Central Banks Could Hold the Cards This Week
Could today's underperformers by tomorrow's broad-market standouts?
by Todd Salamone
7/28/2012 9:40:54 AM
The bulls proved victorious yet again last week, as encouraging developments in Europe overshadowed lackluster earnings from the tech sector. However, as Todd Salamone points out, investors' appetite for risk could increase even more this week, should global central-bank moves pan out in the bulls' favor. Meanwhile, Rocky White examines the conventional wisdom to stay away from equities that sit out major market rallies -- and the results might surprise you. Finally, we preview this week's notable economic and earnings events, and check out a few sectors of note.
Notes from the Trading Desk: News from Europe Could Jolt Stocks Out of Their Trading Range
By Todd Salamone, Senior VP of Research
"Within our mandate, the ECB is willing to do whatever it takes to preserve the euro and, believe me, it will be enough."
- European Central Bank (ECB) President Mario Draghi, July 26, 2012 "Spanish and Italian bond markets rallied yesterday as investors cheered Draghi's signal that the ECB is prepared to intervene to reduce soaring yields. Now he has to deliver, or face deep disappointment on financial markets, analysts said. The risk in doing so is alienating key policy makers on the ECB council, such as Bundesbank President Jens Weidmann. The Bundesbank reiterated its opposition to bond purchases today."
- Bloomberg, July 27, 2012 "Going back to early June, the SPX has grinded higher in a very choppy fashion ... staring at resistance from the 2011 calendar-year high ... support at 1,333 -- double the March 2009 low and a 38.2% retracement of the June low and July high..."
- Monday Morning Outlook, July 14, 2012 "Since April, we've seen a huge spike in short interest on all optionable stocks ... 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 ... In conclusion, the odds of higher prices are still very good right here."
- Monday Morning Outlook, July 21, 2012 Well, finally some news out of Europe that's a little easier to digest. In addition to the Opening Ceremonies and the arrival of the 2012 Summer Olympic Games in London, ECB President Mario Draghi sent a signal that bold action may be taken by the ECB to stabilize the euro -- a message market participants have long been waiting for in the midst of the continuing European sovereign-debt crisis. So, as athletes from around the world battle it out during the coming weeks, the brutal competition between bulls and bears since April -- which has essentially resulted in a stalemate -- may take on a new twist.
The S&P 500 Index (SPX - 1,385.97) roared higher on Draghi's remarks, and broke north of the roughly 40-point range -- between the 1,333 area (double the March 2009 low) and the area just above 1,370 (2011's calendar-year high) -- it's been exploring since mid-June. While this is encouraging, we've had a few "fake-out" moves above 1,370 that eventually reverted this month, so we'll continue to watch this level. But, as the Bloomberg excerpt above describes, all eyes will be on the ECB meeting next Thursday -- which could be a catalyst that dictates a move out of the short-term range, in one direction or the other, depending on the outcome.
With support on the SPX holding in the 1,333 area last week, another encouraging sign for the bulls was the CBOE Market Volatility Index's (VIX - 16.70) failure to topple the area that is 50% above this year's intraday and closing lows of 13.66 and 14.26, respectively. This resistance area is between 20.44 and 21.39, and, as you can see on the chart below, the VIX failed to overtake this region before falling back below the round-number 20 strike late in the week. We have talked about the importance of this neighborhood in the past, and continue to view it as significant.
Turning to option activity on the VIX and major exchange-traded funds (ETFs) like the SPDR S&P 500 ETF (SPY - 138.68), PowerShares QQQ Trust (QQQ - 64.87) and iShares Russell 2000 Index ETF (IWM - 79.32), we are observing major call activity on VIX options, amid little put activity on the SPY, QQQ and IWM. Our takeaway on this light put activity on equity-based ETFs is that hedge funds remain underweight, and the fact that this group is not in accumulation mode could be why the market has struggled in recent months. The good news for the bulls is that equities have been relatively resilient, despite a lack of a major bid from the hedge-fund players.
Moreover, as you can see in the chart immediately below, the surge in the VIX's 20-day buy (to open) call/put volume ratio has been coincident with a decline in equities. In prior instances when this ratio trended higher, equities coincidentally rose, and our interpretation was that hedge funds were using VIX calls to hedge equity long positions they were accumulating. This pattern has changed, and we view the rise in the VIX call/put volume ratio as a sign of speculative bets against the market. In other words, we believe speculators are purchasing VIX calls in anticipation of profiting from a sell-off in equities that drives VIX futures higher. This interpretation is certainly consistent with the build-up in short interest in recent months, as noted by Ryan Detrick in last week's Monday Morning Outlook. We find this interesting, as any unwinding of these bearish speculative bets could be supportive of equities. Furthermore, a rollover in this ratio could have bullish implications, as it could signal more short-covering.
In conclusion, we remain bullish, as expectations are low, which sets up a favorable risk/reward environment for the bulls. Short-term traders should be aware that we are at the top of the recent range, and should have exposure to both a breakout and a failure at resistance. The sentiment backdrop suggests a breakout above the range could drive a sustainable rally, with the outcome of the ECB meeting next week a potential catalyst.
Indicator of the Week: Stocks Contrary to a Big Market Move
By Rocky White, Senior Quantitative Analyst
Foreword: Last week saw some big daily moves by the market, including four triple-digit gains (one of those was a 200-point day) from the Dow Jones Industrial Average (DJI - 13,075.66). One thing you often hear is that when the market makes a sizeable move in one direction, it's a sign for individual stocks that move in the opposite direction. For example, on a big down day, investors will often point to stocks that had gains and say their outperformance is a sign of strength. This week, I'm tracking individual stocks after big market moves to confirm or deny the assertion.
Stock Returns After Big Market Moves: I looked into this claim by going back to the beginning of 2011 and finding all days when the market fell at least 1.5%. Then, I tracked individual returns of S&P 500 Index (SPX - 1,385.97) stocks over different time frames following these big down days. The table below summarizes the returns of the stocks that were up on those big down days, and it also shows the summary of the other stocks for comparison.
As alluded to earlier, the conventional wisdom is that stocks that were up on those down days are showing strength, and should outperform other stocks. However, looking at the returns, I don't come to that conclusion. Across all time frames, the returns on the stocks that were up on those big down days are pretty much the same as those that were down. This is not to say the data is not useful; some traders may layer on other criteria or use it as a confirmation for a trade. But as a standalone indicator, this analysis does not show an edge that can be exploited.
Big Market Gains: The next chart really shoots down this theory. Here I do something similar to above, but I look at days when the SPX gained 1.5% or more. Then, I followed the stocks that were down on those days, and compared them to other stocks. The table below shows those stocks that were down actually outperformed the other stocks over the next month of trading, though that outperformance disappears when you go further out. This suggests that instead of being a sign of weakness, you might look to buy these stocks as they play catch-up with the others.
That being said, Friday was a great day for the markets, with the SPX gaining 1.9%. Below is a list of stocks in that index that were down that day. According to the analysis above, some of them should be offering some pretty good buying opportunities.
This Week's Key Events: Payrolls and Central Banks In Focus
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 agenda is relatively light, with manufacturing data from both the Chicago Fed and Dallas Fed on tap. On the earnings docket are Cal-Maine Foods (CALM), CIT Group (CIT), Loews Corp. (L), Anadarko Petroleum (APC), Cirrus Logic (CRUS), Herbalife (HLF), Hologic (HOLX), Seagate Technology (STX), and Texas Roadhouse (TXRH).
Tuesday
- The Street will digest the latest personal income and spending stats, the Case-Shiller home-price index, the Chicago purchasing managers index (PMI), farm prices from the Department of Agriculture, and the monthly consumer confidence report. Among the companies on the earnings docket are Pfizer (PFE), Aetna (AET), Archer-Daniels Midland (ADM), BP plc (BP), Coach (COH), Deutsche Bank (DB), Goodyear Tire & Rubber (GT), U.S. Steel (X), Allstate (ALL), Career Education Corp. (CECO), DreamWorks Animation (DWA), Electronic Arts (EA), Papa John's International (PZZA), Take-Two Interactive Software (TTWO), True Religion Apparel (TRLG), and WebMD (WBMD).
Wednesday
- The economic calendar is packed with the regularly scheduled crude inventories report, the Mortgage Bankers Association (MBA) mortgage index, July's auto and truck sales, the latest construction spending figures, and the Institute for Supply Management (ISM) manufacturing index. However, all eyes will likely be on the Automatic Data Processing (ADP) employment report – typically viewed as a precursor to the government's payrolls data – and the Federal Open Market Committee (FOMC) policy statement. Reporting earnings are Avon Products (AVP), Boston Beer Company (SAM), Burger King (BKW), Comcast (CMCSA), Garmin Ltd. (GRMN), Harley-Davidson (HOG), Intrepid Potash (IPI), Marathon Oil (MRO), MasterCard (MA), Owens Corning (OC), Overseas Shipholding Group (OSG), Prudential Financial (PRU), Time Warner (TWX), Transocean Ltd. (RIG), Weight Watchers International (WTW), and Yelp Inc. (YELP).
Thursday
- Employment data will remain in the spotlight, with initial and continuing jobless claims – as well as factory orders for June – slated for release. In addition, all eyes will be on Europe and the European Central Bank (ECB) meeting. In the earnings spotlight will be Kraft Foods (KFT), General Motors (GM), Clorox (CLX), Diana Shipping (DSX), DirecTV (DTV), Duke Energy (DUK), hhgregg (HGG), Kellogg (K), Lear (LEA), Monster Worldwide (MWW), OfficeMax (OMX), Plains Exploration & Production (PXP), Teva Pharmaceuticals (TEVA), Activision Blizzard (ATVI), Blue Nile (NILE), CBS Corp. (CBS), LinkedIn (LNKD), OpenTable (OPEN), Sunoco (SUN), ZAGG Inc. (ZAGG), and Zipcar Inc. (ZIP).
Friday
- The economic calendar wraps up with a bang, as traders will hone in on the Labor Department's highly anticipated nonfarm payrolls report and unemployment figures for July, as well as the ISM services index. On the earnings front, we'll hear from Procter & Gamble (PG), Agrium (AGU), Beazer Homes (BZH), and NYSE Euronext (NYX).
And now a few sectors of note...
Dissecting The Sectors
| | Sector | Leisure/Retail
Bullish |
Outlook: June same-store sales were reported on July 5 -- and while the results were mixed, price action in the sector was strong. Meanwhile, despite three straight months of waning consumer spending, the SPDR S&P Retail ETF (XRT) has declined only slightly, implying that expectations for retailers are already low. In fact, we've noticed a pattern of slight dips on poor macro-economic news, and large advances on encouraging macro news, pointing to an appealing risk/reward set-up for this group. On the charts, XRT is holding steady above support in the $56 area, home to its July 2011 peak, while 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. In the restaurant sector, for example, only 51% of analysts' ratings are "buys," even though the majority 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) -- the latter of which recently reported solid quarterly earnings and upped its full-year sales forecast -- are still being targeted by short sellers and put buyers. As the skeptics capitulate to the bulls' club, these under-loved names could enjoy contrarian boosts.
| | 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, thanks to encouraging earnings reports from sector components PulteGroup (PHM) and Meritage Homes (MTH), both of which soared to multi-year highs. What's more, even an earnings miss from Ryland Group (RYL) resulted in just a modest pullback. Some of our other preferred names in the group include D.R. Horton (DHI), Toll Brothers (TOL), and Lennar (LEN), the latter of which recently broke out above congestion in the $30 area. This technical feat 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 is roughly half the "since inception" price of the XHB, 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. Meanwhile, another homebuilding ETF we monitor is the iShares Dow Jones U.S. Home Construction Index Fund (ITB), which pulled back to around $16 last week. This level marks the fund's April 2010 peak, and also coincides with double the October 2011 low. The $17.80-$18 region is also another area to keep an eye on, as it represents a 50% year-to-date gain for the ITB. All of the aforementioned stocks -- DHI, LEN, MTH, PHM, TOL, and RYL -- sport substantial short-to-float ratios of 10% 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 nearly all daily closes since early May. That said, there has been some choppiness in the group of late, with the XLF's 320-day moving average emerging as support early last week. This trendline currently resides in the $14 neighborhood, which corresponds to heavy put open interest at the August 14 strike, home to more than 135,000 puts outstanding. Going forward, short-term traders should be cautious of potential put-related support for XLF. Among sector components, Citigroup (C), JPMorgan Chase (JPM), and Goldman Sachs (GS) have gained little-to-no ground since reporting earnings, despite an unwinding of short interest. This suggests some of the weaker bearish hands have hit the exits, while the more confident bears are digging their heels in for a long stay. Meanwhile, Bank of America (BAC) and Morgan Stanley (MS) were punished outright after earnings, with the shorts finding little motivation to abandon their winning bets. And speaking of earnings, 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. Nevertheless, laggards like C, JPM, MS, and Wells Fargo (WFC) 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.
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