Monday Morning Outlook: Two Key Trendlines to Watch on the S&P 500 Index
Hedge funds could be starting to unwind their bearish bets on stocks
by Todd Salamone 8/27/2011 11:56 AM
schaeffersresearch.com
Stocks ended higher for the first week in five, giving investors a brief respite from the long, grueling slog that has been the month of August. Fed Chairman Ben Bernanke's Friday speech helped boost the bulls, even though he neglected to unveil any revolutionary new stimulus measures. Instead, Bernanke promised that the Federal Open Market Committee (FOMC) would take a long, hard look at its tool kit during September's two-day meeting -- which means we can all look forward to another solid month, at least, of "will he or won't he?" speculation about QE3. In the meantime, the major market indexes are still on shaky ground, and Wall Street is staring down the barrel of three straight days' worth of jobs data.
In this uncertain environment, Todd Salamone is still keeping a watchful eye on the market's deep-pocketed players. Recent options activity suggests that hedge funds may be regaining their appetite for equities, just as gloomy headlines are stacking up about these big-money investors. Meanwhile, Rocky White takes a retrospective look to find out whether the market's miserable August is a harbinger of more pain to come. Finally, we wrap up with a preview of the major economic events for the week ahead, as well as a few sectors of note.
Notes from the Trading Desk: Has Hedge-Fund Pessimism Already Peaked?
By Todd Salamone, Senior VP of Research
"Hedge-Fund Bets Against S&P 500 at Highest Since 2008"
The Wall Street Journal, August 25, 2011
"Icahn Gained on $2 Billion Bet Against S&P"
Bloomberg, August 22, 2011
"Hedge Funds Most Bearish Since July 2009 After Global Equities Retreat 15%"
Bloomberg, August 19, 2011
During the past few weeks, through our analysis of option activity on major exchange-traded funds (ETFs) -- the SPDR S&P 500 Trust (SPY), iShares Russell 2000 Index Fund (IWM) and PowerShares QQQ Trust (QQQ) -- we suggested that hedge funds were turning sour on the market, and went so far as to speculate that they were actively shorting the market. As you can see by the headlines above, various news stories last week confirmed our words of warning.
Hedge fund managers can change course in the blink of an eye, with $2 trillion in assets at their disposal. Bears, take note: This group, which has disappointed investors lately with lackluster returns, has unusually low equity exposure, even as the major market indexes have shown signs of stabilization during the past couple of weeks. Sure, hedge funds could use this week's rally to add to their short positions, and this would likely pressure equities. But, at this juncture, might they be thinking of covering their bearish bets? After all, equities rallied on the heels of Fed Chairman Ben Bernanke's keynote speech at Jackson Hole, Wyo., where central bankers from around the world gathered this past week. For those of you who don't remember, this annual event sparked the year-end rally in 2010, and a potential replay of last year is likely top-of-mind for market-moving players.
At the very least, it appears the relentless shorting activity has lightened up, as the combined 20-day buy-to-open put/call ratio on the SPY, IWM, and QQQ has finally turned higher. Remember, an uptick in this ratio is what bulls would like to see as evidence of a potential bottom forming. Since calls are used to hedge short equity exposure, a rising put/call ratio indicates that major players, such as hedge funds, are turning less negative, which means short-covering activity and/or cash moving in from the sidelines could spark a rally. And the timing of this ratio turning higher is certainly intriguing, as it comes at a time when the general investing public is finally made aware that hedge funds have turned negative on the market. In other words, just as retail-level traders are catching on, there is new evidence that the pessimism that has driven stocks lower is decreasing.
If a post-Jackson Hole rally occurs, like it did last year, it would happen in the context of a weaker technical backdrop. For example, ahead of the 2010 meeting, the S&P 500 Index (SPX - 1,176.80) was sitting just above its 80-week moving average, whereas it's trading below this trendline at present. After Friday's rally, bulls would prefer that the SPX immediately trade back above this moving average, which is currently at 1,209.40.
That said, we find it interesting that in both 2010 and 2011, equities had tested a long-term moving average of historical significance just ahead of the central bank summit. This year, it was the 40-month moving average, which was tested earlier in August. As you can see on the chart below, this trendline has carried major significance, having previously caught the 1987 crash low, and then acting as support in 1990 and 1994. Moreover, this trendline acted as resistance right ahead of the May 2010 "flash crash." If the SPX immediately heads lower from here, this is a moving average that we will continue to focus on in the weeks ahead.
The 1,133 area could also prove psychologically important through the end of the month, as it marks the 10-year breakeven on the SPX as of the close of trading this Wednesday, Aug. 31. For what it's worth, the 10-year breakeven based on the September 2001 month-end close is 1,040, just above the SPX's July 2010 low.
After Friday's advance, there is still work to be done to repair the technical backdrop, as it has been a volatile, choppy ride since the Aug. 9 lows. Encouraging for the bulls is that the CBOE Market Volatility Index (VIX - 35.59) remains well below 50, major equity indexes remain above historically significant long-term moving averages, and there are signs that heavy pessimism among hedge fund managers is dissipating.
In this environment, we recommend you dip your toes into highly shorted equities that are trading at long-term support -- such as consumer discretionary stocks that have pulled back recently, but are still in the black for 2011. If a bottom is in place, these equities will likely outperform. However, continue to maintain exposure to gold and bonds, and avoid the large-cap financials.
Indicator of the Week: Looking Past August to September Seasonality
By Rocky White, Senior Quantitative Analyst
Foreword: What a tough August it has been. The S&P 500 Index (SPX) is down 8.9% with a few days remaining, putting us on pace for the third-worst August we've seen in the last 30 years. Only 1998 and 1990 were worse, with the index falling 14.6% and 9.4%, respectively.
Since we're in a hurry to get this month over with, I'm going to start talking about September. The two tables below show the SPX's monthly returns over the last five- and 10-year time frames. September has been positive four of the last five years, averaging a 1.86% return. That's a pretty decent performance, making September the fourth-best month over that time frame. Over the last 10 years, though, September averages a loss of about 1% --ranking it ninth out of the 12 calendar months.
Awful Augusts: There is a silver lining to the very painful August we've endured. Historically speaking, when the SPX tanks in August, the last four months of the year tend to bounce back in a big way. Below are the 10 worst August returns over the last 30 years, and you can see how the market performed during the rest of the year. Only once did the market end lower, in 1981.
The average gain for those 10 years is 8.5% over the last four months of the year (that's about 28% annualized). So, in those years listed below, traders who sold their equity holdings in a panic during the late-summer drop missed out on significant gains for the rest of the year.
This Week's Key Events: Pins and Needles Ahead of August Payrolls
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 economic calendar kicks off Monday with pending home sales for June, and personal income and spending stats for July. Donaldson Co. (DCI), LDK Solar (LDK), and Winn Dixie Stores (WINN) are expected to report earnings.
Tuesday
- The S&P/Case-Shiller 20-city home price index for June, the Conference Board's consumer confidence index for July, and the minutes from the latest meeting of the Federal Open Market Committee (FOMC) are all set to hit the Street on Tuesday. Earnings are due out from Barnes & Noble (BKS), Dollar General (DG), and Vera Bradley (VRA).
Wednesday
- Employment data starts to trickle in on Wednesday, with the release of ADP's private-sector payrolls report for August and the Challenger, Gray & Christmas update on monthly job cuts. Also due out are July's factory orders and the Chicago purchasing managers index (PMI) for August, as well as the usual update on weekly petroleum supplies. Coldwater Creek (CWTR), Hovnanian Enterprises (HOV), Joy Global (JOYG), and Shuffle Master (SHFL) will share the earnings spotlight.
Thursday
- Initial jobless claims are due out on Thursday, as is the ISM manufacturing index for August. Also on the day's docket are July's construction spending and auto sales for August. On the earnings front, we'll hear from Ciena (CIEN), Finisar (FNSR), H&R Block (HRB), and Quiksilver (ZQK).
Friday
- The Labor Department's much-anticipated nonfarm payrolls report for August will be released ahead of the open on Friday, capping off our three-day deluge of jobs data. Campbell Soup (CPB) headlines a quiet day of earnings.
And now a few sectors of note...
Dissecting The Sectors
Sector Leisure/Retail
Bullish
Outlook: After flirting with a technical breakdown earlier this month, the SPDR S&P Retail ETF (XRT) showed some resilience last week. The fund crossed back above its 80-week moving average, and settled Friday's session comfortably north of this significant trendline. From a sentiment perspective, XRT's 50-day buy-to-open put/call volume ratio seems to have bottomed out after a lengthy decline. Going forward, an uptick in this ratio would confirm that big-money players are once again building long positions in the retail space. Within the group, we're drawn to stocks in solid technical uptrends that remain surrounded by skepticism. Chipotle Mexican Grill (CMG), Lululemon Athletica (LULU), and AutoNation (AN) have racked up double-digit percentage gains in 2011, easily surpassing the broader market -- yet all three equities have been heavily targeted by short sellers, and the majority of analysts also remain dedicated to the bearish camp. Meanwhile, Green Mountain Coffee Roasters (GMCR) has been the target of speculative put buying, even though the shares have rallied roughly 200% year-to-date. As these discretionary stocks continue to outperform on the charts, a capitulation by the bears could provide a fresh influx of buying pressure. Sector Large-Cap Tech
Bearish
Outlook: Last Friday, OmniVision Technologies (OVTI) became the latest victim of a particularly weak round of tech-sector earnings. The shares plummeted to a new annual low as traders panned the company's disappointing financial guidance, fresh on the heels of similarly bleak earnings reactions from the likes of Dell (DELL) and Hewlett-Packard (HPQ). From a technical standpoint, the PowerShares QQQ Trust (QQQ) spiraled lower after a recent test of the $60 level -- which represents exactly half its all-time high of $120, set back in March 2000. Furthermore, the trust remains stuck beneath its year-to-date breakeven level, located near the $54 area. This former layer of support now seems to be emerging as stubborn resistance for QQQ. Within the tech sector, semiconductor stocks could prove to be a particular pocket of weakness, as analysts remain surprisingly upbeat on this underperforming group. The percentage of "buy" ratings on components of the Semiconductor HOLDRS Trust (SMH) peaked at 58.2% in late July, hitting its highest level since May 2010. Meanwhile, the percentage of "sells" is resting near an annual low. In the same optimistic vein, a few upbeat analysts have recently flagged the poor price action in chip stocks as a buying opportunity. With SMH faring even worse than the broader QQQ in 2011, this defiantly bullish attitude suggests that semiconductors could be vulnerable to a shift in sentiment as the weak technical performance continues.
Sector Financials
Bearish
Outlook: Banks continue to struggle, due to lingering uncertainty about European debt exposure and new warnings about the threat of recession. Bank of America (BAC) got a high-profile boost this past week, thanks to a vote of confidence from none other than Warren Buffett -- but the underperforming blue chip remains stifled by resistance at the $8 level, which marked the site of a bearish gap in early August. Taking a broader look at the group, the Financial Select Sector SPDR (XLF) pared its weekly losses after falling to a new two-year low of $11.81 on Tuesday. However, XLF remains pinned beneath its 20-day moving average, as well as the formerly supportive $13.50 area -- either of which could thwart any short-term rally attempts. Meanwhile, media coverage on the group is still bullishly slanted, with pundits pointing to "attractive valuations" in the wake of recent declines. Likewise, data from Zacks indicates that 62.8% of analyst ratings on finance stocks are of the "buy" or better variety, despite the group's dismal price action and mounting fundamental challenges. This stubbornly bullish configuration leaves plenty of room for additional downgrades going forward, which could exacerbate the weak price action. |
