Monday Morning Outlook: Three Sentiment Indicators We're Watching Now
After six straight weeks of selling, the RUT and COMP are now in the red for 2011
by Todd Salamone 6/11/2011 10:47 AM
schaeffersresearch.com
The major market indexes have now suffered their sixth consecutive weekly decline, with last Thursday standing out as the only positive session for U.S. stocks in the month of June. Rising economic anxieties continued to keep buyers at bay, and the Dow Jones Industrial Average (DJIA) grabbed headlines by breaching the 12,000 level for the first time since March. In the face of this extended technical breakdown, negative sentiment is fast approaching the kind of fever pitch that has coincided with recent market bottoms.
However, as we head into expiration week, Todd Salamone warns that the biggest risk to the bullish case might be fear itself. Meanwhile, Rocky White explains why traders who haven't totally lost their risk appetites might want to roll the dice on stocks hit hard by the recent downturn. Finally, we wrap up with a few sectors of note, as well as a preview of the week ahead.
Notes from the Trading Desk: Growing Fear as Stocks Revisit Year-to-Date Breakevens
By Todd Salamone, Senior VP of Research
"... the bulls could have the upper hand during the next couple of weeks, due to the potential unwinding of short positions associated with big put open interest just below current levels on the SPDR S&P 500 ETF (SPY - 130.42) and the iShares Russell 2000 Index Fund (IWM - 80.88). On Friday, it was encouraging to see both exchange-traded funds (ETFs) close at or slightly above these major levels of put-related support, located at the June 130 and June 80-81 strikes, respectively. The longer SPY and IWM remain above these put strikes, the greater the odds of a short-covering rally as expiration nears. A major breach of these strikes -- a lower-probability scenario, but certainly a possibility -- would lead to accelerated selling in the short term, as shorting of futures would pick up considerably, potentially creating a cascade down to 1,250-1,260 on the SPX, which would be its breakeven point for 2011."
-- Monday Morning Outlook, June 4, 2011
Unfortunately for bulls, the key strike prices (SPY 130 and IWM 80) cited in this space last weekend were quickly penetrated to the downside at the beginning of this past week, and by Friday afternoon the S&P 500 Index (SPX - 1,270.98) found itself trading south of 1,270 at its lows. As we mentioned last week, the shorting of futures related to this break below put-heavy strikes on key index and ETF options likely led to accelerated selling. There were a few attempts to rally back above these key strikes, but it was all for naught.
Big-cap financials were among the hardest-hit stocks Friday, as worries grew about the Federal Reserve's expanded oversight and increased capital requirements for banks with $50 billion or more in assets. A CNBC report surfaced late in the day suggesting that the bank capital surcharge for "systematically important financial institutions," or Sifis, may be smaller than expected, which lifted the sector briefly off its session lows -- but the Financial Select Sector SPDR (XLF - 14.83) could not sustain a rally into the close.
We closely monitor year-to-date returns, as sometimes you'll see an individual equity or index stall or find support around their breakeven levels for the year. Note, for example, that the SPX's March closing low at 1,256.88 was near the 2010 year-end close of 1,257.64. Per the table below, in the days ahead, we will be watching these YTD breakeven levels closely for signs of further deterioration in the technical backdrop. After six consecutive weeks of selling, the Russell 2000 Index (RUT - 779.54) has undergone a precise 10% correction, and the Nasdaq Composite (COMP- 2,643.73) has pulled back to the vicinity of its uptrending 200-day moving average. Can the RUT and COMP quickly move back into positive territory and avoid a sustained period of being in the red?
YTD Breakeven Levels for Major Market Indexes
Several sentiment indicators that we follow are approaching levels that have been consistent with bottoms during various corrective phases since the 2009 market bottom. For example:
1. The 10-day moving average of the equity-only, buy-to-open put/call volume ratio on options traded on the International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX) is approaching levels that marked key bottoms in February and July 2010. Growing negative sentiment will tend to pressure stocks, so bulls need to see a roll-over in this ratio before concluding a bottom is in place.
2. Sentiment among hedge fund managers is negative, which is consistent with the pervasive bearishness prior to rallies that began in the final months of 2010, and March and April 2011.
We quantify sentiment in this group by analyzing the buy-to-open put/call volume ratio on key exchange-traded funds. When hedge fund managers are bullish, they are aggressively purchasing puts on major ETFs to hedge long stock positions -- but right now, puts are not being purchased at a brisk pace relative to calls, suggesting hedge fund managers are on the sidelines. Bulls would like to see evidence that these deep-pocketed participants are stepping back into the market, and a turn higher in this ratio would be one clue. However, as we've noted previously when this ratio is declining, stocks could succumb to pressure due to the absence of hedge fund participation, particularly as retail investors continue to pull cash from domestic equity funds.
3. The most recent American Association of Individual Investors (AAII) weekly survey revealed only 24% of investors were bullish, while 48% were bearish. This is the lowest bullish percentage and highest bearish percentage since late August 2010. Since March 2009, bullish readings below 25% have marked major buying opportunities.
The negative sentiment backdrop suggests that a positive catalyst could fuel a strong rally. However, in the absence of such a catalyst to reverse the current decline, the risk to the bullish case is the growing climate of fear feeding upon itself, and thereby creating a further deterioration in the technical backdrop.
As suggested in recent weeks, continue to be open to both long and short opportunities, as current price action favors the bears, but an unwinding of this heavy pessimism could quickly spoil a bear's fortunes. The use of options -- via long straddle plays, and/or a good mix of calls and puts, which can deliver leveraged returns with limited dollars at risk -- is a terrific way to navigate the current environment.
If you are long and want exposure to a potential reversal of sentiment that drives stocks higher, but also have concerns about additional volatility into the summer, consider the purchase of August- or September-dated index options as a hedge.
As we enter expiration week, resistance lies in the 1,290-1,295 area on the SPX, with the March lows in the 1,250-1,255 area providing potential support on a continued decline.
Indicator of the Week: Laggards & Leaders Following a Market Pullback
By Rocky White, Senior Quantitative Analyst
Foreword: There have been a couple of notable streaks with the S&P 500 Index (SPX) lately, but neither of them have been good. The first six days of June were all down, marking only the second time since 2000 that a month started off with so many down days (the last time was October 2008). Also, the SPX just wrapped up its sixth straight week of declines. This is the sixth time that has happened since 2000. So, we know it's been bad out there -- but what does this tell us about which stocks we should play going forward? This week, I'm taking a look at what history tells us about lengthy losing streaks in the market. Should we be invested in the stocks that have done well during the decline, or should we think about moving into the ones that mimicked the market and sold off during the decline?
Laggards and Leaders: Using SPX stocks and going back to 2000, I looked at times where the market fell four straight weeks (there weren't enough data points if I assumed six weeks). There were 15 instances when this happened, not including the most recent. Next, I broke the stocks down into whether they were up (leaders) or down (laggards) during the four-week losing streak. The table below shows how those stocks fared during the following week.
The table is also broken down by whether the SPX was higher or lower the following week. When the SPX continued lower for a fifth straight losing week, the lagging stocks continued to worsen as well, averaging a loss of 2.14%. The stocks that outperformed during the decline continued to hold up better, averaging a smaller loss of 0.56%, with nearly half of the stocks trading higher.
However, what if the market goes higher during that fifth week? That's when it's best to have exposure to the laggards. When the next week is higher for the market, the lagging stocks returned 5.34% on average, with 79% of them on positive ground. The leading stocks were also positive, but averaged a significantly smaller gain of 1.91%.
Leaders and Laggards - One-Week Returns
Here's a similar-looking table with the same kind of analysis -- but instead of looking at the next week, I looked at the next four weeks. If the SPX is down in the four-week period following four straight losing weeks, the leaders and laggards have returns that are quite similar. The average return for the lagging stocks is a little worse (-5.63% vs. -5.13%), but their median return is a little better than the leading stocks (-4.74% vs. -4.93%).
But look at the results when the market moves higher in the next four weeks. Investors who were willing to stick their necks out and buy the lagging stocks were rewarded handsomely. The stocks that were negative during the decline averaged a return of 12.5% during the ensuing four-week advance. This is far better than the stocks that advanced during the decline, which gained just 3.42% on average.
Leaders and Laggards - Four-Week Returns
This Week's Key Events: Inflation Reports Headline a Data-Heavy Week
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
* There are no economic releases of note on Monday's agenda. Quanex Building Products (NX) and Pure Bioscience (PURE) are expected to report earnings.
Tuesday
* Tuesday will feature retail sales results and the producer price index (PPI) for May, along with the government's business inventories report for April. On the earnings front, we'll hear from Best Buy (BBY), FactSet Research Systems (FDS), and Capstone Turbine (CPST).
Wednesday
* As usual, we'll hear the weekly update on domestic petroleum inventories on Wednesday. Also on the docket are May's consumer price report (CPI), the Empire State manufacturing index for June, and reports on industrial production and capacity utilization. Scheduled to report earnings are Finisar Corporation (FNSR) and WSP Holdings (WH).
Thursday
* Thursday brings us weekly jobless claims, May's housing starts and building permits, and the Philly Fed index for June. It's a relatively busy day for earnings, with quarterly reports from Actuant (ATU), Kroger (KR), Pier 1 Imports, Inc. (PIR), Smithfield Foods (SFD) and Research In Motion Limited (RIMM) on the calendar.
Friday
* The week wraps up with the Reuters/University of Michigan consumer confidence index for June, as well as the Conference Board's leading economic indicators for May. No major earnings reports are scheduled.
Note: I am including this week's note on large-cap tech.
Sector
Large-Cap Tech
Bearish
Outlook: For some time, we've advised against buying into the hype surrounding big-cap tech stocks. Many Wall Street pundits cited Cisco Systems (CSCO) as a "bargain" following a bearish gap in February, but the stock has since tumbled to a string of new multi-year lows. With less than 1% of CSCO's float sold short, and 15 analysts still doling out a "buy" or better rating on the shares, the tech giant could be vulnerable to a capitulation by the remaining bulls. Likewise, fellow Dow member Microsoft (MSFT) is sitting on a hefty year-to-date loss, yet 66% of brokerage firms maintain an optimistic rating on the stock -- opening the door for potential downgrades in the event of continued technical weakness. One risk to the bearish case is the PowerShares QQQ Trust (QQQ) pulling back to its 200-day moving average, suggesting downside may be limited during the near term. However, the fund's 50-day buy-to-open put/call volume ratio has rolled over from its recent peak, which could be a sign that big-money players are no longer accumulating shares. |
