As Investor Anxiety Spikes, Risks to the Bullish Case Can't Be Ignored
Will first-quarter earnings season serve as a catalyst higher for this choppy market?
by Ryan Detrick, CMT 4/14/2012 10:55:11 AM
Stocks suffered their steepest losses of 2012 last week, thanks to revived concerns about Spain's fiscal fortitude and China's decelerating growth rate. In fact, the level of panic on Wall Street has ratcheted up significantly, with a survey of the current sentiment landscape suggesting that investors are all but ready to write this bull's obituary. Filling in for Todd Salamone this week is Senior Technical Strategist Ryan Detrick, who's been keeping a close eye on the action in small caps as a barometer for the broader market. Amid rising expectations for a correction of painful proportions, Ryan takes a look back at previous rallies to determine whether the current uptrend has overstayed its welcome. Meanwhile, as April-dated options enter their final days as the front-month series, Rocky White explains why the negative price action this expiration cycle could bode ill for stocks in the short term. Finally, we wrap up with a preview of the busy week of earnings reports ahead, as well as a few sectors of note.
Notes from the Trading Desk: Investors and Money Managers Are Running Scared
By Ryan Detrick, Senior Technical Strategist
As Todd Salamone touched on last week, the odds are good that we'll continue to trade in a choppy phase for the time being. With the S&P MidCap 400 Index (MID - 964.41) having issues near 1,000, and the S&P 500 Index (SPX - 1,370.26) bouncing around 1,400, we could see more of this action in the near-term. There were a few technical indicators suggesting that some weakness could be on the horizon -- but overall, after a brief five-day losing streak and 4% pullback, it's amazing how much worry has come back into the marketplace.
The next major driver for the stock market will be first-quarter earnings season. What continues to impress me is how drastically the estimates have been cut over the past few months. Back in September, the consensus was for 10% year-over-year growth in first-quarter earnings. Then, at the start of the year, it was down to 4%. Now I'm actually hearing a good deal of talk that earnings will be negative for the first time since the financial crisis. The odds are strong that analysts have once again low-balled earnings estimates, and should the quarterly results come in just a little bit better than expected, this could spark yet another rally.
Technically, the 1,360 area in the SPX held as support last week, but I continue to think the action in small caps holds the key to the overall market. The March lows of 785 on the Russell 2000 Index (RUT - 796.29) held as support, and just a little below that is the RUT's 320-day moving average. This trendline has been fairly significant over the past several years, and a violation of this area could signal that more pain is coming.
One major positive for the market going forward is how much worry there is. In fact, just this week, I saw an article talking about "The 5 Big Fears Hanging Over the Stock Market". Think about that for a second. Less than two weeks ago the SPX was making new multi-year highs, yet all we ever seem to hear about are all of the reasons not to be invested.
Investors are running scared, as well. Data from EPFR Global showed that equity funds had total net redemptions of $9.26 billion in the week ended April 11, which was a new high for the calendar year. And incredibly, the American Association of Individual Investors (AAII) saw a drop of more than 25% in the number of bulls -- down to only 28% during the last week, compared to 38% the previous week. In fact, that 28% bullish was the lowest reading since September 2011. By no means is this is a flawless indicator, but previous breaks of the 30%-bullish barrier have marked a number of short-term bottoms in the SPX going back to 2009.
Also, according to the National Association of Active Investment Managers (NAAIM), active managers cut their exposure to stocks last week by the largest amount since late November. Quantitative Analyst Chris Prybal provides a closer look at this data point, but it is yet another sign of how extreme the fear has been on this 4% pullback.
Going forward, some other definite positives we're seeing include a few clues that big money could be getting back into stocks here. As Todd has mentioned numerous times over the past months, we think activity on CBOE Market Volatility Index (VIX) futures and major equity-based ETFs is hedging-related. In other words, this activity could suggest institutions are in the process of making either bearish or bullish bets. Back in March, this option activity was a cause for concern, but now we're seeing signs that deep-pocketed players are putting their cash back to work. The 20-day buy-to-open put/call ratio on the SPDR S&P 500 ETF (SPY), PowerShares QQQ Trust (QQQ), and iShares Russell 2000 Index (IWM) has turned higher, and in the past this has had bullish implications for stocks.
Not to be outdone, VIX is also seeing a rebound in call buying. As the chart below shows, when the VIX's 20-day buy-to-open call/put ratio has turned higher from similar lows, it can be a very bullish signal for the overall market.
We've heard a lot of talk that this rally has gone "too far, too fast," and is ripe to fall flat on its face for various reasons. In fact, just on Friday, I noticed an article citing how "old" the bull is as a reason to be fearful. Just for comparison, we looked back at previous major bull rallies to see where, exactly, this one stacked up in terms of percentage gain and duration. Well, our current bull market is 784 days old and up 106%. There aren't many rallies we can compare this one to -- and looking at the rallies from 1982 and 1995, the results were interesting, to say the least.
First, we are roughly in line with both of those bull markets, as you can see below, and if we keep following the returns from each of those previous rallies, the SPX will be up near new all-time highs by the end of this year. At the end of 2012, we will be 968 days into the bull market. If it follows suit with the 1982 rally, that would mean an SPX close of 1,571. Should it track the move of the 1995 rally, that would put the SPX clear up at 1,613 -- a new all-time high. Of course, this doesn't mean either scenario will necessarily pan out, but it does make the point that we've seen rallies this strong before, and stocks very well could continue to move higher. Then, when you consider how much negative sentiment we are still seeing toward this rally, there's a good chance the overall uptrend will still be firmly in place by the end of this year.
And let's not forget that this week is April options expiration. Looking back over the past 12 years, this has historically been a strong week, although the past two have been a little weaker. Expiration weeks have also tended to be somewhat more volatile than usual over the past 12 months, as the past nine have seen the SPX move more than 1%, with several weeks triggering moves of 3% or more in just five days. For a closer look at the market's performance during expiration weeks, check out Rocky White's commentary on the following page.
In conclusion, there are definitely concerns out there, and we can't simply ignore them. A slowdown in China or more issues in Europe could put a major stop to the bull market, but overall, we continue to feel there are still more reasons to be bullish than bearish for longer-term investors. In the near term, some continuation of the recently choppy price action could occur -- but eventually, that will give way to higher prices, as the dour outlooks on the economy and stock market will once again be proven too gloomy.
Best of luck in your trading.
Indicator of the Week: April Expiration Week
By Rocky White, Senior Quantitative Analyst
Foreword: At the end of this week, equity options are set to expire. The table below shows that expiration week has tended to be a bit bearish over the last couple of years -- averaging a slight loss, with 52% of those weeks being positive. One misconception about expiration week is that it is always highly volatile. It is assumed that traders exiting option trades and rolling new positions -- along with the hedging of new positions, or taking off hedges -- naturally leads to big market fluctuations. However, measuring volatility by standard deviation of returns, you see expiration weeks are actually less volatile than other weeks. Perhaps the potential for volatility is there, but over the last couple of years, it has not actually been realized.
Day of the Week: So where does expiration week go wrong? Below, I show how each day has fared during expiration week. One thing that stands out is that, despite a high percentage of days being positive, the week itself averages a negative return (see table above). For example, 67% of Thursdays during expiration week have been positive, but the average return on Thursday is actually a loss of 0.11%. This tells us there were some pretty dramatic down days on Thursdays. Friday also averages a loss, although 70% of those days have been positive.
This next table shows the last five expiration weeks by day, along with the return for the week. Note that in each of the last four expiration weeks, both Thursday and Friday are positive.
This Coming Week: These last couple of weeks have been tough for the market. The S&P 500 Index (SPX) has shed about 2% so far during the April expiration cycle. There has not been a negative cycle heading into expiration since August 2011. Looking back to 2010 again, the table below shows this is not a good omen for expiration week. When the cycle is negative heading into those last five days, expiration week has typically extended the losses, with the SPX dropping, on average, another 1.5%. The index managed a positive finish only two out of six times in those situations. If the cycle is positive, then expiration week averages a gain, and is positive over half the time.
Below are the six instances when the SPX was sitting on a loss for the expiration cycle heading into its final week.
This Week's Key Events: Dow Earnings, Manufacturing Data Set to Move Markets
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 week gets started with a flurry of economic reports, including retail sales, business inventories, the Empire State manufacturing index, and the National Association of Home Builders (NAHB) housing market index. A busy week of earnings begins with quarterly results from Citigroup (C), Mattel (MAT), Charles Schwab (SCHW), and Gannett (GCI).
Tuesday
- Tuesday's calendar features data on housing starts and building permits, as well as industrial production and capacity utilization. The earnings arena will see action from IBM (IBM), Intel (INTC), Johnson & Johnson (JNJ), Coca-Cola (KO), U.S. Bancorp (USB), Goldman Sachs (GS), Yahoo (YAHOO), Cree (CREE), State Street (STT), Intuitive Surgical (ISRG), Linear Technology (LLTC), and McMoRan Exploration (MMR).
Wednesday
- The usual report on weekly crude inventories is due out Wednesday, and Wall Street will also hear the latest earnings from American Express (AXP), eBay (EBAY), Yum Brands (YUM), Marriott (MAR), Bank of New York Mellon (BK), BlackRock (BLK), Cubist Pharmaceuticals (CBST), F5 Networks (FFIV), Halliburton (HAL), Huntington Bancshares (HBAN), Qualcomm (QCOM), SLM Corp. (SLM), and VMware (VMW).
Thursday
- Thursday's docket includes weekly jobless claims, existing home sales, the Philadelphia Fed's manufacturing index, and the Conference Board's index of leading economic indicators. Earnings season kicks into high gear, with quarterly results due out from Bank of America (BAC), DuPont (DD), Microsoft (MSFT), Travelers (TRV), Verizon (VZ), Advanced Micro Devices (AMD), Southwest Airlines (LUV), Capital One (COF), Chipotle Mexican Grill (CMG), Freeport-McMoRan Copper & Gold (FCX), Philip Morris (PM), SanDisk (SNDK), Nokia (NOK), Peabody Energy (BTU), EMC Corp. (EMC), Morgan Stanley (MS), and New York Times (NYT).
Friday
- There are no major economic reports scheduled for Friday, but Wall Street will mull over earnings results from General Electric (GE), McDonald's (MCD), Under Armour (UA), Honeywell (HON), Kimberly-Clark (KMB), and Schlumberger (SLB).
And now a few sectors of note...
Dissecting The Sectors
| | Sector | Leisure/Retail
Bullish |
Outlook: The jobs market appears to have hit a soft patch lately, with March payrolls falling short of expectations. However, the four-week moving average of first-time jobless claims remains near a four-year low, and consumer-level inflation edged up at a slower pace last month -- pointing to an improving fundamental backdrop for shoppers, and, by proxy, consumer discretionary stocks. In fact, retailers managed a composite same-store sales gain of 6.9% for March, surpassing the 5.3% improvement predicted by analysts. On the charts, the SPDR S&P Retail ETF (XRT) is still a technical outperformer, with the fund finding a foothold above its 50-day moving average amid last week's rocky trading. 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, which creates the potential for upside surprises. A few of our other current favorites include retailers AutoZone (AZO), Advance Auto Parts (AAP), and Whole Foods Market (WFM), along with restaurateurs Chipotle Mexican Grill (CMG) and Domino's Pizza (DPZ). 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: Housing data continues to come in hot-and-cold. However, a batch of coolly received reports in recent weeks gave the SPDR S&P Homebuilders ETF (XHB) a chance to fill in its bullish gap from Feb. 3. In fact, XHB on Friday notched a sixth consecutive weekly close above the $20 level, which previously marked the fund's May 2010 peak. Plus, following a recent earnings miss from KB Home (KBH), XHB found a foothold near the site of its February highs, in the $20.50 area. From here, the fund still has room to rally up to $23.25 -- which is half its all-time high, reached only three months after XHB was launched in 2006. Despite the improving price action in the sector, analysts remain overwhelmingly negative. With 82% of builders trading above their 200-day moving averages, these names have attracted only 42% "buy" ratings from brokerage firms. However, a recent preponderance of put buying on XHB suggests that hedged players are starting to dip their toes into housing stocks, which could be a boon for the group during the near term. In fact, the 50-day buy-to-open put/call volume ratio for the fund is now resting near its highest level since 2007, which indicates that big-money investors are actively acquiring shares of sector components. As further evidence, Goldman Sachs is launching a fund to buy home-loan bonds, with the investment giant asserting that "stabilization in U.S. housing fundamentals is creating an attractive investment opportunity." Some of our preferred names in the sector are Lennar (LEN), Toll Brothers (TOL), Meritage Homes (MTH), PulteGroup (PHM), and D.R. Horton (DHI), all of which sport relatively high short-to-float ratios. Going forward, these builders could benefit from upgrades or short-covering activity as the technical and fundamental performance continues to surpass the Street's low expectations. As a point of caution, Barron's just featured an optimistic cover story titled "Home Prices Ready to Rebound" -- suggesting some optimism may be priced in, and the XHB could pull back in the short term. However, a dip that is contained above $20 would be healthy, in our view, as we still believe in the potential reward in this sector. What's more, the bullish cover is not out of touch with the positive price action, making the contrarian implications less relevant.
| | Sector | Gold
Bearish |
Outlook: Lately, we've been seeing several danger signs that point to potential short-term weakness for the SPDR Gold Trust (GLD). First, as Jim Paulsen of Wells Capital Management recently observed, valuations for the underlying metal relative to stocks, bonds, and other assets have soared off the charts lately, hinting that a correction may be overdue -- particularly as gold sheds its "fear premium" in the face of recovering consumer confidence. Looking at the options markets, total buy-to-open option volume on the ETF imploded recently, and continues to decline. This occurrence has previously coincided with periods of range-bound or negative price action for GLD. Meanwhile, the fund's front-month put/call implied skew has recovered from its recent lows, but this has yet to provide any kind of meaningful bid for the shares -- marking a deviation from past trends. From a technical perspective, the outlook is similarly unsettling. The fund turned lower in late February after an unsuccessful test of resistance in the $175 area, and GLD has since plummeted through its 140-day moving average. This trendline has played a key role as both support and resistance in the past, and it's currently serving as a stubborn technical ceiling. Even more troubling, we've started to see some bullish coverage on gold in the financial media. From a contrarian perspective, this optimism in the face of deteriorating price action has distinctly bearish implications. That said, we're keeping a close eye on support from the $160 area and GLD's 320-day moving average, which could limit downside during the short term. |
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