Monday Morning Outlook: From Double Tops to Double Lows, Technicals Still Reign
Heavy out-of-the-money puts could provide an expiration-week floor for the SPX
by Todd Salamone 4/9/2011 1:04 PM
schaeffersresearch.com
The headlines last week seemed to suggest high drama in the market, as traders responded to the threat of a shutdown by the U.S. government, another earthquake for disaster-stricken Japan, and a flurry of monetary policy maneuvers from central banks around the globe. However, the major market indexes settled the week right where they started -- namely, on the wrong side of psychologically critical technical levels. As we stand on the cusp of both options expiration and a brand-new season of corporate earnings reports, Todd Salamone offers a few points to ponder about the level of engagement among hedge funds and retail level investors.
Following Todd's train of thought, Rocky White attempts to resolve conflicting signals from investor sentiment surveys and mutual fund flows. Finally, we wrap up with a few sectors of note, as well as a preview of the week ahead -- which includes a healthy dose of inflation data, along with earnings announcements from the likes of Alcoa and Bank of America.
Notes from the Trading Desk: Two Points to Ponder this Expiration Week
By Todd Salamone, Senior Vice President of Research
"For the Dow and other major market indexes, important resistance levels lie just overhead that could impact short-term trading patterns. The good news for bulls -- as we have discussed in previous weeks -- is that the sentiment backdrop is one that suggests there is still firepower on the sidelines to drive equities through these critical overhead levels..."
- Monday Morning Outlook, April 2, 2011
A rate hike by the European Central Bank (its first since 2008, and very much expected), another rate hike by the Chinese (which investors have grown to expect), domestic retail sales numbers that were generally well-received, and the prospect of a U.S. government shutdown amid partisan budget disagreements were the major headlines last week. While there was a lot to read and write about, equities did very little on a net basis during the week, with major technical resistance levels coming into play -- as anticipated.
For example, the Dow Jones Industrial Average (DJIA - 12,380.05) made a brief move above its February high in the 12,400 area, but closed the week below this round-number level.
The S&P 500 Index (SPX - 1,328.17) ventured above its March 2009 double-low in the 1,333 area, but a sustained move through this level continues to elude the index, which closed the week below 1,333 once again. In fact, there has been only one weekly close above 1,333 this year, which occurred in mid-February.
The Russell 2000 Index (RUT - 840.89) experienced an achievement of sorts, albeit a short-lived one. Last week, the RUT rallied above its all-time high of 856.48, set in July 2007 -- which also happens to be 150% above its March 2009 low. But the small-cap index immediately reversed course from its new record peak of 859.08, and closed the week below the 850 level.
Finally, the S&P 400 Midcap Index (MID - 987.62) made a valiant run at the 1,000 millennium mark -- but it wasn't to be, as the index was soundly rejected.
So it's quite clear that overhead technical levels are having a stifling impact at present, as the Dow and other indexes contend with everything from "double-top" to "double-low" to "round-number" resistance areas simultaneously.
In addition to revealing the market's reaction to the narrowly averted government shutdown, Monday also marks the unofficial start of earnings season, with Alcoa's (AA) first-quarter report due out after the closing bell. Moreover, since the first Friday of the month was on April 1, expiration week is upon us already, and trading will also be impacted by the expiration of equity and index options.
Look for 1,300 on the SPX to act as potential support on a decline. There is major put open interest getting set to expire at the 1,300 strike on SPX options, and at the 130 strike on SPDR S&P 500 ETF (SPY - 132.86) options, which could be supportive. On the upside, resistance comes into play in the 1,345 area, which marks this year's high.
The good news for bulls as we enter earnings season is that expectations appear to be low. An article in a popular financial publication captured the sentiment heading into the earnings season by pointing out that "investors will be scouring for signs of margin damage," and went on to note the unusually high number of downward revisions in earnings estimates. We'll begin to see the full impact of these reports into the last week of April and the beginning of May, as this time period is really the "heart" of earnings season, given the larger number of companies reporting.
Finally, from a bigger-picture perspective:
"The average hedge fund inched up 0.31 percent in March and is now up 1.99 percent for the year... The broader Standard & Poor's 500 stock index ended the first three months up 5.43 percent."
- Reuters, April 7, 2011
While the market continues to be challenged by overhead technical resistance in the short term, which could results in sideways action or a modest pullback, we continue to be encouraged by the potential sideline cash that could drive equities through resistance. Consider that:
1. The hedge fund industry is now back to its peak size at over $2 trillion dollars. However, the fact that these vehicles underperformed the SPX by such a broad measure in the first quarter suggests to us that they are very much underweight the U.S. equities market. Might discouraged investors pull money from these funds and opt for traditional long funds? Or, will hedge fund managers finally put money to work in a meaningful way in the stock market? Both scenarios have potentially bullish implications for U.S. equities.
2. In the first quarter of 2011, domestic equity funds experienced roughly $12.7 billion in inflows, reversing almost $330 billion in outflows from 2007 through 2010. As we have said before, while the retail investor's renewed interest in stocks is scary to some, the fact that we are potentially in the very early innings of this renewal could be a supportive factor.
The above factors have little to do with the short-term market gyrations, but it is certainly worth pondering for those with an intermediate- and longer-term perspective. We continue to see signs that a few hedge fund managers are dipping their toes back into the market, but they are not doing so in an aggressive manner.
Indicator of the Week: Sentiment Surveys Contradict Fund Flows
By Rocky White, Senior Quantitative Analyst
Foreword: Investors Intelligence (II) takes a survey of investment publications and determines the percentage that are bullish and percentage that are bearish (they can also designate a publication somewhere in between). Only a month ago, I wrote about the poll --which has been showing a lot of optimism. We contrarians, of course, typically interpret this as bearish, but I made the case that optimism was not necessarily as high as it could be, given the context of a very strong market. I pointed out that optimism is inevitable when the market goes on a two-year run like the one we've had. I also pointed out that optimism, according to the poll, had been falling since the beginning of the year, despite the market gaining about 5% in the first quarter.
Recent II Poll: Well, I can't make those points anymore. The most recent II poll showed an unexpected jump in optimism. The chart below shows the percentage of bullish publications, minus the bears. Note that the latest reading has crossed above the 40% mark, which is generally viewed as extreme optimism. The last time it reached that height was just in time to sell before the big crash. Should we turn bearish on the market now?
SPX vs. Bulls-Bears
Our Dilemma: How can we as contrarians not be shouting at everyone to sell right now? It's because there is other data that seems to conflict with the conclusions of the sentiment poll. Before I explain, we need to realize why exactly sentiment polls are contrarian indicators. The thinking goes that when the polls show overwhelmingly bullish sentiment, then it's assumed that everyone has bought into the market. Sideline cash is limited, which caps the upside potential, and the biggest risk is that suddenly everyone heads for the exit at once -- causing a crash. Similarly, when polls are very bearish, then it's assumed everyone has sold, so the market has nowhere to go but up.
Here's the dilemma, though: Other indicators suggest investors are still sitting on a lot of sideline cash. If this is the case, then the market has a lot further to go. Each leg up for the market makes the investors on the sidelines more aware that they are missing the rally. As they capitulate and buy into the market, it will continue to drive prices higher.
Fund Flows: For example, below is a chart of cumulative mutual fund flows using data from the Investment Company Institute (ICI). According to the data, about $280 billion left the market from the end of 2007 until March 2009, when the market bottomed. At that point, money began flowing back into the market -- until the May 2010 flash crash spooked investors, causing more outflows. All in all, of the $280 billion that fled the market during the crash, only about $30 billion (around 10%) has been returned into the market over the last two years. This suggests to me that there's still a lot of money that can potentially be invested back into the market.
SPX vs. Cumulative Fund Flows
The chart below also suggests the presence of money on the sidelines. It shows the total shares short for all stocks in our database. Rather than simply representing negative bets on the market, the data is an indicator of hedge fund activity. Hedge funds deploy many strategies that involve shorting stocks. When hedge funds heavily invest in equities, you naturally see short interest increase. That's why the S&P 500 Index (SPX) was powering higher before 2008, despite the heavy shorting.
You may notice that the shares short continued higher after equities began to fall. This is most likely because even when equities initially fell, hedge funds continued to deploy their capital into commodity stocks, which did not begin to fall until the middle of 2008. When commodities finally broke down and the crash was in full swing, hedge funds were forced to deleverage.
Currently, total shares short are at the lowest point since early 2007, suggesting hedge fund money that left equities has not returned. If/when it does, it could be a huge catalyst to propel the market higher.
SPX vs. shares short
Implications: Why does the data above seem to conflict? There are some potential explanations for this. The II sentiment poll that implies extreme optimism is a good gauge of the retail investor, while the fund flow indicators may be dominated by institutional money. Retail investors may be back into equities while the big money players are still sitting on the sidelines -- or, more likely, finding other places to put their money (bonds, currencies, etc.).
A bear could spin this by asking, "Would you rather have your money with the retail investor (dumb money) or with the big institutions and hedge funds (smart money)?" A bull could theorize that hedge funds that continue to miss the rally, causing their returns to suffer, will eventually have to capitulate and buy equities. It's the big-money players who can really drive the market, and wherever they go, you want to be there first and not be late.
This Week's Key Events: Alcoa Kicks Off First-Quarter Earnings Reports
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
* There are no major economic reports slated for Monday, but Chicago Fed President Charles Evans is scheduled to speak at the Annual Risk Conference. Earnings season unofficially begins with the release of Alcoa's (AA) first-quarter results after the close.
Tuesday
* Tuesday brings us the February trade balance, as well as import/export prices and the Treasury budget for March. Fastenal (FAST) is scheduled to report earnings.
Wednesday
* The Fed's Beige Book report for April is due out Wednesday, along with February's business inventories and the regularly scheduled update on crude inventories. On the earnings front, we'll hear from ASML Holding (ASML) and JPMorgan Chase (JPM).
Thursday
* As usual, weekly jobless claims are scheduled to hit the Street on Thursday. Inflation data also starts to roll in, with the release of the producer price index (PPI) and core PPI for March. Hasbro (HAS), Progressive (PGR), and Google (GOOG) are expected to report earnings.
Friday
* The week wraps up with a flurry of economic data, including industrial production, capacity utilization, the consumer price index (CPI) and core CPI for March, the preliminary April Reuters/University of Michigan sentiment survey, and the Empire State manufacturing index for April. There are also a few notable earnings announcements on the calendar, with quarterly reports due out from Bank of America (BAC), Mattel (MAT), and Infosys (INFY). |
