Stop Trying to Outsmart the Market
Strength in junk bonds and housing could bode well for equity bulls
by Ryan Detrick, CMT 7/21/2012 10:59:55 AM
It was a winning week for U.S. stocks -- even if it didn't really feel like it on Friday. But while familiar euro-zone concerns are still flaring up, last week also brought a number of well-received earnings announcements, along with a few resoundingly upbeat reports on the housing sector. Another flood of quarterly earnings is set to hit the Street this week, including the latest results from Apple (NASDAQ:AAPL) and a number of other heavy hitters. So, now that July options expiration is behind us, can stocks finally gather enough positive momentum to tackle looming resistance levels? Filling in for Todd Salamone this week is Senior Technical Strategist Ryan Detrick, who cites several indicators to offer the bulls some midsummer cheer. Meanwhile, Rocky White takes a look at the harsh post-earnings plunge in Chipotle Mexican Grill (NYSE:CMG), and wonders whether this one-time outperformer can resume its winning ways. Finally, we preview this week's notable economic and earnings events, and check out a few sectors of note.
Notes from the Trading Desk: Will Stocks Catch a Lift as Shorts Hit the Bricks?
By Ryan Detrick, CMT, Senior Technical Strategist
Well, we had a nice bounce going until the S&P 500 Index (SPX - 1,362.66) ran into resistance near the 1,370 area on Friday. As Todd mentioned last week, there were heavy calls on the SPDR S&P 500 ETF (NYSEARCA:SPY - 136.47) at the 137 strike, and this was already an area the SPX had trouble with back in early July -- so it was a logical place for stocks to hit a roadblock, and that's exactly what happened. Still, bigger picture, the lows from early June are still intact, and the overall uptrend is firmly in place.
Turning to the fundamental outlook, we continue to see signs the economic recovery is slowing. Overall, earnings are coming in better than the Street's much-lowered expectations, yet revenue is missing the mark in a lot of cases. The big question on everyone's mind is whether this is just a slowdown in the recovery, or the beginning of a major recession.
With that said, there are still two areas holding up well that make me think the economy won't tank, and could very well improve drastically during the second half of the year. Housing and junk bonds are both showing some major improvements, and this is definitely an encouraging sign. The majority of the housing data over the past two months has been very positive. In fact, housing starts in June came in at their highest level in three years. Turning to junk bonds, they can be a very good gauge of economic growth. Think about it -- these are bonds on the riskiest of companies, and improvements here show an appetite for risk. Why would anyone buy bonds if you think the company paying would just default? Right now, various junk bonds are breaking out -- suggesting the economy could be on much better footing than most give it credit for.
Chart courtesy of StockCharts.com
Touching on the technicals, that 1,370 area we talked about was definitely a trouble spot. Not to be outdone, though, the Dow Jones Industrial Average (DJI - 12,822.57) is close to 13,000, and the Russell 2000 Index (RUT - 791.54) is flirting with 800. We've found that these psychologically significant big, round numbers can indeed act as sticking points. As long as the SPX is above its double low of 1,333, we are still firmly bullish -- but we'd love to be able to clear all of these other areas sooner rather than later.
Speaking of higher prices, here's a chart that suggests new highs could be coming soon. If you look at the cumulative new highs versus new lows at the NYSE, it has just made another new peak. This shows there are many more new highs than lows, and anytime you get a lot of stocks breaking out to new highs, the overall market will normally follow suit. The bottom line is, internals remain very strong here -- and there's nothing wrong with that.
Chart courtesy of StockCharts.com
Now let's take a look at some of the various sentiment indicators we follow. The reality is, most of these indicators are still flashing extreme skepticism, and that is nearly always a good sign for contrarian investors. Remember, no matter how bad the news seems, when expectations are extremely low it is much easier to surprise to the upside. That is exactly where we find ourselves here.
Probably my favorite sentiment indicator right now is what's happening in short interest. Since April, we've seen a huge spike in short interest on all optionable stocks (there are about 2,600 in our database). In fact, the number of shares sold short recently climbed above the peak seen last September. What is extremely encouraging here for the bulls is that short interest just ticked lower, suggesting the shorts could be covering. We've long considered increasing short interest to be a headwind for stocks, and that headwind now appears to be receding. The last time short interest was this high and rolled over, we had a 30% rally in the SPX over the next six months. I have no clue if this will happen again, but it's another sign that siding with the bulls is probably a wise move.
Another indicator that continues to bode well for the bulls is the 10-day, equity-only, buy-to-open put/call volume ratio on the International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX). This ratio recently peaked at its highest level since March 2009, but has since rolled over. Think about that -- we had just a 10% pullback in the SPX, yet there was similar put buying to what we saw at a major generational panic bottom. This is simply amazing, and also sums up the overall level of fear that is out there. This ratio is still firmly pointing lower, and as you can see, a lower ratio has historically been rather bullish for equities.
It's worth touching on mutual fund flows, as well. Looking at domestic equity mutual funds, we've got record outflows over the past 12 months of around $175 billion. What's really amazing to me is that, historically, the 12-month flows tends to move with the overall market. Yet, what has happened since the lows last summer is an increase in outflows, along with a steadily higher stock market. From a contrarian point of view, this could be extremely powerful, as it shows how much more potential there is for higher prices should any flows make their way back to equities.
And here's a chart that also plots bond fund flows. This isn't a huge surprise, but there has been about $200 billion in bond fund inflows during the past 12 months, trouncing the record outflows from domestic equity funds. We have our concerns over bonds here, as this is now an extremely crowded trade. The potential for money to shift out of the popular bond trade and into the much-less-popular equity trade is a very real possibility as equity prices continue to move higher.
Finally, here's a real head-scratcher. We know most investors want nothing to do with this market, after getting burned by such incidents as the flash crash, the ill-fated Facebook IPO, and various scandals at banks (led by JPMorgan's "London Whale" mess). Well, here's more proof of just how low expectations are. The American Association of Individual Investors (AAII) sentiment poll came out last week with just 22% bulls, which is the lowest reading since August 2010. Plus, this marks the 11th straight week of more bears than bulls.
Schaeffer's Quantitative Analyst Chris Prybal looked into the historical data, and found this is the sixth-longest such streak since 1987. Looking at the previous five times this has occurred, after 10 straight weeks of more bears the bulls, the SPX is up an average of more than 5% over the next 30 trading days -- and it was higher all five times over the next 30-day period. Below is a chart of the 10-week moving average of the AAII bulls since 2002. As you can see, this is the lowest it's been since March 2009, and it's down near previous major buying points going back over the last 10 years. Makes you think this surprise summer rally might continue, doesn't it?
In conclusion, the odds of higher prices are still very good right here. Nonetheless, financials and select Chinese Internet names look rather weak, and bearish positions on some of these names could very well be a decent hedge, should the market stall out for any reason.
I'll leave you with a great quote from Colm O'Shea, as stated in the latest "Market Wizards" book by Jack Schwager:
"I think the biggest mistake people make is to assume there is an answer when, in fact, there may be no good answer." Don't beat yourself up finding reasons to outsmart the market. First and foremost, the uptrend is firmly in place. Then, when you consider our accommodative Fed, low valuations, and historically low sentiment -- it all adds up to a strong likelihood of higher prices at least through the remainder of this year, if not further out. Keep it simple.
Best of luck in your trading.
Indicator of the Week: Stocks After They Crash
By Rocky White, Senior Quantitative Analyst
Foreword: Burrito maker and high-flying stock Chipotle Mexican Grill (NYSE:CMG) got crushed on Friday in reaction to a bad earnings report. The stock lost about 21% of its value in one day. I thought this was interesting enough to look back at other stocks in similar situations to see how they performed going forward. Hopefully, we can get some idea as to where CMG and other recently hard-hit stocks might go from here.
Following a Big Drop: I went back to 2000 and looked at all stocks that had a market capitalization of at least $1 billion. Then I found the ones that fell at least 20% on a single day and looked at how they did moving forward. The table below summarizes the returns.
Overall, the returns look pretty good, averaging a gain of 33% one year later. However, there is some survivorship bias in my method, as I only have a list of currently active stocks. Companies that went bankrupt are not included in this study. While the three-month performance shows a positive return of 3.76%, more than half of them are negative.
The table above probably does not give us the kind of clear-cut guidance we were hoping for, but this next table might be of a little more help. Obviously, the first metric we at Schaeffer's look at to distinguish stocks is sentiment. What I did was consider the stock's analyst ratings on the day it fell 20% or more. Based on this data, you can probably see why we're contrarians -- stocks with bearishly slanted analyst ratings clearly outperformed the others. If fewer than 40% of analysts had a "buy" on the stock, it averaged a gain of 11% in the next three months. If the percentage of "buys" was 70% or more, the stock averaged a slight loss three months later. The outperformance is significant over all time frames.
Recent Big Drops: Below are the stocks that met the criteria above which have suffered single-day drops of 20% or more since the beginning of June. Note that a couple of the stocks have already made back their huge losses, including Select Comfort (NASDAQ:SCSS) --despite a high "buy" percentage -- and Centene (NYSE:CNC). Meanwhile, New Oriental Education & Technology Group (NYSE:EDU) is on the table twice, as it crashed two days in a row. According to our analysis above, which shows bullish returns on stocks where the analysts are most bearish, CMG is the most attractive stock on the list below going forward.
This Week's Key Events: Facebook, Apple Fight for the Earnings Spotlight
Schaeffer's Editorial Staff
Here is a brief list of some of the key market 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 is light on Monday, featuring only the Chicago Fed's national activity index. On the earnings front, quarterly results are expected from McDonald's (MCD), Baidu (BIDU), Halliburton (HAL), Hasbro (HAS), Texas Instruments (TXN), VMware (VMW), and Zions Bancorporation (ZION).
Tuesday
- The FHFA home price index is due out on Tuesday, along with earnings from Apple (AAPL), AT&T (T), AK Steel (AKS), Altria Group (MO), Biogen Idec (BIIB), Broadcom (BRCM), Ctrip.com (CTRP), EMC Corp. (EMC), Juniper Networks (JNPR), Lockheed Martin (LMT), Netflix (NFLX), Peabody Energy (BTU), Regions Financial (RF), and Under Armour (UA).
Wednesday
- New home sales will hit the Street on Wednesday, as will the regularly scheduled report on crude inventories. On deck to report earnings are Boeing (BA), Caterpillar (CAT), Akamai Technologies (AKAM), AOL Inc. (AOL), Bristol-Myers Squibb (BMY), Citrix Systems (CTXS), Corning (GLW), Ford Motor (F), GlaxoSmithKline (GSK), Motorola Solutions (MSI), Nasdaq OMX Group (NDAQ), PepsiCo (PEP), RadioShack (RSH), Ryland Group (RYL), US Airways (LCC), Western Digital (WDC), and Zynga (ZNGA).
Thursday
- The economic agenda heats up on Thursday, with reports including weekly jobless claims, durable goods orders, and the pending home sales index. Meanwhile, earnings are on tap from 3M Company (MMM), Exxon Mobil (XOM), Facebook (FB), Amazon.com (AMZN), Amgen (AMGN), Boston Scientific (BSX), Colgate-Palmolive (CL), Consol Energy (CNX), Dunkin' Brands (DNKN), International Paper (IP), Moody's (MCO), New York Times (NYT), Potash Corp. of Saskatchewan (POT), PulteGroup (PHM), Sprint Nextel (S), and Starbucks (SBUX).
Friday
- Friday brings the advance reading on second-quarter gross domestic product (GDP), plus the final Thomson Reuters/University of Michigan consumer sentiment index for July. Wrapping up the week's slate of earnings are Chevron (CVX), Arch Coal (ACI), D.R. Horton (DHI), Helmerich & Payne (HP), Legg Mason (LM), Newmont Mining (NEM), and Weyerhaeuser (WY).
And now a few sectors of note...
Dissecting The Sectors
| | Sector | Leisure/Retail
Bullish |
Outlook: As 30-year mortgage rates sit near record lows and refinancing becomes more commonplace, retail and leisure names could benefit from an increase in discretionary spending. In fact, JPMorgan Chase recently reported that credit-card spending rose 10% sequentially in the second quarter, and 12% year-over-year. At the same time, the amount of outstanding loans decreased by 2%. In short, consumers are spending more, but carrying a lower collective balance. June same-store sales were reported on July 5 -- and while the results were mixed, price action in the sector was strong. From a sentiment standpoint, Wall Street has stubbornly low expectations for consumer-dependent stocks. In the restaurant sector, for example, only 52% of analysts' ratings are "buys," even though 68% of components are trading above their benchmark 200-day moving averages. Elsewhere in the leisure space, technical outperformers like Dick's Sporting Goods (DKS) and Under Armour (UA) are still being targeted by short sellers and put buyers. Taking a broader look, the Schaeffer's put/call open interest ratio (SOIR) for the SPDR S&P Retail ETF (XRT) is just 10 percentage points shy of an annual peak, at 6.00. In other words, puts outnumber calls by six-to-one among options due to expire in three months. On the charts, XRT is holding steady above its 40-day moving average, and resistance at its 80-day trendline appears to be weakening. This latter moving average, along with the $61-62 area, remains on our radar as a short-term point of concern. Overall, though, contrarians should continue to target scenarios where outperforming retail stocks remain underappreciated by the crowd.
| | Sector | Homebuilding
Bullish |
Outlook: The housing sector has seen some positive developments in 2012, as record-low mortgage rates have reignited interest in the real-estate market. The group got another shot in the arm last week, after a fresh batch of reports showed both the National Association of Home Builders (NAHB) housing market index and housing starts rising to multi-year highs. Within the group, D.R. Horton (DHI), Lennar (LEN), Meritage Homes (MTH), PulteGroup (PHM), and Toll Brothers (TOL) are some of our preferred names. LEN's recent breakout above congestion in the $30 area could be a positive signal as the SPDR S&P Homebuilders ETF (XHB) tries to overcome a technical foe of its own. The $22 level, which roughly coincides with a 50% retracement of the ETF's 2006 highs, has repeatedly emerged as resistance in 2012. On the flip side, we continue to watch support at the $19 level -- which corresponds with the site of XHB's 2011 high and its 160-day moving average, currently docked near $20. During the near term, a move below this region would be a point of concern. Investors may opt to hedge any long positions on homebuilding names with XHB puts. All of the aforementioned stocks -- DHI, LEN, MTH, PHM, and TOL -- sport substantial short-to-float ratios of 7.5% or greater, as well as a relatively high percentage of "hold" and "sell" ratings from analysts. With a healthy amount of pessimism already priced into these names, builders could benefit from a short squeeze or analyst upgrades as their performances continue to surpass the Street's low expectations.
| | Sector | Big-Cap Banks
Bearish |
Outlook: Amid ongoing regulatory and macroeconomic concerns, large-cap banks continue to display weak price action. The Financial Select Sector SPDR Fund (XLF) has been fighting a losing battle with its 80-day moving average, which has rejected all but one daily close since early May. We've been warning about the potential for sudden short-covering rallies in big-cap banks, and that scenario played out with a number of sector notables after earnings -- including Citigroup (C), JPMorgan Chase (JPM), Goldman Sachs (GS), and Wells Fargo (WFC). However, the positive momentum was short-lived, as each one of these stocks has already surrendered its event-related gains. Now that some of the weaker bearish hands have been shaken out of their positions, mega-cap banks have resumed their technical underperformance -- and it seems that the more confident bears are digging in their heels for a long stay. Meanwhile, sector peers Bank of America (BAC) and Morgan Stanley (MS) were punished outright after earnings, with the shorts finding little motivation to abandon their winning bets. In fact, overall, the nation's five largest banks -- C, BAC, GS, JPM, and MS -- recorded their weakest first-half revenue figures in four years, according to Bloomberg. Elsewhere, laggards like C and JPM are still sporting a preponderance of "buy" ratings from analysts, so a round of downgrades could apply further pressure to these struggling securities during the near 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. |
