Is the Stage Set for a Summer Rally?
Election-year history and recent option-buying trends could point to a surprisingly strong season
by Ryan Detrick, CMT 6/23/2012 10:15:56 AM
Stocks ended modestly lower last week, despite relatively predictable Greek elections and an extended bond-buying program from the Federal Reserve. Weighing on Wall Street was the central bank's downwardly revised forecast for inflation and economic growth, and upwardly revised projection for the U.S. unemployment rate. Exacerbating those concerns was a wash of dismal domestic data on Thursday, including a disappointing report on Philadelphia-area manufacturing, and a jump to year-to-date highs in the four-week moving average of initial jobless claims. However, as Ryan Detrick points out, there's more than one "buy" signal flashing right now -- on the technical, sentiment, and historical fronts. Meanwhile, Rocky takes it one step further by dissecting the most accurate technical indicators of late, and highlighting a few potential stocks to keep an eye on. Finally, we wrap up with a look at this week's notable earnings and economic events, as well as a few sectors of note.
Notes from the Trading Desk: Are We Carving Out Another Major Bottom?
By Ryan Detrick, Senior Technical Strategist
Senior Vice President of Research Todd Salamone is out this week, so I'll be filling in for him. As he mentioned last week, there's a good chance we may have reached a bottom, and although we sold off a little this week, I still think that is the case. Remember, it took nearly eight weeks for the bottom to form last summer, and although it can be frustrating, there's a better-than-average chance we are carving out another major bottom now.
Following up on the CBOE Market Volatility Index (VIX - 18.11) head-and-shoulders chart Todd mentioned last week, it played out rather well. The VIX absolutely imploded earlier in the week, as some calm came after the Greek election went off without a hitch. Now, it did spike later in the week after Thursday's 250-point drop, but it ran into strong resistance near the neckline. All in all, this chart continues to look bearish, and as we all know, lower volatility should open the door for higher equity prices.
Getting to some charts that caught our attention earlier this week, the S&P 500 Index (SPX - 1,335.02) broke up above its 50-day moving average, and this caused some mini-celebrations in trading circles and the media. We've done studies on this trendline before and have never found much significance. Sure enough, just overhead the 80-day acted as firm resistance. We've seen this before, where the 50-day might give way only for the more significant 80-day to act as firm support or resistance. I'd feel much better if the SPX could get back up above the 80-day here.
Chart courtesy of StockCharts.com
Speaking of the 50-day moving average, I stumbled across a chart on Wednesday that I found interesting. Turns out, the SPX's 50-day trendline is near a rather significant area going back to early 2008. Below is a chart of just the SPX's 50-day moving average with no daily price action. We've noted many times how we like to look for charts or technicals that others simply aren't following, and I think it's safe to say this is one chart most traders aren't watching.
Chart courtesy of StockCharts.com
In case you weren't aware, our traders are writing more on our website, and you can find a lot of their thoughts on our Trading Floor Blog. Several times recently, Schaeffer's Senior Equities Analyst Joe Bell has noted potential resistance from the neckline of a head-and-shoulders top in the iShares Russell 2000 Index ETF (IWM - 77.48), which nailed Thursday's big drop. Not to be outdone, both the SPX and the Financial Select Sector SPDR ETF (XLF - 14.33) ran right into Fibonacci retracements before correcting. Be sure to stay on top of this blog for more real-time thoughts and ideas.
Chart courtesy of StockCharts.com
One indicator we follow that could be flashing a nice "buy" signal under the surface is the 10-day equity-only buy-to-open put/call volume ratio on the International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX). This ratio recently reached its highest level since March 2009, and has since rolled over. Think about that, we are seeing as many puts being bought now as we did back at a major historical low. You have to like seeing that if you are bullish here. As you can see below, past rollovers and moves lower have been terrific "buy" signals. We'll continue to follow this one, but we could be looking at a very significant surprise summer rally, should it play out.
Something I discussed on our site recently that is worth a quick revisit is how the market tends to fare during election years in the normally weak May-to-October timeframe. Not too surprisingly, the market does well during this historically weak period. Without getting too political, parties will do what they have to do to spark the economy or stock market ahead of an election. With it being an election year, this is another reason to expect higher prices this summer and fall. Below are the results of what you might expect from the Dow Jones Industrial Average (DJI - 12,640.78) with a Democrat in office.
Even more impressive are the results when a Democrat is in office and up for re-election. This has happened only three times since 1950, but the May-to-October period was higher every time for the Dow, with an average return of nearly 10% -- something to remember as we move closer to the election.
Todd has done a great job over the past several weeks of noting just how negative the broad-market sentiment has been, and that's why we think we are in the process of making a major bottom. Again, we'd rather be buyers when everyone is scared, and this week there was a rather peculiar market call that caught my attention. Specifically, Goldman Sachs came out with a bearish call, looking for an SPX move down to 1,285. What is worth noting is back in late March, the firm called this one of the best buys in a generation. And that call was within days of the Spring peak. Take from this what you want, but I'm sure watching it as a contrarian "buy" signal.
Chart courtesy of StockCharts.com
All in all, sentiment toward equities is still near historically low levels. No one wants to own stocks after two 50% crashes in the past decade, the "Flash crash," and, more recently, the hedge disaster at JPMorgan Chase (JPM) and the initial public offering (IPO) issues of Facebook (FB). Remember, though, the SPX is still up about 100% since its March 2009 lows. Although there is no "perfect" chart, I still think the SPX's 80-week moving average is one to be watching here. This trendline has been very significant since 2003, and there's a good chance it once again points to a very nice buying opportunity. As long as we can stay above this trendline, and considering the amount of negativity that is still out there, you want to stay long and expect higher prices -- no matter what you hear or read about in the media.
Good luck in your trading.
Indicator of the Week: Comparing Technical Tools
By Rocky White, Senior Quantitative Analyst
Foreword: Technical analysis involves evaluating a stock simply by looking at its price chart. There are a lot of tools used these days for technical analysis that are available on pretty much any charting software. This week, I'm taking a look at some of the more popular technical indicators to see which ones have worked the best and worst over the past several years.
The Indicators: I went back to 2007 and looked at optionable stocks that averaged at least a million shares traded daily and closed above $5. Taking a simple look at some technical indicators, I found the dates on which stocks had a "buy" signal, and then found their stock returns over the next month. Here's a quick description of the indicators that I considered:
- RSI: The RSI (Relative Strength Index) is an oscillator that ranges from zero to 100. A low-number reading suggests a stock is oversold and ready to bounce. A typical "buy" level for this indicator is when it falls to below 30.
- MACD: The MACD (Moving Average Convergence/Divergence) is calculated using the difference in two different moving averages for a stock. A moving average of that difference is then used and called the signal line. A common "buy" signal is generated when the MACD crosses above that signal line.
- Golden Cross: A golden cross is when a shorter-term moving average crosses above a longer-term moving average. In the analysis below, I used 50-day and 200-day moving averages.
- Moving Average Crossover: This is simply looking at the stock crossing above a certain moving average. I compared returns after the stock crossed above 50- and 200-day moving averages.
- Bollinger Bands: These use a moving average, and then bands are placed two standard deviations above and below that moving average. When the stock touches the lower band, it is often considered oversold and a bounce in the stock price is expected.
The Results: Below is a table summarizing all results since 2007. Some indicators signal much more than others, as we see the MACD and Bollinger Bands generated over 20,000 "buy" signals each, while the golden cross signal only had about 3,500 "buy" signals. The table shows the MACD and Bollinger Bands were the best indicators over this time frame, going by average return. A golden cross showed positive returns as well, while the other "buy" signals all led to losses in the stocks, on average.
However, when dealing with the stock market, indicators tend to fall in and out of favor. Therefore, I broke the returns down to look at the signals generated this year only. The table below shows us what signals have been best in more recent times. Note that all signals are showing negative average returns except for one: a crossover of the 50-day moving average. It's also the only indicator with over 50% positive returns. The MACD, which was the best indicator since 2007, averages a 1% loss after a "buy" signal for 2012. Yet the MACD is still the second-best signal for the year, since it's the least negative of the other signals.
50-Day Crossover Last Friday: It just so happens there were a significant number of stocks crossing above their 50-day moving averages last Friday. Knowing these signals have worked recently, I figured this may be a good starting place to be looking for short-term trades. Below are liquid stocks that broke above their 50-day moving averages on Friday and have gained at least 10% so far this year.
This Week's Key Events: Data and Earnings from the Housing Sector
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 kicks off on Monday with new home sales and the Dallas Fed's manufacturing survey. Apollo Group (APOL) is due to report quarterly earnings.
Tuesday
- Tuesday features the S&P/Case-Shiller home price index, the Richmond Fed's manufacturing index, and the Conference Board's latest consumer confidence report. Companies stepping up to the earnings plate include LDK Solar (LDK) and H&R Block (HRB).
Wednesday
- Durable goods data, pending home sales, and the regularly scheduled crude inventories report will hit the Street on Wednesday. Meanwhile, investors will get a chance to mull over earnings results from Lennar (LEN), General Mills (GIS), Monsanto (MON), and Paychex (PAYX).
Thursday
Thursday's round-up will include weekly jobless claims, the Kansas City Fed's manufacturing index, and the final first-quarter gross domestic product (GDP) figures. Wall Street can expect earnings reports from Research in Motion (RIMM), Family Dollar (FDO), Nike (NKE), TIBCO Software (TIBX), American Greetings (AM), Accenture (ACN), Smith & Wesson (SWHC), and Schnitzer Steel (SCHN).
Friday
- The week concludes on Friday with personal income and spending data, the Chicago purchasing managers index (PMI), and the final estimate of the Thomson Reuters/University of Michigan consumer sentiment index for June. KB Home (KBH), Finish Line (FINL), and Constellation Brands (STZ) will wrap up the week's slate of quarterly earnings.
And now a few sectors of note...
Dissecting The Sectors
| | Sector | Leisure/Retail
Bullish |
Outlook: Consumer spending remains healthy, with a 2.9% uptick in this metric during the first quarter contributing two percentage points to the gross domestic product (GDP). Also encouraging is a string of new record lows in 30-year mortgage rates, as potential refinancing activity could free up discretionary funds among U.S. consumers. That said, same-store sales for May were a mixed bag: the collective number slightly outpaced estimates, but Kohl's (KSS) numbers came in worse than expected. The big winners included TJX Companies (TJX) and Ross Stores (ROST). Plus, domestic retail sales fell for a second straight month in May, matching April's 0.2% decline, which was previously reported as a gain. On the charts, the SPDR S&P Retail ETF (XRT) remains in a solid long-term uptrend, extending its recent bounce from the $56 area -- home to its 160-day moving average and July 2011 peak. Restaurants, including Buffalo Wild Wings (BWLD) and Chipotle Mexican Grill (CMG), are particularly compelling at the moment, with the group sporting just 51% "buy" ratings as roughly 74% of sector components trade atop their 200-day moving averages. A couple of other names we like from the broader retail sector include O'Reilly Automotive (ORLY) and Whole Foods Market (WFM). Sherwin-Williams (SHW) is another intriguing contrarian setup, given the equity's strong price action, 18% "buy" ratings, and more than 45% rise in short interest over the last two reporting periods. With skepticism still prevalent toward consumer-dependent stocks, contrarians can continue to capitalize on situations where sentiment has yet to catch up with bullish technicals.
| | Sector | Homebuilding
Bullish |
Outlook: The housing sector has seen some positive developments in 2012, thanks in part to record-low mortgage rates, which have reignited interest in the real-estate market. Home building permits climbed 7.9% to 780,000 last month, from an upwardly revised 723,000 in April -- exceeding analysts' projections, and marking the reading's highest level since September 2008. Plus, the National Association of Home Builders (NAHB) housing market index -- which measures homebuilders' sentiment -- rose to 29 this month, marking its highest reading since May 2007. This uptick surpassed analysts' expectations, who were expecting the index to remain flat with May's downwardly revised reading of 28. Technically speaking, we're continuing to monitor the SPDR S&P Homebuilders ETF (XHB), which found recent support at the $19 level. This key chart region is the site of XHB's 160-day moving average, 2011 high, and heavy front-month put open interest, so the rebound from $19 is a welcome development for bulls. During the near term, a break of this level would be a point of concern. As a further point of caution, we've seen some positive coverage of homebuilders lately, including a recent Barron's cover story titled "Home Prices Ready to Rebound." However, we think this optimism is in the very early innings after years of negativity, and other sentiment data we track suggests there is still plenty of skepticism surrounding homebuilding stocks. For now, investors may opt to hedge any long positions held on homebuilding names by employing XHB puts. Some of our preferred names in the sector are Lennar (LEN) -- set to report earnings this week -- as well as Meritage Homes (MTH), PulteGroup (PHM), Toll Brothers (TOL), and D.R. Horton (DHI) -- all of which sport relatively high short-to-float ratios of 9% or greater, as well as a preponderance of "hold" and "sell" ratings from analysts. With a healthy amount of pessimism already priced into these names, builders could benefit from short-covering activity or future upgrades as their performance continues to surpass the Street's low expectations.
| | Sector | Big-Cap Banks
Bearish |
Outlook: Three notable banking names that look particularly bearish from a contrarian perspective are JPMorgan Chase (JPM), Goldman Sachs (GS), and Citigroup (C). All have seen call buying outpace put buying in recent months, even as these stocks have trended lower. What's more, JPM and C continue to earn positive marks from their peers; JPM has 15 "strong buys" out of 25 overall analyst ratings, while Citigroup has 13 "strong buys" from the 21 brokerage names that follow it. While JPM bounced last week, its rebound was capped by its 10-week moving averages. On the flip side, C ended another week in the red, after Moody's weighed in with its lowest possible credit rating for the firm. Against this backdrop, the stage is now set for a possible move back down to annual-low territory for all three stocks. |
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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