Monday Morning Outlook: Strength in Tech Could Force Shorts to Cover
The stock market's positive price action in January could bode well for the rest of 2012
by Todd Salamone 1/28/2012 10:50 AM
schaeffersresearch.com
The Federal Reserve made some minor waves last week, when policymakers opted to extend their forecast for ultra-low interest rates through late 2014. Traders were initially cheered, but a softer-than-expected GDP reading on Friday was a sobering reminder of the reasoning behind the Fed's accommodative stance. The S&P 500 Index (SPX) ended the week nearly unchanged, with equities taking a breather to consolidate some of their year-to-date gains. On the other hand, the tech sector was a notable pocket of strength, as evidenced by a major technical victory for the PowerShares QQQ Trust (QQQ).
Meanwhile, the sentiment backdrop is flashing mixed signals. Fund managers appear to be growing more bullish, but Todd Salamone notes that retail investors have yet to find their way back into this market. With these potential buyers still apparently rooted to the sidelines, Todd outlines the major support and resistance levels that could come into play for the SPX this week. Meanwhile, Rocky White runs the numbers to determine whether the market's positive January performance bodes well for the month of February. Finally, we wrap up with a preview of the key economic and earnings reports for the week ahead, along with a few sectors of note.
Notes from the Trading Desk: Should Investors Trust a Low-Volume Rally?
By Todd Salamone, Senior VP of Research
" ... the PowerShares QQQ Trust (QQQ) comes into the week just below major resistance in the 60 area. As you might remember from previous commentaries, the 60 level is important, as it represents half the QQQ's March 2000 all-time high at 120. The 59-60 area has marked peaks in the QQQ since February 2011..." "... the ratio of call buying to put buying on VIX futures, smoothed by a 20-day moving average, is approaching highs at which the ratio has peaked and preceded market tops. However, upon digging further, it's worth noting that the total buy-to-open option volume on VIX futures during the past 20 days is extremely small relative to the volume at past peaks last year. In fact, buy-to-open option volume on VIX futures is currently about half its 2011 peak, even as the call/put ratio approaches its highs. This would suggest that, while hedge fund activity has become more bullish of late, there are still a number of deep-pocketed players sitting on the sidelines."
- Monday Morning Outlook, January 21, 2012
"According to [Investment Company Institute], mutual-fund investors pulled $804 million from domestic equity funds during the second week of January, which more than reversed the $734 million of net inflows that went into those same funds a week earlier. These readings continue to show extreme reluctance among mom-and-pop investors to dive back into stocks."
- The Wall Street Journal, January 26, 2012
Another technical battle was won by the bulls last week, with the popular PowerShares QQQ Trust (QQQ - 60.40) closing above the 60 level -- which represents half the all-time high achieved in early 2000. The advance above 60 came after a year-long battle in which the QQQ tried, but failed, to rally above this important level.
This technical breakout may have major significance, since many hedge fund managers are drawn to the technology group. In fact, a recent Goldman Sachs report estimated that just over 20% of net portfolio exposure among hedge funds is in the Information Technology group, and six of the top 10 largest holdings among individual equities are within this group. For those playing the short side, the technical breakout may be causing pain, and could trigger potential short-covering in the immediate future. And for those fund managers that are currently underweight equities, cash may be deployed toward this sector in the weeks ahead as the positive price action pulls them off the sidelines.
As discussed last week, it is still apparent that hedge fund managers are in accumulation phase, after coming into the year underweight equities. Furthermore, there is fresh evidence of hedging activity in the options market as stocks make their way higher. For example, the 20-day buy-to-open put/call volume ratio on the QQQ, SPDR S&P 500 ETF (SPY), and iShares Russell 2000 Index Fund (IWM) continues to advance from low levels. Fund managers will purchase IWM, QQQ, and SPY puts to hedge long equity positions they are accumulating.
Moreover, call options on CBOE Market Volatility Index (VIX - 18.53) futures are used to hedge long positions, since the VIX moves inversely to equities on sharp market declines. The VIX's 20-day buy-to-open call/put ratio continues to advance too, as call buying heats up. The direction of both of these ratios is indicative of a hedge fund community that is getting more bullish, sparking a bid for equities.
With retail investors still in denial, as evidenced by equity fund outflows, bulls will continue to depend on fund managers to drive stocks higher in the immediate term. That said, from a longer-term perspective, considerable sideline money from retail investors represents future buying power, but it is anyone's guess as to when they finally become believers -- new highs in the S&P 500 Index (SPX - 1,316.33 ), which would occur 200-plus points above Friday's close? New highs in the Nasdaq Composite (COMP - 2,816.55), more than 2,000 points above Friday's close? Or, perhaps it will take a major change in the daily headlines that have cast doubt on the future?
Regardless, we find it of interest that some market watchers have voiced concern about the low volume during this rally, and how this may be a bearish indicator. We can't help but remember this same kind of warning as the market rallied from the 2009 bottom. A contrarian take could be that low volume is a signal that many participants, including hedge funds and retail investors, remain on the sidelines and thus can be viewed as future buyers.
In fact, we cannot help but notice how total volume on Dow Jones Industrial Average (DJIA - 12,660.46) components perked up ahead of the 2000-2003 bear market, and how low volume in 2003-2004 relative to prior months simply indicated a pause that preceded higher volume and higher stock prices into 2007.
We remain bullish and reiterate our view that short-term pullbacks should be used as buying opportunities. We continue to keep a close eye on hedging activity, as the hedge fund players can turn on a dime.
Potential short-term resistance for the SPX is at 1,320, the site of the pre-Lehman Brothers high in 2008, and 1,345-1,350, which was the site of resistance in 2011. Short-term support is in the 1,285-1,290 area, site of a late-October peak.
Indicator of the Week: The January Barometer
By Rocky White, Senior Quantitative Analyst
Foreword:The expression "January Barometer" refers to the theory that the market's performance during the month of January sets the tone for the rest of the year. In other words, a positive January leads to a positive year, and a negative January sets the tone for an underperforming year.
The data below for the Dow Jones Industrial Average (DJIA) since 1950 suggests there is something to the January Barometer. When the Dow is positive in January, then the rest of the year is positive 83% of the time, averaging additional gains of 9.59%. Compare that to the Dow's performance when January is negative. In those years, the February-December returns are positive just half of the time, with an average gain of 2.04%.
This current month has been a particularly strong January. In the past, when January is up or down more than 3.5%, the "barometer" phenomenon is even more pronounced. The bottom of the table shows that when the Dow is up big, then the average return for the rest of the year is over 11% -- but if it's down big, the average advance is only 0.32%.
January Barometer for February: For many traders, 11 months is a pretty long holding period -- so let's take a shorter-term perspective on the January Barometer. Below is a table showing how the Dow fares during the month of February in relation to January's price action. As with the full-year results, a positive January typically leads to a positive February. When the Dow closes higher in January, February goes on to average a return of 0.57%, and is positive 63% of the time. When January is negative, February is negative more than half the time, and averages a loss of more than 1%. However, an outsized return in January has not necessarily translated into a bigger return for February. If January is up more than 3.5%, the average February gain is not as big as if January is simply positive.
Individual Stocks: Next, I broke the January Barometer down to an individual stock level. Specifically, I looked at the number of times since 2000 that a stock's return in February followed the same direction as January. In other words, the number of times January was up AND February was up, or January was down AND February was down.
Below are all the stocks where January predicted February's direction at least 80% of the time. I also included the average return for each stock in February, and the percentage of the time it has been positive since 2000. Looking at the top two stocks on the list -- Avery Dennison (AVY) and Travelers Companies (TRV) -- the February return followed suit with the January return 11 out of 12 times (92%). So far this year, AVY is up and TRV is down. If we expect this pattern to repeat, then AVY will go on to have a positive February, and TRV will suffer a negative February.
This Week's Key Events: January Jobs Data Punctuates a Busy 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
- The economic calendar kicks off Monday with a report on personal income and spending. Earnings are due out from Wendy's (WEN), Hologic (HOLX), Plum Creek Timber (PCL), Mindspeed Technologies (MSPD), and Wolverine World Wide (WWW).
Tuesday
- Tuesday brings us the latest S&P/Case-Shiller home price index, the Chicago purchasing managers index (PMI), and the Conference Board's consumer confidence report. Earnings season heats up with quarterly results from Exxon Mobil (XOM), Amazon.com (AMZN), UPS (UPS), Mattel (MAT), Archer Daniels Midland (ADM), U.S. Steel (X), Valero Energy (VLO), ARM Holdings (ARMH), Biogen Idec (BIIB), Broadcom (BRCM), CIT Group (CIT), Illumina (ILMN), L-3 Communications (LLL), Oshkosh (OSK), and Tellabs (TLAB).
Wednesday
- Employment data starts to trickle in on Wednesday, with the release of ADP's private-sector payrolls report. Also on tap are the ISM's manufacturing index, construction spending, motor vehicle sales, and the usual weekly update on crude inventories. On the earnings front, we'll hear from Marathon Oil (MRO), Marathon Petroleum (MPC), Allstate (ALL), AOL (AOL), Chipotle Mexican Grill (CMG), Qualcomm (QCOM), Electronic Arts (EA), Green Mountain Coffee Roasters (GMCR), JDS Uniphase (JDSU), Las Vegas Sands (LVS), BE Aerospace (BEAV), BMC Software (BMC), Concur Technologies (CNQR), Corinthian Colleges (COCO), Shutterfly (SFLY), and Whirlpool (WHR).
Thursday
- Weekly jobless claims will hit the Street on Thursday. Sharing the earnings spotlight will be International Paper (IP), Kellogg (K), MasterCard (MA), Merck (MRK), Allergan (AGN), Gilead Sciences (GILD), Boston Scientific (BSX), Beazer Homes (BZH), M/I Homes (MHO), Blackstone Group (BX), Acme Packet (APKT), NetSuite (N), Cavium (CAVM), Digital River (DRIV), CME Group (CME), Diamond Offshore Drilling (DO), Sunoco (SUN), Dow Chemical (DOW), Genworth Financial (GNW), New York Times (NYT), Royal Caribbean Cruises (RCL), and Starwood Hotels & Resorts (HOT).
Friday
- The Labor Department's marquee report on nonfarm payrolls will dominate headlines on Friday, and traders will also digest the latest data on factory orders and the ISM's services index. Meanwhile, the week's slate of earnings wraps up with quarterly reports from Clorox (CLX), Tyson Foods (TSN), American Axle (AXL), Estee Lauder (EL), Simon Property Group (SPG), and Weyerhaeuser (WY).
And now a few sectors of note...
Dissecting The Sectors
Sector Utilities
Bullish
Outlook: The positive momentum in the utility sector has dimmed lately, as this traditionally defensive group has cooled its heels amid strength in the broader equities market. However, within the context of the longer-term uptrend in the PHLX Utility Sector Index (UTY), pullbacks like the one we're seeing now are not unusual, and we would view these dips as buying opportunities. In fact, as predicted, UTY last week briefly retreated to the $455 area -- a site of former resistance in mid-2011 -- after breaching its 80-day moving average. However, by the time Friday's closing bell sounded, UTY had reclaimed a foothold above its 80-day trendline, currently located just shy of $463. In addition to the sector's long-term technical outperformance, and the appealing dividend yields of many utility stocks, there's an unwarranted amount of pessimism surrounding the group. Drilling down, 80% of stocks in the electric utility group are trading above their 200-day moving averages, but they've attracted only 41% "buy" ratings from brokerage firms. Meanwhile, the gas utility group boasts 83% of stocks trading above their 200-day moving averages -- yet these names have garnered only 37% "buy" ratings. Within the utility sector, Duke Energy (DUK) and Consolidated Edison (ED) have turned in impressive uptrends over the past year, and both securities are lingering near annual-high territory. 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: The trend of improving employment data continued last week, when the four-week moving average of initial jobless claims declined to 377,500. Additionally, consumer-level inflation remains virtually stagnant, pointing to an improving fundamental backdrop for the U.S. consumer -- and, by proxy, consumer discretionary stocks. On the charts, the SPDR S&P Retail ETF (XRT) remains a technical outperformer. XRT notched another week of impressive gains, with the fund extending its lead above formerly staunch resistance at $54, and making a run at its July 2011 all-time high at $56.44. For those seeking a bullish play in the retail/leisure space, we recommend focusing on stocks in solid technical uptrends that are surrounded by skepticism. A few of our current favorites include retailers AutoZone (AZO), Advance Auto Parts (AAP), Nordstrom (JWN), and Whole Foods Market (WFM), along with restaurateurs Chipotle Mexican Grill (CMG), Domino's Pizza (DPZ), and McDonald's (MCD). With skepticism still lingering toward these consumer-dependent stocks, contrarians can continue to capitalize on situations where sentiment has yet to catch up with the bullish technical performance.
Sector Homebuilding
Bullish
Outlook: Builders were hit with some downbeat data last week, as reports on pending sales and new home sales both fell short of expectations. Despite this deviation from the recent trend of improving statistics, the SPDR S&P Homebuilders ETF (XHB) ended the week comfortably higher, lifted in part by a positive earnings report from sector component D.R. Horton (DHI). The firm's well-received quarterly results came on the heels of a similar upside surprise from fellow builder Lennar (LEN) earlier this month. On the charts, XHB is trading solidly above its 160-week moving average, which is now turning higher. This trendline covers a roughly three-year period of time, dating back to the peak of the 2008 financial crisis. However, there's still plenty of negativity levied against builders, even as fundamental data continues to improve. Stocks such as LEN, DHI, KB Home (KBH), and Meritage Homes (MTH) all sport sizable accumulations of short interest, and one brokerage house recently slapped the sector with a round of downgrades. Going forward, these names could benefit from upgrades or short-covering activity as the technical and fundamental performance continues to surpass the Street's low expectations.
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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