Monday Morning Outlook: On the Edge of a Technical Cliff
Psychologically critical technical levels are still up for grabs
by Todd Salamone 6/18/2011 12:45 PM
schaeffersresearch.com
It was a rather hollow victory on Wall Street Friday, as the Dow limped to its first (barely) positive week since April. Despite some wild gyrations during the course of the week, the technical picture really hasn't changed that much, with the major market indexes still lingering near their respective year-to-date breakeven levels. However, Todd Salamone warns that traders also have a few high-profile trendlines to monitor in the days ahead, as a breach of these key technical levels could spell serious trouble for stocks. Meanwhile, Rocky White digs deep into recent option activity to find out how hedge-fund managers are positioning their portfolios -- and whether these big-money players might be moving back into the market anytime soon.
Notes from the Trading Desk: Key Trendlines to Watch as Bulls and Bears Battle
By Todd Salamone, Senior VP of Research
"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... 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."
-- Monday Morning Outlook, June 11, 2011
It wasn't pretty by any stretch of the imagination, but most major U.S. stock indexes -- with the exception being the Nasdaq Composite (COMP - 2,616.48) -- snapped the string of six consecutive losing weeks, eking out small gains for the week. The S&P 500 Index (SPX - 1,271.50) , which rose a mere 0.52 point over the past five trading days, found resistance and support around the levels we identified in this space a week ago.
Considering the market came into last week's trading short-term oversold, and considering the slightly more positive news backdrop (including better-than-expected retail sales and leading economic indicators in the U.S., and a unified front from France and Germany on the Greek debt crisis), it quite frankly wasn't an overly impressive advance after six consecutive losing weeks. It was, however, like the typical expiration week we have grown accustomed to experiencing, with some very short-term trading opportunities for those catching the peaks and valleys -- but a mean-reverting tendency overall.
We continue to focus on year-to-date (YTD) breakeven levels as potential areas of support. Moreover, we find it quite interesting that the popular 200-day moving averages for each of the major domestic benchmarks that we follow are sitting around these respective YTD breakeven points. Given the importance of these levels, we updated last week's table with the site of each benchmark's 200-day moving average for your reference.
YTD Breakeven Levels for Major Market Indexes
It certainly appears, based on the market's price action on Wednesday and Friday, that the bears are lining up to crush any rally attempts, as pessimism continues to dominate due to European sovereign debt uncertainty, inflation concerns, the looming end of QE2, and monetary-tightening maneuvers in emerging markets. All of the major market indexes dropping into the red for the year, and simultaneously below their 200-day moving averages, would no doubt add to the increasingly negative psychology and embolden the shorts.
As we've been noting for several weeks, the big-money players continue to move to the sidelines. According to the most recent Bank of America-Merrill Lynch survey of 282 fund managers controlling $828 billion in assets, only 27% of respondents were overweight equities, down from 41% in May. Moreover, a net 18% reported being overweight in cash -- the highest percentage since June 2001, and up substantially from 6% the month prior.
Unfortunately, our analysis of the options market suggests that this growing negative sentiment has yet to climax. This is evident in the chart below, which displays the ratio of puts bought to open, relative to calls, on three major exchange-traded funds (ETFs). This ratio tends to move higher when fund managers are in equity accumulation mode, as they purchase puts on these broad-based ETFs to hedge their long stock positions. This ratio is currently declining, suggesting that deep-pocketed players are not back in accumulation mode yet. However, the ratio is hovering near levels where it has turned higher in the past, as Rocky White discusses in greater depth on the next page.
The good news for the bulls, as we discussed last week, is that the widespread pessimism we are seeing is very similar to that which has existed at various correction lows since the market bottomed in early 2009. Said another way, the risk to the bears is the tremendous unwind potential from short-covering activity, or sideline money suddenly reemerging. This risk is heightened as long as the major market indexes stay in the black on a year-to-date basis, and hold above their respective long-term moving averages.
We continue to advise avoiding, or even shorting, big-cap financial names and big-cap technology stocks. Long exposure can be concentrated in retail/leisure names and gold.
Indicator of the Week: Buy-to-Open Put/Call Ratio for Major ETFs
By Rocky White, Senior Quantitative Analyst
Foreword: To say the market has been weak lately would be an understatement. Until this last week's modest gain, the S&P 500 Index (SPX) was down for six consecutive weeks. So, how are money managers reacting? One way to find out is by looking at the option activity on exchange-traded funds (ETFs) that track the major market indexes, as these ETFs are popular hedging vehicles for fund managers. This week, we'll take a look at this indicator and try to shed some light on the recent weakness in the market.
BTO Put/Call Ratio: As mentioned above, options on index-based ETFs are often used as hedging vehicles. The chart below combines data from three ETFs that follow three major indexes: the SPDR S&P 500 ETF (SPY), the iShares Russell 2000 Index Fund (IWM), and the PowerShares QQQ Trust (QQQ). Furthermore, using proprietary data from the major options exchanges, we are able to focus solely on buy-to-open (BTO) volume -- which eliminates option activity generated by sellers, giving us a clearer view of the motive behind the trades.
Below is a chart showing the combined BTO put/call ratio for SPY, IWM, and QQQ over the past year. When the ratio goes up, it typically means fund managers are buying put options to hedge as they increase their long equity exposure. The ratio recently peaked in the middle of April -- a point in time at which the market had one more leg higher before the six-week slide began. One promising sign is that the last two troughs in the ratio occurred just below the 2.2 line on the chart, and both marked great buying opportunities. Currently, we're not too far away from that level.
SPX with BTO Put/Call Ratio
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Digging Deeper: Any ratio, including the one above, has both a numerator and a denominator. Separating the puts (numerator) from the calls (denominator) provides a little more information as to why, exactly, the ratio is falling. Looking at the current data, we see that call volume has increased almost 35% since the ratio's mid-April peak, while put volume has decreased about 6%.
SPX with BTO Calls and BTO Puts
So, why the sudden uptick in call buying? The chart below offers a clue. As noted earlier, options on these major ETFs are primarily used for hedging. The chart below shows the total number of shares sold short on all equities in our database, which has been rising over this recent period of market weakness. As a result, there's a good chance investors are buying calls to hedge these new short positions.
SPX with Shares Short (millions)
In other words, not only is there a lack of buying in the market (as suggested by both the downturn in equities and the coincident decrease in put hedging), but short sellers have also come off the sidelines to place new bets against stocks. This short-selling activity has surely played a part in the market's decline over the last several weeks.
Implications: To sum up, the BTO put/call ratio on the three major hedging ETFs has fallen dramatically in recent months. This drop has been due in large part to an increase in call buying, which may be the result of short sellers putting on hedges as they add new bearish bets -- which has likely contributed to the market's weakness over the past several weeks. Going forward, we'll be keeping a close eye on these indicators to find out how investors are positioning their portfolios. In an email discussion on the topic, Todd Salamone summed up exactly what we're looking for when he said, "Bulls would want the BTO ratios to begin moving higher as evidence that shorting activity is decreasing, and/or increased put buying is occurring coincident with share accumulation."
This Week's Key Events: Fed Decision, Housing Data, and First-Quarter GDP Due Out
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 major economic reports scheduled for Monday. Wall Street newcomer Renren (RENN) is expected to report earnings.
Tuesday
* On Tuesday, existing home sales for May will hit the Street. Earnings are due out from Adobe Systems (ADBE), Barnes & Noble (BKS), Gerber Scientific (GRB), Jabil Circuit (JBL), and Walgreen Co. (WAG).
Wednesday
* Wednesday brings the regularly scheduled update on domestic petroleum supplies, but all eyes will likely be on the Federal Open Market Committee (FOMC) when they issue their latest decision on monetary policy at 2:15 p.m. Eastern. On the earnings front, we'll hear from Bed Bath & Beyond (BBBY), CarMax (KMX), FedEx (FDX), and Red Hat (RHT).
Thursday
* Thursday's calendar includes initial and continuing jobless claims, as well as new home sales for May. The day's earnings docket features quarterly reports from ConAgra (CAG), Discover Financial Services (DFS), H&R Block (HRB), Lennar Corp. (LEN), Oracle (ORCL), and Rite Aid (RAD).
Friday
* The week wraps up with a bang, as Friday promises the latest revision to first-quarter gross domestic product (GDP) and durable goods orders for May. Command Security Corp. (MOC) will round out the week's slate of earnings reports. |
