The Bullish Risk is High as Investor Anxiety Spikes
First-quarter Earnings Season May be the Catalyst for a Higher Choppy Market!
By Ian Harvey
April 16, 2012
Stocks suffered their steepest losses of 2012 last week, thanks to revived concerns about Spain's fiscal fortitude and China's decelerating growth rate. In fact, the level of panic on Wall Street has ratcheted up significantly, with a survey of the current sentiment landscape suggesting that investors are all but ready to write this bull's obituary. There has been rising expectations for a correction of painful proportions therefore a survey of small caps as a barometer for the broader market is in order.
Investors and Money Managers Are Running Scared Causing Bullish Risk
“The holiday-shortened week seemed to be a case of the bulls going on holidays early! By the time the market closed on Thursday, a few of the favorite major equity benchmarks pulled up just short of psychologically significant round-number levels. There are many theories floating around as to why this occurred……such as……looking ahead to the start of first-quarter earnings season, there appears to be evidence that this choppy trading range could eventually resolve itself to the upside -- even if hedge fund managers continue to sit on the sidelines as they have done so for quite awhile now!”
- Market Risk Aware Investors, April 08, 2012
As was discussed slightly last week, the odds are good that there will be a continuation for trade to experience a choppy phase for the time being. With the S&P MidCap 400 Index (MID - 964.41) having issues near 1,000, and the S&P 500 Index (SPX - 1,370.26) bouncing around 1,400, we could see more of this action in the near-term. There were a few technical indicators suggesting that some weakness could be on the horizon -- but overall, after a brief five-day losing streak and 4% pullback, it's amazing how much worry has come back into the marketplace. Even after yesterday’s great rally start the markets pulled back considerably, particularly the Nasdaq Composite Index (COMP – 2,988.40) notching the worst performance of its peers, and dropping 22.9 points, or 0.8%, lower than last week’s close.
Earnings Season a Bullish Risk?
“It has the potential to be stomach-churning roller-coaster ride -- and it will come after stocks suffered their worst weekly performance of the year and their second weekly loss in a row…..In case investors did not have enough to worry about in the week ahead, this chart from The Wall Street Journal shows that analysts have been steadily lowering their earnings estimates for the quarter and the year.”
-The Week Ahead in the Stock Market, April 16, 2012
Obviously, the major driver for the stock market will be first-quarter earnings season. What continues to impress is how drastically the estimates have been cut over the past few months. Back in September, the consensus was for 10% year-over-year growth in first-quarter earnings. Then, at the start of the year, it was down to 4%. Now some of the analysts are saying that earnings will be negative for the first time since the financial crisis. The odds are strong that analysts have once again low-balled earnings estimates, and should the quarterly results come in just a little bit better than expected, this could spark yet another rally.
Technically, the 1,360 area in the SPX held as support last week, but it appears that the action in small caps holds the key to the overall market. The March lows of 785 on the Russell 2000 Index (RUT - 796.29) held as support, and just a little below that is the RUT's 320-day moving average. This trendline has been fairly significant over the past several years, and a violation of this area could signal that more pain is coming.
The Fear Factor Behind the Bullish Risk
One major positive for the market going forward is how much worry there is. In fact, just last week, an article talking about "The 5 Big Fears Hanging Over the Stock Market" highlighted this fact. This is extreme “nonsense-thinking” -- less than two weeks ago the SPX was making new multi-year highs, yet all that is spoken about now are all of the reasons not to be invested.
Investor Sentiments Adding to the Bullish Risk Anxiety
Investors are running scared, as well. Data from EPFR Global showed that equity funds had total net redemptions of $9.26 billion in the week ended April 11, which was a new high for the calendar year. And incredibly, the American Association of Individual Investors (AAII) saw a drop of more than 25% in the number of bulls -- down to only 28% during the last week, compared to 38% the previous week. In fact, that 28% bullish was the lowest reading since September 2011. By no means is this is a flawless indicator, but previous breaks of the 30%-bullish barrier have marked a number of short-term bottoms in the SPX going back to 2009.
Also, according to the National Association of Active Investment Managers (NAAIM), active managers cut their exposure to stocks last week by the largest amount since late November. This is yet another sign of how extreme the fear has been on this 4% pullback and adding to the bullish risk factor.
Hedge Fund Managers and Bullish Risk Concerns
“Evidence that some hedge fund managers are shying away from equities comes from the analysis of option activity, as put buying on major exchange-traded funds has declined, in turn driving put implied volatilities on the SPDR S&P 500 ETF Trust (SPY) lower relative to call implied volatilities ….. But recent put buying on major Exchange-Traded Funds - ETFs did reach the levels of spring 2011, which preceded a 7% pullback in the SPX.”
-Hedge Fund Nervousness May Cause Stocks to Drop!, March 26, 2012
Going forward, some other definite positives we're seeing, off-setting the bullish risk dilemma, include a few clues that big money could be getting back into stocks here. As has been mentioned on numerous occasions over the past months, it is very probable that activity on CBOE Market Volatility Index (VIX) futures and major equity-based ETFs is hedging-related. In other words, this activity could suggest institutions are in the process of making either bearish or bullish bets. Back in March, this option activity was a cause for concern, but now we're seeing signs that deep-pocketed players are putting their cash back to work.
The 20-day buy-to-open put/call ratio on the SPDR S&P 500 ETF (SPY), PowerShares QQQ Trust (QQQ), and iShares Russell 2000 Index (IWM) has turned higher, and in the past this has had bullish implications for stocks.
Also, the VIX is also seeing a rebound in call buying. As the chart below shows, when the VIX's 20-day buy-to-open call/put ratio has turned higher from similar lows, it can be a very bullish signal for the overall market.
The Rally – “Too Far, Too Fast” – Additional Bullish Risk
There has been a lot of talk that this rally has gone "too far, too fast," and has “run-its-race”, therefore it will fall flat on its face for various reasons – another bullish risk factor. Now articles are coming to the fore citing how "old" the bull is as a reason to be fearful – another bullish risk fear factor.
Therefore, to look at the comparison of previous major bull rallies to the present situation, to see where, exactly, this one stacked up in terms of percentage gain and duration, is important. The current bull market is 784 days old and up 106% -- which makes it difficult for comparison rallies as there are none that similar to compare to – but, looking at the rallies from 1982 and 1995 (the closest similarities), the results were very interesting.
First, the present rally is roughly in line with both of those bull markets, as you can see below, and by continuing to follow the returns from each of those previous rallies, the SPX will be up near new all-time highs by the end of this year. At the end of 2012, the rally will be 968 days into the bull market. If it follows suit with the 1982 rally, that would mean an SPX close of 1,571. Should it track the move of the 1995 rally, which would put the SPX clear up at 1,613 -- a new all-time high. Of course, this doesn't mean either scenario will necessarily pan out, but it does make the point that we've seen rallies this strong before, and stocks very well could continue to move higher. Then, when you consider how much negative sentiment – bullish risk factors – that are still being seen toward this rally, there's a good chance the overall uptrend will still be firmly in place by the end of this year.
April Options Expiration
Also, adding to the bullish risk this week is April options expiration. Looking back over the past 12 years, this has historically been a strong week, although the past two have been a little weaker. Expiration weeks have also tended to be somewhat more volatile than usual over the past 12 months, as the past nine have seen the SPX move more than 1%, with several weeks triggering moves of 3% or more in just five days. For a closer look at the market's performance during expiration weeks, check out the article “April Expiration Week - Market Indicator for the Week Ahead”, April 16, 2012
Conclusion to Bullish Risk
There are definitely concerns in the market place in regard to the bullish risk factors and their effect on the investor -- and by simply ignoring them does not make them go away. A slowdown in China or more issues in Europe could put a major stop to the bull market, but overall, it appears that there are still more reasons to be bullish than bearish for longer-term investors. In the near term, some continuation of the recently choppy price action could occur -- but eventually, that will give way to higher prices, as the dour outlooks on the economy and stock market will once again be proven too gloomy.
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