Monday Morning Outlook: Bulls Hesitate as SPX Churns in Tight Trading Range
Stocks are chopping lower as hedge funds tap the brakes -- and the little guy hits the exits
by Todd Salamone 3/12/2011 12:01 PM
It was a hectic week in the equities market, as traders were faced with ongoing violence in Libya, new conflicts in Saudi Arabia, dismal global economic data, and a devastating natural disaster in Japan. Stocks wrapped up the week solidly lower, but the CBOE Market Volatility Index (VIX) remained stuck beneath a few key trendlines -- prompting Todd Salamone to ponder whether the current VIX level is too complacent, given the current uncertainty hovering over world markets. Meanwhile, Rocky White takes a closer look at investor sentiment surveys, and tries to determine whether optimism is approaching troublesome levels. Finally, we wrap up with a look at the week ahead, as well as a few sectors of note.
What the Trading Desk Is Expecting: Should Be an Interesting Expiration Week...
By Todd Salamone, Senior Vice President of Research
"With all the talk about the SPX doubling a couple of weeks ago, it appears some hedge fund managers may have taken this as a cue to become less aggressive in accumulating equities. Our analysis of option activity on the iShares Russell 2000 Index (IWM), PowerShares QQQ Trust (QQQQ), and SPDR S&P 500 ETF (SPY) shows the combined buy-to-open put/call ratio on these funds rolling over, suggesting that the purchase of portfolio protection that usually occurs with equity accumulation has slowed. Previous such rollovers in the ratio have preceded range-bound periods or declines."
Monday Morning Outlook, Feb. 26, 2011
Since we first hypothesized that hedge fund managers may no longer be in accumulation mode in late February, not a whole lot has changed. As you can see in the graph below, the 20-day buy-to-open combined put/call volume ratio continues to trend lower on the SPDR S&P 500 ETF Trust (SPY), PowerShares QQQ Trust (QQQQ), and iShares Russell 2000 Index Fund (IWM). For those of you who are new to this column, the theory here is that put buying will increase relative to call buying on major exchange-traded funds (ETFs) as fund managers accumulate new long positions.
In that same late-February report, we noted that retail investors were coming back into domestic funds -- a new source of demand that the market has typically been lacking for the last few years. Our conclusion was that this could be a bullish omen, as investors coming off the sidelines could further drive a rally.
Last week, however, domestic funds experienced outflows. With a lack of hedge fund accumulation, and negative headlines once again driving the little guy away from the market, the broad market has indeed been pressured during the past few weeks. The S&P 500 Index (SPX -- 1,304.28) has been entrenched in a choppy decline between 1,300 and 1,333 since the last trading day of February.
The bulls are encouraged by the fact that the SPX, Russell 2000 Index (RUT -- 802.83) and Dow Jones Industrial Average (DJIA -- 12,044.40) continue to find support at their key respective round-number levels of 1,300, 800, and 12,000. This resilience is impressive amid negative headlines related to geopolitical concerns in North Africa and the Middle East, in addition to the uncertainty created with Friday's earthquakes in Japan, and the resulting tsunamis along the Pacific Coast.
"The CBOE Market Volatility Index (VIX --19.06) comes into this week trading at a critical juncture. Last week, we discussed the late-February pop in the 'fear index' that was capped at the VIX's 200-day moving average, which is currently situated at 22.31... Like its 200-day counterpart, the 80-week trendline has had historical significance. Bulls would prefer to see the VIX remain below these long-term moving averages, while caution should be exercised if the index were to move above them."
Monday Morning Outlook, March 5, 2011
As we enter expiration week, we continue to monitor the behavior of the CBOE Market Volatility Index (VIX -- 20.08). The past five days' worth of action was almost a mirror image of the week of Feb. 22, as the VIX moved back above the significant 20 level early in the week, and then peaked at its 200-day moving average around mid-week before moving lower once again. The one difference last week is that the VIX closed above 20. As we mentioned previously, bulls would prefer that the VIX remain below its 200-day moving average, at 21.85, and its 80-week moving average, currently situated at 22.27.
On Thursday and Friday, we observed that while the SPX traded south of its Feb. 24 low, the VIX remained well below its late-February high of 23.22. To some, this relatively muted reaction in the VIX might feel like complacency, or may be interpreted as having bearish implications, since the "fear index" failed to reach new heights as the market touched three-week lows.
But here's something to ponder about this "muted" VIX move. In March 2009, when the market made its bear-market lows, the VIX only rose to the mid-50s -- well short of the 90 level it achieved months prior to the market's bottom. Demand for portfolio protection had dried up as many investors moved to the sidelines, and had little invested in the market to insure. After all, why buy index and ETF puts for hedging purposes if you are in cash?
If investors already own portfolio protection via index or ETF puts, or have a higher-than-normal cash allocation, the need for portfolio protection decreases. If this is indeed why the VIX made a relatively muted move last week, it would suggest that fear and caution are alive and well, which has bullish implications.
"...while low-volatility periods have previously given way to higher-volatility 'stormy' periods, low volatility was a four-and-a-half-year fixture after the 2000-2002 bear market, when the 20-day SPX historical volatility ranged between 6 and 16 from May 2003 through March 2007."
Monday Morning Outlook, Feb. 19, 2011
While on the subject of volatility, note in the below chart that SPX historical volatility is approaching the 16 level again, where it peaked following a mild correction in November 2010. The 16 area also defined peaks from 2003-2007, as we alluded to a few weeks ago. Bulls would prefer that historical volatility peak in this region again as a confirmation that low volatility is here to stay for more than a few months.
Finally, the SPY comes into expiration week resting just above peak put open interest at the 130 strike, which is equivalent to 1,300 on the SPX. Anything can happen during expiration week -- from delta-hedge selling related to the enormous put open interest below current levels, to a short-covering rally related to the expiration of the put open interest. Probabilities favor the short-covering rally, but watch out below if delta-hedge selling occurs, where big put strikes essentially act like magnets if penetrated.
Admittedly, there is a lot to digest this week. In our view, the long-term outlook remains bullish, but the short-term outlook still suggests choppy action between 1,300 and 1,333 for the SPX. If 1,300 breaks decisively, look for the 1,270 area to be the next level of support, as it's the site of the SPX's 80-day moving average. If a breakout above 1,333 occurs, 1,343 would be the next speed bump, as it's the site of the mid-February high.
Indicator of the Week: Investors Intelligence Sentiment Survey
By Rocky White, Senior Quantitative Analyst
Foreword: As contrarians who closely monitor investor sentiment, we naturally keep a close eye on sentiment polls. Currently, most sentiment polls are registering very high levels of optimism. However, you must interpret the poll in the context of a strongly advancing market. The S&P 500 Index (SPX) has nearly doubled over the last two years. That would make even the most faithful of bears admit defeat and turn bullish.
Below is a chart showing the results from the latest sentiment poll conducted by Investors Intelligence. Sure enough, there is a high level of bulls and a low number of bears. Bearish pundits may use this data to suggest extreme levels of optimism, signifying the market has topped out.
However, optimism may not be as high as what the raw numbers suggest. Notice in the chart below that similar levels of optimism were seen in the middle of 2003, which marked the very early stages of a four-year bull market. Also, despite the fact that the SPX is showing healthy year-to-date gains, the percentage of bulls has been falling steadily all year.
SPX vs. Bulls and Bears
Prior Bull Markets: As I mentioned earlier, you should expect a high level of optimism in a bull market as compared to a bear market. So, I wanted to see whether the current level of optimism is, in fact, out of the ordinary when you consider the strength of the market. Therefore, I compared this bull market to past bull markets. The SPX is up about 90% in the last two years. The other bull markets I looked at were August 1987, April 1999, and February 2005, which had two-year returns of 79%, 83%, and 45%, respectively.
The table below tracks the percentage of bulls over the last year, as compared to the results during the second year of the aforementioned bull markets. Compared to previous bull markets, the current optimism is by no means at an extreme. The average percentage of bulls over the last year is 47%, which is lower than any of the other previous bull markets we looked at. Also, despite the fact the SPX is up 90% in two years, the highest reading of bulls reached in the last year was 59% -- which is lower than any of the other high readings. Furthermore, in none of the other bull markets did the percentage of bulls fall below 30%, but it has for this current one.
Crash Confidence Index: My theory is that there is not quite as much confidence in this market as what the sentiment polls are showing. Articles talking about the shaky fundamentals of this economy are still coming out. Imagine trying to be a bear over the last two years. You list all your reasons why the market should tank, but it keeps going higher and higher, and you start to feel foolish. At some point, you'll throw your arms up and say "Fine! I don't understand it, but I'm bullish simply because I'm tired of being wrong." That's the collective feeling I'm sensing in these sentiment polls.
In fact, I think the sentiment poll conducted by the Yale School of Management supports my belief. They ask investors (both institutional and individuals) if they are confident that there will not be a stock market crash in the next six months. If optimism was at an extremely high level, a large number of investors should say there will not be a crash in the next six months. However, the chart below shows only around 30% of respondents are confident that there will not be a crash. This percentage is up, of course, since the March 2009 bottom, but it's nowhere near where it was pre-2008. These investors may say they're bullish, but that does not necessarily mean they're truly confident in this market.
SPX vs. Individual/Institutional Investors
This Week's Key Events: Fed Statement and Inflation Data in Focus
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 pace of earnings reports slows to a trickle this week, but a few notable names on Monday are General Steel Holdings (GSI), Tsakos Energy Navigation (TNP), and Neutral Tandem (TNDM). Meanwhile, the economic calendar is bare.
Tuesday
* The key economic event Tuesday will be the Fed's 2:15 p.m. decision on monetary policy, but the day also brings the latest Empire State manufacturing data and the National Association of Home Builders' housing market index for March. On the earnings front, we'll hear from Pacific Sunwear (PSUN), DSW (DSW), and Vera Bradley (VRA).
Wednesday
* Inflationary data starts to roll in Wednesday, with the release of the producer price index (PPI) and core PPI for February. Harbin Electric (HRBN), General Maritime (GMR), Guess (GES), and Medivation (MDVN) will share the earnings spotlight.
Thursday
* All eyes will be on the consumer price index (CPI) and core CPI data for February, but that's not the only economic report of note. Traders will also hear the Conference Board's index of leading indicators for February, the Philly Fed index for March, and last month's industrial production and capacity utilization data. The earnings calendar includes FedEx (FDX), Lululemon Athletica (LULU), and Nike (NKE).
Friday
* Overseas developments may drive the market action on Friday, as there are no major U.S. earnings or economic reports of note. |
