At Dow 14,000, Don't Fight the Uptrend
Why moves above round-number levels haven't always been cause for celebration
by Todd Salamone 2/2/2013 10:25:00 AM
A Fed announcement, January's jobs report, and more multi-year highs for stocks ... while none of these events were shocking, they certainly kept investors engaged. The Dow waited until Friday to overtake 14,000, but does this mean smooth sailing ahead, or a temporary stopping point? While Rocky White looks at the historical implications of this millennium mark, Todd Salamone examines the present sentiment landscape, including reasons why this rally likely has more fuel in the tank.
- Why a low VIX could be a good thing
- 2 sentiment risks to the bullish case
- The historical significance behind Dow 14,000
Finally, we close with a preview of the major economic and earnings events for the week ahead, plus a featured sector to watch.
Notes from the Trading Desk: How Low Can the VIX Go?
By Todd Salamone, Senior V.P. of Research
"In the first quarter of 2012, there were several periods in which the SPX went sideways for a week or two, but the sideways action was resolved with an advance to new high, followed by a very mild pullback that presented a buying opportunity. Overall, the SPX rallied at a few points here and there amid low volatility, which appears to be the case at present."
- Monday Morning Outlook, January 26, 2013 "...there are plenty of warning signs that show why the rally could be due for a pause. Contrarians say low short interest levels, combined with a low VIX and overly bullish investor sentiment indicate the market could be due for at least a short-term turn."
- The Wall Street Journal Morning MarketBeat, January 29, 2013 "'On paper it might look like a good idea to add cheap protection,' Marais, who helps oversee $327 billion at Schroders as head of multi-asset investments and portfolio solutions, said in a phone interview yesterday."
-Bloomberg email, January 22, 2013 The first quarter of 2013 continues to follow the low-volatility upward trajectory of 2012's first quarter, which we discussed in depth last week. As of Thursday, the S&P 500 Index (SPX - 1,513.17) found itself sitting right around the previous Friday's close (at 1,498.11 versus 1,502.96). But on Friday, the broad-market index powered above 1,500 on the strength of a well-received employment report, and the CBOE Market Volatility Index (VIX - 12.90) -- which had ticked nearly two points higher in the second half of January -- gapped lower after this important economic data was released.
In addition to those indices mentioned last week, another major benchmark took on a huge, psychologically significant round number on the first trading day of February, as the Dow Jones Industrial Average (DJIA - 14,009.79) began its assault on 14,000. Including Friday's trading, there are only three months in the DJIA's history that 14,000 has been touched. But per the chart below, there has never been a monthly close above this millennium mark. Moreover, the failure at 14,000 in October 2007 preceded a roughly 50% haircut into early 2009. (Be sure to read page two for Rocky White's commentary on the DJIA and its historical tendencies when challenging millennium levels.)
Meanwhile, "off the chart" call buying on the VIX continues, on the heels of record call buying last quarter. I found the excerpts in The Wall Street Journal and Bloomberg interesting in the context of the chart below, which shows huge call buying amid a powerful rally in the market. While some commentators have credited this rally to the return of the retail player, we would argue that cheap portfolio protection is encouraging fund managers who have missed the rally to move off the sidelines.
So, in contrast to some folks who have cited a low VIX as reason to expect a decline, a low VIX may be driving professional traders into the market. Another scenario is that with some benchmarks hitting record highs, fund managers are being forced into the market, and the record VIX call buying reflects apprehension about doing so at current levels. Regardless of their motivations, to the extent that more portfolios are crash protected, there is less selling pressure on pullbacks, as hedged professionals are less apt to panic than unhedged money.
Amid the VIX call buying, VIX call open interest is on pace to achieve record levels once again. Active participation among professional traders is encouraging, but something to be on guard for is their equity exposure growing to the point that they can no longer support the market. If VIX call buying suddenly disappears, it would be red flag, especially if the market's momentum appears to slow. For now, this does not appear to be the case, with the SPX hitting multi-year highs, and VIX call buying still extremely healthy.
How low can the VIX go? One area we will be watching, if the VIX continues to decline, is the area between 11.36 and 11.61. These levels represent, respectively, half the Dec. 28, 2012 closing and intraday peaks at 22.72 and 23.23. In previous commentaries, we have mentioned the peculiar action in the VIX in terms of bottoming at half highs or peaking at levels 50% or 100% above previous lows.
While the market's upward momentum continues -- with potential support from retail players chasing the market higher, short-covering activity, or funds leveraging up -- we see a couple of risks from a sentiment perspective.
First, this past week, the National Association of Active Investment Managers (NAAIM) reported a multi-year high in equity exposure, with the reading above 100 suggesting this group is fully invested. A reading of 200 would suggest a leveraged long position.
Also, according to Investor's Intelligence (a survey of advisors), the percentage of bears is approaching 20%. As you can see on the second chart below, when the bearish percentage is this low, and the SPX is approaching round numbers, the market has been vulnerable to setbacks.
Our thought right now is to not fight the market's momentum, since professionals are hedged. But if the strong technical backdrop begins to weaken and you see signs of a shift in sentiment from growing optimism to growing pessimism, that would be the point at which to re-evaluate bullish positions.
Indicator of the Week: Dow 14,000 and 1,000-Point Intervals
By Rocky White, Senior Quantitative Analyst
Foreword: Last Friday, the Dow hit 14,000 for the first time since late 2007. We all remember what happened soon after that. If not, the chart below should jog your memory. These even-level intervals can be psychological barriers for an index as they run into them, and can be viewed by the public as "expensive" or "cheap." For example, it's a lot more common to hear someone say, "the Dow will top out at 14,000," rather than, "the Dow will top out at 13,626."
In the same sense, these levels can be magnets. For example, if/when the Dow clears 14,000, then you may see a quick and smooth rise up to 15,000 before sputtering (wouldn't that be nice for the bulls). This week, I'm taking a look to see how the Dow performs once it rises into one of these even levels (and see if they are, in fact, speed bumps).
10K, 11K, 12K, 13K and 14K: In case you doubt psychological barriers play a role in market prices, take a look at the table below. What I did was go back to 1999 (when the Dow first crossed 10,000) and looked at how the index did after touching one of these even levels (10K, 11K, 12K, 13K or 14K). I only counted it if the Dow had been below the level for at least a month before crossing above the level.
As it turns out, the Dow really struggles at these levels -- look at the one-year returns. The typical one-year return for the Dow since 1999 is 3.04%. But when it just crosses one of these even levels, it averages a loss of 4.05%, showing a positive return just 36% of the time.
Finally, here's a table breaking down the one-year returns by the even level that was touched by the index. This will be the third time the Dow has hit 14,000. The first two times were in July and October 2007. Hopefully, the third time's the charm.
This Week's Key Events: Earnings Season Rolls Through the Tech Sector
Schaeffer's Editorial Staff
Here is a brief list of some key market events scheduled for the upcoming 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 begins on the economic front with the Census Bureau's latest data on factory orders. Elsewhere, Baidu (BIDU), Clorox (CLX), Gilead Sciences (GILD), and Yum! Brands (YUM) will all take to the earnings stage.
Tuesday
- The economic calendar is light on Tuesday, aside from the Institute for Supply Management's (ISM) non-manufacturing index for January. Meanwhile, Walt Disney (DIS), Sirius XM Radio (SIRI), BP plc (BP), Chipotle Mexican Grill (CMG), Expedia (EXPE), Kellogg (K), Panera Bread (PNRA), Take-Two Interactive Software (TTWO), Toyota Motor (TM), UBS AG (UBS), and Zynga (ZNGA) will unveil their respective earnings announcements.
Wednesday
- Wednesday features the latest Mortgage Bankers Association (MBA) mortgage index, as well as the weekly crude inventories report. Green Mountain Coffee Roasters (GMCR), Visa (V), Akamai Technologies (AKAM), CVS Caremark (CVS), DeVry (DV), GlaxoSmithKline (GSK), Time Warner (TWX), and Yelp (YELP) will each take turns in the earnings confessional.
Thursday
- On Thursday, we'll get the usual update on weekly jobless claims, preliminary productivity and labor costs for the fourth quarter, as well as the latest consumer credit data. Earnings results are due out from Sprint Nextel (S), LinkedIn (LNKD), Coinstar (CSTR), CIGNA (CI), ON Semiconductor (ONNN), OpenTable (OPEN), Philip Morris International (PM), Sony (SNE), and Teva Pharmaceutical (TEVA).
Friday
- We'll round out the week with the latest trade balance figures, as well as wholesale inventories for December. Meanwhile, Wall Street will digest earnings results from AOL (AOL), CBOE Holdings (CBOE), and Moody's (MCO).
And now a sector of note...
Internet
Bullish
A number of prominent web-based companies have caught our bullish attention in recent weeks, due to the winning contrarian combination of strong price action amid continued skepticism. Plus, as earnings season progresses, a number of Internet heavyweights -- including eBay (EBAY), Google (GOOG), and Netflix (NFLX) -- have rallied after exceeding analysts' expectations. Coming up this week, we will hear from Expedia (EXPE) and LinkedIn (LNKD). Nevertheless, technical standouts like NFLX, EXPE, and LNKD stand to potentially benefit from short-covering activity, as short interest represents, respectively, 21%, 9%, and 6% of these equities' floats. There is also room for more Wall Street experts to shift to the bullish camp. NFLX has 18 "hold" and five "sell" or worse ratings, compared to just six "buys," while LNKD has 14 "hold" ratings versus 15 "buy" or better votes. The story is similar for EXPE, with 10 "holds" versus eight "buy" or better recommendations. During the near term, analyst upgrades or price-target hikes could spur additional buying demand for these outperformers. The First Trust Dow Jones Internet Index (FDN - 42.79) tracks a basket of roughly 40 Internet names -- including all of the aforementioned companies. The FDN is continuing to consolidate near all-time highs, and the $42 level remains important. This area is 50% above the ETF's October 2007 high and October 2011 low, and the security's lowest point this week was $42.05, which coincided with the ETF's ascending 10-day moving average.
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. |
