Monday Morning Outlook: Bulls on the Ropes as VIX Snaps Short-Term Slump
Stocks are under pressure ahead of two major consumer confidence reports
by Todd Salamone 9/24/2011 9:29 AM
schaeffersresearch.com
On the heels of a triumphant September expiration week, stocks took a quick, drastic turn for the worse. The sell-off started in earnest on Wednesday afternoon, when the Federal Open Market Committee flagged "significant downside risks to the economic outlook." Gloomy manufacturing data out of China and Europe raised the bearish stakes even higher, and then Moody's took its downgrade stick to a generous handful of banks in the U.S. and Greece. By Thursday night, the G-20 finance ministers felt compelled to issue a special statement, reassuring investors that all necessary steps would be taken to support global financial markets.
So, negative headlines continue to stack up, and clarity is still in short supply on Wall Street. On the plus side, the major market indexes have yet to break below historically significant chart levels, as Todd Salamone explains this week. But while stocks are poised above tried-and-true support, the VIX is edging into potentially troublesome territory -- setting the stage for what could be another volatile week ahead. As Todd outlines the must-know trendlines, round numbers, and retracement levels to watch for the SPX, RUT, and MID, Rocky White delves into recent option activity to determine why hedged players may be ditching VIX for the SPY. Finally, we wrap up with a preview of the notable economic and earnings events to watch this week, along with a few sectors of note.
Notes from the Trading Desk: Can Stocks Hold Long-Term Support?
By Todd Salamone, Senior VP of Research
"Equities have stabilized since their early August lows, but they are by no means out of the woods from a technical perspective. For example, the SPX remains below the 1,225 area, which is the site of its 80-month moving average and a 50% retracement of the July high and August low. Furthermore, the Nasdaq Composite (COMP) comes into the week trading just below its 2011 breakeven level of 2,652.87 -- an area that provided support in March and June, but could now act as resistance. Finally, the Dow Jones Industrial Average (DJIA) is looking up at its 2011 breakeven level of 11,577.51. Given the popularity of the Dow, this demarcation line between positive and negative year-to-date territory could be psychologically significant for investors." "The CBOE Market Volatility Index (VIX) also comes into the week at a significant level, as it closed just below 31 on Friday. Previous trips down to 31 in mid-August and late August were resolved with sharp moves back above 40 within only a matter of days. As we said last week, bulls would like to see the VIX break back below 30... If the VIX were to move above 42.56, the trend of lower highs would be broken, making a move above 50 a higher-probability event that the bears would like to see."
- Monday Morning Outlook, September 17, 2011
After an impressive expiration-week rally, equities experienced an equally impressive decline last week, as the Fed's newly announced "Operation Twist" program -- selling $400 billion in short-term Treasuries to buy longer-term Treasuries -- did nothing to inspire investors. Moreover, lingering concerns about Greek debt and worries about slowing world growth, led by the U.S., Europe and China, drove heavy selling last week.
The sell-off may not have been a huge surprise to some of you, as the major market indexes came into last week trading below key levels of resistance, and at the top of a month-long trading range. The Dow Jones Industrial Average (DJIA - 10,771.48) and Nasdaq Composite (COMP - 2,483.23), in fact, both attempted to move back into the black for 2011 -- but this attempt was quickly thwarted, as you can see below.
The CBOE Market Volatility Index (VIX - 41.25) repeated a pattern that we've been seeing lately, quickly moving to the 40 area from the prior week's close near 31. Last week's VIX advance was different from other recent moves, as it traded above 42.56, breaking a pattern of lower highs. The action in the VIX could be favorable to bears, as the broken string of lower highs could be signaling a move above the 50 area, or at the very least, another move up to 50. As we have said before, most VIX rallies dating back to 1997 have peaked in the 50 area, including the one in early August.
Unlike last week, the benchmark indexes we follow enter this week's trading at or just above significant areas of potential support, which is something the bulls have going for them in the days ahead. With the International Monetary Fund (IMF), World Bank, and Group of 20 (G-20) finance leaders meeting over the weekend, the outcome of this event might determine if we rally strongly off support, or nosedive beneath it. For example:
- The SPX's 40-month moving average sits at 1,108.29, just 28 points below Friday's close. In fact, last week's SPX low was at 1,114.22, just six points above this historically important moving average, per the chart below. Interestingly enough, SPX 1,105 marks a 38.2% Fibonacci retracement of the 2009 trough and 2011 climax.
- The 650 level on the Russell 2000 Index (RUT - 652.43) acted as support in January, March and July 2008, so we are sitting right on this potential floor as we enter next week's trading. A break of 650 could lead to a move down to the round 600 level, which is the site of the 2010 lows, as well as a 50% retracement of the 2009 low and 2011 high.
- The S&P 400 Midcap Index (MID - 794.43) comes into the week 3.5% above its 80-month moving average, a trendline that marked important lows in 2002-2003 and 2010 (see chart below). The index will attempt to close the month of September above 800, which is double its 2009 low. For Fibonacci retracement followers, the MID is sitting just above a 38.2% retracement of its 2009 low and this year's high.
With equities pulling back to potential long-term support areas as negative sentiment continues to grow, now is a good time to add equity exposure to your portfolio for a potential rally back to the resistance areas discussed last week. But be careful if there is a break of support, as short-covering activity or a shift from other assets will not be as urgent, undermining the potential reward for the risk you are taking.
Indicator of the Week: Hedging with VIX Calls vs. SPY Puts
By Rocky White, Senior Quantitative Analyst
Foreword: The market took a huge hit last week, with the S&P 500 Index (SPX) down about 6.5%. It makes you forget the SPX was up over 5% the week before. With the huge swings in the market recently, I thought it might be a good idea to see how the CBOE Market Volatility Index (VIX) is reacting. The VIX often moves in the opposite direction as the SPX, and it surged above 40 in the first half of August before pulling back down toward 30 after the index's 5% gain a couple of weeks ago. Last week's tumultuous trading split the difference, pushing the VIX back above 40.
Option Activity: Below is a chart showing the buy-to-open call/put ratio for the VIX. Money managers often hedge long portfolios by buying VIX calls. As you can see, the ratio climbed above 3.0 just as the VIX began to spike above 40 in early August. Since then, the ratio has been in a steady decline toward 1.0 -- meaning investors are now buying roughly as many VIX puts as VIX calls.
The above chart shows the buy-to-open call and put volume on VIX options, along with the SPX, rather than the VIX, to show the market action driving the VIX option activity. Note the recent plunge in VIX call buying, along with the relatively high level of VIX put options. While VIX calls can be used to hedge long portfolios, money managers similarly buy VIX puts to hedge short portfolios. The chart below confirms that short selling has been on the rise, so it's not a surprise to see this increase in VIX puts.
Hedging with SPY Options: An alternative to hedging with VIX options is hedging with SPDR S&P 500 ETF (SPY) options. VIX call buying has fallen off a cliff lately, but SPY put buying is at a very elevated level. While you'll always have different investors using different vehicles to hedge with, this activity suggests that some VIX hedgers may be finding alternative methods to protect their portfolios.
This could be the result of the VIX reaching such a high level recently. Some investors may like VIX options because they're cheaper and require less capital -- but that's only true when the VIX is low, say around 20. Plus, you'll likely get a truer hedge using index options. Now that the VIX is above 40, the capital required to hedge with VIX options is not so far removed from SPY options. With that playing field more or less leveled, money managers may be moving to SPY options to take advantage of the truer hedge.
This Week's Key Events: Second-Quarter GDP, Consumer Confidence Data on Tap
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
The economic calendar kicks off on Monday with the release of new home sales data for August. Quarterly earnings are due out from Cal-Maine Foods (CALM) and Ferrellgas Partners (FGP).
Tuesday
On Tuesday, the Street will be graced with the S&P/Case-Shiller home price index for July, the Conference Board's gauge of consumer confidence for September, and the Richmond Fed manufacturing index. Walgreen (WAG), Accenture (ACN), Jabil Circuit (JBL), Sealy Corp. (ZZ), and Paychex (PAYX) are expected to report earnings.
Wednesday
Last month's durable goods data will be released on Wednesday, along with the regularly scheduled crude inventories report. Darden Restaurants (DRI), Family Dollar Stores (FDO), Mosaic (MOS), and Texas Industries (TXI) will share the earnings spotlight.
Thursday
On Thursday, we'll hear the final second-quarter gross domestic product (GDP) from the Commerce Department, pending home sales data for July, and the usual report on weekly jobless claims. Worthington (WOR), DemandTec (DMAN), Micron Technology (MU), AZZ Inc. (AZZ), and Xyratex (XRTX) are among the day's notable earnings reports.
Friday
The economic calendar wraps up Friday with reports on personal income and spending for August, the Chicago purchasing managers' index (PMI), and the final Reuters/UMich consumer sentiment index for September. There are no major earnings reports on the day's docket.
And now a few sectors of note...
Dissecting The Sectors
Sector
Leisure/Retail
Bullish
Outlook: The SPDR S&P Retail ETF (XRT) gave back some ground on the charts last week, surrendering its short-lived perched above the round-number $50 level and its year-to-date breakeven at $48.36. However, XRT remains north of support in the $45 region, which previously served as resistance in 2007 and 2010. From a sentiment perspective, we have yet to see a meaningful uptick in XRT's 50-day buy-to-open put/call volume ratio, which would be an indication that big-money players are once again building long positions in the retail space. With these points of caution in mind, we remain upbeat on select outperformers within the group, and recommend focusing on stocks in solid technical uptrends that remain surrounded by skepticism. Chipotle Mexican Grill (CMG) and Lululemon Athletica (LULU) have racked up double-digit percentage gains in 2011, easily surpassing the broader market -- yet both equities have been heavily targeted by short sellers, and the majority of analysts also remain dedicated to the bearish camp. Meanwhile, speculative options traders continue to favor puts on Ralph Lauren (RL) and Green Mountain Coffee Roasters (GMCR), which have turned in solid technical uptrends of their own in 2011. Amazon.com (AMZN) is another one to watch, with the shares pulling back to support after finding a new all-time high of $244 last Monday -- even as short sellers have been ramping up their bearish bets against the online retailer. As these high-flying discretionary stocks continue to outperform on the charts, a capitulation by the skeptics could provide a fresh influx of buying pressure. Sector
Large-Cap Tech
Bearish
Outlook: From a broad perspective, the tech-rich Nasdaq Composite (COMP) found resistance last week about 10 points south of its year-to-date breakeven. In similar fashion, the PowerShares QQQ Trust (QQQ) recently spiraled lower after a test of the $60 level -- which represents exactly half its all-time high of $120, set back in March 2000. Within the tech sector, semiconductor stocks could prove to be a particular pocket of weakness, as analysts remain surprisingly upbeat on this underperforming group. The percentage of "buy" ratings on components of the Semiconductor HOLDRS Trust (SMH) peaked at 58.2% in late July, hitting its highest level since May 2010, and remains at an elevated 56.6%. Meanwhile, the percentage of "sells" is resting near an annual low. In the same optimistic vein, a few upbeat analysts have recently flagged the poor price action in chip stocks as a buying opportunity. However, with a slew of semiconductor names recently slashing their financial guidance in the face of weak demand trends -- TriQuint Semiconductor (LSCC) and Xilinx (XLNX) jumped on the bandwagon this past week, joining the likes of Novellus Systems (NVLS) and Texas Instruments (TXN) -- the outlook for this struggling group seems unlikely to improve anytime soon. With SMH faring even worse than the broader QQQ in 2011, the semiconductor sector as a whole could be vulnerable to a shift in sentiment toward the bearish end of the spectrum as the weak technical performance continues.
Sector Financials
Bearish
Outlook: Bad news continues to roll in for the banking sector, as Moody's lowered its debt ratings for Bank of America (BAC), Citigroup (C), and Wells Fargo (WFC) this past week. The ratings agency maintained a negative outlook on all three banks, noting that the U.S. government is "more likely now than during the financial crisis to allow a large bank to fail should it become financially troubled." Plus, concerns continue to linger about European debt exposure, further weakening the already-shaky fundamental outlook. Taking a broader look at the group, the technical backdrop for the Financial Select Sector SPDR (XLF) remains bearish, with the fund sitting on a steep year-to-date decline of nearly 27%. XLF tumbled lower in late August after an unsuccessful test of the $13.50 level, which previously served as major support during 2010. Going forward, this area could prove to be a troublesome resistance level. Meanwhile, the 20-day buy-to-open call/put volume ratio for XLF moved higher recently, suggesting that short sellers could be returning to place new bearish bets against the sector. However, traders should keep an eye on the aforementioned $13.50 region, as a move back above this area would be a risk to any short positions in the big-cap financial sector.
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. |
