Protecting Your Portfolio Amid 'Cliff' Uncertainty
How will the SPX fare during Thanksgiving week?
by Todd Salamone 11/17/2012 11:15:49 AM
Stocks spent most of the week swimming in red ink, thanks to escalating uncertainty about the looming "fiscal cliff." However, signs of bipartisanship brought a few buyers from the sidelines on Friday, with congressional leaders calling initial negotiations "constructive." As Todd Salamone notes, purchasing options "insurance" might help the bulls sleep better at night, as will keeping a close watch on potential support for the S&P 500 Index (SPX). Meanwhile, Rocky White takes a walk down memory lane, and explains why the selloff thus far in November could have bearish implications this week.
- Levels of potential support to watch on the major indexes
- Why a Monday pop could be in the cards
- A history lesson on Thanksgiving week returns
Finally, we wrap up with a preview of the major economic and earnings events for the week ahead, plus a featured sector to watch.
Notes from the Trading Desk: Levels to Watch This Holiday Week
By Todd Salamone, Senior V.P. of Research
"Last week's decline could have been exacerbated by a bearish 'call unwind, put delta hedge,' as the large put strikes act as magnets once momentum picks up to the downside. If Friday's stability holds through early next week, the opposite (bullish) mechanics could be in play -- a bullish put unwind that drives the market significantly higher. That said, should the market weaken, a visit to SPX 1,350 (or SPY 135), would not be surprising. Short-term traders should be prepared for both scenarios."
- Monday Morning Outlook, November 10, 2012 "$SPX don't be surprised if we pop Monday morning, given some of this week's selling was expiration-week/delta-hedge related"
- @ToddSalamone, Twitter, Friday, November 16, 2012 Last week, we discussed the November open interest configuration on the SPDR S&P 500 ETF Trust (SPY - 136.37), and left open the possibility that a move down to the 135 area could be in the cards, with the comment that short-term traders should be prepared for a bullish unwind or a continued delta-hedge decline, down to the 135 strike on the SPY. It turned out that the latter scenario played out, with Friday's low around the 135 strike -- host to the largest out-of-the-money put open interest in the November series going into last week's trading, one of several strikes that would act as a magnet during a delta-hedge decline, and the strike most likely to be defended. Combine this with the fact that the SPY 135 area represents a former area of resistance in 2011, and is theoretically a key round number (coincides with 1,350 on the S&P 500 Index), and the ingredients were in place for a potential move to this strike by Friday's expiration.
Admittedly, there was a catalyst for the Friday reversal from the morning lows, as news came out that Democrats and Republicans were making progress on budget talks, an uncertainty that has cast doubt among many market participants, particularly after the November elections. As these talks progress, be on the lookout for various headlines surrounding the "fiscal cliff" negotiations to move markets one way or the other.
Absent any major negative news this weekend, we would not be surprised to see a Monday morning pop, as the S&P 500 Index (SPX - 1,359.88) is oversold and, if indeed some of last week's selling can be attributed to a delta-hedge decline, the dearth of this delta-hedge selling can be further supportive. We find it intriguing that May 2012 expiration week followed a very similar script (delta-hedge decline), as the 14-day Relative Strength Index (RSI) reached an oversold reading of 23 ahead of a Monday morning pop higher. This past week, the 14-day RSI reached an oversold 26 reading. The risk in using an oversold indicator is that oversold can stay oversold, and right now the primary short-term trend is lower.
We see other similarities that might suggest a Monday pop is on the horizon. For example, at the end of May expiration week, the SPX came into the new trading week sitting on the late-October 2011 peak at 1,280 (the dashed horizontal line on the chart below). This week, the SPX finds itself sitting in the area of various 2011 calendar-year highs (solid line on chart below). As a "for what it's worth," the 1,347 low on Friday marks a 61.8-percent Fibonacci retracement of this year's June low and September high.
With the uncertainty regarding the imminent "fiscal cliff," the question on everyone's mind is, "Is the worst behind us in regards to the action during the past few weeks?" From a technical perspective, we think the SPX's 2011 highs in the 1,340-1,350 area must hold, even if this is part of a basing process instead of a "V"-type rally. If not, we are at risk of a move down to the June low in the 1,280 area.
From a sentiment perspective, we are seeing some signs that fear is reaching an extreme among market participants. For example:
1. The most recent American Association of Individual Investors (AAII) poll is showing the most bearish reading since the August 2011 bottom, suggesting those retail players that are actively engaged are not feeling good about the market's prospects.
2. Equity option buyers, who grew optimistic right ahead of the election, are downright pessimistic, as the five-day put/call volume ratio is trading around extreme lows.
3. Total short interest on SPX components remains just below the levels of this time last year, which means the short-covering play is still intact. The caveat here is the shorts are feeling a lot less pain now than a few weeks ago, so the urge to cover is not as great now.
Notice above that I bolded the word "some." I did this because we are not seeing extremes in negative sentiment in the National Association of Active Investment Managers (NAAIM) survey -- not like extremes that have marked past bottoms. Note that these investors were extremely bullish at the top, and many seem to be holding on to this view. This is a risk to the bullish case.
We remain bullish, and one way to manage the bullish view is the purchase of exchange-traded fund (ETF) puts, as the CBOE Market Volatility Index (VIX - 16.41) has remained low, and it's still below the area that is 50% above the 2012 low. With SPY 20-day historical volatility around 15%, at-the-money put options expiring Dec. 22 are reasonably priced at around 17% implieds. Such insurance may allow you to better sleep at night as discussions in Washington proceed.
Indicator of the Week: Thanksgiving Week
By Rocky White, Senior Quantitative Analyst
Foreword: It's Thanksgiving week. We know to expect some pretty low volume during the four-day trading week, but what can we expect as far as returns? This week I'll look at the last 20 years to see how the market has behaved, and I'll also find some stocks that tend to do well during the holiday week.
Thanksgiving Over the Past 20 Years: The table below gives a quick summary of how the S&P 500 Index (SPX) has performed during Thanksgiving week over the past 20 years. In a nutshell, the index logs a higher average return, but the median return is lower while the percent positive is the same.
In this next table, I broke down those 20 returns depending on how the market was doing for the month of November when heading into the week. The market is currently down around 4% for the month. This does not bode well for this week. While the average return is higher if November is negative heading into the week, that's mainly because of one very large return during the very volatile time in late 2008, when the SPX was down 17% heading into Thanksgiving week. The market gained 12% the week of Thanksgiving that year. Take out that return and the index averages a loss of 1.25%. However, even including that return, the median return is a 1.24% loss, with only three of the seven returns positive.
By Day of the Week: I broke down the Thanksgiving week returns by weekday. Thursday, of course, isn't a trading day. As you can see below, the week typically gets off to a slow start. Monday is the only day of the week that is positive less than half the time, and then Tuesday is the only day that averages a negative return. The day before Thanksgiving and the day after have been pretty bullish, each averaging a gain of more than 0.2% and both have been positive 65% of the time. I also show typical returns for each day of the week, for comparison.
Individual Stocks: Finally, here's a table showing which stocks have done well during the past 10 Thanksgiving weeks. Those top six stocks (bolded) have been positive during the week in nine of the last 10 years. The rest are the ones with the best average return that have been positive eight times.
There aren't any turkey producers on the list, but there are quite a few retail names and apparel companies, as well as Apple Inc. (AAPL). Maybe those are investors buying up stocks they expect to have a strong Christmas season?
This Week's Key Events: Housing Data and the Thanksgiving Holiday
Schaeffer's Editorial Staff
Here is a brief list of some key market events scheduled for the upcoming 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 holiday-shortened week kicks off with existing home sales and the National Association of Home Builders (NAHB) housing market index. Wall Street can expect earnings reports from Agilent Technologies (A), Lowe's Companies (LOW), Brocade Communications Systems (BRCD), Urban Outfitters (URBN), and Tyson Foods (TSN).
Tuesday
- Tuesday's economic docket includes housing starts and building permits. Also, Fed Chairman Ben Bernanke is on deck to speak at 12:15 pm EST. Elsewhere, investors will have the chance to digest earnings results from Hewlett-Packard (HPQ), Salesforce.com (CRM), Best Buy (BBY), Campbell Soup (CPB), H.J. Heinz (HNZ), and Medtronic (MDT).
Wednesday
- Weekly jobless claims, the Conference Board's index of leading economic indicators, and the final reading of the Thomson Reuters/University of Michigan consumer sentiment index for November will hit the Street on Wednesday, along with the regularly scheduled crude inventories report. Meanwhile, Deere & Company (DE) will be stepping up to the earnings plate.
Thursday
- The market is closed on Thursday in observance of Thanksgiving.
Friday
- There are no major economic reports scheduled for Friday, nor are there any notable earnings results due for release. The equity and options markets will close at 1:00 p.m. EST.
And now a sector of note...
Gold
Bullish
We continue to view the gold space as an area poised for continued upside, as investors and speculators target higher prices in the yellow metal and seek opportunities outside of traditional equities. Since Aug. 1, the SPDR Gold Trust (GLD) has gained roughly 7%, while the broad-market SPDR S&P 500 ETF (SPY) is slightly lower during the same time period. In the past 20 days, on a relative-strength basis, GLD has trumped the broader S&P 500 Index (SPX) by nearly six percentage points. Although the gold ETF retreated slightly this past week, it remains solidly above its 320-day moving average following a successful test of this support early last week. The ETF and this trendline have some history, as the 320-day marked a key bottom in late December 2011, then switched roles to provide short-term resistance this past June. In sentiment news, buy-to-open option volume has been increasing of late, which has historically been a good sign for the yellow metal. Since Nov. 1, in fact, volume has surged by 33%. As overall option activity builds, it's a sign that bulls are in accumulation mode and using GLD calls to speculate on higher prices and/or GLD puts to hedge a long futures position.
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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