Market Outlook
The Week Beginning Monday,
August 30, 2010

I believe that it is important to point out to all my readers, especially those who are not already members of S.O.M.E. (as members are already well-aware of my trading strategy!), that the more volatile the market becomes, whether it trades up or down, is more beneficial to us, as the returns on our options increase dramatically, as observed throughout June and July, so far.

I must say I am a great supporter of the bulls, but will play-along with the bears to extract as much value from our options plays, as possible. I am a great believer in things moving forward and improving as time progresses but I also know that we have to play-the-game to extend our profits. The only catch in this type of market is “knowing” or realizing in which direction it will take, and it seems that we have been able to fulfill this decision in most cases, to gain our profitability.

This Week’s Economic Reports

There are still quite a few major economic indicators available this week, which are:-

Monday –

• The Commerce Department will release personal income and spending reports for July.

Tuesday –

• The Case-Shiller home price index,

• The Chicago Purchasing Managers' Index and

• The Conference Board's Consumer Confidence Index for August

Wednesday –

• Weekly report on U.S. petroleum supplies,

• The ADP report on private sector job growth in August,

• The Institute for Supply Management (ISM) will release its manufacturing index for August, and

• The Commerce Department will report on construction spending in July and auto sales for August.

Thursday –

• Weekly initial jobless claims.

• July reports on factory orders, and

• pending home sales

Friday –

• The Labor Department's numbers on nonfarm payrolls,

• The unemployment rate in August, and

• The ISM will also release its services index for August

This Week’s Major Earnings Reports

• Origin Agritech Ltd. (SEED) and

• Winn-Dixie Stores Inc. (WINN)

Tuesday –

• Dollar-General Corp. (DG) and

• DSW Inc. (DSW)

Wednesday –

• Charming Shoppes Inc. (CHRS),

• H.J. Heinz. Co. (HNZ),

• Joy Global Inc. (JOYG),

  Collective Brands Inc. (PSS), and

• Hovnanian Enterprises Inc. (HOV)

Thursday –

• Del Monte Foods Co. (DLM) and

• H&R Block Inc. (HRB)

Friday –

• Campbell Soup Co. (CPB)

Normally, the week before Labor Day is quiet on Wall Street. Volume peaks early and fades steadily into Friday when those who haven't disappeared already leave early for the long weekend.

This year, it's likely to be a noisy week.

The final days of summer could bring more disappointing manufacturing and employment data, setting the stage for a choppy September.

Even with a rally Friday, the Dow and S&P 500 were down about 0.7 percent in the past week, and are now down more than 3 percent for the month of August. Treasury yields continued to slide, with the 10-year touching a 19-month low yield of 2.418 mid-week, before rising to 2.652 percent Friday.

"History says you don't want to stick your head out there. If you're going to rent a boat and go sailing in the Caribbean, you don't do it in the hurricane season, and that's kind of what the equities market is like. We're entering hurricane season. Be careful," said Doug Cliggott, U.S. Equity Strategist at Credit Suisse.

Economic data in the past week painted a dismal picture of the housing market and showed weaker orders for finished goods.

It's true that there aren't a lot of earnings reports with the potential to move markets next week. If you want candidates, try construction equipment maker Joy Global (JOYG), homebuilder Hovnanian (HOV), food giant H.J. Heinz (HNZ) and the Toronto-Dominion Bank (TD).

The real action will come in how the markets react to important economic reports that will come every day, starting with a report on personal income for July on Monday and ending with the big report on August payroll employment and joblessness on Friday.

In fact, the week ahead has the potential to look and feel like the one that preceded it: Lots of arguing and lots of volatility, all building up to Friday.

"I think this week maybe ISM is more important this time around because business investment has been the bright spot in the economic recovery, and we're seeing signs of slippage. There's a risk we get an ISM new order print below 50 next week, given what we're seeing in the regional Fed surveys," said economist Jonathon Basile, also with Credit Suisse.

There is also some Chinese data of note, including manufacturing PMI on Wednesday and non manufacturing PMI Friday. Traders are also expecting a Bank of Japan meeting early in the week as speculation swirls that Japanese officials may take action to reign in the rising yen.

Sentiment

One poll to watch is the weekly American Association of Individual Investors (AAII) survey. When they are negative on the market, it usually marks bullish short-term trading opportunities. In the poll released on Thursday, only 21% surveyed were bullish, while 49% were in the bearish camp. This was the lowest percentage of bulls since March 5, 2009, when only 19% were bullish. So, in terms of the low percentage bulls, we are at an extreme. However, keep in mind that in March 2009, 70% were bearish, whereas 49% are bearish now. So, in that context, we are not quite at a bearish extreme.

Other polls that are interesting were the Spectrem Affluent Investor Confidence Index and the Spectrem Millionaire Investor Confidence Index, released on Monday, Aug. 25. (The former index measures the investment confidence and outlook of households with $500,000 or more in investable assets; the latter is self-explanatory.) The Spectrem Millionaire Investor Confidence Index fell 11 points in August to minus 18, its biggest drop since June 2009, pushing it to the lowest level since that date. While one might interpret this as bearish for the market, contrarians should note that June 2009 proved to be an excellent buying opportunity.

There has been an enormous outflow from equity funds and into bond funds, and the potential bullish implications for equities longer term. Also, the Investment Company Institute reported that there were 15 consecutive weeks in which investors pulled money out of U.S. equity funds. This is another extreme that short-term market participants should note, as it too may have contrarian implications.

Technical Indicators

It is of interest that the "Hindenburg Omen," an indicator that is designed to predict market crashes, and which has flashed multiple times recently, has created quite the buzz in the investment community. It may be of no surprise that technicians have discussed this development, but it is yet another technical indicator that has made its way into mainstream media, including financial websites and even some general interest local radio stations.

If it isn't enough that the economic and political backdrop are scaring the living daylights out of retail and institutional investors, a multitude of chart patterns ("death cross," bearish "head and shoulders," "Hindenburg Omen") have added to the building "wall of worry." We cannot say for certain the long list of concerns is fully factored into the market, but to the extent that they are, the headline risk may not be as great as advertised.

S&P 500 Index (SPX)

On the other hand, the bullish implications of a potential "inverse head and shoulders" pattern on the S&P 500 Index (SPX) is not being advertised. The May/June lows would make up the "left shoulder," with the July low at 1,010 the "head." If support holds at 1,040, this would make up the "right shoulder" in the pattern, with the neckline in the 1,130 area. A bullish "inverse head and shoulders" play would offer technicians the most reward versus risk, as the possibility of this bullish pattern playing out does not seem to be on the radar of many traders.

Moreover, the SPX is currently trading just above support from its rising 80-week moving average, a trendline that marked lows in November 2009 and last month.

With retail investors in cash-raising mode, the risk is continued evidence at present that hedge funds continue to favor bonds over stocks. Note that it was a combination of short covering and stock accumulation among hedge funds that drove the market higher in 2009, and it will likely be the hedge funds that bid the equity market higher before the general public. As I said a few weeks ago, there is a great deal of ammunition available for a longer-term market rally, but it is difficult to determine when exactly this will be fired.

Options

From a shorter-term perspective, there is a tremendous amount of put open interest just below current levels on major exchange-traded funds that we follow. If the market stabilizes during the next few days, short covering related to expiring put open interest in the next few weeks could support a rally from SPX 1,040, the lower boundary of the current trading range. But if support breaks, sellers of the index puts will short futures to offset losses from the sold puts, leaving the market vulnerable to a quick, sharp decline.

If you are an options player, we have found straddles as the ideal low-risk, high- reward play given the possibilities discussed above.

Personal income and spending for July

Personal income may offer some cheer because of gains in private wages, IHS Global Insight forecasts. The economic consultants see income rising 0.4%, following a June with no gain. There will be little growth in spending and only nominal inflation pressures.

Consumer confidence

A number of surveys show stabilization in confidence, despite all the worries about the markets.

The index is expected to inch up to 52.5 in August after falling for two months in a row. That would match the small improvement already announced Friday in the Reuters/University of Michigan sentiment index.

S&P Case-Shiller Home Price Index

Nomura Securities is forecasting that the widely watched index will show a 3.1% year-over-year rise for June, down from a year-over-year gain of 4.6% in May. Other measures of house price growth have suggested house price inflation began to cool in midsummer. This may signal the beginning of a downward trend in home prices going forward.

Chicago Purchasing Managers Index

This can move markets. Nomura sees the index falling to 56.0 from 62.3 in August (a reading of 50 indicates growth). Other regional manufacturing surveys released for the month have shown the economy softening.

Minutes from the Federal Reserve's Aug. 10 meeting

The members of the Federal Open Market Committee, the Fed's rate-making body, have been arguing with each other a lot about how much stimulus the economy needs from the Fed. The disagreement should appear in the minutes. But conditions have softened since the meeting that the disagreements may be buried for now.

The Institute for Supply Management Manufacturing Index for August

This report is important, and most analysts believe it will reflect the economy's slow slog downward. Orders and production indicators have been struggling, and backlogs and inventories are just drifting. Vendor performance should improve (i.e. delivery times should quicken), which will be a drag on the ISM headline. The Eastern regional surveys were all either lackluster or downbeat. IHS Global Insight sees the index falling from 55.5 in July to 51.5. Nomura Securities is looking for a reading of 53.5.

U.S. auto sales for August

The auto industry has seen mostly steady growth since the end of the Cash for Clunkers program last summer. Expects sales to hit an annualized 11.6 million units, up slightly from July's 11.5 million units.

Construction spending for August

Based on dismal reports on building permits and housing starts and on new and existing home sales, don't hold your breath for a good report.

Jobless claims

The department reported claims for the weekend ending Aug. 21 at 473,000, down from the prior week's 504,000. There are hopes that the Aug. 14 filings were the worst.

Factory orders for July

Orders for manufactured goods likely increased by just 0.3% from June. That's a reflection of the weakness that has swept over the economy this spring.

Pending home sales

This looks at sales contracts signed but not expected to close for up to two months. The expiration of tax credits in April gutted sales for the next several months. But some in real estate have argued a rebound should start to emerge this fall.

ISM non-manufacturing index

Expect a small decline in the index to 53, which means growth is still going on. A bright spot in the report: Travel and tourism services appear to be holding up well. Visits to Yellowstone National Park hit a new high this summer.

Payrolls and unemployment for July

Most analysts see the national unemployment report rising slightly from July's 9.5% rate. IHS sees a 9.6% rate; Nomura is looking for 9.7%. Expect another decline in nonfarm payrolls as the Census Bureau continues to drop workers and as state and local governments cut back. IHS sees private employment growing by 30,000. Nomura sees only 15,000.

Introduction

There were some headlines early last week that President Obama's approval rating (as reported by Gallup) for the week prior fell to 43%. That was the lowest level of his presidency. Therefore, does the presidential approval rating drive the stock market in any way? Or maybe it's the other way around; does the stock market drive the approval ratings? In the analysis below, the return on the Dow Jones Industrial Average is compared to the approval rating of the current president and of past presidents. Approval rating data from Gallup goes back to 1938.

The Last Two Administrations

It is interesting that the approval ratings of the last two presidents (Obama and Bush) could not have been more negatively correlated with the stock market.

Below is President Obama's approval rating along with the Dow since he took office. The market has been very strong for a lot of his presidency and has been sideways for the last several months. But his approval rating has been steadily declining almost since day one. A lot of different things that have nothing to do with the stock market can influence a president's approval rating. It depends on the events of the time. However, in our current situation, the speculation is that the way people view the economy is heavily influencing the way they feel about the president. If this is the case, then the lower approval rating may end up being a good indicator. In other words, the president's approval rating is dropping because people are afraid in this economy. But that level of fear is a healthy driver of the stock market.

Below is a table averaging the return of the Dow over different time frames depending on the president's approval rating. Again, the data goes back to 1938 and it was collected by Gallup. The data is not in constant intervals but averages out to be about one reading per month.

As was pointed out earlier, the president's approval ratings are often based on factors that have no implications for the stock market. So consider that when looking at the data. That being said, it doesn't look like the approval numbers are contrarian indicators. The market has done worst across the time frames when the presidential approval numbers are in the 20s. The market does better than average three months and six months later when the approval numbers get to the 80s. Again, take it for what it's worth, but the best six-month and 12-month returns happen when the approval ratings are in the 40s, which is where they are currently for President Obama.

***Further evidence of market conditions can be seen in representations of charts below.

Introduction

It was an interesting week to say the least for the markets. The markets began the week by breaking down under an important support level on high volume. After a few volatile days, the markets ended up closing out the week on a strong note. Despite this strong finish to the week, the markets remain vulnerable and traders should remain cautious of the notion that a bottom is in.

The S&P500 as represented by the S&P 500 SPDRS (NYSE:SPY) ETFbroke under an important support level earlier this week as it fell below the $106 level. This was a pivot low earlier in July and with SPY falling below this level it negates the pattern of higher highs and higher lows. Despite the strong close at the end of the week, SPY remains below a price cluster formed over the past couple of weeks and its declining 20 and 50-day moving averages. While there is the potential that SPY will hold important support at this level, it will likely take more time and a retest before an important low is formed.

The markets are once again making it difficult for traders as they mixed some very important technical failures with a strong close this week that hints at an attempt to bottom out. The possibility of a bounce from this level is very real, especially in light of the markets being oversold on a few indicators. However, the path of least resistance is lower now, with the indexes in a near term pattern of lower lows and lower highs. Traders will need to closely monitor how the indexes deal with last weeks highs if tested in the coming week. In the grand scheme of things, the general indexes remain in a much larger trading range established over the past year. All the indexes are trading closer to the bottom of this range, and coupled with the recent price action, it is making for a vulnerable environment. Traders should continue to trade cautiously until a clearer direction emerges or become adventurous and start ”trading options”.

Introduction

The stocks in this group took a hit over the past week and in looking at department store stocks, it's easy to see why. The department store stocks are suffering from renewed fears of a weakening economy which has been driving investors away from consumer discretionary stocks. The department store stocks are already breaking down and have charts that are clearly in trouble.

In looking at the chart for Saks Incorporated (NYSE:SKS), you can clearly see that SKS is in danger of heading lower. It was correcting in a channel through most of the summer as it drifted down from its April high near $10.50. It attempted to clear the top of the channel in July but abruptly turned lower a few days later. It is currently testing its July low which could temporarily halt the decline, but it will take much more consolidation to improve the health of its chart.

The department store stocks have been showing a great deal of weakness, and many of these stocks are currently testing important levels as they head lower. The more likely scenario near term is that they find support at these levels, but the real test will be in how enthusiastic buyers are a week from now. These charts will need much more time before a solid base can develop and the threat of them continuing lower is very high. In order for a more solid base to form, these lows would have to hold followed by a successful retest or even a transition to higher lows and higher highs.

The S&P 500 tested the 1,040 level twice during last week, both times ending the day with gains. The level has consistently attracted buyers over the past 10 months and was significantly breached only once during a brief stint in July.

"Here we are sitting at this important support level, having pulled back 8 percent (on an intraday basis) in three weeks, you potentially set up for a reversal," said Richard Ross, global technical strategist at Auerbach Grayson in New York.

The benchmark Standard & Poor's 500 index finished last week at 1,064 on Friday. If the 1,040 level is breached, the S&P 500 could fall into a lower range around 1,020 to 1,010. However, the index runs into resistance at its 14-day moving average at 1,076.65, providing only limited scope on the upside.

Based on data going back to 1950, the Stock Traders Almanac says the month of September is historically the worst month for all three stock indices.

The average loss for the Dow in September is 1 percent and S&P 500, on average loses 0.7 percent. However, in four of the last five Septembers, stocks have gone higher (with the exception of the brutal September of 2008).

Doug Cliggott, U.S. Equity Strategist at Credit Suisse, expects to see more earnings warnings. "The bad news is the global economy is slowing down. We think that's going to impact corporate profits, and we think profit growth is going to flatten out. The negative of that is we think consensus estimates are probably going to have to come down quite a bit. I think the rate of deceleration has taken everyone by surprise.

"This is a much more abrupt slowdown in activity than we were thinking, and I've got to think it's a more abrupt slowdown in growth than a lot of corporate managements were expecting," said Cliggott. "The third quarter is the first quarter since the fourth quarter of 2008 where we might see a significant number of earnings misses, and you should see lowering of near-term guidance."

Cliggott expects the S&P 500 to finish the year near its current level, between 1050 and 1125.

As stocks lost ground, bonds prices have been rising and yields, which move inversely, declined. Friday's big rally in stocks brought a reversal for Treasurys.

Investors will be closely following comments from executives at big industrial companies like and Boeing (BA) at Morgan Stanley's Global Industrials Unplugged Conference next week.

Intel Corp (INTC) cut its third-quarter revenue estimates in a surprise on Friday. Although investors shook off the news after an initial fall, bleak outlooks from large corporation at the heart of the economy could rattle investors.

"Intel's preannouncement is indicative of the PC replacement cycle, which is an indication of business spending. It's not good news," said Barry Knapp, Barclay's Capital head of equities portfolio strategy. "What you're hearing from Intel, Cisco (CSCO) or durable goods is not business spending remaining strong."

Knapp expects to hear more technology companies preannounce after the Labor Day weekend. "I think there's a chance September could be pretty ugly, in which case I was thinking we could go down and retest the lows at 1010 (on the S&P 500). It may be we go below 1000," he said.

Federal Reserve Chairman Ben Bernanke boosted stocks on Friday by signaling the Fed is ready to act if the economy worsens. But more weakness in upcoming indicators like non-farm payrolls and Institute for Supply Management surveys would intensify fears the economy is sliding back into recession.

"There is this continual trend toward numbers falling short of expectations," said Nick Kalivas, equity analyst at MF Global in Chicago. "My guess is you'll see some selling come in again next week on these numbers."

Pimco senior market strategist, Tony Crescenzi, said the Fed's minutes, scheduled for release Tuesday afternoon, may now be anticlimactic after Bernanke's speech. The Fed chairman's major speech, delivered at the Jackson Hole, Wyo. Fed conference helped calm the markets, despite the fact that it did not detail the course of further quantitative easing some bond traders were expecting.

"There seems to be contingency plans in the works, but the Fed right now feels it's not necessary to either discuss or detail or put them in place...and secondly and very importantly, the Fed's outlook on the economy hasn't changed materially," said Crescenzi.

He also does not expect the Fed to release a changed economic forecast with the minutes of the Aug. 10 meeting. "Apparently, the forecast of the August 10 meeting among members hadn't changed enough to warrant aggressive action. More of what is involved in the contingency planning will be revealed as we go, particularly if the data is weak...In the policy statement September 21, some of the contingency planning might be revealed," he said. September 21 is the next Fed meeting date.

As usual there will be a series of secondary labor market data playing second fiddle ahead of the Friday's jobs number. ADP's jobs report on Wednesday is expected to show the private sector added 18,000 jobs in August, down from 42,000 in July.

Weekly claims for jobless benefits are tipped to remain solidly elevated on Thursday, edging up to 475,000 compared to 473,000 the week before.

With significant risks on the horizon, many investors may think twice about getting into the market at the start of September, historically the worst performing month for all three major indexes.

That may be especially true given the three day break the following week when U.S. markets shut to observe Labor Day on Monday, Sept. 6.

Scott Marcouiller, chief technical market strategist at Wells Fargo Advisors in St. Louis, said he found it hard to envision a rally in the current environment.

"Right now the market is locked into short-term thinking," he said.

Options

Investor sentiment remains negative. In the options market, investors bought S&P 500 puts, giving them the right to sell S&P futures at a fixed price, although the most actively traded option on the S&P 500 (SPY.P) ETF was the $107 call, suggesting some bullish trades ahead of the coming week.

"Overall investor sentiment in the option market has become very skeptical, with put buying widely exceeding call purchases," said Ryan Detrick, technical senior analyst at Schaeffer's Investment Research in Cincinnati.

The put-to-call ratio, a measure of investor sentiment, was at 0.61 as of Thursday's close compared to a 21-day ratio of 0.59.