Monday Morning Outlook: DJIA Extends Winning Streak to Six Weeks
Jobs data continues to cast pall on rally
by Todd Salamone 1/8/2011 10:51 AM
schaeffersresearch.com
January tends to be one of the weakest months of the year, but the bulls successfully battled through the first trading week of 2011. The Dow Jones Industrial Average advanced for the sixth straight week, toppling the 11,600 mark and making a serious run at 11,700. Looking ahead, Todd Salamone, Senior Vice President of Research, is watching the Russell 2000 Index's advance on the 800 level. Next, Senior Quantitative Analyst Rocky White wonders whether the year's first week of trading offers any clues about the rest of the month. Finally, we wrap up with a look at some key economic and earnings reports slated for release this week.
Recap of the Previous Week: Monday Rally Tells Tale
Schaeffer's Editorial Staff
The ball dropped on the New Year and ignited a nearly 100-point rally on the Dow Jones Industrial Average on the first trading day of the year. The Dow drifted into the next several days, but Monday's surge was enough to put the first week of 2011 into the "win" column.
The economic news Monday was good, and several developments out of the corporate sector were even more encouraging. Manufacturing in the U.S. expanded for the 17th straight month in December, according to the Institute for Supply Management. Bank of America Corp. (BAC) agreed to pay Fannie Mae and Freddie Mac nearly $3 billion to buy back bad loans that were issued by its Countrywide Financial division, bringing some closure to a particularly ugly episode of the financial crisis. And in seeming confirmation that it is indeed a new year, a Goldman Sachs (GS) investment in Facebook valued the six-year-old social networking site at $50 billion. The Dow leaped out of the gate, climbing above 11,700, before settling back to close at 11,671, for a still respectable gain of 93 points, or 0.81%.
The big news Tuesday came in the afternoon, when the Federal Open Market Committee released the minutes of its December meeting, revealing that Fed officials believe the economy is getting better, in a kinda sorta way, but that we're not out of the woods yet. The Dow yawned, but managed to tack on 0.18% by the end of the day.
Payroll processor ADP reported Wednesday that the private sector added an almost too-good-to-be-true 297,000 jobs during December, the highest one-month increase the firm had ever reported. Meanwhile, Qualcomm (QCOM) said it would buy Atheros Communications (ATHR) for $3.1 billion. The Dow added 0.27%. It was a modest gain, but the close at 11,722.89 represented a two-year high. The Standard & Poor 500 Index (SPX) likewise recorded a two-year high of 1,273.85, while the Nasdaq Composite's (COMP) close at 2,709.89 was its highest in three years.
Following several weeks of generally positive economic and earnings reports, it seems traders were ill-equipped to deal with a round of disappointing headlines Thursday. Retail sales for December came in softer than expected, with Macy's (M), Target (TGT), and The Gap (GPS) all falling short of expectations. It was the first seriously downbeat note from the retail sector since the holiday season kicked off after Thanksgiving. The Labor Department, meanwhile, reported that jobless claims rose in the previous week at a higher-than-expected clip. The Dow slipped 0.22%.
Wednesday's ADP report on private-sector job gains set the bar high for the government's numbers on Friday. According to the Labor Department's count, the U.S. added 103,000 jobs in December, lower than the increase of 175,000 expected by analysts. The unemployment rate fell to 9.4%, a bigger-than-expected drop, but that was chalked up to a smaller pool of job seekers. Meanwhile, the financial sector faltered after a Massachusetts court ruled against Wells Fargo (WFC) and US Bancorp (USB) in a key foreclosure ruling. Finally, Federal Reserve Chairman Ben Bernanke told Congress, "We have seen increased evidence that a self-sustaining recovery in consumer and business spending may be taking hold." The Dow fell as low as 11,599 at midday, but eventually pared its loss to 0.19%, finishing at 11,674.76. For the week, the Dow added 0.8%, while the SPX gained 1.1%. The COMP won the weekly battle of the indexes, advancing 1.9%.
What the Trading Desk Is Expecting: Are Hedge Funds Still Sitting Out Rally?
By Todd Salamone, Senior Vice President of Research
"Hedge funds returned 1.7 percent in December... The Standard & Poor's 500 Index climbed 6.7 percent, the most for the U.S. benchmark in December since 1991."
--Bloomberg News, Jan. 7, 2011
After reading the above excerpt from a Bloomberg News article, I thought about comments during the past several weeks in Monday Morning Outlook suggesting that hedge funds are sitting out the stock market rally, based on our analysis of option activity on major exchange-traded funds (ETF). In light of the serious underperformance of hedge funds relative to the S&P 500, as described in the Bloomberg story, it is quite evident that this group is seriously underinvested in U.S. stocks. The implication continues to be that the current rally carries additional short-term risk, as weaker hands have driven stocks higher in recent weeks. These participants will likely be the first to panic sell on any hints of negative news, as we saw at the beginning of 2010.
The fact that unhedged equity buyers are driving stocks is worth acknowledging, as the momentum can change swiftly, if negative headlines hit the newswires and such weaker hands panic. On the other hand, it is nice to know that there are deep-pocketed players sitting on the sidelines, who are capable of scooping up equities on pullbacks. In addition to the fact that hedge fund managers are seriously underinvested in stocks, there is enormous sideline money among retail folks. Retail investors withdrew cash from domestic equity funds from 2008 through 2010, but have recently displayed signs of moving back into equities, albeit slowly. Moving forward, bulls would like to see the broader indexes take out key resistance levels that are situated just overhead, or remain above former areas of resistance, as stronger hands bid the market higher.
On the technical front, for example, it appears a battle has emerged between bulls and bears since the burst higher out of the gate in the first 90 minutes of trading in 2011. A question remains whether or not the 1,250 level on the S&P 500 Index (SPX) -- site of the 61.8% Fibonacci retracement of the 2007 high and 2009 trough -- is really behind us.
Another question revolves around the Russell 2000 Index (RUT) taking out a key overhead level, as a quick run up to the 800 century mark on the first trading day of the year was followed by a sharp dive back below 800 the next morning. Since the first day of trading last week, the RUT has not challenged 800 again. The 800 level has had historical significance, acting as resistance during a tight range for two months in late 2006 and early 2007, and dancing around this century mark in a +50/-50 range from late 2006 into most of 2007. The 850 area, in fact, marked the RUT top in 2007.
Per the chart below, there is a hint of good news for bulls in our analysis of the 20-day buy-to-open put/call volume ratio on the QQQQ, IWM, and SPY, which has stabilized recently at former lows, and is now at its highest level in a month. Admittedly, this ratio has been volatile in recent weeks. But, if it continues to move higher from the current low level amid strength in the market, it would signal hedge fund managers moving back into the U.S. equity market from an underweight position, which would have bullish implications. This is an indicator that we continue to follow closely.
We continue to look favorably upon the intermediate and long term, but short-term risk and reward appears to be more balanced. Momentum, combined with the possibility of underweight hedge fund managers moving back into equities, is countered by the following short-term risks:
1. Exuberance among equity-only option buyers, as call buying has dominated put buying on a relative basis.
2. January weakness during the past 10 years.
3. The CBOE Market Volatility Index still trading at a rich premium to SPX historical volatility.
Our message remains the same. With equity options cheap, buy call options on stocks you favor in lieu of purchasing stock, as calls allow you to commit less to the market, letting you manage risk and use leverage to reap higher returns. If you prefer the equity route, you can use index puts to hedge your long positions.
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Indicator of the Week: First Five Days of the Year
By Rocky White, Senior Quantitative Analyst
Foreword: We've just had two years in a row with the S&P 500 Index (SPX) up double digits! Hopefully we'll continue that streak in 2011. With one week of the New Year under our belts, we're off to a decent start in 2011. The S&P 500 was up moderately in the first week of trading. This week I'll take a look to see what this tells us about the rest of January and whether it can possibly mean anything for the year.
January: January has actually been a pretty weak month over the last several years. Specifically, over the last 10 years, only two months have averaged a worse return than January (February and June). However, what if we're up after the first five trading days of January? The table below shows that's actually a pretty bad sign going forward. Since 1990, when we are up through the first five days, the rest of January on average loses 1.64% and is higher only 38% of the time. Compare that to if we're down through the first five days. In that case, January is higher 63% of the time, averaging a gain of 2.10%.
S&P 500 Index returns for first five days of the year since 1990
Below is a table that shows the results in each year since 2000. Only twice has January gone higher after the first five trading days (2001 and 2007). In both of those years the market was down after the first five days.
S&P 500 Index returns, by year, for first five days of the year since 1990
Rest of the Year: The price action in the first five days is signaling a pullback in the near term. Can it possibly mean anything for the rest of the year? I don't think I'd ever consider a year-long trade based on five days of price action, but just for fun, let's see what it looks like. Below, we see that the numbers are more encouraging. When the first five days are positive, the market has averaged a gain of over 10% and is higher 77% of the time. If the first five days are negative, the market lags a bit, averaging only a 3% gain for the rest of the year.
S&P 500 Index returns for the rest of the year following first-five-day returns
This Week's Key Events: Alcoa Will Kick Off Earnings Season
Schaeffer's Editorial Staff
Alcoa Inc. (AA) reports fourth-quarter earnings after the close on Monday, marking the start of earnings season. 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
* There are no major economic reports scheduled for Monday. Alcoa Inc. (AA) and Apollo Group Inc. (APOL) will report earnings.
Tuesday
* The Commerce Department will report on wholesale inventories for November. Scheduled to report earnings are Lennar Corporation (LEN) and Supervalu Inc. (SVU).
Wednesday
* The Fed will release its Beige Book for January. We'll also get the usual weekly report on crude inventories. Clarcor Inc. (CLC) and Infosys Technologies Limited (INFY) plan to report earnings.
Thursday
* The Labor Department will give us its weekly look at jobless claims and producer price index figures for December. The Commerce Department will release trade balance data for November. Intel Corp. (INTC) will report earnings.
Friday
* The Labor Department will report on consumer-level inflation in December in the form of the consumer price index, while the Commerce Department will release December retail sales figures. Industrial production numbers for December are due from the Fed. Finally, the University of Michigan will give us its first peek at consumer sentiment in January. JPMorgan Chase & Co. (JPM) will report earnings. |
