3 Factors That May Sway Markets This Week
One sentiment survey we track may be putting up a caution flag
by Todd Salamone 8/10/2013 9:40:53 AM
Absent an abundance of market-moving data, investors were left to spend the week dissecting comments from a number of Fed officials. The key takeaway from these central bankers was that a tapering of bond-buying efforts might come sooner rather than later. The few market watchers who did trade -- as weekly volume on the S&P 500 was at a multi-year low -- took profits, and the Dow unceremoniously snapped its six-week winning streak. This week, Todd Salamone looks at three factors -- the put/call ratio, short selling, and looming options expiration (and revisits some key levels on the charts) -- to see whether last week's low-volume decline should give the bulls pause, or signal the next buying opportunity.
- For your review: round-number levels to watch.
- One indicator that suggests a continued pullback.
- Rocky White illustrates why too much optimism can be a bad thing.
Finally, we close with a preview of the major economic and earnings events for the week ahead, plus our featured sector.
Notes from the Trading Desk: Dissecting Potential Short-Term Scenarios
By Todd Salamone, Senior V.P. of Research
"With earnings season about to slow, the Federal Open Market Committee (FOMC) meeting behind us, and major economic reports released last week, it wouldn't be surprising if equities hesitate around key round-number year-to-date gain (YTD) levels ... some profit taking may emerge as major benchmarks trade at round-number percentage YTD gains, or round-number percentage gains above key breakout areas. But the good news for bulls is that many have missed this rally, which leaves little in the way of profit-taking potential."
- Monday Morning Outlook, Aug. 3, 2013 "Two failures at $SPX round-number 1,700 intraday ... Since mid-April '12, short interest on $SPX component stocks has grown nearly 20%. The $SPX is up 22% during this period"
- @toddsalamone on Twitter, Aug. 8 and Aug. 9, 2013 There was very little in the way of market-moving news over the past week, the exception being various Fed governors reminding us that bond purchase tapering could begin soon, depending on incoming economic data. I emphasize "reminding" because this is not new information from the Fed, but apparently it put some in profit-taking mode, with volume very low. Isn't it amazing that low-volume declines in the context of strong price action are not interpreted as bullish, but low-volume advances inspire a chorus of bears?
As we cautioned in last week's report, key benchmarks have been turned away from round-number, year-to-date percentage-gain levels -- some of which corresponded with round-number percentage gains above key breakout levels. In fact, after breaking back below the round 1,700 area, the S&P 500 Index (SPX - 1,691.42) experienced a few failed attempts on Thursday and Friday to close back above this level. For your convenience, immediately below are the key levels overhead that we identified last week as potential speed bumps:
- Russell 2000 Index (RUT - 1,048.40): 1,060 (25% YTD gain and 25% above 850, which marked major peaks in 2007 and 2011)
- SPX: 1,700-1710 (century mark and 20% YTD gain)
- Dow Jones Industrial Average (DJI - 15,425.51): 15,725-15,750 (15,725 marks a 20% YTD gain, with 15,750 50% above a major low in October 2011)
- S&P 400 MidCap Index (MID - 1,237.70): 1,250-1,275 area (1,250 is 25% above resistance at 1,000, and 1,275 marks a 25% YTD gain)
S&P 500 Index (SPX) 30-minute chart last week -- 1,710 marked the peak on Monday, while 1,700 was sold during the rest of the week
With resistance lingering overhead, one sentiment indicator that we closely monitor is suggesting a higher-than-normal probability of a continued pullback in stocks. As seen in the graph below, the 10-day moving average of the all-equity, customer-only, buy (to open) put/call volume ratio is back to the 0.50 area.
The last time the ratio was at 0.50 was in May, and this preceded a 5% pullback over the course of the following month. The lower this ratio is, the more optimism there is among option speculators. Note that this ratio is currently at the lower boundary of its two-year range and (with one exception) such optimism has come before pullbacks during the past couple of years.
Our database shows this ratio was as low as 0.32 in January, 2011. Moreover, during the bull market of the 1990s, it wasn't unusual to see put/call volume ratios (buy-to-open data wasn't available to the public in these days) that ran in the 0.30-0.35 range ahead of pullbacks. The point is that this ratio does have room to move lower, especially if the SPX continues to find support in the 1,685 area. This marked the index's late-July closing low as well as its May peak, plus it is 25% above a key low in November 2012.
If the ratio turns higher (a sign that short-term optimism is giving way to fear) amid a break of the aforementioned support, we would not be surprised to see a continued pullback to intermediate support in the 1,640-1,650 zone, site of the 50-day and 80-day moving averages, with 1,640 representing a 15% year-to-date gain. A worst-case, lower-probability scenario is a pullback to the round-number 1,500 area, site of a trendline connecting lower highs since 2009 and a 12% decline from the recent peak.
But, as we mentioned last week, modest pullbacks should be viewed as buying opportunities, as the market has experienced strong momentum despite a plethora of naysayers. As the tweet in the excerpt above suggests, some market participants have shorted equities into this advance, and may be looking for exit points to stop out losing positions. Such short-covering activity is potentially supportive during pullbacks, as we have seen during prior pullbacks in recent months.
Next week is August options expiration, and if volume continues to languish as it did last week, we would not be surprised to see major exchange-traded funds (ETFs), such as the SPDR S&P 500 ETF Trust (SPY - 169.31) and the iShares Russell 2000 ETF (IWM - 104.04) trade between peak levels of put and call open interest that expires next Friday.
For example, as it stands now, option premium sellers would love to see the SPY close next Friday between 169 and 170 to maximize the number of outstanding contracts expiring worthless. The SPY 170 level is equivalent to S&P 1,700, where sellers emerged late last week, as noted above.
Indicator of the Week: Investors Intelligence Sentiment Survey
By Rocky White, Senior Quantitative Analyst
Foreword: Stocks have been outstanding for over four years now, so naturally there is a significant amount of optimism being shown in the weekly Investors Intelligence (II) sentiment survey. This sanguinity can be a concern, but the polls often move with the markets somewhat, so the bearish implications are bit subdued. When stocks are as strong as they've been for such a lengthy period of time, even some of the most fervent bears will capitulate and expect more gains. As such, when the trend is this solid, a good gauge of sentiment is to see how eager or reluctant the bulls are to turn bearish when the market makes a small pullback.
What was interesting in the most recent poll was that the bears reached their lowest level in over two years. The last time there were so few bears was in May 2011, just before the market pulled back about 20%. This week, I'm going to break down the historical poll data, and see if we can gain any insight into what to expect going forward.
Stock Returns & II Bears: In the most recent II poll, the percentage of bears was just 18.5%. As I mentioned, that's the lowest percentage in over two years. I went all the way back to 1980 and grouped the readings into six brackets, so there was roughly the same number of returns in each one. The table below shows how the S&P 500 Index (SPX) did over the next three months, depending on the percentage of bears in the II poll.
You can see the most recent reading falls in the top bracket, which is among the lowest percentage of bears. It is evident from the data that the higher the number of bearish investors, the better the market tends to do. Conversely, the fewer the number of bears, the worse the market tends to perform. It's a confirmation of our contrarian philosophy, and, in this case, it's a cause for concern.
Stock Returns & II Bulls: Similar to what I did above, I did the same thing below, but, instead, looked at the percentage of bulls. There are a lot of bulls in the recent poll, but it's not at the extreme that the bears are at. The percentage of bulls was 51.6%, which falls in the "49% - 54%" bracket, or the second from the bottom. The returns in that bracket are the worst of the six brackets.
In conclusion, the Investors Intelligence (II) Sentiment Survey is just one tool we use to gauge the mood of the market. We're happy to see the historical results validate our contrarian beliefs, but we're not encouraged that it's putting up a caution flag.
This Week's Key Events: Wal-Mart's Quarterly Report Marks the Unofficial End to Earnings Season
Schaeffer's Editorial Staff
Here is a brief list of some key market events scheduled 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
- The week kicks off with the Treasury budget for July. Entering the earnings confessional are Buckeye Technologies (BKI), Golden Star Resources (GSS), IAMGOLD (IAG), InterOil (IOC), SINA (SINA), and Sysco (SYY).
Tuesday
- Slated for Tuesday are retail sales figures, import and export prices, and business inventories. On deck to report earnings are Brocade Communications Systems (BRCD), Cree (CREE), Flowers Foods (FLO), JDS Uniphase (JDSU), Myriad Genetics (MYGN), Photronics (PLAB), and Valspar (VAL).
Wednesday
- The producer price index (PPI) and core PPI, as well as the weekly crude inventories report are on tap for Wednesday. Lining up at the earnings booth are Cisco Systems (CSCO), Deere (DE), Macy's (M), Agilent Technologies (A), JinkoSolar Holding (JKS), NetApp (NTAP), NetEase (NTES), Pinnacle Foods (PF), Renren (RENN), and Silver Wheaton (SLW).
Thursday
- Scheduled for release Thursday are the consumer price index (CPI), weekly jobless claims, the Empire State manufacturing survey, Treasury International Capital (TIC) data, industrial production and capacity utilization numbers, the National Association of Home Builders (NAHB) housing market index, and the Philadelphia Fed manufacturing survey. On the earnings docket are Wal-Mart Stores (WMT), Kohl's (KSS), Aeroflex (ARX), Applied Materials (AMAT), Bally Technologies (BYI), Estee Lauder (EL), Nordstrom (JWN), Pan American Silver (PAAS), Perrigo (PRGO), ReneSola (SOL), and Red Robin Gourmet Burgers (RRGB).
Friday
- The week closes out with housing starts and building permits, preliminary productivity and labor costs for the second quarter, and the preliminary August reading of the Thomson Reuters/University of Michigan consumer sentiment index. There are no notable earnings reports slated for Friday.
And now a sector of note...
Leisure
Bullish
The leisure sector has been a solid outperformer in 2013, as evidenced by the 33.5% gain the PowerShares Dynamic Leisure & Entertainment (ETF) (PEJ) has tacked on year-to-date -- a 14.9 percentage-point advantage over the broader S&P 500 Index (SPX). Additionally, the ETF ran to a record peak of $30.88 on Thursday -- extending its lead above the round-number $30 mark, which represents double its June 2005 inception low. What's caught our attention as contrarians is the amount of skepticism levied toward this outperforming sector. Looking at the 28 tickers we follow in the sector, 93% currently sit above their 200-day moving average, yet only 51% of analysts maintain a "buy" rating, down from 59% a year ago. Also, short interest represents 11.5% of the available float, on average, and represents more than 20 days' worth of pent-up buying demand. Among specific equities we're following are Orbitz Worldwide (OWW), TripAdvisor (TRIP), Live Nation Entertainment (LYV), and Lions Gate Entertainment (LGF). Each of these names has outperformed the broader S&P 500 Index (SPX) throughout the past three months, yet it would take at least a week to cover the shorted shares of each stock. An unwinding of this pessimism in the face of the sector's continued momentum could translate into a contrarian boon down the road.
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