Monday Morning Outlook: Seven Percent July Gain was DJIA's Best Advance in a Year
The 1,115 level could pose a technical challenge for the SPX
by Todd Salamone 7/31/2010 11:02 AM
schaeffersresearch.com
The Dow Jones Industrial Average (DJIA) was flat for the week, but gained 7.1% during the month of July -- its biggest monthly advance in a year. Meanwhile, the S&P 500 Index (SPX) and the Nasdaq Composite (COMP) also skyrocketed to 6.9% monthly gains. Looking ahead, Todd Salamone, Senior Vice President of Research, is seeing more put buying on major exchange-traded funds, which we interpret as hedge funds buying protection when they are in accumulation mode. However, Todd is also worried about intermediate-term turbulence amid midterm elections and a regulatory environment that is anything but business-friendly. Later, Senior Quantitative Analyst Rocky White finds that the 1,115 level has been smackdown territory for the SPX several times this year. In fact, 1,115 is the approximate level at which the SPX kicked off the year, and Rocky wonders whether the index's level at the beginning of the year functions as resistance in tough markets (and vice versa, acting as support in uptrending markets). You'll be interested in his findings. Finally, we wrap up with a look at some key economic and earnings reports slated for release this week.
Recap of the Previous Week: A Flat Week, But a Great Month
By Joseph Hargett, Senior Equities Analyst
The week was mostly a wash, with the Dow Jones Industrial Average adding about 40 points. But what a month! All three major market indexes sprinted to healthy gains of approximately 7% in July. With earnings season in full swing, bulls found a lot to like in a parade of mostly positive reports. Even so, bulls were chastened by increasing evidence that the road to economic recovery could be slow and painful, and the final week of the month was mostly flat.
Stocks picked up on Monday where they left off the previous Friday, and the Dow skipped ahead another 100 points, or nearly 1%. Traders were encouraged by an upbeat outlook from business bellwether FedEx (FDX), and a 23.6% increase in new home sales for June.
After three straight days of 100-point gains, the bulls took a breather on Tuesday, with the DJIA eking out a 0.12% gain. DuPont (DD) reported solid second-quarter earnings and lifted its full-year forecast, and the S&P/Case-Shiller home price index rose in May, echoing Monday's upbeat housing stats. However, the U.S. consumer remained wary; the Conference Board reported that its Consumer Confidence Index fell to a five-month low of 50.4 in July.
Boeing (BA) set a gloomy tone for Wednesday with a second-quarter earnings miss; the aerospace giant also disappointed with its outlook for the full year. Moreover, traders heard yet another confirmation that the economic recovery remains weak when the Commerce Department reported that U.S. durable goods orders fell 1% in June. The Fed whistled the same tune with the afternoon release of the Beige Book, in which most of the 12 Federal Reserve districts reported stagnant or slowing economic progress. The Dow backpedaled all day long, finally settling on a loss of 0.38%.
Slightly disappointing outlooks from the likes of Exxon Mobil (XOM) and Colgate-Palmolive (CL) were offset by slightly better-than-expected numbers on jobless claims on Thursday. However, St. Louis Fed President James Bullard shook things up by raising the specter of "Japan-style" deflation if the Fed keeps interest rates too low for too long. "With a little bit weaker numbers on the economy and inflation a little bit low," Bullard said, "people are starting to talk about the possibility of a Japanese-style outcome for the U.S." The Dow fought a battle with the breakeven line for most of the day, but swooned into the close, losing 0.29%.
Second-quarter gross domestic product (GDP) data was released first thing Friday morning, revealing slower-than-anticipated economic growth. The Dow tumbled more than 100 points in the first 15 minutes. But the bulls fought back, aided partly by a report showing robust manufacturing activity in the Midwest, with the Dow finishing the session with a tiny loss of 0.01%. For the week, the DJIA was flat, adding 0.4% For the month, though, the index added a very healthy 7.1%, marking its biggest monthly gain in a year. Meanwhile, the SPX gave back 0.1% last week, but tacked on 6.9% for the month, while the COMP surrendered 0.7% for the week, but added 6.9% in July.
What the Trader Is Expecting in the Coming Week: Watching the Hedge Funds for Clues
Todd Salamone, Senior Vice President of Research
"Investors more than halved their equity overweight positions this month and boosted bond holdings as their expectations for global economic growth collapsed, a survey from BofA Merrill Lynch showed on Tuesday [July 13] ... Hedge funds' net exposure to equity markets - measured as long minus short as a percentage of capital — fell to 18 percent, the lowest level since March 2009, from 29 percent in June ... Investors' overweight in U.S. equities tumbled to 7 percent this month from 20 percent."
Reuters News, July 13, 2010
"The 1.65 trillion hedge-fund industry, after posting its worst second-quarter performance in a decade, is taking less risk, using less debt and making fewer trades, according to data from securities exchanges and brokers including Credit-Suisse AG and JPMorgan Chase & Co. Hedge-fund clients of Zurich-based Credit Suisse held 24 percent of their assets in cash in June, compared with 19 percent three months earlier."
Bloomberg News, July 30, 2010
If you believe that hedge funds are the predominant force in the current market environment, as we do, the trends reported by articles such as these are extremely relevant. These stories were produced for public consumption during the past couple of weeks, but our daily analysis of option activity on major exchange-traded funds (ETF) has indicated for weeks now what has been revealed in these articles.
Below is a chart of the combined 20-day buy (to open) put/call volume ratio on three major ETFs - the SPDR S&P 500 ETF Trust (SPY), the PowerShares QQQ Trust (QQQQ), and the iShares Russell 2000 Index Fund (IWM). Hedge funds are heavy users of these products, and will often buy puts on these exchange-traded funds when they are accumulating individual stocks.
A rising buy (to open) put/call volume ratio is often indicative that the hedge fund world is in accumulation mode, as they buy ETF puts to hedge long positions. However, a decreasing ratio of put volume to call volume can point to less put protection being purchased, which is often a sign that hedge fund managers have had their fill, resulting in a loss of bullish market momentum or leaving the market vulnerable to a corrective phase. As you can see, the ratio moved sharply lower in late April/early May, an indication that hedge fund managers were no longer in buying mode.
With retail investors pulling money from equity funds for three-plus years, this leaves little room for traditional fund managers to accumulate stocks. It is the hedge funds and high-frequency traders who are dominating market action at present. Therefore, when hedge fund managers are not actively bidding stocks higher, there is little chance the stock market will make any significant headway. Worse yet, if hedge fund managers are in distribution mode, corrections occur. Finally, if hedge funds are neither aggressively buying nor selling shares, it is the mean-reverting actions of high-frequency traders that influence the market, often resulting in painful trading-range action.
Referring back again to the chart above, it is encouraging if you are a market bull to see the 20-day buy (to open) put/call volume ratio turn higher from relatively low levels earlier this month, as it suggests that hedge fund managers with heavier-than-normal cash positions are in accumulation phase once again. The big question is whether or not they'll remain in buying mode for a sustained period, as in 2009.
This relates to a comment that I made on CNBC this past Thursday about the firepower that exists at present for a strong bullish move in equities. The statement was qualified with the uncertainty related to the timing of such a move, as investors continue to fret over the slowdown in economic growth amid a regulatory environment that is far from "business friendly," and tax reform that may not be "investor friendly" in the year ahead. Throw in the upcoming midterm elections in November, and such uncertainty could drive hesitancy among potential investors.
Turning to the technical backdrop, the SPX comes into the new week trading not far below stiff resistance in the 1,115-1,120 region. For long-time readers of Monday Morning Outlook, you might remember the significance of this area, which served as resistance for several weeks in late 2009, as traders focused on the 1,121 level being a 61.8% Fibonacci retracement of the 2007 high and 2009 low.
Presently, in addition to the Fibonacci significance of the 1,120 area, there are important trendlines converging in the 1,115-1,120 zone -- specifically, the 80-day, 160-day and 200-day moving averages could continue their role as resistance in the near term. Moreover, 1,117 is the site of the SPX's June closing high, and 1,115.10 is the site of 2009's close. (For more on the potential importance of year-end closes as support/resistance levels, be sure to read Rocky White's "Indicator of the Week" segment on page 2.)
With the SPX still below 1,120, the bears are still in the driver's seat. A short-term swing lower could push the SPX back to the 1,040-1,050 area. But, if hedge fund managers are indeed in accumulation mode -- which current option activity on major ETFs suggests -- look for 1,120 to be penetrated to the upside.
Given the firepower on the sidelines, our advice is to retain long exposure, but continue to hedge so that you can stay whole during periods of market turbulence.
Finally, I'll leave you with seasonality statistics as we move into the month of August. During the past 30 years, the month of August has ushered the SPX higher 63% of the time, for an average gain of 0.40%. The average percentage gain ranks ninth out of the 12 months. However, the month of August has been even better for investors since the turn of the century. During the past 10 years, the SPX has finished higher eight times during August, and the average monthly return of 0.90% ranks it third out of the 12 months.
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: S&P 500 Resistance at 1,115
By Rocky White, Senior Quantitative Analyst
Foreword: Bernie Schaeffer pointed out in an e-mail that the S&P 500 Index (SPX) got smacked down this past week just as it was about to move into positive territory for the year. The same thing happened in June. Is this by accident? Perhaps, but it also may be that 1,115 (about where the SPX began the year) is acting as some sort of resistance level. Are traders psychologically anchoring the index to where it stood at the beginning of the year?
As the index approaches this level from below, traders seem to view prices as becoming high- and therefore begin selling. Or maybe big-money players have an interest in whether the market finishes up or down for the year. If so, then the SPX's trek toward the 1,115 region might prompt a bunch of hedging and/or speculative activity, which should ultimately send the index in one direction or the other, depending on whether the bulls or bears win out.
Look at 2009 in the chart below. The S&P 500 began the year in a freefall, bottoming out in March. From early March until the end of the year, the market steadily climbed 67% higher. In fact, the only time the market struggled for any length of time was from May through July, just as the index was moving into positive territory for the year.
More Historical Results: These few observations made me curious, so I went back to 1972 on the S&P 500. I determined where the index began the year and called it the 0% YTD line. Finally, I calculated the returns for the market depending on whether the SPX approached this 0% YTD line from below or from above. If the barometer approached it from below, then I called it a resistance line; a summary of the results is in the top table (red). If the index approached it from above, I called it a support line, as reflected in the green table below.
The returns are pretty interesting. The findings support the theory that the index's level at the beginning of the year can act as support or resistance for the market. Focusing on the one-month returns when the SPX has approached this level from below, we find the indez has a tendency to get knocked down. It's positive in the next month only 35% of the time, and averages a loss of nearly 1%. On the other hand, when the market is positive and the SPX approached this level from above, the month was positive 64% of the time, averaging a return of 3.84%.
S&P 500 YTD returns 0% YTD line as support and resistance
This Week's Key Events: More Earnings, and Jobless Numbers on Friday
By Joseph Hargett, Senior Equities Analyst
Earnings season continues at a busy clip. 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
* The Commerce Department will release its construction spending report for June on Monday. We'll also get a look at the Institute for Supply Management (ISM) Index for June. Humana Inc. (HUM), Loews Corp. (L), MannKind Corp. (MNKD), Aflac Inc. (AFL), Evergreen Solar Inc. (ESLR), General Cable Corp. (BGC), SBA Communications Corp. (SBAC), and Verisign Inc. (VRSN) will release their quarterly earnings reports.
Tuesday
* The Commerce Department will weigh in again on Tuesday morning with reports on personal income, personal spending and factory orders for June. We'll learn about July auto sales in the afternoon. Archer Daniels Midland Co. (ADM), ArvinMeritor Inc. (ARM), Coach Inc. (COH), D.R. Horton Inc. (DHI), Duke Energy Corp. (DUK), The Dow Chemical Co. (DOW), Marathon Oil Corp. (MRO), MasterCard Inc. (MA), MGM Resorts International (MGM), Molson Coors Brewing Co. (TAP), OfficeMax Inc. (OMX), Pfizer Inc. (PFE), The Procter & Gamble Co. (PG), Rowan Companies Inc. (RDC), Solarfun Power Holdings Co. Ltd. (SOLF), Tenet Healthcare Corp. (THC), Anadarko Petroleum Corp. (APC), AvalonBay Communities Inc. (AVB), CBS Corp. (CBS), Force Protection Inc. (FRPT), Leap Wireless International Inc. (LEAP), Novatel Wireless Inc. (NVTL), priceline.com Inc. (PCLN), STEC Inc. (STEC), True Religion Apparel Inc. (TRLG), and Whole Foods Market Inc. (WFMI) are scheduled to report earnings.
Wednesday
* The market will be graced with the weekly report on U.S. petroleum supplies on Wednesday, along with the ISM services index, but the Street will likely pay the most attention to the ADP report on private sector employment, the first of three days worth of employment data. Agrium Inc. (AGU), AOL Inc. (AOL), Garmin Ltd. (GRMN), IntercontinentalExchange Inc. (ICE ), Polo Ralph Lauren Corp. (RL), Qwest Communications International Inc. (Q), Sirius XM Radio Inc. (SIRI), Time Warner Inc. (TWX), TRS Automotive Holdings Corp. (TRW), Transocean Ltd. (RIG), and Yamana Gold Inc. (AUY) will post their quarterly results.
Thursday
* The weekly report on initial jobless claims will be released on Thursday. Beazer Homes USA Inc. (BZH), Diana Shipping Inc. (DSX), DIRECTV (DTV), Fuel Systems Solutions Inc. (FSYS), Hyatt Hotels Corp. (H), Liz Claiborne Inc. (LIZ), Playboy Enterprises Inc. (PLA), Time Warner Cable Inc. (TWC), Activision Blizzard Inc. (ATVI) and Kraft Foods Inc. (KFT) will report earnings.
Friday
* On Friday, the Labor Department will release the month's highly anticipated nonfarm payrolls and unemployment reports. Joining the earnings parade will be China Sunergy Co. Ltd. (CSUN) and Dynegy Inc. (DYN). |
