Monday Morning Outlook: DJIA Chalks Up a Weekly Win
Expiration week could provide tailwind if ... big if ... euro is stabilized
by Todd Salamone 5/15/2010 9:45 AM
It was a volatile week that ended with the Dow Jones Industrial Average (DJIA) scoring a healthy TKO -- thanks largely to Monday's 400-point relief rally. The CBOE Market Volatility Index (VIX) reflected that volatility. Although it settled down from its readings in the low 40s the previous week, the VIX still ended the week at an elevated 31.24. Looking ahead, Todd Salamone, Senior Vice President of Research, remains worried about the weakness in the euro, but he's heartened by several technical indicators. Todd also shares some thoughts from the Las Vegas Money Show, where he and Bernie Schaeffer made presentations last week. Next, Senior Quantitative Analyst Rocky White takes a look at the weekly Investors Intelligence poll, a survey we regularly monitor. Not surprisingly, investors were shaken by the May 6 "flash crash." Rocky explains why he's encouraged by the desertion of these fair-weather bulls. Finally, we wrap up with a look at some key economic and earnings reports slated for release this week.
Recap of the Previous Week: Dow Bounces Back From "Flash Crash"
By Joseph Hargett, Senior Equities Analyst
You'd be forgiven for thinking Wall Street might be shell-shocked coming into the week, given the bruising it had just suffered, wiping out all of the year's gains. In fact, the exact cause of the brief, but terrifying 1,000-point plunge in the Dow Jones Industrial Average (DJIA) on May 6 remained uncertain, although regulators told Congress they were zeroing in on the activity of a single futures trader.
But traders were cheered when the European Union (EU) and the International Monetary Fund (IMF) agreed on a near $1 trillion rescue package to aid debt-riddled nations across the euro zone. Even before the market opened on Monday, futures were suggesting a 400-point rally, and sure enough, the bulls rode back into town on a 404-point wave. The Dow high-fived its way to a 3.9% gain, while the S&P 500 Index (SPX) and the Nasdaq Composite (COMP) did even better, advancing 4.4% and 4.1% respectively.
The bulls spent Tuesday digesting their gains. Worries persisted about the European bailout package, but traders in the U.S. were encouraged by an upbeat earnings forecast from Dow component Intel Corp. (INTC) and growing private-sector hiring. Nonetheless, the Dow slipped 0.3% for the day.
The bulls resumed their climb on Wednesday. The government reported that the U.S. trade deficit widened in March, but it also said U.S. exports increased by 3.2%, the highest level since late 2008, pointing to health in the manufacturing sector. The Dow ended the day with a sprightly 1.4% gain.
Nonetheless, the European debt issue haunted the week, with worries that tough new austerity measures in southern Europe will dampen economic growth. The U.S. financial sector was also under fire all week, as Congress turned its full attention to financial reform, tightening rules on everything from bank practices to credit cards to ratings agencies. As if the increased oversight wasn't unnerving enough, The Wall Street Journal reported on Wednesday that federal investigators are looking into the marketing of mortgage derivative products by Morgan Stanley (MS), while The New York Times reported Thursday that State Attorney General Andrew Cuomo wants to know if MS and seven other leading banks intentionally misled ratings agencies in order to inflate the ratings on their mortgage products. By the end of Thursday, the Dow surrendered more than 100 points, or 1.1%.
Traders heard more good economic news Friday. Sales continued to rise at American retail stores in April, while other reports -- on industrial production, manufacturing and consumer confidence -- also indicated that the economic recovery is progressing. But Wall Street still couldn't shake those euro zone blues, and the Dow spent much of the session trading down 200 points or more. When the dust settled Friday, the Dow had bounced back from its session lows, but still retreated nearly 163 points.
Despite logging back-to-back triple-digit losses, the Dow held on to Monday's gains. For the week, the DJIA added 2.3%, marking its first weekly gain since mid-April. Elsewhere, the SPX rose 2.2% for the week, and the Nasdaq led the pack with a weekly gain of 3.6%.
What the Trader Is Expecting in the Coming Week: All Eyes on Europe
By Todd Salamone, Senior Vice President of Research
In last week's Monday Morning Outlook, the following observation was made:
"The pullback has caused technical damage, with the SPX closing below its January highs in the 1,150 area, and its 160-day moving average. The 160-day trendline contained the SPX's early February lows, when fears about Greece's debt issues first emerged... The good news is that the SPX heads into next week trading above 1,050, the site of its February lows. The index also remains above its 200-day moving average... For what it is worth, the 200-day trendline supported the SPX in 1997, after 'Asian Contagion' worries spread and pushed stocks into a corrective mode."
Mirroring the price action of the 1997 "Asian Contagion," the S&P 500 Index (SPX) rallied powerfully from its 200-day moving average early last week, in response to a loan package from the European Union and the International Monetary Fund to the euro zone's most heavily indebted nations. The rally pushed the SPX back above its 160-day moving average, situated at 1,120, and the January highs in the 1,150 area. But after an unsuccessful attempt to overtake its 50-day moving average in the 1,175 area, the SPX retreated 3.1% on Thursday and Friday. The SPX closed the week at 1,135 - below its January highs, but above the 160-day moving average, in a slight technical improvement relative to last week.
As Bernie summarized in his keynote presentation last week at the Las Vegas Money Show, levels of importance on the SPX include the round 1,100 level, which is not only the SPX's 200-day moving average, but also represents about a 10% correction from the recent highs. Bernie also mentioned that we are keeping a close eye on the 1,167 level, as this is the site of the 160-month moving average, a trendline that acted as support at the bear-market bottom in 2002-2003. Moreover, when this moving average was breached in October 2008, it was a major sell signal. A month-end close above this level would support the notion that the SPX is in bull mode.
With the euro hitting fresh lows on Friday, it is evident that European worries continue to weigh negatively on investors in the U.S. market. The sell-off that began late Thursday and through Friday indicates there is a lot of fear about negative financial developments over the weekend. But a possibility this weekend would be government officials looking to implement a plan specifically designed to stabilize the euro, and this would be most effective if they can get U.S. cooperation. It is our belief that such cooperation is very plausible, as we don't think Washington wants to see the dollar get overly strong from here.
Last week's rescue package did nothing to stabilize the euro, and such stabilization is of very high priority over the short term. If in fact officials do something over the weekend to prop up the euro, we could see a huge equity rally on Monday. In the absence of such a plan, there could be follow-through selling.
Another potential catalyst this week is the expiration of May options. There is massive out-of-the-money put open interest on various indexes and exchange-traded funds that is getting set to expire. Should the market find any type of stability, whether technical or news-based, the unwinding of short positions related to the expiration of the out-of-the-money puts could create a tailwind for the stock market.
I'll conclude with a message that I've made in this forum on several occasions, and a message I found myself repeating at the Las Vegas Money Show last week, during presentations or in casual conversation with the many visitors to our booth. That is, ensure your long positions are hedged, and engage in strategies that reduce risk and give you profit opportunity on unexpected events. This may take on even more importance now, with the technical backdrop questionable and volatility on the rise – the CBOE Market Volatility Index (VIX – 31.24) has experienced nine consecutive closes above its 200-day moving average.
Prepare for the investing week ahead. Every week, Bernie Schaeffer and his staff provide you with their insight about what has happened and, more importantly, what will happen in the market. We dig deep and show you what's happening behind the scenes, and tell you which indicators are predicting major market moves. If you enjoyed this week's edition of Monday Morning Outlook, sign up here for free weekly delivery straight to your inbox.
Indicator of the Week: Investors Intelligence Survey
By Rocky White, Senior Quantitative Analyst
Foreword: Every week Investors Intelligence releases a sentiment survey that we monitor closely. The poll tracks the percentage of investors who are bullish, bearish, and those who foresee a correction. As contrarians, we tend to regard high levels of optimism as a bearish indicator going forward, and we see high levels of pessimism as bullish. The poll released last week was especially interesting, because it was taken during the turmoil of a couple of weeks ago.
Below is a chart of the bullish responses minus the bearish responses along with the S&P 500 Index. The higher this figure, the more optimism there is among investors. We consider optimism to be at an extreme when the difference in the bulls and bears gets to around 40%. With the strength of the market over the last year or so, it is not all that surprising that we had optimism nearing that level. It was encouraging when optimism decreased so significantly in the most recent survey, as the bulls minus bears line fell below 25%.
II bull-bear percentage versus the SPX since January 2005
Interpreting the Current Survey: As I mentioned earlier, it was not that surprising that optimism was at such a high level prior to the release of the last sentiment survey. Then after the tumultuous week a couple of weeks ago, you would suspect that optimism would come down some.
A key question is: How much did optimism fall? A large drop in optimism would signal that bullish respondents were bullish simply due to the strong market price action. It would reveal that they really believe the market is on shaky ground, since it took only a couple of days of losses and some volatility to change their minds.
We would be encouraged by that exposed fear. It would be worrisome if optimism did not fall much (or even increased). This would show stubbornness among investors, if not even price action against their convictions would sway them from that bullish stance. This situation would be dangerous because investors already in the market reduce the potential upside, and a further fall would force them to capitulate and drive the market lower. The more stubborn the bulls, the steeper the next pullback will be.
So, how much did optimism fall? Below is a table showing the bulls dropped from 56% to 47% and the bears increased from 19% to 25%. Therefore, the bulls minus bears line went from 37% before the market correction to 23% in the most recent survey.
SPX levels versus skew between II bull and bear percentages
To gauge how big of a drop this is, I went back to 1972 and found all the times there was a significant amount of optimism (bulls above 50%) and found how the survey reacted to a one-week market pullback of at least 3%. There have been 30 similar situations. Measuring optimism in terms of the difference in bulls minus the bears, it is the fifth biggest drop in optimism that we have seen. It's encouraging from the standpoint that it signals nervousness among investors.
Historical Results: You'll recall that the bulls minus bears number fell from 37% to 23% in the most recent survey -- a 14-point difference. Out of the 30 cases we found above, there were 12 times when it fell by more than seven points. The first chart below is a summary of S&P 500 returns following those 12 instance times is below. The second table below shows the 18 other times that the bulls/bears difference was less than seven points.
Note the top table is much more bullish in the shorter term, with that bullishness fading the farther out you go. The historical results below back up our conjecture that you want to see optimism fall significantly during a market pullback, rather than just a moderate fall in optimism.
Returns following drops in II bullish readings and returns following spikes in bullish readings
Implications:You can see that in the short run especially we are glad to see such a significant decrease in optimism as determined by the Investors Intelligence sentiment survey. In such a bullish environment, it is hard to get an accurate measure of sentiment because it's natural for people to be in the bullish camp when things are going so good. The market's recent pullback and volatility has exposed the anxiety of investors to be quite high. That's good news, as we believe that fear is crucial in sustaining a market uptrend.
This Week's Key Events: Inflationary Data on Tap
By Joseph Hargett, Senior Equities Analyst
Here is a brief list of some of the key events 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
* Monday is devoid of economic reports, while Lowe's Companies Inc. (LOW), Agilent Technologies Inc. (A), and SINA Corp. (SINA) are on tap to present their quarterly earnings figures.
Tuesday
* April's building permits, producer price index (PPI), core PPI, and housing starts will arrive on Tuesday. On the earnings front, Abercrombie & Fitch Co. (ANF), Ambac Financial Group Inc. (ABK), The Home Depot Inc. (HD), Wal-Mart Stores Inc. (WMT), Analog Devices Inc. (ADI), and Hewlett-Packard Co. (HPQ) are scheduled to release their quarterly reports.
Wednesday
* Wednesday brings the weekly report on U.S. petroleum supplies, as well as the April consumer price index (CPI) and core CPI. Taking their turn in the earnings confessional are BJ's Wholesale Club Inc. (BJ), Deere & Co. (DE), Applied Materials Inc. (AMAT), Hot Topic Inc. (HOTT), and Limited Brands Inc. (LTD).
Thursday
* Weekly initial jobless claims hit the Street on Thursday, followed by April's leading economic indicators and May's Philadelphia Fed manufacturing index. Dollar Tree Inc. (DLTR), GameStop Corp. (GME), Ross Stores Inc. (ROST), Staples Inc. (SPLS), Tidewater Inc. (TDW), Aeropostale Inc. (ARO), Brocade Communications Systems Inc. (BRCD), Dell Inc. (DELL), salesforce.com inc. (CRM), and Marvell Technology Group Ltd. (MRVL) are scheduled to report earnings.
Friday
* Friday closes the week with a whimper, as there are no economic reports on the docket. AnnTaylor Stores Corp. (ANN) and Frontline Ltd. (FRO) round out the week's earnings reports. |
