaced estimates, but certain individual figures came in worse than expected. On the charts, the SPDR S&P Retail ETF (XRT) remains in a solid long-term uptrend, and the $56 area continues to be supportive. You may recall this level is home to the ETF's 160-day moving average and the site of the July 2011 peak. Additionally, this area is home to big put open interest in the now front-month July series, where more than 25,000 contracts reside. In the past month, we have seen more put buying than call buying on several strong names in the group, even ones that have gained in value over the same time period, such as Sherwin-Williams (SHW), Wal-Mart Stores (WMT), Bed Bath and Beyond (BBBY), Dollar Tree (DLTR), and Target (TGT). Short interest on XRT, meanwhile, has started rolling over from a three-month high but it would still take more than five days to unwind the remaining shorted shares. The restaurant sector, including names such as Buffalo Wild Wings (BWLD) and Chipotle Mexican Grill (CMG), is particularly compelling at the moment, with the group sporting just 50% "buy" ratings even as roughly 68% of sector components trade atop their 200-day moving averages. With skepticism still prevalent toward consumer-dependent stocks, contrarians can continue to capitalize on situations where sentiment has yet to catch up with bullish technicals.
| | Sector | Homebuilding
Bullish |
Outlook: The housing sector has seen some positive developments in 2012, thanks in part to record-low mortgage rates, which have reignited interest in the real-estate market. Pending home sales for April dropped 5.5%, however -- falling short of expectations, hitting a year-to-date low, and raising concerns that the recovery might have a speed bump or two in its path. While this monthly decline adds risk to the sector, the index still climbed 14.4% in April on a year-over-year basis. Technically speaking, we remain interested in the price action of the SPDR S&P Homebuilders ETF (XHB), which recently found support at its 160-day moving average this week (also the site of last year's high). Of potential concern from a technical perspective are the ETF's 40-day and 80-day simple moving averages (both perched near $20.75), which have been rolling over of late. As a further point of caution, we've seen some positive coverage of homebuilders lately, including a recent Barron's cover story titled "Home Prices Ready to Rebound." However, we think this optimism is in the very early innings after years of negativity, and other sentiment data we track suggests there is still plenty of skepticism surrounding homebuilding stocks. For now, investors may opt to hedge any long positions held on homebuilding names by employing XHB puts. Some of our preferred names in the sector are Lennar (LEN), Meritage Homes (MTH), PulteGroup (PHM), Toll Brothers (TOL), and D.R. Horton (DHI) -- all of which sport relatively high short-to-float ratios of 9% or greater, as well as a preponderance of "hold" and "sell" ratings from analysts. Short interest on the overall ETF is turning lower from all-time highs, and this unwinding of bearish positions could be a tailwind for the group. With a healthy amount of pessimism already priced into these names, builders could benefit from short-covering activity or future brokerage upgrades as the group's performance continues to surpass the Street's low expectations.
| | Sector | Big-Cap Banks
Bearish |
Outlook: If the price action in the broader market turns decidedly bearish or even remains range-bound, big-cap banks will collectively stay especially vulnerable. Schaeffer's Senior Technical Strategist Ryan Detrick recently pointed out the Financial Select Sector SPDR ETF (XLF) "looks ripe for further lower prices" after resolving a bearish flag pattern to the downside. The ETF is also trading back below its 320-day moving average, located near former support in the $14.30 area. Last month, we saw a big pop in short interest on the ETF, coming off its lowest level since April 2011. A similar short-interest pop in August 2011 preceded weakness into the fall. Three notable mega-cap names within this group looking particularly bearish from a contrarian perspective are JPMorgan Chase (JPM), Goldman Sachs (GS), and Citigroup (C). All have seen call buying outpace put buying during the past several weeks, even as these stocks have drifted lower over the same time period. What's more, JPM and C continue to earn positive marks from their peers; JPM has 13 "strong buys" out of 24 overall analyst ratings, while Citigroup has 11 "strong buys" from the 20 brokerage names that follow it. Recent thwarted rally attempts in JPM, GS, and C have now set the stage for possible retreats to annual-low territory, which is just a few percentage points away for all three stocks.
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