Why We're Not Panicking Over Europe Anymore
The VIX still has room to run lower from here
by Todd Salamone 4/28/2012 9:15:30 AM
Stocks ended solidly higher last week, as traders effectively brushed off a Spanish debt downgrade, a disappointing unemployment report, a slimmer-than-forecast GDP rise... oh, and the collapse of the Dutch government. While any one of these headlines might have sparked a selling spree in the not-so-distant past, Todd Salamone breaks down a few notable data points that help to explain the market's growing resilience. But while Europe may finally be priced in -- at least, for now -- Todd also notes several looming technical levels that could keep a lid on stocks going forward. Then, Rocky White runs the numbers to find out which traits the market's monthly outperformers have in common. Finally, we wrap up with a preview of the key economic and earnings events for the week ahead, as well as a few sectors of note.
Notes from the Trading Desk: Quantifying the Growing Fear Among Investors
By Todd Salamone, Senior VP of Research
"A number of hedge funds bought Spanish CDS at the start of the month, say industry insiders, helping drive up the price to more than 500 basis points earlier this week from below 350 basis points in February... While funds have kept positions relatively small on concerns over lower liquidity in some credit markets and a fast-changing political environment, managers are generally still short stocks -- betting on falling prices -- looking at sectors such as banks... Most hedge funds are still bearish on the euro zone's debt crisis." - Reuters, April 27, 2012
"... we find it interesting that some key U.S. equity benchmarks are trading just under key round-number areas, while others trade just above key round numbers -- creating potential crosswinds, from a technical perspective... The above technical and fundamental crosswinds could last for several weeks, but bulls should find it encouraging that price action has been somewhat muted relative to previous pullbacks induced by European sovereign debt issues. We think this is due to the fact that major players, such as hedge funds, have not been as heavily exposed to stocks, and therefore there are fewer sellers..."
"The VIX has plenty of room to move lower before retesting its March lows, even though Twitter sentiment suggests the VIX is 'cheap.' The VIX peaked at 21.06 on April 10 when earnings season began, continuing a series of lower highs in place since the beginning of the year. The peak this month was 50% above the mid-March low, continuing the uncanny behavior in which the VIX tends to peak 50% above -- or double or triple -- its previous lows." - Monday Morning Outlook, April 21, 2012
Last week, we noted the resilience of the U.S. stock market amid headlines related to European sovereign debt issues, which have been surfacing on and off again since early 2011. Our explanation for this resilience was that hedge funds -- who have pretty much dictated the direction of the market, given that retail investors continue to flee domestic equity funds -- already had a relatively low allocation to U.S. equities, substantially removing potential selling pressure in the market.
As we ascertained from a Reuters article on Friday, excerpted above, hedge funds are making bets against Spanish debt through the purchase of illiquid credit default swaps (CDS). So, the market participants that have the power to drive the U.S. market one way or the other have been seeking bearish opportunities overseas, which may explain why you don't see the panic selling related to Europe that prevailed throughout last year. It appears funds are positioned for a negative environment in Europe, reducing the element of surprise as it relates to the U.S. market. In fact, amid a downgrade of Spanish debt and domestic GDP data that came in weaker-than-expected, both U.S. stocks and equities in Spain managed to rally on Friday.
In fact, just as the S&P 500 Index (SPX - 1,403.36) was hitting lows in the 1,360-1,370 area a couple of weeks ago, we observed that underweight hedge funds were dipping their toes back into the stock market, as evidenced by increased call buying on CBOE Market Volatility Index (VIX - 16.32) futures and an uptick in put buying on equity-based exchange-traded funds (ETFs), such as the SPDR S&P 500 ETF (SPY), iShares Russell 2000 Index (IWM), and PowerShares QQQ Trust (QQQ). It's encouraging for the bulls that such funds have ample cash to deploy to the market on pullbacks, and option activity that we continue to observe suggests that some hedge funds are again accumulating stocks, and using options on the VIX and major equity ETFs to hedge.
One thing that has particularly intrigued us, as contrarians, is the amount of fear that has come into the marketplace, in what has so far proven to be a mild short-term pullback within the context of impressive price action during the past several months.
For example, this past week, the American Association of Individual Investors' (AAII) weekly sentiment survey revealed that there are more bears than bulls, with only 27.6% of individual investors taking a bullish stance, as 37.4% claimed to have a bearish view. The bullish percentage is the lowest in 2012, and is also the lowest reading since September 2011, when the SPX was carving out a major bottom in the 1,100-1,150 zone.
In order to better quantify the fear by analyzing what traders are doing, as opposed to thinking, the bearish surge in the AAII survey is confirmed in the equity options market. Per the chart below, check out the spike in the 10-day customer-only, equity-only buy-to-open put/call volume ratio. As you can see, equity put option buying has reached its highest point since last fall, and is at a level that not only marked a bottom during the May 2010 flash crash, but also preceded the SPX's breakout above 1,350.
As we head into this week's trading, the following indexes are above important round-number century or millennium levels:
- Dow Jones Industrial Average (DJIA - 13,228.31) - above 13,000
- Nasdaq Composite (COMP - 3,069.20) - above 3,000
- Russell 2000 Index (RUT - 825.47) - above 800
- S&P 500 Index (SPX - 1,403.36) - above 1,400
But work remains, as the Dow's high on Friday was the site of the April 2 closing peak, and the RUT is perched just below its February and March highs in the 830-840 area. Moreover, the S&P MidCap 400 Index (MID - 999.40) comes into the week below the important 1,000 millennium level, and the Dow Jones Transportation Average (.TRAN - 5,267.39) remains below 5,500, which has marked peaks since 2007.
While technical speed bumps remain in place, we are encouraged by the sentiment backdrop, as there is sideline money and short-covering potential to push major benchmarks through resistance.
Furthermore, the last time the SPX was trading in the 1,400 area, the VIX was bottoming around 14.00. With the VIX at 16.36 coming into this week's trading, a bull could argue it has more room to fall before another period of short-term weakness. In fact, the next major low in the VIX could occur around 11.50, which would be half the recent peak.
Indicator of the Week: Multiple Indicators & Monthly Returns
By Rocky White, Senior Quantitative Analyst
Foreword: With April coming to a close, we are about a third of the way through the year. The first three months of the year were very bullish for stocks, while April has struggled. This week, I'm taking a look at how individual stocks have performed, depending on certain characteristics.
Returns by Market Cap: The first indicator I'm looking at is market capitalization. Looking at the stocks in our database, I separated out the 20% that had the highest and lowest market caps, and found their average return each month. I also show the returns of the other stocks. The chart suggests that January would have been a good time to be long the small-cap stocks, and March also shows small-cap outperformance. One interesting note is that as we've struggled in April, the small-cap stocks have not given back any more than the big-cap stocks, as is often the case.
Prior Month's Return: Another thing I looked at was how stocks have performed depending upon their prior month's returns. Often, it seems the stocks that perform the best during one period do the worst over the next period, and vice versa. This is how it happened in January. The worst stocks in December averaged a gain of almost 13% in January, while the best-performing stocks in December averaged just a 7% gain. April is not as typical. With the market struggling in April after three great months, you might expect to see some of the outperformers from March getting hit the hardest. However, the best stocks in March have lost less than the worst performers.
Call and Put Buying: Finally, another indicator I looked at was the buy-to-open (BTO) option volume data. We get data from three different exchanges -- the Chicago Board Options Exchange (CBOE), the International Securities Exchange (ISE), and the NASDAQ OMX PHLX (PHLX) -- that specifically isolates option volume that was buyer-initiated. Looking solely at this indicator, the data suggests that stocks with a predominance of call buying have fared better than those with heavy put buying of late. Each month, except for February, shows that stocks with the lowest put/call ratio heading into the month have the best returns. In fact, during the flattish month of April, the stocks with the most call buying compared to put buying show a slight gain, on average.
This Week's Key Events: Wall Street Awaits April Jobs Data
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 week kicks off on Monday with data on personal income and spending, as well as the Chicago purchasing managers index (PMI). We'll hear earnings results from Anadarko Petroleum (APC), Herbalife (HLF), Humana (HUM), LDK Solar (LDK), Shutterfly (SFLY), Sohu.com (SOHU), Sourcefire (FIRE), and Veeco Instruments (VECO).
Tuesday
- Tuesday's economic calendar features the ISM manufacturing index, construction spending, and auto sales. On the earnings front, quarterly reports are due out from Arch Coal (ACI), Avon Products (AVP), Biogen Idec (BIIB), BP (BP), Broadcom (BRCM), Chesapeake Energy (CHK), Office Depot (ODP), OpenTable (OPEN), P.F. Chang's China Bistro (PFCB), Pfizer (PFE), Sirius XM Radio (SIRI), and Valero Energy (VLO).
Wednesday
- The ADP private-sector payrolls report is due out on Wednesday, along with factory orders and the usual report on weekly crude inventories. Comcast (CMCSA), CVS Caremark (CVS), Garmin (GRMN), Hartford Financial Services (HIG), JDS Uniphase (JDSU), MasterCard (MA), Onyx Pharmaceuticals (ONXX), Time Warner (TWX), ValueClick (VCLK), Visa (V), Weight Watchers (WTW), Whole Foods Market (WFM), Yelp (YELP), and Zillow (Z) are all scheduled to step into the earnings confessional.
Thursday
- Employment data continues to roll in on Thursday, when the latest weekly jobless claims will share the spotlight with the ISM services index. Earnings are expected from Alpha Natural Resources (ANR), American International Group (AIG), Fuel Systems Solutions (FSYS), James River Coal (JRCC), Level 3 Communications (LVLT), MGM Resorts (MGM), Randgold Resources (GOLD), Royal Gold (RGLD), Southwestern Energy (SWN), SunPower (SPWR), and Western Refining (WNR).
Friday
- The week wraps up with the Labor Department's report on nonfarm payrolls and the unemployment rate. We'll hear earnings from Arcos Dorados (ARCO), Duke Energy (DUK), Estee Lauder (EL), Exelon (EXC), and The Washington Post (WPO).
And now a few sectors of note...
Dissecting The Sectors
| | Sector | Leisure/Retail
Bullish |
Outlook: The jobs market appears to have hit a soft patch lately, with March payrolls falling short of expectations. However, consumer spending remains healthy, with a 2.9% uptick in this metric during the first quarter adding two percentage points to gross domestic product (GDP). In fact, retailers managed a composite same-store sales gain of 6.9% for March, surpassing the 5.3% improvement predicted by analysts. What's more, overall retail sales improved 0.8% last month, blowing past the consensus analyst estimate of 0.3%. On the charts, the SPDR S&P Retail ETF (XRT) is still a technical outperformer, with the fund notching its highest weekly close on record last Friday. The fund enters this week trading just below its all-time high of $63.04, which was tagged just last month. For those seeking a bullish play in the retail/leisure space, we recommend focusing on stocks in solid technical uptrends that are surrounded by negative sentiment, which creates the potential for upside surprises. Last week, well-received earnings from O'Reilly Automotive (ORLY) provided a halo lift for a few of our preferred retail names, AutoZone (AZO) and Advance Auto Parts (AAP). Other current favorites include Macy's (M), Limited (LTD), and Whole Foods Market (WFM), along with restaurateurs Chipotle Mexican Grill (CMG) and Domino's Pizza (DPZ). With skepticism still lingering toward these consumer-dependent stocks, contrarians can continue to capitalize on situations where sentiment has yet to catch up with the bullish technical performance.
| | Sector | Homebuilding
Bullish |
Outlook: The housing sector was an unexpected pocket of strength last week, thanks to upbeat data on pending home sales and a better-than-forecast earnings report from Ryland Group (RYL). On the heels of this positive news, the SPDR S&P Homebuilders ETF (XHB) bounced from support at its 80-day moving average, located near the $20 level -- a round-number area that previously marked the fund's May 2010 peak. From here, the fund still has room to rally up to $23.25, which is half its all-time high, reached only three months after XHB was launched in 2006. Despite the improving price action in the sector, analysts remain overwhelmingly negative. With 85% of builders trading above their 200-day moving averages, these names have attracted only 44% "buy" ratings from brokerage firms. However, a recent preponderance of put buying on XHB suggests that hedged players are starting to dip their toes into housing stocks, which could be a boon for the group during the near term. In fact, the 50-day buy-to-open put/call volume ratio for the fund is now resting near its highest level since 2007, which indicates that big-money investors are actively acquiring shares of sector components. As further evidence, Goldman Sachs is launching a fund to buy home-loan bonds, with the investment giant asserting that "stabilization in U.S. housing fundamentals is creating an attractive investment opportunity." Some of our preferred names in the sector are Lennar (LEN), Toll Brothers (TOL), Meritage Homes (MTH), PulteGroup (PHM), and D.R. Horton (DHI), all of which sport relatively high short-to-float ratios. Going forward, these stocks could benefit from upgrades or short-covering activity as the technical and fundamental performance continues to surpass the Street's low expectations. As a point of caution, Barron's recently featured an upbeat cover story titled "Home Prices Ready to Rebound" -- suggesting some optimism may be priced in, and XHB could pull back in the short term. However, a pullback that is contained above $20 would be healthy, in our view, as we still believe in the potential reward in this sector. What's more, the bullish cover is not out of touch with the positive price action, making the contrarian implications less relevant.
| | Sector | Gold
Bearish |
Outlook: Lately, we've been seeing several danger signs that point to potential short-term weakness for the SPDR Gold Trust (GLD). First, as Jim Paulsen of Wells Capital Management recently observed, valuations for the underlying metal relative to stocks, bonds, and other assets have soared off the charts lately, hinting that a correction may be overdue -- particularly as gold sheds its "fear premium" in the face of recovering consumer confidence. Looking at the options markets, total buy-to-open option volume on the ETF imploded recently, and continues to decline. This occurrence has previously coincided with periods of range-bound or negative price action for GLD. Meanwhile, the fund's front-month put/call implied skew has recovered from its recent lows, but this has yet to provide any kind of meaningful bid for the shares -- marking a deviation from past trends. From a technical perspective, the outlook is similarly unsettling. The fund turned lower in late February after an unsuccessful test of resistance in the $175 area, and GLD has since plummeted through its 140-day moving average. This trendline has played a key role as both support and resistance in the past, and it's currently serving as a stubborn technical ceiling. Even more troubling, many technicians are now betting on an inverse head-and-shoulders pattern for GLD -- interestingly enough, a formation that was not at the forefront of technical playbooks when it developed in the equities market. If this pattern doesn't play out as expected on GLD, some technical-related selling could be expected. That said, we're keeping a close eye on its 320-day moving average and the $160 area, which could limit downside during the short term. |
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.
|
