Monday Morning Outlook: DJIA Rang Up 11% Gain in 2010
Strong second half propelled indexes to big annual wins
by Todd Salamone 1/1/2011 11:45 AM
Stick a fork in it: The year 2010 is done. The verdict? "Not too shabby," Senior Quantitative Analyst Rocky White concludes below. All three major market indexes registered double-digit annual gains, settling near annual highs. Looking ahead, Todd Salamone, Senior Vice President of Research, takes the long view as he gazes out on 2011, and concludes, "We remain bullish on U.S. equities." But Todd also concedes the case for a pullback at the beginning of the year. Next, Rocky reviews some historical stock data and reports that January and February have been weak performers in recent years. At the same time, though, Rocky finds that strong year-end performance often presages a bullish first quarter. Finally, we wrap up with a look at some key economic and earnings reports slated for release this week.
Recap of the Previous Week: Flat End to a Strong Year
Schaeffer's Editorial Staff
Good night, 2010. Farewell, "flash crash." Good riddance, vuvuzelas. However, some of the headlines of the old year will continue to resonate in the new. Unemployment remains high. European debt issues haven't gone away. Talking heads are still debating the effectiveness -- and wisdom -- of QE2. Most of us will see slightly larger paychecks in 2011, thanks to the tax cut extension engineered by President Obama. And despite a rocky summer, the stock market is apparently on track to continue its amazing 21-month rally off of the March 2009 low.
The final week of 2010 didn't offer even a hint of the drama we saw earlier in the year (apologies to those of you buried by Sunday's blizzard). Instead, we saw the usual low-volume holiday lull, with the market coasting into the end of the year on its own momentum. In fact, between the holiday and the blizzard, hardly anyone bothered to show up for work on Wall Street on Monday, and those who did were bummed by China's second interest rate hike in 10 weeks. The Dow Jones Industrial Average slumped 0.16%.
On Tuesday, traders weighed a discouraging housing survey (prices are still slipping, according to the Case-Shiller index) against the latest in a round of upbeat retail sales reports (two separate surveys reported consumers were back in force this holiday season) and concluded the glass was half full. The Dow reversed Monday's loss with a gain of 0.18%.
Despite a lack of major news developments to supply fuel, the Dow made a noble run at 11,600 on Wednesday, but gave back most of those gains by the close, advancing only 0.09%. Even so, the Dow's finish, at 11,585.38, would turn out to be its highest close of the year.
The economic news on Thursday was generally encouraging: new jobless claims fell below the 400,000 mark, and well below expectations; the Chicago Business Barometer, a measure of manufacturing activity, reached its highest level in 22 years; and pending sales of existing homes rose 3.5% in November. Go figure: The Dow reacted by losing 0.14%.
Friday was slow. We looked out the window and saw an empty parking lot. But the news ticker sprang to life a few times. CVS Caremark Corporation (CVS) said it will spend $1.25 billion to acquire the Medicare prescription drug business of Universal American (UAM). Borders Group, Inc. (BGP) said it has suspended payments to vendors, including publishers, as it tries to refinance its debt. The Dow inched ahead by 0.07%. For the week, the Dow was virtually flat, advancing only 0.04%, plateauing after a steady 5.2% march upward for December. The S&P 500 Index was similarly torpid for the week, settling in the black by only 0.07%, but registering a 6.5% win for the month. The Nasdaq Composite, on the other hand, slipped 0.5% in the final week of the year, but gained 6.2% for the month.
The final tally for the year: The Nasdaq Composite led the charge with an impressive 17% surge, followed by the S&P 500 Index, which advanced 13%, while the Dow brought up the rear, at 11%. Still, not too shabby, indeed.
What the Trading Desk Is Expecting: Standing Tall in the Bulls' Camp
By Todd Salamone, Senior Vice President of Research
2010 is behind us, with the major indexes booking double-digit gains for the year, led by strong performances from the consumer discretionary, transportation, commodities and real estate sectors. Groups that were underperformers included big cap pharmaceuticals, telecommunications, broker/dealers and Treasury bonds. The underperformance of Treasury bonds is especially notable, as retail investors ditched stocks in 2010, preferring to plow money into bond funds. Two bear markets and a "flash crash" earlier this year created a risk-averse monster, and it remains to be seen if stocks will finally be viewed more favorably in the year ahead.
Longer-term, we remain bullish on U.S. equities. While we have stated the long-term bullish case from a sentiment perspective before, we'll repeat our drivers, as bullet No. 2 is now official:
1. Let's start with media sentiment. Two separate decades of negative returns on the S&P 500 Index (SPX) were punctuated by very bearish stock market cover stories in major national publications. In 1979, following a negative 10-year return in the SPX, BusinessWeek published a cover story entitled, "The Death of Equities." Thirty years later, in 2009, after another negative 10-year period for the SPX, Time magazine published a cover story entitled, "It's Time to Retire the 401(k)." The first of these proved to be a powerful contrarian indicator at the time, and the second is proving to be an excellent contrarian indicator at present.
2. Fund flows: 2010 marked the first year since 1979-1981 in which there were three straight years of outflows from stock funds. The end of the 1979-1981 period proved to be a powerful buying opportunity –- will history repeat? Our best guess is yes.
3. In 2000, many market observers believed that the dot-com era heralded "The New Economy," and that productivity gains would usher in years of strong economic growth. (At the time, the yield curve was inverted, indicating the potential for recession). The widespread adoption of this popular phrase –- and the belief in it authenticity -- preceded two bear markets in the next decade. In 2010, many skeptics believed the economy had settled into a "New Normal," a period of stagnant growth, high unemployment and potential inflation. Will the pessimism represented by this new buzz phrase help usher in a decade of strong stock returns? The yield curve is far from inverted, implying growth expectations could be understated among those investors in the "New Normal" camp.
With the SPX moving out of an historic oversold condition in March 2009, the technical backdrop is getting healthier. For example, in December, the SPX experienced its first monthly close above its 80-month moving average since September 2008. As you can see in the chart below, this trendline has had significance in the past, including marking an important bottom in 1982.
This bullish sentiment and technical environment is supported by several other factors as we move into 2011, including:
1. Accelerating stock buybacks
2. Accelerating M&A activity
3. An extension of the capital gains and dividend tax cuts originally set to expire in 2011
4. The third year of a presidential term is historically bullish
5. An accommodative Fed
At present, the short-term bullish outlook is supported only by a strong technical backdrop, with the SPX advancing above the 1,250 area in mid-December. But we are seeing optimism enter the market recently, which means we may be vulnerable to a short-term pullback. For example:
1. Equity call buying relative to put buying on the Chicago Board Options Exchange and International Securities Exchange is at an extreme.
2. The CBOE Market Volatility Index (VIX) is now trading at a level that is twice SPX historical volatility. During the past two years, when the VIX is trading at such a high premium to SPX historical volatility, a mild to large pullback soon followed. The last time this indicator signaled was early November, ahead of a 3.8% retreat in the SPX.
3. For the first time since late April, domestic stock mutual funds experienced net inflows last week. The inflows are minute relative to the enormous outflows during the past three years, but one has to wonder if this eight-month "extreme" in optimism might precede a pullback in stocks? After all, during the past 10 years, the month of January experienced a correction, or marked the start of a correction, in five of those years (2002, 2003, 2008, 2009 and 2010).
Support for the SPX is in the 1,220-1,230 area, site of the highs in April and November 2010. Resistance is in the 1,300 area, which acted as support and then resistance in the first nine months of 2008.
In closing, we at Schaeffer's Investment Research would like to wish you and your families a prosperous 2011.
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Indicator of the Week: Strong Fourth Quarters
By Rocky White, Senior Quantitative Analyst
Foreword: After being down nearly 8% in the first half of the year, the S&P 500 Index (SPX) roared back in the second half, gaining over 10% in each of the final two quarters. So, for all of 2010, the SPX gained about 13%. Not too shabby. This week I'll take a look at what these late-year surges mean for the next few months, and I'll also take a general look at what the market typically does at the beginning of a new year.
Strong Fourth Quarters: As I mentioned, the last quarter of 2010 was up over 10%. Does that translate into momentum for the beginning of the New Year, or does the outstanding quarter normally precede an early year pullback? Below is a table that looks at SPX data since 1975. When the fourth quarter is up over 10%, January has been simply mediocre. It averages an increase of 0.46%, whereas a typical January averages a gain of 0.95%. However, the market must do pretty well in the following February and March, because the entire first quarter is very bullish after a 10% fourth quarter. It has been up five of six times, averaging a gain of almost 5%.
Chart of January and Next Quarter Returns
General Seasonality : Getting a little more general, the beginning of the year has been pretty weak over the last couple of decades. Below are tables showing monthly data for the SPX over the last 10 and 20 years. January is pretty weak, ranking 10th among the 12 months over the last 10 years, and eighth over the last 20 years. February is even worse than January. It's the absolute worst month over the last 10 years, and second worst over the last 20. This data is suggesting that we could struggle early in the New Year.
Chart of SPX Returns in January
This Week's Key Events: Monthly Jobs Report Due on Friday
Schaeffer's Editorial Staff
The world, or at least our little corner of it, returns to work this week, with a full roster of jobs data and a little more insight into the Fed's thinking. 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 Commerce Department will report on construction spending in November, while the Institute for Supply Management (ISM) will release manufacturing data for December. There are no major earning reports currently scheduled.
Tuesday
* The minutes from the December meeting of the Federal Open Market Committee will be released, offering us a behind-the-scenes look at the give-and-take among policymakers. The Commerce Department will report on November factory orders, and automakers will divulge December sales figures. Scheduled to report earnings are The Mosaic Company (MOS) and Sonic Corporation (SONC).
Wednesday
* The ISM will publish its services index for December, while Challenger, Gray & Christmas and ADP will provide separate looks at the employment picture. We'll also get the usual weekly report on crude inventories. Family Dollar Stores Inc. (FDO) and Ruby Tuesday Inc. (RT) will report earnings.
Thursday
* The Labor Department will give us its weekly look at jobless claims. Constellation Brands Inc. (STZ), Monsanto Company (MON), Global Payments Inc. (GPN), IHS Inc. (IHS), Immucor Inc. (BLUD), Lawson Software Inc. (LWSN), Schnitzer Steel Industries Inc. (SCHN), and The Shaw Group Inc. (SHAW) plan to report earnings.
Friday
* Nonfarm payrolls and the unemployment rate for December are due from the Labor Department. AZZ Incorporated (AZZ) and Robbins & Myers Inc. (RBN) will report earnings. |
