The Week Ahead
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 the year.
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.
Key Events This Week
This Week’s Economic Reports
There are still a few major economic indicators available this week but have slowed to a trickle. Here is a brief list of some of the key events this week:-
• Conference Board's leading indicators for November.
This Week’s Major Earnings Reports
Note:-All earnings dates listed below are tentative and subject to change.
• FuelCell Energy Inc. (FCEL)
• Best Buy Co. Inc. (BBY) and Hovnanian Enterprises Inc. (HOV)
• Joy Global Inc. (JOYG)
• Actuant Corp. (ATU), Discover Financial Services (DFS), FedEx Corp. (FDX), General Mills Inc. (GIS), Pier 1 Imports Inc. (PIR), Rite Aid Corp. (RAD), Oracle Corp. (ORCL), Research In Motion Limited (RIMM) and Take-Two Interactive Software Inc. (TTWO).
• There are no major earnings reports scheduled for Friday.
Outlook for This Week
It is quite interesting for the markets when analysts, researchers, etc., have differing opinions on a situation, and in this case, the week ahead for the stock market –which could help to explain why the week will be elfish!
On one side of the mirrors-view-point, we have pessimism – where the December rally is seen as reaching its climax, with dwindling volume, excess optimism, and history, which all points to a stock market that could be running out of steam.
On the optimistic side of the mirror -- we have the view that this year's miracle won't be limited to 34th Street as it will spill onto Wall Street as well. This is backed up by the recent agreement to extend the Bush-era tax cuts which will help lift the markets in the final weeks of December, analysts say, with retail stocks expected to be among the top beneficiaries.
Late-year advances, known as "Santa Claus rallies" because of their proximity to Christmas, occur on a seasonal jump in bullish sentiment, as well as window dressing -- a strategy used by fund managers to improve the appearance of their funds by chasing strong performers.
Therefore, this week may well be noisy. There are important economic reports and events coming up, including a Federal Reserve meeting and an important tax vote, plus earnings reports from the likes of Best Buy (BBY), Hovnanian (HOV), FedEx (FDX), General Mills (GIS), Oracle (ORCL) and Research In Motion (RIMM).
And this will be the last full week of trading before we get into the holiday season.
U.S. stock investors in the days ahead may contend with managers’ year-end positioning, with stocks coming off two weeks of gains that pushed the S&P 500 and the Nasdaq Composite to multi-year highs.
“Most of the things that people are anxious about are not going to drive trade. There is the chance of a wild card for sure, but don’t know that any data or announcements where the stage isn’t already set,” said Sandy Lincoln, chief investment strategist at M&I Investment Management.
Far from the usual quiet seen this time of year, the upcoming final days before Christmas promise a flurry of major business and political headlines. MarketWatch's Rex Crum reports. “We’re getting to get into the end-of-the-year” trade involving position squaring by portfolio managers and other investors, Lincoln said.
Recap of Past Week
The Nasdaq Composite (2,637.54) closed at its highest level in three years, while the S&P 500 Index (1,240.40) scaled heights it hadn't achieved in more than two years. Even the underachieving Dow Jones Industrial Average managed to climb above 11,400 in the final 30 minutes of trading on Friday.
The dollar in the past week rose about 1.4 percent against the euro and 1.5 percent against the yen, helped by U.S. higher Interest rates.
Even with the rate rise, stocks in the past week gained, with several indexes touching multi-year highs. The S&P 500 rose 1.3 percent to 1240, its highest level since September, 2008, while the Nasdaq rose 1.8 percent to 2637, its highest close since Dec. 31, 2007. The Russell also was a winner, up 2.7 percent at 776, its best close in three years. The Dow was the laggard, up just 28 points, or about 0.25 percent at 11,410.
After a lengthy period of cash-hoarding by corporate America, the recent week saw a spate of dividend hikes or talk of future payments to shareholders.
GE, the country’s biggest conglomerate, on Friday said it would hike its quarterly dividend by 17% to 14 cents a share, with the move the second hike in GE’s payout to shareholders this year. The dividend, however, is still well under the 31 cents in play before GE slashed its dividend in 2009 as the maker of jet engines and turbines rushed to save cash during the financial crisis.
Another large manufacturer, Honeywell International Inc. (HON), also said on Friday it would raise its dividend, by 10%. The head of GE Capital, the company’s finance arm, told investors during the week the unit expects to hike profit in the next two years and restart dividend payments to its parent company in 2012.
Honeywell is expected to lay out its financial targets in the week ahead.
Western Union Co. (WU) also hiked its dividend last week, while grocer Whole Foods Market Inc. (WFMI) said it would revive a payout and Tyco International Ltd. (TYC) said it would ask for shareholder approval to increase its dividend by 20%.
The week ended with signs a tax-cut package would pass the Senate, helping push bond yields upward for another day, as investors viewed the legislation as likely to boost economic growth as well as the U.S. deficit. Read more on Senate tax deal.
The tax-cut deal would also extend benefits to the long-term unemployed, while putting “a few more dollars in paychecks for those who still have a job this holiday season,” noted Standard & Poor’s analysts David Wyss and Beth Ann Bovino in a research note.
The Week Ahead
When trading resumes on Monday, that will start the last five-day trading week before Christmas. The following week will be cut short by the holiday. With Dec. 25th falling on Saturday this year, the U.S. stock market will be closed on Friday, Dec. 24th, in observance of the Christmas holiday.
Stocks head toward the year end on a tail wind, but traders are watching a number of cross currents that could hold back gains in the week ahead.
These Cross Currents are :-
The biggest event for markets are Congressional votes on a tax package compromise that would extend Bush-era tax cuts for two years and provide a one-year break on Social Security taxes for individual tax payers. Wall Street has already embraced the plan and has factored in more robust economic growth for 2011, and higher stock prices, because of it.
Goldman Sachs chief strategist David Kostin is one of those who recently issued a forecast for 2011. He expects the S&P 500 to reach 1450 by the end of 2011, and that is because of the prospect of better economic growth.
"It's really about the U.S. recovery, and you look at election cycles. The third year of presidential terms are historically good years for the stock market," Kostin said.
The other big event in the coming week is Tuesday's Fed meeting, which is not expected to generate any major news. The Fed is expected to use its post-meeting statement to do little more than restate its flexibility on its controversial quantitative easing program. There is also a full calendar of economic reports, including retail sales, and consumer and producer inflation data.
The tax plan is likely to pass, despite the fact it is meeting resistance, said Potomac Research Group chief political strategist Greg Valliere. The plan is before the Senate Monday and probably before the House later in the week.
"As long as rate increases are reasonably steady, then it wouldn't be a cause for concern...In an absolute context, rates right now are 3.25 and that, on a historic basis, is extremely low. But an important aspect of this is why rates are up. Rates are up because the prospects for growth are higher.”
"I think the question is when do we get it? There's a remote chance they won't get it done by the Christmas break...I think the Democrats are foolhardy if they don't do it, and wait for January because they've got a new, much more conservative Congress coming in," he said.
Another major force being watched by traders is the selloff in the bond market, which has sparked an unexpected run up in interest rates. The yield on the 10-year rose to a six-month high in a volatile week of trading. Even after most traders had left for the day Friday, the 10-year continued to tick higher and was at 3.319 percent in late afternoon. Some stock traders say they will worry if it begins to head toward 4 percent.
"As long as rate increases are reasonably steady, then it wouldn't be a cause for concern," said Goldman Sachs' Kostin. "...In an absolute context, rates right now are 3.25 and that, on a historic basis, is extremely low. But an important aspect of this is why rates are up. Rates are up because the prospects for growth are higher."
Pimco strategist Tony Crescenzi agrees rates are rising on better economic news. Pimco Thursday moved its 2011 forecast to growth of 3 to 3.5 percent from 2 to 2.5 percent because of the hefty stimulus from the tax package.
"(10-year) Treasurys (yields) have largely held in a 3 to 4 percent range...it seems that the 3 to 4 percent range is the range that's likely to hold intact for awhile. A move above 4 percent entails many months of strong employment gains...we're not even close to the point where we'd have reason to be above 4 percent on that basis," Crescenzi said.
David Ader, chief Treasury strategist at CRT Capital, said some of the action in Treasurys is the result of year-end positioning. He believes about 80 percent of the big bond selloff was the result of overly aggressive positioning ahead of the Fed's quantitative easing program.
The Fed, in November, said it would purchase $600 billion in Treasurys, a plan that was expected to drive interest rates lower. But the Fed first started talking about easing in August and that drove speculative buyers into bond market, sending rates to the low of the year in October. Once the Fed started buying Treasurys, bonds started to sell off and rates began to rise.
"To the extent that this was a painful unwind of positions, I think people have gone from long to flat to a little degree short...It looks like it should have run its course," Ader said of the selloff. He said some of the selling is also related to fears of greater U.S. deficits, and the fact than the tax vote has sparked a bipartisan feud is not a good sign for future cooperation on fiscal matters.
Crescenzi said he believes yields might have been even higher at this point, were it not for the Fed's quantitative easing program. For that reason, he expects the Fed to continue with the full amount of QE, despite speculation that a stronger economy may reduce the need. The Fed easing program is helping reflate the economy, in that it is driving investors to riskier assets, like stocks. Crescenzi also expects the Fed to restate its commitment to QE in its statement Tuesday.
"It will be indicated somehow that current policies will be sustained. There will be no hint contained in the statement that some alternative is being considered, like the purchases will be curtailed," he said.
Investors are also keeping their eyes on the possibility of a weekend rate hike from China, and the meeting of European heads of state late in the week.
Forex.com's Brian Dolan said the anticipated rate move by China, already a factor in commodities selling this past week, could be a catalyst for more profit-taking. He does not expect European leaders to take any significant actions that would impact the sovereign debt situation. "The spreads have started to back up in the Euro zone periphery versus Germany. If that continues, the euro is going to keep under pressure," he said.
Trading volume will fall off rapidly the week of Dec. 20, with markets closed on Friday for Christmas Eve, and it will be low right up to Dec. 31, also a Friday. But the low volume will also leave the market vulnerable to more-than-the-usual volatility. So, your best bet is not to pay too much attention to the results of those two weeks.
This week, the S&P 500 has broken through closely watched resistance levels and has climbed for six of the last eight days to close at fresh two-year highs.
But gains have been accompanied by decreasing participation. Average volume during the last three days of the week was 7.76 billion, well below this year's daily average of 8.62 billion.
"We are entering now the beginning of the seasonal pattern where volume really dries up," said Nicholas Colas, chief market strategist at the ConvergEx Group in New York. "It seems like it's starting a little sooner than usual.
The 15-day moving average of the advance/decline ratio on the New York Stock Exchange, a measure of the proportion of advancing to falling stocks, has started to slip and currently stands at around 1.5. It peaked this year in July at about double that, according to Reuters data.
In addition, the 3-day moving average of stocks making new 52-week highs has also turned lower after a spurt at the start of the month. It now stands at around 125, down from more than 250 at the start of the month.
The breadth and ratios have not been "on board" this rally of late, according to a report from McMillan Analysis Corp. Equity-only put-call ratios remain on "sell" signals, the analysts say.
The S&P 500
In the week ahead, five S&P 500 companies are expected to report four-quarter results, starting with retailer Best Buy Inc. (BBY) on Tuesday.
The estimated earnings growth rate for the S&P 500 for the final quarter of the year is 31%, with the financial, material and energy sectors tallying the highest growth rate for the quarter, according to Thomson Reuters analyst John Butters.
Chart-minded investors are bullish. The S&P 500 has closed well above 1,228, the 61.8 percent Fibonacci retracement of the 2007-2009 bear market slide, a key technical level.
"When a market surpasses a certain retracement level, then the probability increases of a rise to the next retracement level, which in this case would be a 76.4 percent retracement and that's a ways up at 1,362," said Chris Burba, short-term market technician at Standard & Poor's.
The 1,120 level, the top of a recent trading range, is seen as strong support.
On Friday, the S&P 500 closed at 1,240.40 and was up 1.3 percent for the week.
Expectations for this Week
Leadership by the Small Caps
The S&P 500 Index (SPX) broke out above this year's prior peaks and closed the week at 2010 calendar highs. In last week’s “Weekly Outlook”, there were five reasons stated for the possibility of a breakout, and they boiled down to the following:
1. Evidence of hedge fund accumulation through our analysis of option activity.
2. Small cap leadership.
3. Resilience amid a stream of negative headlines in the month of November -- the market bent, but didn't break.
4. The CBOE Market Volatility Index (VIX) converged around the same level as SPX 20-day historical volatility, a "buy" signal during the past couple of years.
5. Our "Black Friday" indicator – if the first week after Black Friday is positive, the market tends to be strong into the rest of the year.
Let's quickly review where we stand on the first four indicators above. The last cannot change, and is bullish into year-end. The combined 20-day buy-to-open put/call volume ratio on the SPDR S&P 500 ETF Trust (SPY), PowerShares QQQ Trust (QQQQ) and iShares Russell 2000 Index Fund (IWM) took a turn lower, implying hedge funds stepped away once again.
PowerShares QQQ Trust (QQQQ)
After further analysis, it is obvious that option activity on the QQQQ was driving much of the action in the combined ratio, as the 20-day buy-to-open put/call volume ratio experienced a significant drop, from 2.05 to 1.43. The takeaway would be to avoid the large-cap technology names at this juncture, especially with the QQQQ still trading just below the October 2007 peak in the 55 area. These names could be in for a period of underperformance, as long-term resistance resides above and hedge fund players don't seem too interested at the moment.
iShares Russell 2000 Index Fund (IWM)
As long-term resistance lingers overhead on the QQQQ, the IWM's move above $75 looks constructive, with the implication being that small-cap leadership is still in place, which we view favorably.
Note in the chart below that this month's advance has pushed the IWM above a trendline that connected the July 2007, October 2007, and September 2008 peaks. With the SPX trading above the 61.8% retracement of its 2007 peak and 2009 low, and above its 2010 highs, the technical backdrop is bullish for the most part, though retests of these former resistance areas cannot be ruled out.
”Bad News – Good New” Syndrome
On Friday, China announced that it raised reserve requirements 50 basis points for the sixth time this year, but stocks still rallied, as investors focused instead on a surge in U.S. exports in October, improving consumer sentiment, and General Electric's (GE) second dividend increase in a year.
The bottom line is that the market still continues to be relatively resilient in the face of "bad" news, and respondent to "good" news. China's statistics agency announced Saturday that consumer inflation surged 5.1% in November, a 28-month high. The release date was pushed back a day, causing some investors to brace for a major negative surprise.
The caution ahead of this release might be viewed as healthy, as "would be" buyers stepped aside or bought protection ahead of the report. In fact, the "buy protection" trade may have been on Friday, as the VIX increased as stock prices rose.
Turning to our "VIX premium" indicator, the VIX is still trading around actual SPX volatility. This is encouraging, as corrections have tended to occur when the VIX is at a significant premium to actual SPX volatility, as you can see on the chart below.
Those bidding stocks higher last week could have been unhedged market participants chasing momentum names, and such activity could go on into year-end. Unhedged players drove the market advance in late 2009, eventually setting the market up for a significant correction beginning in mid-January. Said another way, when unhedged hands are in accumulation mode, additional risk accompanies such an advance, as they are the first to panic when negative news hits. Therefore, we would prefer to see a year-end rally accompanied by increasing buy-to-open put/call volume ratios on the major exchange-traded funds (ETFs) that we monitor.
Finally, next week marks the expiration of options with a Dec. 18 expiration date. How has December expiration weeks fared since 2000? See the tables below for a summary. Will the first December expiration of this new decade be a repeat of the 2000 disaster, or does the 80% win rate since 2000 hold more weight?
"Santa Claus Rallies"
Late-year advances, known as "Santa Claus rallies" because of their proximity to Christmas, occur on a seasonal jump in bullish sentiment, as well as window dressing -- a strategy used by fund managers to improve the appearance of their funds by chasing strong performers.
It helps that stocks are already on an uptrend, with the Standard & Poor's 500 Index .SPX trading at two-year highs.
Increased sentiment "is not totally uncommon at this time of year," said William Delwiche, an investment strategist at Robert W. Baird & Co in Nashville. "Year-end and holidays tend to make people cheerful and optimistic about the New Year."
The gains, which can be amplified by the period's light trading volume, have helped make December a historically strong month.
According to Thomson Reuters Datastream, the S&P 500 has gained an average of 1.5 percent in December since 1975, the third-best month behind April and November. The index is up 5 percent so far this month.
"Santa Claus rallies don't come on specific catalysts so much as an intangible sense out there, and this year that sense is strong and to the upside," said Joseph Greco, managing director at Meridian Equity Partners in New York.
"The tax deal gave us a huge shot in the arm, we're seeing consistent strength in retailers, and it's possible that we could get a move of 2.5 (percent) to 3 percent up from here," Greco said.
Sentiment on retail stocks has been bullish lately, thanks to encouraging reads on consumer spending in the holiday shopping season. Analysts said the tax deal is adding to that positive bias.
"For the first time in several years, the consumer is back in play, especially if the tax deal comes through the way it has been proposed," said Timothy Harder, chief investment officer at Peak Capital Investment Services in Denver, which has about $600 million in assets under management. "As that becomes more certain, companies that target consumers will see that benefit."
While Santa Claus rallies unofficially run in the final week of the year, some retailers have already racked up strong gains. Abercrombie & Fitch (ANF) has surged 11.3 percent in December so far, while luxury retailer Saks Inc (SKS) is up 6.8 percent.
Despite an expected positive end to the year, issues may resurface in January as traders return from vacation and trading volume increases.
"We'll see Santa in December, but then comes the 'January effect' when institutions and managers either take money off the table or really get involved," Meridian's Greco said.
According to Datastream, January is historically the fourth-best month of the year.
"I'm hopeful that once they get a read on how bullish things are, that'll stimulate them to keep things going."
Sentiment and the VIX
Investors appear to have grown complacent as the CBOE Volatility Index, or VIX .VIX, has fallen to levels not seen since April. Stocks have made new highs on almost a daily basis. The S&P 500 .SPX closed on Friday at its highest level since September 2008 and the Nasdaq .IXIC scored its best finish since late December 2007, with many expecting gains to run through the end of the year.
The American Association of Individual Investors' latest sentiment survey shows bullish sentiment reached a four-week high. What's more, bullish sentiment has spent 14 weeks above its historical average -- its longest streak in six years.
That is often seen as a contrarian indicator.
"I don't think we're at any risk of a meaningful sell-off into the end of the year, but I think the basic contours of what the economy looks like are pretty well set," he said.
That sentiment was reflected in the VIX, also known as Wall Street's favorite barometer of investor fear. Although the VIX edged up on Friday, the index has fallen for six of the last nine sessions. It now stands at 17.61 after hitting its lowest since April.
The economic events start in a big way on Tuesday.
The important piece of economic data in the week ahead is retail sales for November, released on Tuesday. That is being watched closely for signs of consumer strength during the holiday season. Holiday sales results are also being closely followed.
Interest Rates And Monetary Policy
The big interest, for investors, will be the Federal Reserve's decision on interest rates and monetary policy, due at 2:15 p.m. ET. The Fed has been highly criticized by China, Germany and other exporting countries because they fear the central bank's plan to buy in $600 billion in bonds by June will push the dollar lower, hurt their markets and cause inflation.
Republicans are terrified that the Fed is just being reckless.
What has happened since the Fed announced its plan in November is that the dollar has risen, as have interest rates. Gold is nearing record highs, silver is at 30-year highs, but crude oil has continued to be range-bound.
It is, however, so early in the plan's execution that one can't make a conclusion with any real statistics.
What the Fed will probably say is that it will complete the plan. It won't change interest rates. It will suggest that the economic recovery is proceeding, but joblessness remains a national crisis.
Retail sales for November from the Commerce Department
Nomura Securities see this report showing a solid 0.7% gain. Consumer confidence has picked up, and there is some evidence of life in the jobs market. Ford Motor (F) announced this week it is expanding a Louisville, Ky., plant.
Producer Price Index for November from the Labor Department
This will help define the food inflation issue. The price of wheat is up 43% this year, largely because of a Russian drought. But droughts like that affect livestock feed prices and livestock prices overall.
Consumer Price Index for November from the Labor Department
This report will also offer a sense of whether inflation is likely to be a serious problem. It may not have appeared much at the grocery shelves yet. Gasoline jumped 10.7% in October, according to AAA's Daily Fuel Gauge report, but only 1.6% in November.
Industrial production for November from the Commerce Department
This is likely to be flat.
Empire Manufacturing Survey and Philadelphia Federal Reserve Bank's manufacturing index
Both for December. The first is due Wednesday from the New York Federal Reserve Bank; the latter comes Thursday. There is some worry with these. New York's October report was weak; Philadelphia's was stronger. The questions is: What's the trend?
Initial jobless claims from the Labor Department
The trend since summer has been for a slow but steady decline. Claims coming below 400,000 will be very bullish.
Housing starts from the Commerce Department
This should show improvement from a lousy report in October that was due entirely to a big decline in multifamily construction. Most economists see a modest gain as multifamily starts and permits rebound. Single-family construction will probably be flat and near record lows. Only a rebound in jobs and getting foreclosures sold will set up a real housing recovery.
Events of Importance
• The Irish opposition party Fine Gael said it will discuss its position on the country's EUR67.5 billion aid package at a meeting of senior party figures next week. Ireland's parliament will vote on it Wednesday, Prime Minister Brian Cowen said Thursday. He said the package negotiated by the International Monetary Fund and the European Union is in the nation's best interest.
• Herman Van Rompuy, president of the European Council, Thursday called for European governments to agree to a limited change to the European Union treaty next week that will allow the creation of a permanent mechanism to bail out troubled EU economies. He said he believed European leaders would do "whatever it takes" to ensure the financial stability of the euro region.
• The council of cash-strapped Harrisburg, the capital of Pennsylvania, is expected to vote on the city's $57 million 2011 budget next week. Harrisburg earlier this week disclosed officials mistakenly failed to fully budget its general obligation debt for 2011 and currently don't have enough to make the next payments due in March.
• Preliminary trade for the yuan-ruble pair will begin on Moscow's Micex exchange next week, while China is looking to use rubles to pay for Russian timber, seafood and coal as the two countries seek to strengthen currency ties while sidestepping the dollar. The Micex will trade CNY3 million ($451,000) daily starting Dec. 15, officials at the country's largest market by volume said at a Moscow conference. Both Russia and China have in the last several years called for countries to lessen their reliance on the U.S. dollar.
This Week’s Earnings Expectations
The week ahead will set up the year-end performance. There aren't a lot of earnings on tap, but they are revealing. Here are the earnings reports to watch:
Best Buy and Hovnanian.
The electronics retailer raised its full-year guidance in September, and indications are that the holiday shopping season started strongly. The commentary on its fiscal-third quarter earnings will be key.
The important piece of Hovnanian's report, which comes after the close, will be its new orders and cancellations.
Joy Global (JOYG)
This company will tell us what global demand for mining construction equipment is. In other words, Joy Global will offer a clear view of China's economic health. China is heavily investing in coal projects.
FedEx, General Mills, Oracle, Research In Motion and office-furniture maker Steelcase (SCS)
FedEx also will help round out the picture of the holiday shopping season as well as the domestic and global economy.
General Mills will tell us if food processors are facing inflationary pressures. Oracle, Research In Motion and Steelcase will give us a view of corporate spending.
Research In Motion has the most to prove. It needs to show that its BlackBerry line of phones has staying power against Apple's (AAPL) iPhone and phones that use Google's (GOOG) or Microsoft's (MSFT) operating systems. (Microsoft is the publisher of MSN Money.)
Even though Steelcase cut its fiscal-third-quarter guidance, Wall Street is hopeful about its prospects. Shares are up 56% since August.
INDICATORS AND MARKET CONDITIONS
Analyst and Stock Performance
Analysts, generally employed by large Wall Street brokerages, give "buy" and "sell" recommendations on individual stocks, and they are a good gauge on where stock sentiment is aligned. This week we take a look back to the beginning of the year and see what analysts were recommending and how those stocks performed.
Analysts in 2010
In this analysis, we look back at the beginning of the year and consider only optionable stocks that had substantial coverage (at least 20 analyst ratings, as reported by Zacks). By settling on a list of 228 stocks, which are then grouped into five brackets, from least popular to most popular, as measured by the percentage of analysts who had "buy" recommendation for those stocks, the results are quite interesting.
The top row of the table represents the 20% of stocks where analysts were most bearish. The percentage of buy ratings on those stocks ranged from 9% to 32%. Despite the skeptical outlook by analysts at the beginning of the year, look at the year-to-date performance in this top row. The S&P 500 Index (SPX) is up about 11% for the year, but those stocks on which analysts were most bearish were up on average 32%. Furthermore, 86% of the stocks in the top row were positive. Stocks with 33% to 43% "buy" ratings also significantly outperformed the entire group of stocks.
On the other end of the spectrum, look at the bottom row, the group of stocks where the analysts were most bullish. Stocks where 68% to 97% of analysts recommended a "buy" averaged a measly 5% return, and less than half of those were positive. In a year that the SPX was up over 10%, that's an awful performance.
Stocks to Watch
Below is a list of stocks that may be suitable for your portfolio. Obviously, you need to thoroughly do your own research before you jump in and buy!
The first step was to look at those stocks in that first row in the table above, representing the 20% of stocks on which analysts were most bearish at the beginning of 2010, Then, look at current analyst rankings on these stocks. Below are stocks which were in that first group at the beginning of 2010, had a return of at least 20% (meaning it outperformed the average stock in our analysis), and yet are still in the bottom 20% of stocks as far as analysts rankings go.
Here's what is expected to happen for many of these. The strong uptrend will not break. They will continue to go up. The analysts will eventually have no choice but to capitulate and admit they were wrong. As those analysts upgrade their recommendations from bearish to bullish, it will provide more catalysts propelling these stocks even higher. In other words, if the market continues higher, it wouldn't be too surprising if 2011 turned out even better for some of these stocks than 2010.
Stocks In A Strong Market
It’s interesting that one of the most difficult trading conditions for a trader to master is buying during a runaway market. Even though most stocks are rising, after a few days, the vast majority of stocks is extended and thus offers inferior risk-reward setups. Even though many of these stocks will continue to rise through overbought conditions, traders are constantly faced with the difficult choice of deciding when a stock is too extended for a safe entry. The safest play for swing traders is to focus on stocks that are relatively close to support, but are still showing strength. By not chasing extended stocks, traders can avoid putting themselves in a situation where they are exposed to a drawdown in an otherwise strong stock.
Salix Pharmaceuticals (NasdaqGS:SLXP)
Salix Pharmaceuticals (SLXP) is a good example of a stock that is showing good overall strength, yet remains in a decent position. SLXP was trading in a wide but well-defined range as it consolidated from July through November (within a larger consolidation). Buyers stormed into SLXP in early November, propelling the stock through the trading range. After surging to new highs, SLXP has settled into a very tight range resembling a bull flag. Traders should watch for a break of this flag as it could present a great trading opportunity.
VeriSign (NasdaqGS:VRSN )
VeriSign (VRSN ) is another stock trading in a very tight consolidation within the context of an uptrend. VRSN has been following a consistent pattern of clearing small bases as it trends higher. It is currently trading in a tight range between $34 and $35.50 as it consolidates the move from its last breakout. A move above this trading range could provide a good opportunity for traders.
Arctic Cat (NasdaqGS:ACAT )
Arctic Cat (ACAT ) is another stock that remains in a good position for traders looking to limit their risk. ACAT broke out of a base in late October and rallied approximately 50% in the span of a few weeks. It has settled into a consolidation that is developing into an ascending triangle between the $13 and $15 levels. Over the past few days, ACAT has narrowed even further and is trading within a range of less than one point. Traders should be on high alert, because a break above this tight range could lead to a sharp move.
Cabela's (CAB) is another stock that is not over-extended in the short term and could present a trading opportunity soon. CAB cleared a larger base in September and after a tight consolidation, it followed through much higher in November. CAB has since settled into a range between $21 and $23 as it works off some of the recent buying pressure. A break above $23 could lead to a new leg up for CAB.
The results between now and New Year's may hint at what may happen in 2011.
In 2007, the market fell back between Dec. 7 and Dec. 31, with the Dow down nearly 3% in that time frame and the S&P 500 off 2.4%. In 2008, the two indexes fell 33.8% and 38.5%, respectively.
In 2008, even as the financial crash was in full flower, the Dow, S&P 500 and the Nasdaq rose 1.7%, 2.7% and 2.4%, respectively, Dec. 12-31.
The 2009 market ended with the Dow up 18.8%, the S&P 500 up 23.5% and the Nasdaq up 43.4% for the year. And that was AFTER falling 25% or so between Jan. 1 and March 9.
It happens, of course, that the market has enjoyed a huge rally since bottoming in July. The Dow was down 7.1% for the year on July 2 and is up 9.4% now.
Momentum like that may carry into 2011. Plus, the third year of a presidential term is usually the best for stocks.
Goldman Sachs chief strategist, David Kostin, said he's spoken to more than 100 clients since announcing his 2011 call earlier this month, and he says many are not as bullish as he is. Kostin said 2011 will be the first year in several where the stock market could be driven by U.S. growth.
"It's about being cyclical versus being defensive, and the idea that growth is continuing is a fundamental building block for our strategy in 2011, in contrast with the strategy of the last couple of years," he said.
He said one area he has been particularly focused on is return-on-equity, and he expects it to continue to improve. In 2010, return on equity was 15 percent, and he sees 117 percent in 2011 and 18 percent in 2012. He said investors should focus on return on equity to evaluate the quality of earnings.
"The reason return-on-equity is important because it relates to price-to-book, and it's a way of combining both growth and valuation in the same analytical framework," he said.
Price-to-book is currently 2.2 times. Based on historic analysis, a 17 percent return-on-equity implies 2.6 price to book. "The idea that the return-on-equity is linked to a price-to-book valuation construct supports a price target much above what we have," he said.
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