Monday Morning Outlook: DJIA Establishes Firm Foothold Above 11,500 Major market indexes ending year on a high note by Todd Salamone 12/24/2010 12:00 PM
The bull market of 2010 slowed, but maintained its upward trajectory as the end of the year pulled into view. The Dow Jones Industrial Average climbed above 11,500 on Tuesday, and then settled into its Snuggie for the rest of the holiday-shortened week. Looking ahead, Todd Salamone, Senior Vice President of Research, sees the rally continuing, although he concedes some short-term risks. Todd was also intrigued by the unusual end-of-week pop in the VIX – the CBOE Market Volatility Index. Next, Senior Quantitative Analyst Rocky White reviews the "third-year" phenomenon: the third year of every presidential term since 1951 has been positive for the market, sometimes spectacularly so. The year 2011 -- just a week away now -- will be Barack Obama's third year in office. Finally, we wrap up with a look at some key economic and earnings reports slated for release this week.
Recap of the Previous Week: Slow and Steady ...but Mostly Slow Schaeffer's Editorial Staff
It was a holiday week, volume was low, news was light, money managers are playing year-end games, a lot of people took time off. Et cetera. You'll hear much the same in the upcoming week. Still, the Dow Jones Industrial Average continued its steady march upward, toppling another round number and closing the week at 11,573.49. Perhaps just as significant, the Dow is now consistently trading in a range it hasn't seen since before the bankruptcy of Lehman Brothers in September 2008.
Appropriately enough, the slow week got off to a slow start. The Boeing Co. (BA) slipped nearly 3% Monday following reports of more delays with its troubled Dreamliner, while American Express (AXP) fell 3.4% after a downgrade by Stifel Nicolaus, prompted by proposed new limits on debit card fees. The two Dow components led the blue chip barometer to a tiny 0.12% loss for the day; both the S&P 500 Index (SPX) and the Nasdaq Composite (COMP) registered small gains.
Financial stocks rose Tuesday after Toronto-Dominion Bank (TD) announced that it had purchased Chrysler Financial for $6.3 billion. The tech sector also showed some spunk, with Adobe Systems (ADBE) and Jabil Circuit (JBL) putting in strong earnings showings. The Dow added 0.48%, and closed above 11,500 for the first time since September 2008. In fact, all three major market indexes closed at multi-year highs.
By Wednesday, the market was well into its Christmas coma. The economy grew by 2.6% in the third quarter, the Commerce Department reported, higher than earlier estimates, but lower than some analysts had expected. The Dow meandered to a 0.23% gain.
Thursday arrived, and hardly a creature was stirring. Bed Bath & Beyond (BBBY) pleasantly surprised with better-than-expected earnings and an upbeat forecast. Jobless claims declined a little, consumer spending increased, and the University of Michigan's consumer sentiment reading rose. The Dow traded in a range of fewer than 40 points all day, finally settling in the black by 0.12%. For the week, the Dow advanced 0.7%. The SPX did slightly better for the week, adding 1%, while the Nasdaq rose 0.9%.
What the Trading Desk Is Expecting: SPX Move Above 1,250 Is Encouraging By Todd Salamone, Senior Vice President of Research
Last week, I mentioned that we continue to expect a rally into year-end, but cautioned that the current advance is carrying more risk relative to past rallies, as there is evidence that unhedged buyers have jumped into the market in recent weeks. While there is nothing wrong with sideline money driving the market higher, and a continuation of this is certainly possible, it should be noted that these buyers might be considered "weaker hands" and be prone to panic selling if negative news hits the market.
Above being said, bulls should find it encouraging that the S&P 500 Index (SPX) rallied again last week, and has now advanced in 14 of the 17 trading days in December. Historically, the week after expiration in a five-week cycle is negative. Moreover, the SPX rallied above the much discussed 1,250 level, which is where it was trading ahead of Lehman's collapse in 2008 and thus a focal point of many technicians.
Except for the SPX's move above 1,250 last week, not much has changed regarding the risks at the present moment. In fact, on Wednesday, the CBOE Market Volatility Index (VIX – 16.47) hit a 2010 calendar-year low. We think this explains why the VIX popped more than 6% on Thursday, with more perceiving "value" in portfolio protection. Normally, on a day ahead of a three-day weekend and little directional movement, one would expect a sharp decline in the VIX. As I mentioned last week, should unhedged players suddenly seek portfolio protection, such activity could be a coincidental headwind.
5 Minute Chart of VIX for December 23 2010
Moreover, note in the chart below that since the second half of 2007, the VIX has had a tendency to bottom in the 15 area, so be open to another increase in volatility. But also take note that the last time the VIX was in the 15 area, in April 2010, the 20-day historical volatility of the SPX was below 8. Said another way, the VIX was more than double SPX historical volatility. When such a "premium" exists, as we have pointed out in the past, the market has run into trouble during the past couple of years.
Right now, the historical volatility reading on the SPX is 10.28, implying the VIX is trading at only a 60% premium to the SPX's historical volatility. For bulls, this is a positive at present. But they should take extra precaution if the VIX is trading double the SPX's historical volatility.
Last week, we discussed the optimism among equity option buyers on the International Securities Exchange and Chicago Board Options Exchange. This optimism may have finally hit an extreme, leaving the market vulnerable to a setback. For example, the 10-day customer-only, equity-only buy-to-open put/call volume ratio turned higher last week, which could be a sign that enthusiasm among these players has peaked. Historically, when such enthusiasm peaks, the market has hit short-term turbulence.
A technical breakdown in the various equity benchmarks amid a continued rise in this ratio would be alarming from a short-term perspective. However, if the market can manage to grind higher or simply consolidate as enthusiasm among this crowd continues to wane, it would be viewed as a positive, as the growing fears prove to be irrational.
The silver lining in this is that we continue to see evidence that hedge funds have a lighter-than-usual allocation to U.S. equities. In fact, there are reports that some managers have suddenly become bullish on European equities. Therefore, hedge funds appear to be in a position to scoop up U.S. equities on a decline, or even keep the current momentum intact. Right now, we aren't seeing clear evidence that they are in accumulation phase, but it is nice to know that the market has been resilient in their absence.
As to how you can navigate the current market environment, our message has not changed from last week. That is, with most equity, index and exchange-traded fund options relatively cheap, you can reduce your risk by using call options in lieu of stocks to play equities that you think have strong rally potential. Or, take advantage of cheap portfolio insurance to hedge your long stock portfolio, especially if the portfolio insurance you have purchased in recent months has expired.
In closing, I'd again like to take the opportunity to wish you, your family and friends the best during this wonderful holiday season.
If you enjoy Monday Morning Outlook...
...we also offer a free Market Recap after the close every day. Did the Dow go up 100 points? Or down? We'll tell you why. We'll also tell you who the big winners and losers were, and we'll share some highlights from our daily articles and blog postings. Market Recap is a quick, but insightful read. Sign up here to have Market Recap delivered straight to your inbox every evening shortly after the close.
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.
Indicator of the Week: The Third Year of the Presidential Term By Rocky White, Senior Quantitative Analyst
Foreword: It is pretty well documented that the third year of the four-year presidential term has historically been bullish. That's good news for the upcoming year, with 2011 representing the third year of Barack Obama's presidency. There are a few theories as to why this is: Investor confidence increases after midterm elections, perhaps because there's more certainty about the direction of the new Congress; incumbent presidents promote market-friendly policies as they prepare their re-election efforts. Of course, it's also possible that it's simply random. Whatever the reasons, the consistency of third-year positive returns over the last 60 years is quite impressive.
Presidential Cycle Returns: Harry Truman succeeded Franklin Delano Roosevelt as president following FDR's death in 1945, and won election to the office in his own right in 1948. Since then, there have been 15 full presidential cycles, and all of them were positive in the third year. The average return in these years is almost 18%. The table below shows the market's third-year performance to be nothing short of amazing when compared to the other years of a presidential cycle.
Below are the 15 individual returns that were the third year of a cycle. Four of the last five returns are over 20%.
By Quarter: Let's be more specific on when we can expect these bullish returns to take place in 2011. Below, I break down the Dow returns by quarter during each year of a presidential cycle. The bullish returns tend to happen early on in the third year, and taper off as the year comes to an end.
Notice that the first quarter of the third year has been positive 87% of the time, and has an average return of 7.6%. This is an extremely high return. One interesting thing about the third year is how its fourth quarter differs from the other years in the presidential cycle. In all other years of a presidential cycle, the fourth quarter is the best quarter for the Dow. However, in the third year of a presidential cycle, the fourth quarter is the worst quarter.
This Week's Key Events: Gone Fishin' Schaeffer's Editorial Staff
We have a full five-day trading week coming up -- hey, and what's with that? No compensating day off on Friday for the New Year's holiday on Saturday? It just doesn't seem right. The calendar is molasses slow; if it was a bicycle, you wouldn't be able to keep it upright. 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 * There are no major economic reports scheduled for Monday. Cal-Maine Foods Inc. (CALM) will report earnings.
Tuesday * The Case-Shiller folks will release their 20-city home price index for October, and the Conference Board will publish its consumer confidence survey for December. There are no major earning reports currently scheduled.
Wednesday * We'll get the usual weekly report on crude inventories. Imperial Sugar Company (IPSU) will report earnings.
Thursday * The Labor Department will give us its weekly look at jobless claims. The Chicago Business Barometer, more commonly known as the Chicago Purchasing Managers' Index, will also be released. There are no major earning reports currently scheduled.
Friday * There are no major economic reports scheduled for Friday. There are no major earning reports scheduled. Tell us again why the market's in session?
Market Data 
Markets 
AI
