Monday Morning Outlook: DJIA Enjoys the View From Above 12,000 Dow and SPX both broke through important round-number levels by Todd Salamone 2/5/2011 12:24 PM
The Dow Jones Industrial Average broke through the 12,000 level Tuesday and then treaded water, or maybe dog-paddled, through the end of the week. Looking ahead, Todd Salamone, Senior Vice President of Research, continues to see evidence that hedge funds are actively accumulating stocks, a bullish indicator. Todd also wants the Russell 2000 Index to hold above 800 – it crept above that level in the final minutes Friday. Next, Senior Quantitative Analyst Rocky White takes a look at the recent low readings on the CBOE Market Volatility Index and wonders whether they signal complacency. Nope, no hints -- you'll have to read it on your own to learn his conclusions. Finally, we wrap up with a look at some key economic and earnings reports slated for release this week.
Recap of the Previous Week: Bulls Take a Breather After Two-Day Rally Schaeffer's Editorial Staff
The Dow Jones Industrial Average made a mighty run at the 12,000 level the previous week, but was rudely rejected in the wake of protests and rioting in Egypt. After a weekend to think it over, the bulls gathered their strength and toppled the millennial marker in a two-day push. And then, they rested.
In fact, all the fireworks came early last week. Although concerns about Egyptian unrest lingered Monday, the Commerce Department said consumer spending rose more than anticipated, and Dow component Exxon Mobil (XOM) soared after it reported a 53% jump in fourth-quarter profit. The Dow rallied 0.58%, to cap its best January performance since 1997. The Dow gained 2.7% for the month, while the S&P 500 Index (SPX) was close behind with a 2.3% monthly gain, and the Nasdaq Composite (COMP) trailed with a mere 1.8% advance.
Monday's bullishness proved prologue on Tuesday. Egyptian President Hosni Mubarak temporarily settled geopolitical jitters by announcing that he will not seek re-election. Pfizer (PFE) and United Parcel Service (UPS) offered sunny earnings reports and outlooks. The Institute for Supply Management's manufacturing index rose at its fastest pace since 2004, and automakers reported strong January sales. The Dow climbed 148 points, or 1.3%, to close atop the 12,000 level for the first time since June 2008. The SPX likewise breached its own round-number psychological barrier, toppling 1,300 for the first time since August 2008. Finally, the Russell 2000 Index (RUT) made another run at 800, but was stopped short. The RUT's failure to hold that level two weeks ago was a disappointment to some technicians.
The Dow stuck to a tight 30-point trading range Wednesday, as traders weighed pictures of renewed violence in Cairo against signals of job growth in the U.S. and positive earnings from Time Warner (TWX) and Electronic Arts (ERTS). The Dow ended in the black by 0.02%, or less than two points.
Bulls had every reason to be upbeat Thursday. First-time jobless claims dropped more than expected, and the retail sector reported strong same-store sales growth in January, proving shoppers were still willing to open their pocketbooks after the Christmas shopping season. Finally, in an appearance at the National Press Club, Federal Reserve Chairman Ben Bernanke reiterated his expectations for a "gradual" economic recovery. The Dow added 0.17%.
Friday was more of the same. Nonfarm payrolls growth was far lower than expected, but some analysts wrote that off to last month's bad weather and cheered upward revisions to figures in November and December. Moreover, the unemployment rate sank to 9%. The Dow advanced a modest 0.25% for the day, and a very respectable 2.3% for the week. The SPX, meanwhile, climbed 2.7% last week, and the COMP led the pack with a 3.1% gain.
What the Trading Desk Is Expecting: Once Again, We're Watching the RUT By Todd Salamone, Senior Vice President of Research
In last week's Monday Morning Outlook, we noted:
* The S&P 500 Index (SPX) was rejected at 1,300, the Dow Jones Industrial Average (DJIA) failed to sustain a move above 12,000, and the Russell 2000 Index (RUT) remained below the 800 century mark.
* Poor earnings and geopolitical uncertainty related to protests in Egypt drove the SPX, DJIA and RUT from this "trifecta" of round-number resistance on Friday, Jan. 28.
* There was still evidence of hedge funds in accumulation mode, a key positive for bulls. We noted that such investors are less likely to panic sell on negative headlines and that SPY volume looked to be climactic on Friday, Jan. 28.
Short-term risk factors included stock market weakness in January in recent years, equity option players not yet at pessimistic extremes, and a rollover in our VIX premium indicator from extreme highs.
Let's review where we stand now:
As we enter Monday's trading, the SPX and DJIA hover just above their round-number resistance levels -- 1,300 and 12,000 -- respectively. In fact, while Dow 12,000 acted as resistance two weeks ago, this level provided support on Thursday morning's pullback.
RUT advances continue to be stymied by the pesky 800 zone, which had significance five years ago and is once again displaying importance. In fact, the RUT has managed only five closes above 800 since it first touched 800 on the first trading day of 2011. Note that Friday's close was barely above 800 in the final minute of trading. So, while bulls are encouraged by the SPX action and the DJIA's latest venture above 12,000, it would be even more encouraging if the RUT sustains a meaningful move above 800.
While concerns eased with respect to Egypt during the past week, such geopolitical uncertainty and the fact that overseas instability can impact the U.S. with short notice makes the case for 1.) having portfolio protection in place to define your risk, and/or 2) using a leverage vehicle, such as options, to play your bullish views with less money at risk.
Continuing on with the subject of hedging, the indicator that we suggested a few weeks ago as having the most relevance is the ratio of combined customer-only buy-to-open put volume relative to buy-to-open call volume on major broad-based exchange-traded funds, such as the SPDR S&P 500 ETF Trust (SPY), iShares Russell 2000 Index Fund (IWM) and PowerShares QQQQ Trust (QQQQ).
When the ratio is advancing in the context of favorable price action, it indicates that hedge fund managers, who typically use ETFs as hedging vehicles, are in accumulation mode (buying their favorite stocks and hedging via the purchase of ETF puts). Since the typical individual investor has yanked cash out of traditional mutual funds during the past few years, it is apparent that hedge fund managers must be in a buying mood for stocks to advance, which appears to be the case at present and during the past several weeks, as illustrated by the graph below.
Turning to the risk factors we identified during the past few weeks:
* January passed by without a market accident, and stocks raced to two-year highs as the calendar flipped to February. That being said, February has not exactly been a bastion of strength during recent years, implying seasonality risk remains with us, per the table below.
* The rollover in our VIX premium indicator continues to be an inconsequential factor. In fact, SPX historical volatility has crept up to 11.3%, and the CBOE Market Volatility Index (VIX – 15.93) declined impressively lower from the 20 area last week. In fact, 20 on the VIX has been an important long-term level, and last week's retreat is another plus for bulls. The VIX is now only 40% above SPX historical volatility, neither in a sell zone nor buy zone at the moment.
* Equity put buying relative to call buying on the Chicago Board Options Exchange (CBOE) and International Securities Exchange (ISE) continues to suggest that optimism is fading among short-term traders relative to a few weeks ago. A shift in sentiment from optimistic extremes is usually coincident with market weakness. Therefore, we find it potentially bullish that optimism is fading within the context of ongoing strong price action, which is very unusual, as you can see on the graph below.
We remain bullish, with hedge funds apparently in accumulation mode and short-term speculators turning more pessimistic within the context of strong price action. Support for the SPX is at 1,300, with the 1,275-1,280 area potentially supportive if 1,300 succumbs to selling pressure. Keep a close eye on 1,333.58 as overhead resistance, as it represents double the level of March 2009.
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Indicator of the Week: Complacency in the VIX? By Rocky White, Senior Quantitative Analyst
Foreword: Last week the S&P 500 Index (SPX) hit its highest level since August 2008. The CBOE Market Volatility Index (VIX), which typically moves in the opposite direction as the market, is naturally at a low level compared to the last couple of years. Many argue that the VIX is showing complacency. This week I'm going to take a good look at some VIX activity which I think may have people re-evaluating that conclusion.
VIX Below 20: Below is a chart of the SPX and the VIX. The VIX has been in steady decline since the May 2010 market pullback. It is now below 20, which the chart shows has signaled some severe declines.
VIX versus SPX since January 2008
Complacency? I'm not so sure the chart proves complacency. The chart below compares the VIX -- which is the expected volatility of the SPX -- to the actual realized volatility. Actual market volatility has declined even faster than the VIX, and currently sits right around 10. This very low volatility has forced the VIX lower. Option buyers simply aren't going to continue paying 30% volatility when the market's true volatility has only been about 10%. Though historical volatility has recently risen, the VIX is still significantly above it. Rather than being complacent, option buyers are just tired of paying for higher volatility than what the market is giving them.
VIX versus SPX historical volatility since January 2010
The chart below shows VIX option buyers aren't feeling complacent. It shows call and put options that were bought to open on the Chicago Board Options Exchange and on the International Securities Exchange. Call buying has accelerated higher since the beginning of the year. These traders are looking for or at least guarding against an increase in the VIX. As mentioned earlier, the VIX and the SPX move in opposite directions, so it can be assumed VIX call buyers are preparing for a market drop.
SPX versus 20-day put OI moving average and 20-day call moving average
Implications: Despite the low VIX, I'm not convinced SPX option premiums are signaling complacency among traders. The VIX is still well above actual realized volatility and there has been a rash of call buying of VIX options. For those who think 20 is an extremely low level on the VIX that cannot be sustained, keep in mind that from 2004 through 2007 the VIX averaged less than 20 for the entire year and in some years the average was closer to 10 than to 20.
This Week's Key Events: Earnings Parade Continues 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 * There are no major economic reports scheduled. Hasbro Inc. (HAS), Humana Inc. (HUM), Loews Corp. (L), Lorillard Inc. (LO), Sysco Corp. (SYY), tw telecom inc. (TWTC), FMC Corp. (FMC) and Gartner Inc. (IT) will report earnings.
Tuesday * There are no major economic reports scheduled. Scheduled to report earnings are ArcelorMittal (MT), Beazer Homes USA Inc. (BZH), Entergy Corp. (ETR), hhgregg Inc. (HGG), Sara Lee Corp. (SLE), Teva Pharmaceutical Industries Ltd. (TEVA), Warner Music Group Corp. (WMG), Buffalo Wild Wings (BWLD), General Cable Corp. (BGC), McAfee Inc. (MFE), NetGear Inc. (NTGR), OpenTable Inc. (OPEN), Pitney Bowes Inc. (PBI), Take-Two Interactive Software Inc. (TTWO), and The Walt Disney Company (DIS).
Wednesday * We'll get the usual weekly report on crude inventories. Alpha Natural Resources Inc. (ANR), The Coca-Cola Company (KO), IntercontinentalExchange Inc. (ICE), Northrop Grumman Corp. (NOC), Polo Ralph Lauren Corp. (RL), Wynn Resorts Limited (WYN), Activision Blizzard Inc. (ATVI), Advance Auto Parts Inc. (AAP), Akamai Technologies Inc. (AKAM), The Allstate Corp. (ALL), Cisco Systems Inc. (CSCO), MetLife Inc. (MET), Prudential Financial Inc. (PRU), and Whole Foods Market Inc. (WFMI) plan to report earnings.
Thursday * The Labor Department will give us its weekly look at jobless claims. BorgWarner Inc. (BWA), Molson Coors Brewing Company (TAP), PepsiCo Inc. (PEP), Philip Morris International Inc. (PM), Scripps Networks Interactive Inc. (SNI), Sprint Nextel Corp. (S), Atheros Communications Inc. (ATHR), Blue Nile Inc. (NILE), Cephalon Inc. (CEPH), The Cheesecake Factory Inc. (CAKE), CB Richard Ellis Group Inc. (CBG), Hoku Corp. (HOKU), Kraft Foods Inc. (KFT), MannKind Corp. (MNKD), Panera Bread Company (PNRA) and Taubman Centers Inc. (TCO) will report earnings.
Friday * The Commerce Department will report on the December trade deficit, and the University of Michigan will deliver its first reading on consumer sentiment in February. Coca-Cola Enterprises Inc. (CCE) will report earnings.
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