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Sunday, July 31, 2011 5:29:05 PM
Monday Morning Outlook: Indexes Test Support Ahead of Historically Humdrum August
What recent option trends reveal about sentiment on Wall Street
by Todd Salamone 7/30/2011 11:16 AM
http://www.schaeffersresearch.com/commentary/content/monday+morning+outlook+indexes+test+support+ahead+of+historically+humdrum+august/observations.aspx?click=home&ID=107367
"Downgrade" and "default" were among the buzzwords swarming Wall Street this week, as all eyes were on Capitol Hill ahead of the Aug. 2 deadline to up Uncle Sam's debt ceiling. The lack of a bipartisan resolution fueled concerns about a possible default, as well as the potential loss of the U.S.'s coveted triple-A credit rating. And while President Obama spoke of both compromise and vetoes, politics – rather than the fiscal health of the federal government – seemingly took precedence. The party divide was further evident as House Speaker John Boehner and Senate Majority Leader Harry Reid pushed their own legislative agendas – to no avail – leaving Wall Street, and the world, in limbo heading into the weekend. As a result, and with help from some uninspiring economic data, the Dow Jones Industrial Average (DJIA) capped off its worst week in more than a year, while the CBOE Market Volatility Index (VIX) skyrocketed more than 40% from the prior Friday.
Against this backdrop, Todd Salamone examines the recent options activity on the major indexes, and what a continuation of these trends could mean for the bulls. Furthermore, he outlines a few potential support levels to watch this week, and analyzes how the current sentiment environment could be a contrarian hindrance in the event of the worst-case scenario: a U.S. debt default. Meanwhile, Rocky White takes an historical look at the S&P 500 Index's (SPX) August-September price action, and how the broad-market barometer tends to fare when investment advisors are bullish. Finally, we wrap up with a preview of the week ahead, as well as a few sectors of note.
Notes from the Trading Desk: Hedging Activity Accelerates Amid U.S. Debt Uncertainty
By Todd Salamone, Senior VP of Research
"The SPX has simply been trading in a 100-point range from about 1,260 to 1,360 since January. Overall, the powerful combination of low expectations, solid earnings, modest valuations, and strong price action remains firmly in place. For the time being, we could very well continue to trade in that aforementioned 100-point range on the SPX -- but longer-term, the odds highly favor an eventual breakout and a strong year-end rally."
"We've noticed the media picking up on some bearish chart formations. Few contrarian indicators are more powerful than this. As we've noted time and time again, once the media starts talking about bearish technical analysis patterns, it could be time to get long...this past week, we saw dire warnings about bearish head-and-shoulders patterns, as well as 'island reversals,' being thrown around in the media. If the past two years have taught us anything, it would be to get ready for a rally soon."
-- Monday Morning Outlook, July 23, 2011 In just one week, the S&P 500 Index (SPX) went from the top to the near-bottom of the aforementioned trading range at Friday's lows. Weighing on Wall Street were growing concerns about a credit-rating downgrade and the possibility of a U.S. debt default, as well as disappointing economic reports on durable goods and second-quarter gross domestic product (GDP). And make no mistake, as stocks retreated, the warnings about a bearish head-and-shoulders formation picked up momentum.
Meanwhile, SPX put buying soared on Wednesday, as traditional fund managers apparently braced for a potentially negative outcome with respect to the ongoing budget battle in Congress. On Thursday, options activity on major exchange-traded funds (ETFs) hinted that some hedge funds may be accumulating short positions or selling long positions, as we noticed that the largest open interest changes included buy (to open) call activity on the iShares Russell 2000 Index (IWM), and put liquidations on both the PowerShares QQQ Trust (QQQ) and SPDR S&P 500 ETF Trust (SPY). The call activity would suggest the potential hedging of fresh short positions, while put liquidations would suggest the possibility of hedged players liquidating long positions as the outlook on a budget deal continued to look bleak.
Last week's option activity on those major ETFs once again created a roll-over in the combined 20-day buy (to open) put/call volume ratio that we closely follow. It's too early to tell if this is temporary or not, as this action was more than likely related to the uncertainty ahead of Congress's Aug. 2 deadline. The risk to the bulls is an extended decline of this ratio, which would suggest continued hedge-fund liquidations and/or increased shorting among hedge funds. The last time this ratio rolled lower from the spot of last week's peak (in March/April), the SPX corrected 7% from top to trough. At Friday's lows, the SPX had dropped about 4.5%.
Finally, retail investors continue to run for the hills, as weekly mutual-fund data showed fund investors withdrew cash from domestic funds for the 13th consecutive week, with $6.5 billion pulled in the latest week -- the largest weekly outflow since the $6.9 billion withdrawn at the June lows.
Speaking of the June lows... You might remember how some indexes bounced from their year-to-date breakeven points and/or their 200-day moving averages, as the European debt crisis was creating market jitters. In a potential replay of June, we find Friday's lows interesting in that:
The IWM's low was 78.14, just 0.1 point below its 2011 breakeven level of 78.24. Will 0% year-to-date support come into play again?
The S&P 400 MidCap's (MID) low was 928.45, just 8 points below its rising 200-day moving average, which is currently situated at 936.73.
The SPX's low was at 1,282.86, around the site of its 200-day moving average, which is at 1,284.90. Amid the bearish technical talk of late, will the index's 200-day trendline resume its role as support?
The Nasdaq Composite's (COMP) low was at 2,724.99, just 12 points below a 50% retracement of the June low and early-July high.
The Dow Jones Industrial Average (DJIA) never retreated below the 12,000 mark, with 12,083 marking Friday's intraday low.
From a contrarian perspective, the risk-reward set-up seems to favor the bulls, as fund managers and retail investors are preparing for a negative outcome with respect to the budget-deal talks. Furthermore, the discounting of a negative outcome occurs as major indexes continue to trade above key areas of support.
That said, whereas most investors appear to be discounting a credit-rating downgrade of U.S. debt – bipartisan deal or no deal -- it is also apparent that many market players are placing low odds on a U.S. default. Therefore, a default is not likely to be priced into the marketplace, and would be the biggest risk to the bulls at this stage in the game.
While we still feel that the risk-reward scales are tipped in the bulls' favor, one should allow for the possibility of support levels breaking, as the final panic may not yet be in place. If support breaks in the absence of a default, we'd be wary of selling into such a breakdown. The risk of doing so is a repeat of August 2010, when a highly-profiled "technical breakdown" created a crowded short trade that eventually morphed into an impressive year-end rally.
Our long model portfolio (Schaeffer's Master Portfolio) has exposure to gold, bonds and several consumer discretionary stocks that are highly shorted, unloved by Wall Street analysts, and displaying strong price action amid favorable earnings momentum.
Indicator of the Week: August and September Sentiment and Seasonality
By Rocky White, Senior Quantitative Analyst
Foreword: July is finally over -- which is good news, considering the S&P 500 Index (SPX) was off by more than 2.1%. It's now been three straight months of negative returns for the market, which hasn't happened since November 2008. Unfortunately, seasonality data may not offer much hope, either. Below, we'll take a look at how the market has typically performed during this time of the year. Looking at the first table, which shows monthly data for the SPX over the last 30 years, we find that August tends to be a very mediocre month. In fact, its 0.45% average return is the fourth lowest of all the months.
Two-Month Time Frames: The table below shows that September has historically been the worst month, on average, over the past 30 years. Therefore, when you look at two-month time frames, the August-September period shows the lowest average return. And while the median return and percent positive of this period aren't the lowest, they're still less than impressive compared to other time frames.
However, this bearish tendency has not been evident in the recent past. In four of the last five years, the August-September period has seen the SPX increase by at least 3.5%.
Investors Intelligence Sentiment Poll: Layering in some sentiment doesn't help paint a better picture for the market going forward, either. The Investors Intelligence (II) poll is a weekly sentiment poll that we follow closely. It polls investment advisors and determines the percentage that are bullish, bearish, or looking for a correction. Despite three straight months of negative returns, the II poll is showing a relatively high number of bulls for this time of the year.
Digging deeper, I looked at the percentage of pre-August bulls each year, and then looked at the return for August based on the percentage of bulls. To give you an idea on where we stand now, over the last 30 years, the percentage of bulls heading into August has averaged about 44% (the range was from 30% to 58%). In the latest poll, 49.5% of advisors were bullish (the next poll was taken last week, but does not get released until Wednesday).
Below shows the SPX's August returns based on the II poll, with three groups of 10 returns. The first column shows data for those years in which the poll was showing advisors to be most optimistic. The percentage of bulls in the poll ranged from 47% to 58% -- where our current reading would land us. As contrarians, we're not surprised to see this group underperform. In fact, the best returns are when the advisors are most pessimistic – but hopefully this is the year we can buck some of these seasonality trends.
This Week's Key Events: Wall Street Braces for July Jobs Data
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 ISM manufacturing index for July and construction spending for June. On the earnings front, we'll hear from Boston Properties (BXP), Loews (L), Allstate (ALL), Humana (HUM), Alkermes (ALKS), Changyou.com (CYOU), Ctrip.com International (CTRP), and Sohu.com (SOHU).
Tuesday
Tuesday brings the latest reports on personal incomes and spending, as well as auto and truck sales for July. Pfizer (PFE), Archer Daniels Midland (ADM), Marathon Oil (MRO), Marathon Petroleum (MPC), Coach (COH), General Growth Properties (GGP), Hyatt Hotels (H), Sirius XM Radio (SIRI), OpenTable (OPEN), and ValueClick (VCLK) are expected to report earnings.
Wednesday
Employment data starts to hit the Street Wednesday, when ADP releases its report on private-sector payrolls for July. Also on tap are the ISM services index, June's factory orders, and the usual report on weekly petroleum inventories. Quarterly earnings are due out from Clorox (CLX), MasterCard (MA), Comcast (CMCSA), Time Warner (TWX), Agrium (AGU), Intrepid Potash (IPI), GT Solar (SOLR), MEMC Electronic Materials (WFR), Tesla Motors (TSLA), and Zipcar (ZIP).
Thursday
Thursday's lone economic report is the regularly scheduled update on weekly jobless claims. American International Group (AIG), General Motors (GM), Kraft Foods (KFT), CBOE Holdings (CBOE), Priceline.com (PCLN), Southwest Airlines (LUV), Alpha Natural Resources (ANR), and A123 Systems (AONE) will share the earnings spotlight.
Friday
On Friday, all eyes will be on the Labor Department's nonfarm payrolls report for July. Later in the session, the Fed weighs in on June's consumer credit trends. The week's earnings calendar concludes with the latest quarterly results from Arch Chemicals (ARJ), Weight Watchers (WTW), Imperial Sugar (IPSU), Washington Post (WPO), and Viacom (VIA).
What recent option trends reveal about sentiment on Wall Street
by Todd Salamone 7/30/2011 11:16 AM
http://www.schaeffersresearch.com/commentary/content/monday+morning+outlook+indexes+test+support+ahead+of+historically+humdrum+august/observations.aspx?click=home&ID=107367
"Downgrade" and "default" were among the buzzwords swarming Wall Street this week, as all eyes were on Capitol Hill ahead of the Aug. 2 deadline to up Uncle Sam's debt ceiling. The lack of a bipartisan resolution fueled concerns about a possible default, as well as the potential loss of the U.S.'s coveted triple-A credit rating. And while President Obama spoke of both compromise and vetoes, politics – rather than the fiscal health of the federal government – seemingly took precedence. The party divide was further evident as House Speaker John Boehner and Senate Majority Leader Harry Reid pushed their own legislative agendas – to no avail – leaving Wall Street, and the world, in limbo heading into the weekend. As a result, and with help from some uninspiring economic data, the Dow Jones Industrial Average (DJIA) capped off its worst week in more than a year, while the CBOE Market Volatility Index (VIX) skyrocketed more than 40% from the prior Friday.
Against this backdrop, Todd Salamone examines the recent options activity on the major indexes, and what a continuation of these trends could mean for the bulls. Furthermore, he outlines a few potential support levels to watch this week, and analyzes how the current sentiment environment could be a contrarian hindrance in the event of the worst-case scenario: a U.S. debt default. Meanwhile, Rocky White takes an historical look at the S&P 500 Index's (SPX) August-September price action, and how the broad-market barometer tends to fare when investment advisors are bullish. Finally, we wrap up with a preview of the week ahead, as well as a few sectors of note.
Notes from the Trading Desk: Hedging Activity Accelerates Amid U.S. Debt Uncertainty
By Todd Salamone, Senior VP of Research
"The SPX has simply been trading in a 100-point range from about 1,260 to 1,360 since January. Overall, the powerful combination of low expectations, solid earnings, modest valuations, and strong price action remains firmly in place. For the time being, we could very well continue to trade in that aforementioned 100-point range on the SPX -- but longer-term, the odds highly favor an eventual breakout and a strong year-end rally."
"We've noticed the media picking up on some bearish chart formations. Few contrarian indicators are more powerful than this. As we've noted time and time again, once the media starts talking about bearish technical analysis patterns, it could be time to get long...this past week, we saw dire warnings about bearish head-and-shoulders patterns, as well as 'island reversals,' being thrown around in the media. If the past two years have taught us anything, it would be to get ready for a rally soon."
-- Monday Morning Outlook, July 23, 2011 In just one week, the S&P 500 Index (SPX) went from the top to the near-bottom of the aforementioned trading range at Friday's lows. Weighing on Wall Street were growing concerns about a credit-rating downgrade and the possibility of a U.S. debt default, as well as disappointing economic reports on durable goods and second-quarter gross domestic product (GDP). And make no mistake, as stocks retreated, the warnings about a bearish head-and-shoulders formation picked up momentum.
Meanwhile, SPX put buying soared on Wednesday, as traditional fund managers apparently braced for a potentially negative outcome with respect to the ongoing budget battle in Congress. On Thursday, options activity on major exchange-traded funds (ETFs) hinted that some hedge funds may be accumulating short positions or selling long positions, as we noticed that the largest open interest changes included buy (to open) call activity on the iShares Russell 2000 Index (IWM), and put liquidations on both the PowerShares QQQ Trust (QQQ) and SPDR S&P 500 ETF Trust (SPY). The call activity would suggest the potential hedging of fresh short positions, while put liquidations would suggest the possibility of hedged players liquidating long positions as the outlook on a budget deal continued to look bleak.
Last week's option activity on those major ETFs once again created a roll-over in the combined 20-day buy (to open) put/call volume ratio that we closely follow. It's too early to tell if this is temporary or not, as this action was more than likely related to the uncertainty ahead of Congress's Aug. 2 deadline. The risk to the bulls is an extended decline of this ratio, which would suggest continued hedge-fund liquidations and/or increased shorting among hedge funds. The last time this ratio rolled lower from the spot of last week's peak (in March/April), the SPX corrected 7% from top to trough. At Friday's lows, the SPX had dropped about 4.5%.
Finally, retail investors continue to run for the hills, as weekly mutual-fund data showed fund investors withdrew cash from domestic funds for the 13th consecutive week, with $6.5 billion pulled in the latest week -- the largest weekly outflow since the $6.9 billion withdrawn at the June lows.
Speaking of the June lows... You might remember how some indexes bounced from their year-to-date breakeven points and/or their 200-day moving averages, as the European debt crisis was creating market jitters. In a potential replay of June, we find Friday's lows interesting in that:
The IWM's low was 78.14, just 0.1 point below its 2011 breakeven level of 78.24. Will 0% year-to-date support come into play again?
The S&P 400 MidCap's (MID) low was 928.45, just 8 points below its rising 200-day moving average, which is currently situated at 936.73.
The SPX's low was at 1,282.86, around the site of its 200-day moving average, which is at 1,284.90. Amid the bearish technical talk of late, will the index's 200-day trendline resume its role as support?
The Nasdaq Composite's (COMP) low was at 2,724.99, just 12 points below a 50% retracement of the June low and early-July high.
The Dow Jones Industrial Average (DJIA) never retreated below the 12,000 mark, with 12,083 marking Friday's intraday low.
From a contrarian perspective, the risk-reward set-up seems to favor the bulls, as fund managers and retail investors are preparing for a negative outcome with respect to the budget-deal talks. Furthermore, the discounting of a negative outcome occurs as major indexes continue to trade above key areas of support.
That said, whereas most investors appear to be discounting a credit-rating downgrade of U.S. debt – bipartisan deal or no deal -- it is also apparent that many market players are placing low odds on a U.S. default. Therefore, a default is not likely to be priced into the marketplace, and would be the biggest risk to the bulls at this stage in the game.
While we still feel that the risk-reward scales are tipped in the bulls' favor, one should allow for the possibility of support levels breaking, as the final panic may not yet be in place. If support breaks in the absence of a default, we'd be wary of selling into such a breakdown. The risk of doing so is a repeat of August 2010, when a highly-profiled "technical breakdown" created a crowded short trade that eventually morphed into an impressive year-end rally.
Our long model portfolio (Schaeffer's Master Portfolio) has exposure to gold, bonds and several consumer discretionary stocks that are highly shorted, unloved by Wall Street analysts, and displaying strong price action amid favorable earnings momentum.
Indicator of the Week: August and September Sentiment and Seasonality
By Rocky White, Senior Quantitative Analyst
Foreword: July is finally over -- which is good news, considering the S&P 500 Index (SPX) was off by more than 2.1%. It's now been three straight months of negative returns for the market, which hasn't happened since November 2008. Unfortunately, seasonality data may not offer much hope, either. Below, we'll take a look at how the market has typically performed during this time of the year. Looking at the first table, which shows monthly data for the SPX over the last 30 years, we find that August tends to be a very mediocre month. In fact, its 0.45% average return is the fourth lowest of all the months.
Two-Month Time Frames: The table below shows that September has historically been the worst month, on average, over the past 30 years. Therefore, when you look at two-month time frames, the August-September period shows the lowest average return. And while the median return and percent positive of this period aren't the lowest, they're still less than impressive compared to other time frames.
However, this bearish tendency has not been evident in the recent past. In four of the last five years, the August-September period has seen the SPX increase by at least 3.5%.
Investors Intelligence Sentiment Poll: Layering in some sentiment doesn't help paint a better picture for the market going forward, either. The Investors Intelligence (II) poll is a weekly sentiment poll that we follow closely. It polls investment advisors and determines the percentage that are bullish, bearish, or looking for a correction. Despite three straight months of negative returns, the II poll is showing a relatively high number of bulls for this time of the year.
Digging deeper, I looked at the percentage of pre-August bulls each year, and then looked at the return for August based on the percentage of bulls. To give you an idea on where we stand now, over the last 30 years, the percentage of bulls heading into August has averaged about 44% (the range was from 30% to 58%). In the latest poll, 49.5% of advisors were bullish (the next poll was taken last week, but does not get released until Wednesday).
Below shows the SPX's August returns based on the II poll, with three groups of 10 returns. The first column shows data for those years in which the poll was showing advisors to be most optimistic. The percentage of bulls in the poll ranged from 47% to 58% -- where our current reading would land us. As contrarians, we're not surprised to see this group underperform. In fact, the best returns are when the advisors are most pessimistic – but hopefully this is the year we can buck some of these seasonality trends.
This Week's Key Events: Wall Street Braces for July Jobs Data
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 ISM manufacturing index for July and construction spending for June. On the earnings front, we'll hear from Boston Properties (BXP), Loews (L), Allstate (ALL), Humana (HUM), Alkermes (ALKS), Changyou.com (CYOU), Ctrip.com International (CTRP), and Sohu.com (SOHU).
Tuesday
Tuesday brings the latest reports on personal incomes and spending, as well as auto and truck sales for July. Pfizer (PFE), Archer Daniels Midland (ADM), Marathon Oil (MRO), Marathon Petroleum (MPC), Coach (COH), General Growth Properties (GGP), Hyatt Hotels (H), Sirius XM Radio (SIRI), OpenTable (OPEN), and ValueClick (VCLK) are expected to report earnings.
Wednesday
Employment data starts to hit the Street Wednesday, when ADP releases its report on private-sector payrolls for July. Also on tap are the ISM services index, June's factory orders, and the usual report on weekly petroleum inventories. Quarterly earnings are due out from Clorox (CLX), MasterCard (MA), Comcast (CMCSA), Time Warner (TWX), Agrium (AGU), Intrepid Potash (IPI), GT Solar (SOLR), MEMC Electronic Materials (WFR), Tesla Motors (TSLA), and Zipcar (ZIP).
Thursday
Thursday's lone economic report is the regularly scheduled update on weekly jobless claims. American International Group (AIG), General Motors (GM), Kraft Foods (KFT), CBOE Holdings (CBOE), Priceline.com (PCLN), Southwest Airlines (LUV), Alpha Natural Resources (ANR), and A123 Systems (AONE) will share the earnings spotlight.
Friday
On Friday, all eyes will be on the Labor Department's nonfarm payrolls report for July. Later in the session, the Fed weighs in on June's consumer credit trends. The week's earnings calendar concludes with the latest quarterly results from Arch Chemicals (ARJ), Weight Watchers (WTW), Imperial Sugar (IPSU), Washington Post (WPO), and Viacom (VIA).
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