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Schaeffers Monday Morning Outlook: Why Bulls Should Keep an Eye on SPX 1,260 Amid rising uncertainty, the S&P 500 Index is hovering near a key technical level
by Ryan Detrick 6/25/2011 12:29 PM

http://www.schaeffersresearch.com/commentary/observations.aspx?ID=106889&trackback=recapezine

After stringing together four straight days of gains, stocks started to come unglued Wednesday afternoon -- right around the time Fed Chairman Ben Bernanke was trying to explain to reporters what the central bank means by "an extended period of time." Despite a rather haphazard weekly performance by the major market indexes, key technical support levels remain intact as we head into the historically bullish month of July. In fact, Senior Technical Strategist Ryan Detrick wonders whether sentiment isn't tipped a little too far toward the "full-tilt panic" end of the spectrum, given the relatively modest pullback in the market. Meanwhile, as key indexes test their respective 200-day moving averages, Senior Quantitative Analyst Rocky White takes a closer look at the significance of this oft-cited trendline. Finally, we wrap up with a preview of the week ahead, as well as a few sectors of note.

Notes from the Trading Desk: Flashing Back to Summer 2010
By Ryan Detrick, Senior Technical Strategist

Are we having fun yet? After a brief four-day winning streak, we sold off the final three days of the week, as troubling news out of the euro zone dominated global trading. One day things are looking better in Greece -- then they aren't. Wait a day, and then the issue is with Italian banks. The market hates uncertainty, and with all the debt drama happening in Europe, there's more than enough uncertainty to go around.

Todd Salamone is out on vacation this week, so I'm stepping in to share my thoughts on the market. The last time I wrote Monday Morning Outlook, back in mid-May, I noted a few areas of technical resistance, as well as the potential for weakness in June. That scenario has played out, but all is not lost for the bulls here. In fact, taking a big-picture look at the market, you have to be rather impressed with the resiliency.

The S&P 500 Index (SPX - 1,268.45) has pulled back only about 8% from its early May peak. When you consider that this retreat comes on the heels of a more than 100% advance since March 2009, that pullback seems pretty acceptable. And when you reflect on just how poor the U.S. economic data has been over the past two months, along with the ongoing euro-zone debt issues -- the resilient price action is that much more impressive.

Technically speaking, the SPX is trading near strong support from its uptrending 200-day moving average, as well as its March 2011 lows.
Daily Chart of SPX since May 2010 With 200-Day Moving Average



Speaking of those March lows... that area also coincides with the SPX's year-to-date breakeven level, as Todd has noted in recent weeks. Add it all up, and the 1,260 region is a critical area to watch as near-term support.

On the sentiment front, numerous indicators are displaying the kind of heavy-handed pessimism that has coincided with previous buying opportunities. Now, this doesn't count for much until the overall price action improves -- but it does suggest we have some wood for the fire should we start to bounce.

For starters, investors continue to take money out of domestic mutual funds at a near-record pace. According to the Investment Company Institute (ICI), there are now net outflows of nearly $4 billion from domestic mutual funds for the year. In fact, more than $12 billion has been yanked out during the past two weeks alone! This level of panic is consistent with recent market bottoms.

Remember, we'd already seen three straight years of equity mutual fund outflows before 2011 even started. Four straight years would be unheard of, especially when you consider some of the amazing gains we've seen during this same time frame. The sad truth is, there have been two constants during this bull market: One, higher prices; and two, the retail crowd has missed out on most of the rally. With retail-level investors bailing on stocks once again, do you really expect the rally to stop now?

Elsewhere, the Investors Intelligence poll is nearing levels of skepticism consistent with past bottoms. The difference between bulls and bears is currently less than 10%. As you can see below, this is nearing the critical 0% area that has marked previous buying opportunities.

II Bulls & Bears with OEX


Our analysis of the options markets suggests that negative sentiment continues to dominate, as evidenced by the 20-day buy-to-open put/call volume ratio for the SPDR S&P 500 ETF (SPY), PowerShares QQQ Trust (QQQ), and iShares Russell 2000 Index Fund (IWM). As Todd has often noted, this ratio tends to move higher when fund managers are accumulating equities, as they purchase puts on broad-focused exchange-traded funds (ETFs) to hedge their long stock positions. This indicator has correctly nailed the recent weakness in the market, and it's currently docked at its lowest level since July 2009. This rock-bottom reading suggests there is plenty of cash on the sidelines to push the market higher very quickly, once these deep-pocketed players return to accumulation mode.
20-Day BTO P/C Ratio for SPY, QQQ, IWM


Finally, check out the strong historical performance of the SPX during the month of July in recent years. Sure, a good deal of this bullish price action is probably a direct result of how bad June has been, but it's reassuring nevertheless as we head into a new month.
SPX Performance by Month



All in all, I see some definite similarities between the current market situation and the summer of 2010. Think back to a year ago: We were in the midst of an 18% correction that took nearly three months to fully form. During that time, we were greeted with a brief economic slowdown at home in the U.S., while euro-zone debt issues continued to fester -- sparking concerns about the long-term life expectancy of the common currency. Not that much different than now, is it?

The only difference is, we have seen much more technical resilience this time around, and I think this is a sign that Mr. Market wants to continue higher. Don't follow the rest of the retail crowd by panicking in the face of bearish headlines. Overall, the price action remains strong, and sentiment continues to be downright dire. This doesn't mean we'll go straight up from here, but it does suggest that the overall uptrend is still alive and well.

Best of luck in your trading.

Indicator of the Week: The 200-Day Moving Average
By Rocky White, Senior Quantitative Analyst

Foreword: The S&P 500 Index (SPX) was pretty much flat again for the second straight week, after declining for six consecutive weeks before that. Now, the index is sitting right on top of its 200-day moving average -- which will hopefully act as support, so this market can regain some traction and move higher once again. With the benchmark index perched squarely atop this closely watched trendline, it's not too surprising to find that roughly half of all stocks in our database are above their respective 200-day moving averages, and roughly half are below. The data is pretty interesting, though, when you look at the results by sector, and then throw some sentiment stats into the equation.
SPX with 200-Day Moving Average


200-Day Moving Averages: Below is a chart of the SPX, along with the percentage of all stocks in our database that are above their 200-day moving average. Over the last several weeks, the percentage has fallen from above 80% to right around 50%. It's intriguing to look at this chart and realize that, at the market's 2007 peak, the percentage of stocks never rose above 80%. Also, that number started plummeting even before the market crash. In fact, the percentage of stocks above their 200-day trendline was falling below 50% just as the market was peaking. At the beginning of 2008 -- after the peak, but before the violent crash -- less than 40% of stocks were above their 200-day moving average.

The last time this indicator fell below 50% was soon after the May 2010 "flash crash." The market quickly found a bottom at that point, and rallied strongly for the next several months.
SPX with Percent of Stocks Above 200-Day MA


By Sector: While 50% of all stocks are above their 200-day moving average, this parity is not consistent across all sectors. The percentage of equities above this trendline are broken down by sector in the table below. The sectors with the most stocks above their 200-day moving average are at the top of the table, and those with the least are at the bottom. I also show the percent of analyst "buy" rankings on each group. It's worthwhile to note where there's a dichotomy between the price action and the analyst rankings -- such as stocks which have held up well during the downtrend, but still have a small number of "buy" ratings from analysts (and vice versa).

Notice the top three sectors in terms of price action (restaurants, food/beverages/soaps, and utilities) each have less than 50% "buy" recommendations. The other sector that sticks out at the top of the table is real estate, with 70% of those stocks above their 200-day moving averages, but only 40% "buy" ratings from analysts. At the bottom of the table, the clear outlier is precious metals. Only about one-quarter of sector components currently sit above their 200-day moving averages, yet 63% of analysts give those stocks a "buy" rating.

Remember, our Expectational Analysis® methodology looks for situations where the price action is positive, but the sentiment is pessimistic -- or, on the flip side, the price action is negative while sentiment is optimistic. If these current price trends continue, it leaves a lot of room for multiple upgrades in the outperforming sectors, and multiple downgrades in the underperforming sectors. That could translate into big moves for those stocks, and big profits for investors anticipating those moves.
Breakdown by Sector


This Week's Key Events: Consumer Sentiment in the Spotlight
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 economic calendar kicks off with the Chicago Fed's manufacturing index, as well as the Census Bureau's report on personal incomes and spending for May. Nike (NKE) and Standard Microsystems (SMSC) are expected to report earnings.

Tuesday

*

The S&P/Case-Shiller home price index for April will hit the Street on Tuesday, accompanied by the Conference Board's consumer confidence index and the Richmond Fed's manufacturing index for June. Quarterly earnings are due out from Progress Software (PRGS), Sealy Corp. (ZZ), and Shaw Group (SHAW).

Wednesday

*

Wednesday features the regularly scheduled report on domestic petroleum inventories, along with a double dose of housing data: May's pending home sales and the weekly MBA mortgage applications index. The earnings calendar heats up with reports from Acuity Brands (AYI), Family Dollar Stores (FDO), General Mills (GIS), KB Home (KBH), Lindsay Corp. (LNN), and Monsanto Co. (MON).

Thursday

*

Weekly jobless claims are on the day's docket, and traders will also eye the Chicago purchasing managers index (PMI) for June. Apollo Group (APOL), Constellation Brands (STZ), Darden Restaurants (DRI), Schnitzer Steel Industries (SCHN), Smith & Wesson (SWHC), and Xyratex Ltd. (XRTX) will share the earnings spotlight.

Friday

*

The week wraps up with the ISM manufacturing index, the final Reuters/University of Michigan consumer sentiment index for June, May's construction spending report, and auto and truck sales for June. Rada Electronic Industries (RADA) is slated to report earnings.

And now a few sectors of note...

Dissecting The Sectors
Sector
Leisure/Retail
Bullish

Outlook: Following a string of disappointing employment reports early in the month, consumer discretionary stocks received a much-needed shot in the arm in mid-June after the Commerce Department revealed a smaller-than-expected decline in May retail sales. From a technical standpoint, the SPDR S&P Retail ETF (XRT) remains in a longer-term uptrend. The major market indexes are hovering near breakeven on a year-to-date basis, but XRT is up 7.4% since the start of 2011. The fund recently bounced from support in the $50 region -- near the site of its rising 160-day moving average -- and managed to gain 2.7% amid last week's lackluster broad-market action. One concern would be a recent roll-over in the fund's 50-day buy-to-open put/call volume ratio, as put buying has been consistent with technical strength in the sector. As a result, exposure to the group should be limited to a few choice outperformers. A couple of equities we favor include AutoZone (AZO) and Green Mountain Coffee Roasters (GMCR), both of which are trading above familiar technical support levels. Despite the positive price action, GMCR has been targeted by speculative put buyers and short sellers, while AZO's analyst ratings are skewed toward the bearish end of the spectrum. Another strong contrarian candidate is Bed Bath & Beyond (BBBY), which gapped higher after reporting surprisingly strong earnings this past week. As these equities continue to outperform, a shift in sentiment toward the bullish camp could contribute to additional upside.
Sector
Gold
Bullish

Outlook: It was a bumpy ride lower for gold during the first several weeks of May, thanks to a widespread commodities sell-off and news of a high-profile investor unloading his stake in the popular "safe haven" investment. However, a recent report revealed that investment demand for gold in China surged to 90.9 metric tons during the first quarter, establishing the emerging market as the world's top buyer of the precious metal. Amid constantly simmering inflationary concerns, ongoing sovereign debt drama in Europe, and economic reports signaling a rough patch in the U.S. recovery, it seems that the fundamental backdrop still supports a bullish case for gold. In fact, the SPDR Gold Trust (GLD) has held up remarkably well in the face of a resurgent dollar. The shares broke below support at their 40-day moving average last week, but GLD found a floor near $146. The July 146 strike is home to heavy put open interest of 24,567 contracts, with another accumulation of 48,080 contracts located at the July 145 put. Going forward, these out-of-the-money puts could create a layer of options-related support for the fund. Plus, GLD's 50-day buy-to-open put/call ratio continues to turn higher from its near-term lows. In recent years, similar rebounds in this ratio have coincided with periods of bullish price action for the ETF.
Sector
Large-Cap Tech
Bearish

Outlook: Big-cap tech continues to suffer, thanks in part to a string of weak earnings reports from the likes of Research In Motion Limited (RIMM), Oracle (ORCL), and Micron Technology (MU). Within the group, Dow component Cisco Systems (CSCO) is one of the most high-profile underperformers. Many Wall Street pundits cited the stock as a "bargain" following a bearish gap in February -- but the stock has since tumbled to a string of new multi-year lows. With only 1.1% of CSCO's float sold short, and 12 analysts still doling out a "buy" or better rating on the shares, the tech giant could be vulnerable to a capitulation by the remaining bulls. Likewise, fellow Dow member Microsoft (MSFT) is sitting on a hefty year-to-date loss of 11.8%, yet 66% of brokerage firms maintain an optimistic rating on the stock -- opening the door for potential downgrades in the event of continued technical weakness. Even more compelling, the PowerShares QQQ Trust (QQQ) recently broke below its 200-day moving average, and this trendline is now threatening to switch roles to act as resistance. Plus, the fund's 50-day buy-to-open put/call volume ratio has rolled over from its recent peak, which could be a sign that big-money players are no longer accumulating shares.
Sector
Financials
Bearish

Outlook: In the current environment of declining interest rates and free-falling home prices, there's just not much to like about financial stocks at the moment -- particularly with sector stalwarts such as Goldman Sachs (GS) and Morgan Stanley (MS) still facing regulatory probes and legal battles dating back to the 2008 market crash. Elsewhere within the sector, Bank of America (BAC), Citigroup (C), and Wells Fargo (WFC) were hit with a downgrade warning from Moody's earlier this month, due in part to lingering uncertainty over the potential ramifications of increased regulation and oversight by the Fed. Nevertheless, there's been a flurry of bullish media coverage on the banking sector during the past several weeks, with the general consensus being that major financial firms are alluringly "cheap" at the moment. Indeed, many of the best-known names within the group, including B of A, Citigroup, Goldman, and Wells Fargo, are sitting on double-digit percentage losses for 2011. JPMorgan Chase (JPM) has also dropped into negative territory for the year, extending a months-long swoon on the charts. Checking out the sentiment backdrop, the 50-day buy-to-open call/put volume ratio for the Financial Select Sector SPDR (XLF) has turned higher lately, which has had bearish implications for the group in the past. Plus, data from Zacks indicates that 58% of analyst ratings on finance stocks are of the "buy" or better variety, despite the dismal price action. Going forward, these underperforming bank stocks look vulnerable to additional downside as this remaining optimism is shaken out.