Monday Morning Outlook: Modest Weekly Gain Brings DJIA Within View of 11,500
Rally intact as holidays approach
by Todd Salamone 12/18/2010 11:22 AM
schaeffersresearch.com
The S&P 500 Index closed at an annual high on Friday. The Dow Jones Industrial Average, meanwhile, closed at an annual peak a day earlier, just a hair's breadth shy of 11,500, but couldn't sustain its charge and fell back slightly on Friday. Looking ahead, Todd Salamone, Senior Vice President of Research, says the rally at the end of 2010 reminds him of the rally at the end of 2009, but worries that unhedged buyers may be more prone to panic selling. Next, Senior Quantitative Analyst Rocky White reviews the performance of the Dow Jones Industrial Average during the weeks of Christmas and New Year's going back to 1900. We won't steal Rocky's thunder, but here's a clue: Ho ho ho. Finally, we wrap up with a look at some key economic and earnings reports slated for release this week.
Recap of the Previous Week: Santa's Got a Brand New Bag
Schaeffer's Editorial Staff
We were all set to report that good old St. Nick smiled on the market last week, when along came Senior Equities Analyst Elizabeth Harrow to tell us that (cover the little ones' ears) Santa doesn't really exist. Reindeer sightings or not, as December crossed the midpoint, the Dow Jones Industrial Average just kept chugging along.
China's leaders said last weekend that they would not raise interest rates, and would instead use other tools to fight inflation in that nation's white-hot economy. That unexpected early Christmas present boosted sentiment across the globe Monday. In the U.S., traders were also intrigued by some merger-and-acquisition headlines, including General Electric's (GE) $1.3 billion bid for Wellstream Holdings, and Dell Inc.'s (DELL) $960 million offer for Compellent Technologies (CML). Still, the bulls remained mostly in check, and the Dow added 0.16%.
Traders were greeted early Tuesday by even more evidence that consumers are in good cheer this holiday season. The Commerce Department reported that retail sales rose for the fifth straight month in November, and at a higher-than-expected rate. In the afternoon, however, the Federal Open Market Committee (FOMC) offered this somber assessment: "The economic recovery is continuing, though at a rate that has been insufficient to bring down unemployment." Even so, the Dow managed to advance 0.42%.
Traders confronted a mixed bag of economic data and news on Wednesday. Moody's Investor Services warned it might downgrade Spain's debt, but manufacturing activity in the U.S. improved, and a New York manufacturing index came in much better than expected. Inflation remained subdued, which also described activity in the market. The Dow took a jog past 11,500 in the morning, but eventually settled for a small loss of 0.17%.
FedEx (FDX) reported second-quarter earnings early Thursday; the shipping giant missed on revenue but offered a bullish outlook based on holiday volume to date. Meanwhile, jobless claims fell again. The Dow strolled to another daily win, gaining 0.36%.
Moody's turned its attention to Ireland on Friday, drastically cutting its debt rating, and casting a pall over trading around the world. But the news back in the U.S. was better. The House of Representatives approved a tax-cut extension. Several names in the tech sector, including Oracle Corp. (ORCL), Research In Motion Limited (RIMM), and Take-Two Interactive Software (TTWO), reported better-than-expected earnings. Finally, the Conference Board's leading economic indicators index for November rose 1.1%. The Dow spent most of the day looking up at the breakeven line, and although it tried mightily in the final hour, couldn't muster a positive finish. The Dow slipped 0.06% for the day but gained 0.7% for the week. The S&P 500 Index and the Nasdaq Composite each recorded smaller weekly wins, at 0.3% and 0.2% respectively.
What the Trading Desk Is Expecting: Potential Headwinds in Sight
By Todd Salamone, Senior Vice President of Research
During the past few weeks, we have made the case for a rally as we head into the end of the year. And Mr. Market is certainly obliging, with the S&P 500 Index (SPX), Nasdaq Composite (COMP) and Russell 2000 Index (RUT) hitting calendar-year highs in a relatively flattish expiration week last week.
Certainly, a case can be made for the rally to continue. Historically, equities have rallied strongly into year-end when stocks advance the week after Black Friday, which occurred this year. Moreover, small cap leadership remains firmly in place, and the market tends to take on a bullish undertone when such stocks are showing the way. Moreover, fund managers trailing the market are likely looking to play catch-up as we close the books on 2010.
In fact, money managers are still relatively under-invested, suggesting there is sideline money that could push stocks higher. The big questions right now are, "Are some of these market participants taking on more risk as they play catch-up? And are those who traditionally purchase portfolio protection foregoing this strategy, viewing it as a potential drag on returns into year-end?" If the answer to either of these questions is "yes," be cautioned that the current rally carries added risk relative to other advances we have experienced in recent months.
Our thought is: Yes, there may be more risk-taking during the present advance. For example, as you can see in the charts below, the behavior of the combined buy-to-open put/call volume ratio on the SPDR S&P 500 ETF Trust (SPY), PowerShares QQQ Trust (QQQQ) and the iShares Russell 2000 Index (IWM) in recent weeks shows a striking resemblance to December 2009, when the market rallied amid a decrease in this put/call ratio.
As long-time readers know, the market usually rallies coincident with an increase in this ratio, as hedged players accumulate stocks and buy portfolio protection along the way. Therefore, in situations when this put/call volume ratio rises along with an advance in stocks, it is a sign of stronger hands in accumulation mode, who are less apt to panic sell on negative news. But when the ratio is decreasing amid a rally, the risk is that weaker, unhedged hands are in accumulation mode, a group that is more apt to panic sell if negative news hits the market. Note that the market experienced a sizable correction in the first quarter of 2010 when news about European sovereign debt issues emerged. Meanwhile, in instances where we have seen hedged buying, the market has experienced only mild setbacks amid negative news.
As we enter a holiday-shortened week, bulls should be cautioned about the following:
1. The CBOE Market Volatility Index (VIX) comes into the week trading around its 2010 lows, implying portfolio insurance is relatively cheap. Those who are not hedged, or who are looking to replace expired insurance, may be active next week, which could create a short-term headwind, as sellers of portfolio insurance will short futures to hedge their positions.
2. Equity-only option buyers executing trades on the International Securities Exchange and Chicago Board Options Exchange during the past 10 trading days have purchased calls over puts at a rate of three to one, the highest ratio in two years. From a sentiment perspective, this is a concern. At the same time, as long as this robust call buying continues, it is a tailwind for equities.
3. The SPX has risen 11 of the 13 trading days in the month of December, but comes into next week situated below the pre-Lehman close of 1,250, a level technicians are closely following.
With most equity, index and exchange-traded fund options relatively cheap, you can reduce your risk by using call options, in lieu of stocks, to play equities that you think have strong rally potential. Or, take advantage of cheap portfolio insurance to hedge your long stock portfolio, especially if portfolio insurance you have purchased in recent months expired last week.
The trend is still on the bulls' side and, like last year, an advance into at least year-end is likely. But keep in mind that if unhedged players drive stocks as they appear to be doing now, the short-term risk-reward proposition deteriorates.
In closing, I'd like to take the opportunity to wish you, your family and friends the best during this wonderful holiday season.
If you enjoy Monday Morning Outlook...
...why not check out Opening View, our daily preview of market activity? Each morning, we analyze the prior day, review the overnight markets, and monitor the morning wires to give you our special Schaeffer's take on the action, before the opening bell. Sign up here to have Opening View delivered straight to your inbox every morning.
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.
Indicator of the Week: Holiday Weeks
By Rocky White, Senior Quantitative Analyst
Foreword: It's the holiday season! Christmas arrives Saturday, and then the New Year the following week. I went back in the past to see what the holiday season tends to bring. It is surely a merry time of year. It looks like sellers go home for the holidays to spend time with their families, while the buyers stick around the office.
Next Couple of Weeks: Below is a table showing data for the Dow Jones Industrial Average all the way back to 1900. I break it down by the week of Christmas, the week of New Year's, and then other weeks. I also show the average returns when you combine those two holiday weeks. The average weekly return for the holiday weeks is 0.81%. That far outpaces the other weeks, which return less than 0.1%. Also, since 1900, the Christmas and New Year's weeks have been positive 69% of the time compared to other weeks, which were positive 55% of the time.
Dow returns during Christmas and New Years weeks since 1900
Consistently Bullish: The graph below was pretty striking to me. I found the weekly returns for each decade since 1900. Then I compared the average return of the holiday weeks (combining Christmas and New Year's) to the other weeks of the year. There was not one decade in which the average return of the holiday weeks lagged the other weeks. There's not even a decade in which the returns are all that close. If history is our guide, then get ready for a very good next couple of weeks.
Dow holiday week returns by decade since 1900
Recent Decade: Finally, I will show you how the holidays have been for the market in the last decade (since 2000). Below is a chart that shows the average returns for each year since 2000 comparing the holiday weeks to the other weeks. The last few years have seen some volatility during this period. In 2007 the holiday weeks were down big-time, then in 2008 the holidays were up big. Other than that, the holidays have been consistently positive, just as they had been in the decades before.
Dow holiday week returns for the current decade
This Week's Key Events: 'Twas the Week Before Christmas...
Schaeffer's Editorial Staff
We have our Christmas shopping done, and hope you do too, so you can concentrate on the market during this short week. 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. Jefferies Group Inc. (JEF), Adobe Systems Incorporated (ADBE), Darden Restaurants Inc. (DRI), Jabil Circuit Inc. (JBL), and Paychex Inc. (PAYX) will report earnings.
Tuesday
* There are no major economic reports scheduled for Tuesday. CarMax Inc. (KMX), ConAgra Foods Inc. (CAG), Hovnanian Enterprises Inc. (HOV), Nike Inc. (NKE), Red Hat Inc. (RHT), Tibco Software Inc. (TIBX), and Cintas Corp. (CTAS) are scheduled to issue their quarterly reports.
Wednesday
* The Commerce Department will supply its latest estimate on third-quarter gross domestic product, and the National Association of Realtors will report on existing home sales for November. We'll also get the usual weekly report on crude inventories. American Greetings Corp. (AM), Walgreen Company (WAG), Micron Technology Inc. (MU) and Bed, Beth & Beyond Inc. (BBBY) will report earnings.
Thursday
* The Commerce Department will report on personal income and spending, durable goods orders, and new home sales for November. The Labor Department will give us its weekly look at jobless claims, and the University of Michigan will release its final reading on consumer sentiment in December. There are no major earnings reports currently scheduled for Thursday.
Friday
* The market is closed Friday for Christmas Eve. |
