Monday Morning Outlook: RUT and MID Face Crucial Tests on the Charts
After a week of wall-to-wall euro drama, portfolio insurance is going to cost you
by Todd Salamone 11/5/2011 10:51 AM
schaeffersresearch.com
Investors could be forgiven for failing to realize that last week's notable economic news included a downwardly revised growth forecast from the U.S. Fed, as well as a fair-to-middling three-day gauntlet of jobs data. For the better part of the past five trading days, perennial bankruptcy candidate Greece dominated the headlines almost entirely, after Prime Minister George Papandreou decided to surprise his euro-zone comrades with a bailout referendum. (Apparently, it's a little more difficult than you'd think to get a continent's worth of politicians on the same page at once.) On the plus side, Papandreou's gambit didn't actually send Greece spiraling into the abyss -- but it didn't exactly inspire confidence among global investors, either.
After snapping their weekly winning streaks, the major market indexes are now planted beneath key levels of resistance. Todd Salamone sees plenty of potential buyers camped out on the sidelines, but he warns that stocks still have more ground to cover before winning over the holdouts. Meanwhile, Rocky White pinpoints a few select outperformers that are trading well above key technical levels, despite a general lack of love from Wall Street. Finally, we wrap up with a preview of the major earnings and economic events for the week ahead, as well as a few sectors of note.
Notes from the Trading Desk: Four Notable Speed Bumps for Stocks
By Todd Salamone, Senior VP of Research
"The RUT is still in the red for 2011, and the MID is barely in the green, with the index's first-half lows just overhead at 920. The fact that the MID is trading around a key round number with historical significance, which also happens to coincide with its year-to-date breakeven, is perhaps the No. 1 risk from a technical perspective. It will be of importance for the MID to make a more convincing move above 900 in order to squeeze more shorts." "The bottom line is, the equity market's backdrop continues to improve, even as many hedge funds have been significantly underinvested and are in the red this year. With more clarity on how Europe plans to address their issues amid an improved technical backdrop, risk-taking could increase significantly and drive stocks higher in the coming months, as fund managers look to play 'catch-up' with the year winding down. Risks do remain, so it's still prudent to hedge your long positions..."
- Monday Morning Outlook, October 29, 2011
Well, we thought we had a little more clarity on the European sovereign debt issues and -- surprise, surprise -- Prime Minister George Papandreou decided early this week that Greek voters should decide whether they wanted to accept the bailout package tailored by European leaders the prior week. The rescue deal included austerity measures that were already unpopular among Greek voters, leaving market participants doubtful of a positive outcome to the proposed referendum. Ambiguity once again became the order of the day with respect to Europe, and key equity indexes -- such as the S&P 400 MidCap Index (MID - 899.46) and PowerShares QQQ Trust (QQQ - 57.80) -- sharply retreated from the resistance levels we discussed in last week's report.
If there is anything we have learned during the past few months, it is that "surprises" have become commonplace, suggesting directional exposure should be hedged, as noted in the excerpt above. The ongoing uncertainty and constant surprises have kept volatility gauges, such as the CBOE Market Volatility Index (VIX - 30.16), relatively elevated compared to their historical averages.
With other world leaders -- including the familiar duo of French President Nicolas Sarkozy and German Chancellor Angela Merkel -- pressuring the Greek government to accept the bailout package, under threat of exile from the euro (another unpopular notion among the disgruntled citizenry), Papandreou spent the rest of the week backpedaling, right up to a narrowly won vote of confidence late Friday. Equities recovered from Tuesday morning's low, and the sell-off was relatively contained by week's end.
The equity market's prospects into year-end still appear to be constructive, as it would seem that a huge build-up in pessimism is still in the early stages of unwinding. For example, an indicator we have not discussed in a long time is the 10-day equity-only, customer-only, buy-to-open put/call volume ratio on the International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX). Yes, this is a mouthful, but it is essentially a measure of investor sentiment.
When the ratio rises from low levels (extreme optimism giving way to pessimism), the market has historically struggled. Moreover, when the ratio peaks at high levels and moves lower (extreme pessimism giving way to optimism), equities have historically advanced. As you can see on the chart below, the ratio recently peaked at its highest level since early 2009 and has turned lower. This could be evidence that the shorts are becoming less bold, and are covering their positions, which -- as we said last week -- could sustain a rally. The bulls should find it encouraging that this ratio has plenty of room to fall, based on historical data.
However, there are several overhead speed bumps, or resistance levels, that continue to pose a challenge for the bulls, and are worth keeping in our view. Specifically:
- The 1,260 region on the S&P 500 Index (SPX - 1,253.23) represents its year-to-date breakeven, as well as significant lows in March and June. SPX 1,253, by the way, is the average year-end target among money managers, as cited in the latest Barron's Big Money poll.
- QQQ 60 is half the all-time high, and has acted as an area of resistance on four trips up to this area in 2011.
- MID 900 is a round-number area that marked the 2007 peak, and the 2011 breakeven is just seven points north of 900.
- The Russell 2000 Index (RUT - 746.49) comes into the week trading in the 750 area, site of its peak ahead of the 2010 "flash crash" and it 320-day moving average, an uncommon long-term average that has been significant in the past. If this trendline is taken out, which the SPX and MID managed to do late last month, the 780 area becomes the next speed bump, site of its 2011 breakeven and support in February, March, and June.
We continue to believe that any advances will be led by small-cap and mid-cap equities and, in fact, small- and mid-cap stocks have been leading the big caps since the lows in early October. In order for this leadership to continue, the MID must sustain a move above 900, and the RUT must get over the 750 mark.
The bottom line is, there appears to be short-covering activity and money moving in from the sidelines as we transition out of an extreme in negative sentiment. With the major equity indexes back in the red, or still in the red, for 2011, some would-be investors may need a little more convincing. That said, there is sufficient buying power available to push equities through the various resistance levels that we have pinpointed for you as we move into year-end. Hedging of your long exposure is still prudent -- although premiums on portfolio insurance are 23% higher than they were the last time we made this recommendation, with the VIX moving from 24.53 to 30.16 over the course of the past week.
Indicator of the Week: Sector Analysis Using Technicals and Sentiment
By Rocky White, Senior Quantitative Analyst
Foreword: I assume most readers are familiar with our contrarian philosophy here at Schaeffer's. Basically, we look for uptrending stocks which are looked upon skeptically by the investing public. This pessimism indicates a lot of potential buyers on the sidelines. As the rally continues, more and more investors will take notice, and that sideline money begins drifting into the stock -- thereby furthering the gains. With any luck, you will have bought into the stock ahead of the rest of the investing crowd, allowing you to enjoy a fast and furious rally.
Sector Analysis: One simple but effective way we analyze sectors is to look at the percentage of stocks that are trading above their 200-day moving average. A sector with a lot of stocks on the rise will show a higher percentage of names above that closely watched trendline. Then, we also look at the percentage of "buy" ratings given to the sector components by analysts.
Based on our contrarian philosophy, we would be bullish on sectors with a high number of stocks above their 200-day moving averages, but with a very low percentage of "buys." Similarly, we look bearishly at sectors that have a minimal percentage of stocks above their 200-day, but a preponderance of bullish analyst ratings.
Looking at the tables below, the first two sectors on the list jump out at you: They're both utilities. The electric and gas groups have about 75% of stocks above their 200-day moving averages, yet the percentage of "buy" ratings from analysts is only 39% for electric utilities, and 48% for gas utilities. These stocks are often considered to be very "boring" and slow-moving, but they have evidently been moving higher for some time now. Clearly, analysts -- and, I'd bet, quite a few others on Wall Street -- haven't noticed or bought into the trend yet.
Compare the utility sectors I just mentioned above to the coal, non-ferrous metals and steel sectors at the bottom of the table. These groups have very few stocks above their 200-day moving averages (just 15%, 14%, and 6%, respectively), yet these names have garnered about 60% "buy" ratings from analysts. It could be just a matter of time before the downgrades start coming in, and investors flee these sectors in search of greener pastures. Where will they put their money next? Why not utilities, which have been doing quite well?
Under-loved Utility Names: Finally, if you're looking for some individual stocks to investigate, below is a table highlighting a number of interesting utility companies. Each of the stocks listed has pretty liquid options, is trading above its 200-day moving average, and has a positive year-to-date return, yet less than half of the analysts rate the stock a "buy."
This Week's Key Events: Cisco Earnings, Consumer Sentiment Data 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
- The economic calendar kicks off Monday with the Fed's monthly report on consumer credit. Earnings reports are due out from BroadSoft (BSFT), Cameco (CCJ), Coeur d'Alene Mines (CDE), Delcath Systems (DCTH), Demand Media (DMD), Dish Network (DISH), Hologic (HOLX), Limelight Networks (LLNW), Progressive (PGR), Rackspace Hosting (RAX), and Vivus (VVUS).
Tuesday
- The NFIB small business optimism index is slated to hit the Street on Tuesday. On the earnings front, we'll hear from Activision Blizzard (ATVI), Blue Nile (NILE), Caribou Coffee (CBOU), Carrizo Oil and Gas (CRZO), China Automotive Systems (CAAS), Clean Energy Fuels (CLNE), E.W. Scripps (SSP), Fossil (FOSL), Hecla Mining (HL), STEC (STEC), Take-Two Interactive Software (TTWO), Toyota Motor (TM), and Vodafone (VOD).
Wednesday
- Data on wholesale inventories is due out Wednesday, along with the usual report on domestic petroleum supplies. The day's earnings calendar includes quarterly results from 99 Cents Only Stores (NDN), Advance Auto Parts (AAP), Ashland (ASH), Cisco Systems (CSCO), Dean Foods (DF), Energy Conversion Devices (ENER), Fuel Systems Solutions (FSYS), General Growth Properties (GGP), General Motors (GM), Green Mountain Coffee Roasters (GMCR), Liz Claiborne (LIZ), Macy's (M), Medivation (MDVN), Ralph Lauren (RL), Silver Wheaton (SLW), and Wendy's (WEN).
Thursday
- Thursday brings a relative onslaught of economic news, including import/export prices, the U.S. trade balance, the Treasury budget, and the weekly report on jobless claims. AMC Networks (AMCX), Hoku Corp. (HOKU), Kohl's (KSS), Molycorp (MCP), Nordstrom (JWN), Nvidia (NVDA), Renren (RENN), Viacom (VIA), and Walt Disney (DIS) will share the earnings spotlight.
Friday
- The week wraps up on Friday with the Thomson Reuters/University of Michigan consumer sentiment survey for early November. The earnings calendar concludes with reports from Brookfield Asset Management (BAM), D.R. Horton (DHI), and Tree.com (TREE).
And now a few sectors of note...
Dissecting The Sectors
Sector Utilities
Bullish
Outlook: The utility sector has emerged as a pocket of technical strength in 2011, with the PHLX Utility Sector Index (UTY) recently breaking out above the $455-$460 region to touch a new three-year high. However, Wall Street hasn't exactly jumped on the bullish bandwagon just yet. Drilling down, 75% of stocks in the electric utility group are trading above their 200-day moving averages, but they've attracted only 39% "buy" ratings from brokerage firms. Meanwhile, the gas utility group boasts the second-highest percentage of stocks trading above their 200-day moving averages among all sectors we follow, at 74% -- yet these names have garnered only 48% "buy" ratings. The broader utility sector also sports some attractive dividend yields, which are certainly a selling point in the context of a choppy market environment. Within the group, Duke Energy (DUK) and Consolidated Edison (ED) have racked up double-digit percentage gains in 2011, and both stocks are within striking distance of their respective annual highs. Nevertheless, there's not a single "buy" endorsement between the two. Going forward, a round of well-deserved upgrades could draw a fresh wave of buyers to the table, helping these stocks extend their positive price action.
Sector Leisure/Retail
Bullish
Outlook: Same-store sales rose 3.4% in October among retailers tracked by Thomson Reuters, falling short of the consensus estimate for a 4.5% increase. However, retail stocks held up well in the face of this shortfall, suggesting that expectations among investors might have been pegged a little lower. Along those same lines, the National Retail Federation is predicting a year-over-year slowdown in holiday sales. For what it's worth, this group underestimated 2010 holiday sales growth by more than half -- leaving room for another potential upside surprise this year. Meanwhile, on the charts, the SPDR S&P Retail ETF (XRT) has been making a run at its all-time high of $56.44, which was touched back in July. One point of caution is the XRT revisiting a 10% year-to-date gain, as the fund stalled around these returns in May and June. We remain upbeat on select outperformers within the consumer discretionary group, and recommend focusing on stocks in solid technical uptrends that are surrounded by skepticism. Amazon.com (AMZN) got hit hard post-earnings, but we still like the shares on a pullback. Looking back, AMZN has a long history of sharp, scary pullbacks that are quickly resolved to the upside, and this pattern appears to be forming once again. Choice restaurant stocks also hold some appeal, with under-loved names like BJ's Restaurants (BJRI), Chipotle Mexican Grill (CMG) and Domino's Pizza (DPZ) basking in the glow of positive earnings reports. As these high-flying discretionary names continue to outperform on the charts, a capitulation by the lingering skeptics could provide an influx of buying pressure.
Sector Gold
Bullish
Outlook: A recent pullback in the SPDR Gold Trust (GLD) was contained by its 120-day moving average, which has played a key role as support over the past couple of years. After meeting up with this reliable technical floor, GLD rallied, breaking out above short-term pressure at its 80-day moving average in the process. On the sentiment front, various indicators we track point to significant pessimism on gold, even as the technical backdrop improves. For example, a recent survey of 121 portfolio managers found that a hefty 34% are bearish on gold. Among all asset classes, only a few predictable underdogs -- U.S. Treasuries, municipal bonds, and European stocks -- garnered a higher bearish vote. Plus, cumulative buy-to-open option volume is beginning to pick up once again on GLD, following a recent plunge in activity. Previous downturns in buy-to-open option volume have corresponded with periods of weak price action, whereas increasing buy-to-open volume has corresponded with strength -- suggesting this latest bounce from trendline support could herald the beginning of the next leg higher within GLD's longer-term uptrend.
Sector Financials
Bearish
Outlook: The financial sector outperformed during the second half of October, taking part in a broad-market advance sparked by signs of progress on the European debt crisis. The bears were stung by this bounce in bank stocks, which propelled the Financial Select Sector SPDR (XLF) back above the historically significant $13.50 area. However, the fund finished Friday back below this formidable chart region, and is now sitting on a substantial year-to-date loss of 16.7%. XLF was smacked lower after testing the $14.40 area, which roughly coincides with the fund's 52-week breakeven level as of the end of November. Going forward, these staunch layers of technical resistance could continue to keep financials under pressure. Meanwhile, short interest on XLF has increased, and we have seen what appears to be hedged call buying on the fund. In the past, heavy shorting amid XLF call buying has preceded periods of weak price action. It remains to be seen if this most recent bout of shorting activity is smart money at work. However, it's worth noting that the financial group rallied strongly at this time last year, as beaten-down banks became a favorite among bargain-hunters. Should the broader market advance into year-end, there is a possibility of repeat performance -- with another possible let-down in 2012. As another point of short-term caution, financials emerged as the least-liked sector in a recent poll of money managers, suggesting that there may be a good deal of pessimism priced into these stocks already. Given this mixed outlook, it may be appropriate to lighten up on short financial exposure at the moment. However, if the price action continues to break down, it could signal an opportunity for the bears to pile back on in earnest.
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.
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