Five Reasons Why Stocks Could Be Set to Tackle Looming Resistance
Examining third-quarter seasonality in context with the Investors Intelligence survey
by Todd Salamone 6/30/2012 2:34:33 PM
It was a winning week for U.S. stocks, as concrete signs of progress on the euro-zone debt crisis sparked an entirely unexpected buying frenzy. In fact, the entire month of June was a runaway victory for bulls -- although the second quarter ultimately went to the bears. So, can Friday's burst of positive momentum continue as we head into the second half of 2012? This week, Todd Salamone dissects the five sentiment indicators that favor the bulls, even as major equity indexes remain below significant technical hurdles. Next, Rocky White examines third-quarter seasonality through a contrarian lens -- and the results may surprise you. Finally, we wrap up with a look at this week's notable earnings and economic events, as well as a few sectors of note.
Notes from the Trading Desk: The Next Technical Tests for the VIX and SPX
By Todd Salamone, Senior VP of Research
"VIX drops continue to be contained in the area that is 50% above the March intraday and closing lows. The obvious conclusion is we get a huge bounce from this area on Monday morning, but then again, it will likely take a gap below this area in order for the VIX to make a sustained move south of this support, which has been in place since mid-May... of interest for bulls is the potential for a bearish 'head and shoulders' pattern on the VIX to develop... a break below the neckline in the 20.00-20.50 area would target a VIX move to 12.00 in relatively short order, which is likely unimaginable to many market participants, given the negative headlines and uncertainty both here and overseas. An imploding VIX would likely be coincident with an explosive rally in stocks."
"...The present sentiment backdrop is consistent with major bottoms during the past few years, suggesting there is enough short-covering potential and sideline money to sustain a sharp rally over a brief period. This in turn would likely spark a volatility implosion..."
- Monday Morning Outlook, June 16, 2012 "$VIX option volume on track to be lowest this year, after a YTD low in VIX option volume yesterday...$VIX second failure this week to take out area 50% above March intraday and closing low (20.49-21.39); SPX 1,315 holds (June 50% retracement)"
- @toddsalamone, June 28, 2012 A couple of weeks ago, we discussed the potential for an explosive rally due to a sentiment backdrop that is extremely negative, as major equity benchmarks were trading above key longer-term support levels, even after a correction in stocks that began in early April. At the time of this discussion, the CBOE Market Volatility Index (VIX - 17.08) was trading at 21.11, more than 23% above Friday's close. The S&P 500 Index (SPX - 1,362.16) was at 1,342.84, 19 points below Friday's close, but riding a roller coaster since our comments in mid-June. So, while we have indeed experienced a volatility implosion, the only major stock explosion higher was this past Friday, after European leaders surprised market participants by unveiling some concrete plans to address the euro zone's sovereign debt problems.
The results from the end-of-week European Union (EU) summit were indeed a surprise, as most analysts were not expecting anything to come out of this meeting. Further evidence of market participants being caught flat-footed was the extremely low put volume on VIX options in the two days prior to the announced outcome of the meeting, including VIX put volume on Thursday that reached calendar-year lows.
While the initial VIX implosion came on the Monday following the Greek elections during the June 18 week, equities languished as doubt emerged that European leaders could reach an agreement at last week's summit to address the region's ongoing debt crisis. Intriguing to us is that the VIX rally last week failed to take out the area between 20.49 and 21.39, which is 50% above the March intraday and closing lows of 13.66 and 14.26, respectively. If you have been following us in recent weeks, you know we have been highlighting this area on the VIX as one of utmost importance. The two trips into this area last week marked peaks in implied volatility, and were coincident with bottoms in the equity market.
The fact that the VIX failed twice at resistance last week, along with a Thursday evening close below a trendline connecting higher lows since June 20, was a plus for bulls and perhaps a "tell" for an explosive market advance on Friday. We could see the VIX moving into the 12-14 area, with 12 being the target for the bearish "head and shoulders" pattern discussed two weeks ago, and 13.86 being the half-high of the 27.73 peak earlier this month. If this area is taken out to the upside during the next few weeks, we would turn cautious in the near term, as a test of the June VIX highs would immediately come back into play.
With the VIX having room to move lower at present, major equity benchmarks come into the week near areas of resistance. For example, after the SPX pulled back to the 1,215 area on Thursday -- a 50% retracement of the June high and low -- it rallied to 1,362.16, which is just below the 2011 high, its peak earlier this month, and the index's 80-day moving average.
As far as other major benchmarks are concerned, the S&P 400 MidCap Index (MID - 941.64) comes into the week trading just below 950 -- a support level in April which acted as resistance in May. Meanwhile, the Russell 2000 Index (RUT - 798.49) enters the week just below the round-number 800 century mark, which is where a trendline connecting lower highs in March and May is currently sitting.
The sentiment backdrop remains one in which these benchmarks can power through their respective resistance levels mentioned above. Consider:
- The disappearance of short covering that began in March and a build in short interest since May has been a major reason stocks have struggled in recent months. An unwinding of the recently added short positions could be a major tailwind for equities in the weeks ahead. In fact, total short interest on components of the SPX is now just slightly below the total of October 2011, which preceded a 25% SPX rally into April on the heels of short covering (see chart immediately below).
- As Ryan Detrick discussed last week, the 10-day, equity-only buy-to-open put/call volume ratio is rolling over from extremely high levels, implying that the unwinding of extreme negative sentiment is underway. Rollovers in this ratio from high levels have historically been concurrent with strong market advances, as it implies pessimism has hit extremes and is now giving way to a more constructive view.
- The most recent survey from the National Association of Active Investment Managers (NAAIM) indicates equity exposure among this group is below average for readings since 2007 and 2012. This lower-than-normal equity allocation among this group is a source of potential fuel for the market.
- The weekly Investors Intelligence (II) survey suggests financial advisors have been slow to acknowledge that the current rally from the early June lows has additional legs. For example, from mid-June to mid-July 2011, the SPX rallied 5.8%, and the bulls-minus-bears reading in this survey increased from 9.6% to 28.0%. During this year's rally from the early June bottom, which is equivalent on a percentage basis, the bulls-minus-bears percentage has moved from 7.4% to only 14%. (For a closer look at II survey results and seasonality, see Rocky White's commentary on page 2.)
- Our analysis of option activity on major exchange-traded funds (ETFs) is showing relatively low hedging activity, suggesting hedge funds are carrying low relative equity exposure. This segment of the market is known for quickly going "risk on" and "risk off." With the "risk on" trade a growing possibility, these players have the ability to support a rally over the next several weeks.
With a positive catalyst from Europe acting as a potential tailwind for equities, amid a sentiment backdrop in which short covering poses a major risk for the bears, the risk-reward favors the bulls. Moreover, earnings season begins in a couple of weeks, and the expectations bar is set low -- which we also see as favorable for bulls. We'll touch more on earnings expectations next week.
Indicator of the Week: Mid-Year Seasonality
By Rocky White, Senior Quantitative Analyst
Foreword: Last week ended the first half of the year, and there are quite a few seasonality aspects to take a look at. This week, I'm looking back over the past 30 years to see if we can get any insight into where this market could be heading. In the analysis below, we'll see what the market has typically done in July and the third quarter -- but we'll also take into account the current sentiment backdrop, which changes everything you've heard about July and the third quarter.
July: Looking back over the last 30 years on the S&P 500 Index (SPX), there doesn't seem to be much reason to be hopeful for the upcoming month of July. It ranks 8th out of the 12 months as far as average return, and has been positive the fewest times, with only 12 positive returns (and, therefore, 18 negative returns).
However, at Schaeffer's, we put a lot of importance on sentiment. In this analysis, layering on a simple sentiment metric gives us pretty bullish results. I took those 30 returns and broke them down depending on investor sentiment, as measured by the Investors Intelligence weekly sentiment survey. The table below summarizes the July returns depending on the percentage of bulls when the month began. You can see that when a high number of investors are bullish (44% or more), July returns average an awful 0.69% loss, with barely a quarter of those being positive. But when there are very few bulls (the most recent poll showed just 39% are bullish) the month averages an impressive 1.49% gain, with over half of those being positive. That's a pretty good case in point on how it pays to be a contrarian.
Third Quarter: This time I went back 30 years and looked at how the SPX fared in each quarter. The story is the same as above. The first table shows the third quarter is by far the most bearish. It's the only one that averages a negative return, and the percentage of positive results -- 57% -- is the lowest of the four quarters.
But there is a clear distinction when you split those 30 returns down the middle depending upon the number of bullish respondents in the Investors Intelligence sentiment poll. When there are fewer bulls, and therefore more pessimism, you see much better returns compared to when there are a lot of bulls. It's not even that close. When there are a low number of bulls, the index averages a 2.51% gain, with 73% of them positive. When there are a high number of bulls, the SPX averages a 2.76% loss, with only 40% of them positive. Again, there are currently a low number of bullish investors according to this survey, which has been good news for the market going forward.
This Week's Key Events: June Jobs Data Punctuates a Quiet Week
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 with the latest ISM manufacturing index and construction spending data. On the earnings front, Acuity Brands (AYI) will unveil its quarterly results.
Tuesday
- Tuesday's calendar features factory orders and auto sales, while the earnings calendar is bare. The major exchanges will close at 1:00 p.m. Eastern.
Wednesday
- The market is closed Wednesday in observance of Independence Day.
Thursday
- Weekly jobless claims, the ADP employment report, and the ISM services index are due out on Thursday. The holiday-delayed weekly report on petroleum supplies will also hit the Street. International Speedway (ISCA) and Xyratex (XRTX) are expected to report earnings.
Friday
- On Friday, all eyes will be on the Labor Department's nonfarm payrolls report for June. There are no earnings reports of note on the day's docket.
And now a few sectors of note...
Dissecting The Sectors
| | Sector | Leisure/Retail
Bullish |
Outlook: Consumer spending remains healthy, with a 2.7% uptick in this metric during the first quarter contributing to a gain in U.S. gross domestic product (GDP). Also encouraging is a string of new record lows in 30-year mortgage rates, as potential refinancing activity could free up discretionary funds among U.S. consumers. That said, same-store sales for May were a mixed bag; the collective number slightly outpaced estimates, but Kohl's (KSS) numbers came in worse than expected. The big winners included TJX Companies (TJX) and Ross Stores (ROST). This week, traders should stay tuned to hear the retail sector's latest same-store sales numbers on Thursday. On the charts, the SPDR S&P Retail ETF (XRT) remains in a solid long-term uptrend, extending its recent bounce from the $56 area -- home to its 160-day moving average and July 2011 peak. Restaurants, including Buffalo Wild Wings (BWLD) and Chipotle Mexican Grill (CMG), are particularly compelling at the moment, with the group sporting just 51% "buy" ratings as roughly 68% of sector components trade atop their 200-day moving averages. A couple of other names we like from the broader retail sector include Internet giant Amazon.com (AMZN), grocer Whole Foods Market (WFM), and select apparel names, such as Under Armour (UA). Sherwin-Williams (SHW) is another intriguing contrarian setup, given the equity's strong price action, 8% "buy" ratings, and 47.5% rise in short interest over the last two reporting periods. With skepticism still prevalent toward consumer-dependent stocks, contrarians can continue to capitalize on situations where sentiment has yet to catch up with bullish technicals.
| | Sector | Homebuilding
Bullish |
Outlook: The housing sector has seen some positive developments in 2012, thanks in part to record-low mortgage rates, which have reignited interest in the real-estate market. Last week brought us several upbeat reports for builders, with new home sales, pending home sales, and the S&P/Case-Shiller home price index all topping consensus expectations. Plus, Lennar (LEN) tagged a new multi-year high on the heels of a well-received quarterly report, while KB Home (KBH) put a bow on the bullish week by rocketing to a double-digit percentage gain after its Friday earnings release. Nevertheless, this string of positive news was greeted by a bearish Barron's article, confirming that negativity still lingers toward the underdog sector. Technically speaking, we're continuing to monitor the SPDR S&P Homebuilders ETF (XHB), which recently found support at the $19 level. This key chart region is the site of XHB's 160-day moving average, 2011 high, and heavy front-month put open interest, so the rebound from $19 is a welcome development for bulls. During the near term, a break of this level would be a point of concern. For now, investors may opt to hedge any long positions held on homebuilding names by employing XHB puts. Some of our preferred names in the sector are LEN, Meritage Homes (MTH), PulteGroup (PHM), Toll Brothers (TOL), and D.R. Horton (DHI) -- all of which sport relatively high short-to-float ratios of 8% or greater, as well as a preponderance of "hold" and "sell" ratings from analysts. With a healthy amount of pessimism already priced into these names, builders could benefit from short-covering activity or future upgrades as their performance continues to surpass the Street's low expectations.
| | Sector | Big-Cap Banks
Bearish |
Outlook: Amid ongoing regulatory and macroeconomic concerns, large-cap banks have turned in a dismal performance on the charts. The Financial Select Sector SPDR Fund (XLF) is currently positioned just below its 80-week moving average, as well as its June 2011 lows -- which could combine to create a powerful layer of technical resistance in the $14.50-$15 neighborhood. Three notable banking names that look particularly bearish from a contrarian perspective are JPMorgan Chase (JPM), Goldman Sachs (GS), and Citigroup (C). All have seen call buying outpace put buying in recent months, even as these stocks have trended lower. What's more, JPM and C continue to earn positive marks from their peers; JPM has 17 "strong buys" out of 24 total analyst ratings, while Citigroup has 13 "strong buys" from the 20 brokerage names that follow it. Reports last week suggested that JPM's trading loss could be much steeper than the $2-billion figure that was previously revealed by the bank, and the stock remains pinned below resistance at its 160-day moving average and the $37 level. This setup leaves the stock very vulnerable to negative brokerage notes during the near term, which could drag JPM further south. Meanwhile, peers C and GS are both staring up at resistance from their respective 40-day trendlines. Against this backdrop, the stage is now set for a possible move back down to annual-low territory for all three stocks. That said, one risk to the bearish case would be the huge increases in short interest on a number of sector heavyweights during the most recent reporting period -- including C, GS, JPM, Bank of America (BAC), and Morgan Stanley (MS). Now, short interest on these names is lingering at the highest levels in months (or years, in the case of BAC and MS). This opens the door for potentially sharp short-covering rallies in the event of positive fundamental developments. |
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.
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