Monday Morning Outlook: S&P 500, Nasdaq at Multi-Year Highs; DJIA Topples 11,400
Outlook points to a continued rally
by Todd Salamone 12/11/2010 11:20 AM
schaeffersresearch.com
The Nasdaq Composite (2,637.54) closed at its highest level in three years, while the S&P 500 Index (1,240.40) scaled heights it hadn't achieved in more than two years. Even the underachieving Dow Jones Industrial Average managed to climb above 11,400 in the final 30 minutes of trading on Friday. In last week's Monday Morning Outlook, Todd Salamone, Senior Vice President of Research, offered five reasons he thought the bull market would continue into the end of the year and beyond. Today, Todd revisits those five indicators. Next, Senior Quantitative Analyst Rocky White takes a look at Wall Street analysts' most-recommended and least-recommended stocks at the beginning of 2010, and then looks at those stocks' actual performance year to date. Care to guess what this confirmed contrarian learned? Rocky has way too much fun doing this sort of thing. Finally, we wrap up with a look at some key economic and earnings reports slated for release this week.
Recap of the Previous Week: SPX, Nasdaq Saunter to New Highs
Schaeffer's Editorial Staff
For the first four and a half days of the week, the Dow Jones Industrial Average just ran in place, trading in an intraday range between about 11,340 and 11,440, and closing in an even narrower range below 11,400. The Dow finally closed above 11,400 on Friday -- its first close above that level since early November -- although it required a last-minute bullish push. But let's not be churlish. The 2010 bull market is still healthy, and the S&P 500 Index (SPX) and the Nasdaq Composite (COMP) both closed the week at multi-year highs.
Traders spent most of Monday digesting a CBS 60 Minutes interview with Federal Reserve Chairman Ben Bernanke, who said the central bank could extend its stimulus efforts if economic conditions demand. Bernanke also defended the central bank against charges that its recent actions will lead to inflation. "Fear of inflation, I think, is way overstated," Bernanke said. At the same time, Richmond Fed President Jeffrey Lacker argued in a speech that the risk of deflation has decreased, and that the Fed should begin putting the brakes on its buying spree. The Dow slipped 0.17% for the day.
The big -- huge -- news Tuesday was the deal between President Obama and Republican leaders to temporarily extend Bush-era tax cuts. Leaders on the Democratic left howled, because the agreement left in place tax cuts for the richest Americans, but Obama argued that the package, which also includes an extension of unemployment benefits and other middle class tax breaks, constituted a new mini-stimulus. "This is real money for real people," said the president. "This package will help strengthen the recovery." Goldman Sachs, for one, agreed, saying the deal will help the economy grow as much as 3.7% in 2011, up from its earlier forecast of 2.7%. In reaction, the SPX and COMP tagged two-year highs, but the bulls soon ran out of steam, and the Dow settled for a miniscule loss of 0.03%.
Home Depot (HD) elevated spirits early Wednesday when it forecast strong earnings for both 2010 and 2011 and announced plans for a stock buyback. McDonald's Corp. (MCD), meanwhile, disappointed with lower-than-expected same-store sales growth. A sleepy Dow rose 0.12%.
Jobless claims declined more than expected early Thursday, usually a boost to the spirits, but the bulls' inertia for the week was established. The Dow slipped 0.02%.
Friday's news was generally upbeat. The government reported early in the day that the U.S. trade deficit unexpectedly narrowed to $38.7 billion in October, a 13% decline from September. Moreover, U.S. exports rose to their highest level in more than two years. On the blue chip front, General Electric (GE) raised its dividend for the second time in a year, and Goldman Sachs upgraded The Procter & Gamble Company (PG). The University of Michigan reported that consumers are gaining confidence. Despite the full menu of cheery data, the Dow remained somnolent through most of the session, clambering above 11,400 only in the last hour. The Dow added 0.35% for the day and a slim 0.2% for the week. Both the SPX and COMP recorded healthier weekly gains, adding 1.3% and 1.8%, respectively.
What the Trading Desk Is Expecting: Small Caps Still Showing Leadership
By Todd Salamone, Senior Vice President of Research
"The SPX comes into the coming week trading around the April and November 2010 peaks. ... As we enter the traditionally strong December month, the possibility of a sustained upside breakout has increased..."
Monday Morning Outlook, Dec. 4, 2010
The S&P 500 Index (SPX) broke out above this year's prior peaks and closed the week at 2010 calendar highs. Last week in this space, we cited five reasons for the possibility of a breakout, and they boiled down to the following:
1. Evidence of hedge fund accumulation through our analysis of option activity.
2. Small cap leadership.
3. Resilience amid a stream of negative headlines in the month of November -- the market bent, but didn't break.
4. The CBOE Market Volatility Index (VIX) converged around the same level as SPX 20-day historical volatility, a "buy" signal during the past couple of years.
5. Our "Black Friday" indicator – if the first week after Black Friday is positive, the market tends to be strong into the rest of the year.
Let's quickly review where we stand on the first four indicators above. The last cannot change, and is bullish into year-end.
The combined 20-day buy-to-open put/call volume ratio on the SPDR S&P 500 ETF Trust (SPY), PowerShares QQQ Trust (QQQQ) and iShares Russell 2000 Index Fund (IWM) took a turn lower, implying hedge funds stepped away once again. After doing some digging, we found that option activity on the QQQQ was driving much of the action in the combined ratio, as the 20-day buy-to-open put/call volume ratio experienced a significant drop, from 2.05 to 1.43. The takeaway would be to avoid the large-cap technology names at this juncture, especially with the QQQQ still trading just below the October 2007 peak in the 55 area. These names could be in for a period of underperformance, as long-term resistance resides above and hedge fund players don't seem too interested at the moment.
As long-term resistance lingers overhead on the QQQQ, the IWM's move above $75 looks constructive, with the implication being that small-cap leadership is still in place, which we view favorably. Note in the chart below that this month's advance has pushed the IWM above a trendline that connected the July 2007, October 2007, and September 2008 peaks. With the SPX trading above the 61.8% retracement of its 2007 peak and 2009 low, and above its 2010 highs, the technical backdrop is bullish for the most part, though retests of these former resistance areas cannot be ruled out.
On Friday, China announced that it raised reserve requirements 50 basis points for the sixth time this year, but stocks still rallied, as investors focused instead on a surge in U.S. exports in October, improving consumer sentiment, and General Electric's (GE) second dividend increase in a year. The bottom line is that the market still continues to be relatively resilient in the face of "bad" news, and respondent to "good" news. China's statistics agency announced Saturday that consumer inflation surged 5.1% in November, a 28-month high. The release date was pushed back a day, causing some investors to brace for a major negative surprise. The caution ahead of this release might be viewed as healthy, as "would be" buyers stepped aside or bought protection ahead of the report. In fact, the "buy protection" trade may have been on Friday, as the VIX increased as stock prices rose.
Turning to our "VIX premium" indicator, the VIX is still trading around actual SPX volatility. This is encouraging, as corrections have tended to occur when the VIX is at a significant premium to actual SPX volatility, as you can see on the chart below.
Those bidding stocks higher last week could have been unhedged market participants chasing momentum names, and such activity could go on into year-end. Unhedged players drove the market advance in late 2009, eventually setting the market up for a significant correction beginning in mid-January. Said another way, when unhedged hands are in accumulation mode, additional risk accompanies such an advance, as they are the first to panic when negative news hits. Therefore, we would prefer to see a year-end rally accompanied by increasing buy-to-open put/call volume ratios on the major exchange-traded funds (ETFs) that we monitor.
Finally, next week marks the expiration of options with a Dec. 18 expiration date. How have December expiration weeks fared since 2000? See the tables below for a summary. Will the first December expiration of this new decade be a repeat of the 2000 disaster, or does the 80% win rate since 2000 hold more weight?
December expiration returns
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Indicator of the Week: Analyst Rankings and Stock Performance
By Rocky White, Senior Quantitative Analyst
Foreword: I'm sure most readers are familiar with our contrarian strategy on stock picking. When the crowd is all on board fancying a stock, especially one that is underperforming, we will look to short it. A stock that everyone hates, we look to play it long. And when we talk about the "crowd," we're often referring to analysts. Analysts, generally employed by large Wall Street brokerages, give "buy" and "sell" recommendations on individual stocks, and they are a good gauge on where stock sentiment is aligned. This week I decided to look back to the beginning of the year and see what analysts were recommending and how those stocks performed (analysts must hate this).
Analysts in 2010: For the analysis, I looked back at the beginning of the year and considered only optionable stocks that had substantial coverage (at least 20 analyst ratings, as reported by Zacks). I settled on a list of 228 stocks. Then I grouped those 228 stocks into five brackets, from least popular to most popular, as measured by the percentage of analysts who had "buy" recommendation for those stocks. The results will astound some people -- although probably not contrarians.
The top row of the table represents the 20% of stocks where analysts were most bearish. The percentage of buy ratings on those stocks ranged from 9% to 32%. Despite the skeptical outlook by analysts at the beginning of the year, look at the year-to-date performance in this top row. The S&P 500 Index (SPX) is up about 11% for the year, but those stocks on which analysts were most bearish were up on average 32% (while the typical stock in our group is up about 20%). Furthermore, 86% of the stocks in the top row were positive, compared to 69% of all stocks in our group. Stocks with 33% to 43% "buy" ratings also significantly outperformed the entire group of stocks. Needless to say, it paid to be contrarian.
Stock returns versus analyst buy ratings
On the other end of the spectrum, look at the bottom row, the group of stocks where the analysts were most bullish. Stocks where 68% to 97% of analysts recommended a "buy" averaged a measly 5% return, and less than half of those were positive. In a year that the SPX was up over 10%, that's an awful performance.
Stocks to watch: Are you looking for stocks for 2011? Here's a list you might want to dig into. Obviously, I wouldn't blindly recommend buying them. What I did was look at those stocks in that first row in the table above, representing the 20% of stocks on which analysts were most bearish at the beginning of 2010. Then I looked at current analyst rankings on these stocks. Below are stocks which were in that first group at the beginning of 2010, had a return of at least 20% (meaning it outperformed the average stock in our analysis), and yet are still in the bottom 20% of stocks as far as analysts rankings go.
Here's what I expect to happen for many of these. The strong uptrend will not break. They will continue to go up. The analysts will eventually have no choice but to capitulate and admit they were wrong. As those analysts upgrade their recommendations from bearish to bullish, it will provide more catalysts propelling these stocks even higher. In other words, if the market continues higher, it wouldn't be too surprising if 2011 turned out even better for some of these stocks than 2010.
Stocks with low percentage of buy ratings an high returns
This Week's Key Events: Pre-Holiday Slowdown
Schaeffer's Editorial Staff
Earnings reports have slowed to a trickle. 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
* There are no major economic reports scheduled for Monday. FuelCell Energy Inc. (FCEL) will report earnings.
Tuesday
* The Labor Department will release the producer price index for November, while the Commerce Department will report on retail sales for November and business inventories for October. The Federal Open Market Committee will issue its latest decision on interest rates. No one expects the Fed to abandon its pledge to keep rates low for an "extended period," but observers will closely examine the language the Fed uses to describe the health of the economy. Best Buy Co. Inc. (BBY) and Hovnanian Enterprises Inc. (HOV) are scheduled to issue their quarterly reports.
Wednesday
* The Labor Department will report on the consumer price index for November. The Federal Reserve will release the Empire State Manufacturing Survey for December and industrial production numbers for November. The National Association of Home Builders will publish its Housing Market Index, a measure of builder confidence, for December. Finally, we'll get the usual weekly report on crude inventories. Joy Global Inc. (JOYG) will report earnings.
Thursday
* The Labor Department will give us its weekly look at jobless claims, while the Commerce Department will report on housing starts in November. The Fed will report on manufacturing activity in the Philadelphia area in December. Actuant Corp. (ATU), Discover Financial Services (DFS), FedEx Corp. (FDX), General Mills Inc. (GIS), Pier 1 Imports Inc. (PIR), Rite Aid Corp. (RAD), Oracle Corp. (ORCL), Research In Motion Limited (RIMM) and Take-Two Interactive Software Inc. (TTWO) plan to report earnings.
Friday
* The only economic report on the docket for Friday is the Conference Board's leading indicators for November. There are no major earnings reports currently scheduled for Friday. |
