Market Outlook
The Week Beginning Monday,
July 05, 2010



Preface

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 May and again last week.

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.

up-coming

Key Events This Week

Note:-All earnings dates listed below are tentative and subject to change.

This Week’s Economic Reports

There are minimal economic indicators available this week, which are:-

Monday –

• The market will be closed for the July 4 holiday on Monday.

Tuesday –

• The Institute for Supply Management Services Index for June

Wednesday –

• Weekly crude inventories,

Thursday –

• The initial jobless claims,

Friday –

• There are no major economic reports scheduled for Friday.

This Week’s Major Earnings Reports

Monday –

• The market will be closed for the July 4 holiday on Monday.

Tuesday –

• There are no major earnings reports scheduled for Tuesday.

Wednesday –

• Family Dollar Stores Inc. (FDO)

Thursday –

• International Speedway Corp. (ISCA)

Friday –

• PriceSmart Inc. (PSMT)

bull-optimism

Outlook for This Week

Three straight days of disappointing jobs data and renewed fears about the strength of the economic recovery effectively extended the previous week's tailspin. The Dow Jones Industrial Average dropped below 10,000 on Tuesday, and kept on going, ending the week with a 4.5% loss.

Investors will be watching retail sales numbers this week to see if consumer spending is picking up. U.S. stock markets and many businesses are closed on Monday for the 4th of July holiday.

Bearish bets in the equity options market, coupled with an increasingly sour view from a technical perspective, suggest stocks will struggle to break from a vicious two-month downtrend this week.

With few catalysts on tap, it could be difficult for investors to find a reason to buy even as recent declines and a jobs report that didn't confirm investors' worst fears present the opportunity for a short-term boost.

Markets will be closed on Monday for Independence Day, and the holiday is expected to depress volume during the week, making equities more vulnerable to large swings following the worst week for the S&P 500 in two months.

"Only about 30 percent of stocks are above their 200-day moving averages, so the vast majority are on a downtrend," said Frank Gretz, a market analyst at Shields & Co in New York.

"The market needs to prove itself with a rally on strong volume, and that's going to be hard to get with the holiday and the bad news we've seen creating more pessimism."

Over the past couple of months, markets have been beset with a string of negative data showing weaker-than-expected retail sales, consumer confidence and plunging home sales. The data was capped by Friday's weak payrolls report.

SPX and VIX

The CBOE Market Volatility Index (VIX) climbed above 30 last week, and hit a high of 37.58 on Thursday, a 32% increase over the previous Friday's close. The spiking action began as the SPX quickly moved below support in the 1,050 area Tuesday morning. While the VIX closed the week sharply below last week's highs, the danger for the bulls is the close above 30 and its 50-day moving average, located at 29.56, which could indicate that volatility is still trending higher.

We have found the VIX's behavior during the past few days peculiar. On the chart below, note the sharp drop that began late in the morning on Thursday, even though the SPX didn't make much headway from Thursday morning into Friday's close. In fact, since the June 29 close, the SPX has lost almost 2%, and the VIX has dropped from 34.13 to 30.12 in the same four days. This is unusual. According to research, the VIX has never declined as much, on a percentage basis, during any other four-day decline of more than 1.5% in the SPX. For what it is worth, the VIX also declined amid a retreat in the stock market in the days leading up to the March 2009 bottom, but the VIX's percentage decline then wasn't as great as we just witnessed.

VIX-since-june28,2010



Clearly, the bears have the bulls on the ropes. The technical backdrop continues to deteriorate, after a failure to move back above the 160-day moving average during a rally in June and last week's break below the recent trading range. So, while pessimism has grown during this period, given the weakening technical backdrop, the pessimism takes on less meaning from a contrarian perspective.

That being said, many technicians interpreted the breakdown below 1,050 last week as a "head & shoulders" pattern sell signal, with the breakdown creating an 880 target on the SPX. Certainly, one has to take note of the bearish development and be open to such a possibility. But, on the-other-hand, the publicity surrounding last week's break of support may have generated a crowded short trade. Remember the publicity surrounding the SPX's move above its 200-day moving average two weeks ago? As we soon found out, the crossover was nothing more than a sell signal, even though many viewed the price action as a bullish development.

So, where is potential support after last week's breakdown? The focus is on the 1,000 area for a multitude of reasons.

1. Per the chart below, the 1,000 area is the site of the SPX's up-sloping 80-week moving average, a trend line that has marked support and resistance in the past.

2. 1,000 also mark’s a 38.2% retracement of the March 2009 low and the April peak.

3. 1,000 is 50% above the 666 intraday March 2009 low.

4. 1,000 is a millennium mark – it proved to be a hesitation point in the summer months of 2003 when the market began to claw back from the bear market lows.

SPX-since-may,2002



"What is the catalyst that will reverse the slide in the markets?" Amid the continued stream of bearish headlines and the weakening technical backdrop, there is little urgency for the shorts to cover and for sideline money to move into the stock market.

With the SPX down nine of the past 10 days, and the PowerShares QQQ Trust (QQQQ) down 10 consecutive days, the market could certainly experience another sharp, short-lived rally. One short-term catalyst that could push the market higher is short covering related to expiring index puts, with July expiration only nine trading days away when the market opens Tuesday morning. But the dark side of this put open interest is that if major put strikes just below currently levels get taken out on the downside, sellers of the puts will add to their short positions, creating sharp, exhaustive-like selling.

Continue to have both put and call exposure for all time horizons you are playing. The Russell 2000 Index's (RUT) close below its 200-day moving average and the 600 level is cause for concern, so think about lightening up in this area if you don't have put protection.

Economic News

One of the few indicators on tap for this week is June same-store sales, which many retailers will report on Thursday, giving insight into the state of consumer spending.

Consumer Spending

Major retailers -- including Target Corp. (TGT), Macy's Inc. (M) and Costco Wholesale Corp. (COST) -- will post June same-store sales Thursday. The roughly 30 retailers tracked by Thomson Reuters are expected to show sales grew 3.4%. UBS analysts recently said retailers concluded the month with a rash of promotions despite a rise in mall traffic as shoppers turned out for Apple Inc.'s (AAPL) new iPhone.

"Consumers are very cautious right now, and we're not looking for much incremental growth at all," said Thomas Nyheim, portfolio manager at Christiana Bank & Trust Co. in Greenville, Delaware.

Nyheim added that discount retailers could be among the few sectors to see improved sales as consumers "trade down" to lower-priced merchandise.

The Institute for Supply Management

The Institute for Supply Management will report Tuesday on the services sector in June. The group's index of nonmanufacturing activity is expected to rise slightly. May was the fifth month in a row that the index was in expansion mode. A day later, the government will detail May consumer-credit statistics and its report on May wholesale inventories is due next Friday.

FINANCIAL REGULATION

New York state lawmakers could vote next week on a bill that would require publicly-traded companies to obtain approval each year from a majority of shareholder votes cast to spend a specified aggregate amount on political communication. Corporations would also be subject to new disclosure rules, forcing companies to file reports to a state agency disclosing the "rationale" for each political expenditure. The bill is an attempt to limit the consequences of the Supreme Court's January landmark ruling that overturned federal limits on corporate political expenditures.

A U.S. appeals court is scheduled to review a lower court ruling overturning the Obama administration's offshore-drilling moratorium. The Fifth U.S. Circuit Court of Appeals has scheduled oral arguments Thursday on the administration's motion to freeze an injunction issued by U.S. District Court Judge Martin Feldman. He struck down the administration's six-month moratorium on deepwater drilling, calling it "heavy handed." Hornbeck Offshore Services Inc. (HOS) and other companies had challenged the moratorium, issued after a giant oil spill resulted from the April explosion and sinking of a rig operated by BP PLC (BP).

Europe

The European Parliament is scheduled to vote Wednesday on new rules that would cap bankers' cash bonuses at 30% of the total bonus, or 20% for particularly high bonuses, in response to criticism of executive compensation. A large part of the bonuses also will be deferred so it can be recovered if investments don't perform as expected.

COMPANY NEWS

Discount retailer Family Dollar Stores Inc (FDO) is scheduled to report quarterly results on Wednesday, the sole S&P 500 company to report this week. The third-quarter earnings reporting season begins in earnest with Alcoa Inc (AA) on July 12.

"Family Dollar has seen some positive trends of late, and they've been picking up market share from other retailers," said John Massey, portfolio manager at SunAmerica Asset Management in Jersey City, New Jersey.

Despite the lack of scheduled reports, a number of companies could give guidance about earnings this week. John Butters, the director of U.S. earnings for Thomson Reuters, said that the week before the start of earnings season "will be the time companies will come out and say, 'This is what we're going to do.'"

As the earnings season nears, Butters noted that there were 1.2 negative company preannouncements for every one positive. Historically, the ratio has been two negatives for each positive.

Toyota Motor (TM) will begin its latest recall this week of 270,000 vehicles worldwide to fix an engine problem. The company will inform Japan's transport ministry Monday that it intends to recall 90,000 vehicles in Japan. That will be followed by a recall of 137,000 vehicles in the U.S., with the remaining vehicles to be recalled in other regions.

Continental (CAL) and United Airlines (UAUA) will meet U.S. regulators this week to review the technical aspects of their planned merger.

INDICATORS AND MARKET CONDITIONS

The Death Cross – The Golden Cross

Two heavily watched moving averages on the S&P 500 Index (SPX) are converging. A lot of technicians are talking about the upcoming "Death Cross." That's when the 50-day moving average of the index crosses below the 200-day moving average. This is looked at as a bearish signal -- especially since the last Death Cross, which happened in late 2007. The market fell more than 40% over the next 52 weeks.

The opposite of the Death Cross is the Golden Cross, which is when the 50-day moves above the 200-day. Below is a chart of the SPX since 1998 with each Golden Cross and Death Cross marked. The Death Crosses that occurred in late 2000 and late 2007 were very good sell signals. The other four simply marked bull market pullbacks.

Death-cross-golden-cross



Understanding The Data

Going back to 1972, there have been 18 Golden Crosses and Death Crosses. Looking at the data following these signals gives some indication of just how reliable it is at predicting the market. The first table below shows the average SPX returns after a signal from one month to one year later. The second table shows the percentage of returns that were positive. The term Death Cross is a lot scarier than the actual returns.

The table shows that the average return three and six months after a Death Cross outperform the typical SPX returns, even though there are fewer positive returns than you would typically find. However, there is underperformance one year later. The results following a Golden Cross are quite impressive relative to what the market usually returns.

SPX-returns-since-1972



Implications of the Indicators

Death Crosses have had mixed results as an indicator, at times signaling the beginning of a painful extended decline, but at other times signaling the end of a short-term pullback. It might be a good idea to have hedges in place.

One thing to keep in mind about these widely watched technical levels is that they tend to garner a lot of media attention. A glaring media spotlight could actually have a contrarian effect on the indicator. For example, if media attention to the Death Cross strikes enough fear into traders, then they might sell before it occurs, or put on hedges so they're not forced to liquidate losing positions. In this situation, the selling pressure is exhausted by the time the Death Cross occurs. Remaining sideline money and the subsequent unwind from the hedges can then actually instigate a rally.

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

Tracking of Market Leaders

One method for keeping tabs on the strength for the stock market is to track the behavior of its leaders. Market leaders are widely held by institutions and their action can reveal the underlying sentiment of these very influential market participants. Weakness in market leaders is often a clear warning that all is not well in the markets. The general markets will rarely make a sustained move without the cooperation of their market leaders and traders can often gain an edge by simply following their behavior.

Amazon.com (Nasdaq:AMZN) has been regarded as a market leader over the past year and a half as it rallied over 100 points from its bear market low in the $30s. It has been in a consolidation since a breakaway gap in November 2009, with solid support near $117 and resistance above in the high $140s. A consolidation following a long rally of several months is normal and actually healthy for a stock. However, AMZN recently broke under its base on high volume. This leaves anyone accumulating stock in this base underwater. The $115 level should be watched moving forward to see if AMZN can reclaim its base.

AMZN-june29,2010



Google (Nasdaq:GOOG) is another stock that can be classified as a market leader. However, GOOG has been underperforming for several months and is currently setting lower highs and lower lows. This is not healthy price action and there are no signs yet of a turnaround. In fact, GOOG just broke down from a small base to set new lower lows.

GOOG-june29,2010



Goldman Sachs Group (NYSE:GS) has been “THE” market leader in the financial sector for years but has struggled since the news of the SEC investigation came out. GS had recovered much of its bear market losses, recovering from under $50 per share to almost $200. Everything seemed to be fine with the stock as it attempted to resume its rally in April until the news came out and GS tumbled sharply. GS broke under its February low a few weeks later and has been struggling under this level since. GS has also fallen into a pattern of lower lows and lower highs and until this trend is reversed, GS traders should remain cautious on the sector.

GS-june29,2010

Apple (Nasdaq:AAPL) is perhaps the best example of how a market leader should be acting through a market correction. Notice how AAPL quickly found buyers on each drop and has basically settled into a consolidation rather than heading lower with the markets. This is healthy behavior and shows support from institutions. While AAPL may not be a screaming buy in this environment, it is important to watch it as a breakdown from AAPL would likely be a huge negative for the markets. The $240 level has held as support recently and this area will be an important level to monitor if the markets continue to deteriorate.

AAPL-june29,2010



While there is a chance the markets can find support at their current levels, most market leaders are revealing an unhealthy environment. Market leaders should be setting higher highs and higher lows or at worst, trading sideways as the markets correct. But while consolidations are healthy and even market leaders need to take a break once in a while, persistent lower lows and lower highs are not healthy price action and until this trend stops, the markets will likely remain in a highly risky environment.

Conclusion

Options Activity

Options activity on exchange-traded funds (ETF) that tracks the S&P 500 benchmark and the Nasdaq suggest that investors are betting on further declines.

"The most actively traded options on the SPDR S&P 500 ETF are the July $100 puts, suggesting traders are hedging for potential losses," said Ryan Detrick, senior technical strategist at Schaeffer's Investment Research in Cincinnati, Ohio. The ETF (SPY.P) fell 0.6 percent to $102.20.

Similar activity was spotted on the PowerShares QQQ Trust ETF (QQQQ.P) which tracks the performance of the Nasdaq 100. The most active trades were on July $41, $40 puts. The ETF closed 0.3 percent lower at $42.47.

"We are in a tremendously oversold situation, but that doesn't mean we can't sell further. Options activity shows that the bears are in control and that the trend will continue," Detrick said.

As of late Friday, 133.94 million shares traded on the SPDR S&P 500 fund, and on Thursday 382.92 million shares exchanged hands, the highest volume since May 21. The 3-month average trading volume is 266.34 million shares.

"When the volume is high on a down day like yesterday and today, it confirms that this is a bear market and that the sellers will be in control."

The QQQ Trust ETF traded 46.19 million shares as of late Friday, but the volume reached 158.69 million on Thursday, compared to a 3-month moving average of 103.50 million.

The Oversold Market

Some analysts and money managers are beginning to see value in the oversold market.

"People are driven by fear. The uncertainty is huge in my view. It is overdone," said David Kotok of Cumberland Advisers. "Markets may be discounting a double dip recession. I do not believe it is coming. Slow growth, high unemployment does not feel good, but it is not shrink. It's growth and for American businesses, it is very profitable. We will see that in the earnings season that starts in a few days."

Kotok said he is now fully invested in the stock market and has been using weakness to buy.

"Could the S&P [SPX] go down 5 percent from here? Sure, but I believe there's a whole bull leg ahead of us," he said.

Richard Bernstein, of Richard Bernstein Capital Management, said he is still positive on stocks, but for now is more neutral and cautious because of the consistently disappointing employment data.

Jobless Claims

"I think it's going to be very difficult to have a sustained advance in the equities market without jobless claims getting better," he said.

"Our view is earnings are still going to be pretty strong, and I think that's probably going to help, but the way I look at it is the global financial markets right now are hinging on the health of the U.S. household sector's cash flow. That's the whole story. Decoupling be damned...If you're worried about the stability of the household sector's cash flow, you have to be worried about a lot of other markets, a lot of other economies around the world," he said.

Jim Paulsen, chief investment strategist at Wells Capital Management, agrees jobs are a key to the market's performance. "We may go down and test that 1000 level in the S&P in the next couple of weeks, but if we do, I would have to think it looks like a great entry point. I think claims will do better before the year is out and that is going to be a great catalyst," he said.

"There are some things that could help sentiment," he said, noting that before the market's began selling off in April, the yield on the 10-year was close to 4 percent, and oil was heading to the high $80s a barrel range, both drags on the consumer. Since the 10-year's yield has slumped, mortgage rates are now at record lows and oil is at $72.14 a barrel, down 8.5 percent in just the past week.

Paulsen and a number of other analysts have said the earnings period, which starts the week of July 12, may provide a temporary positive for stocks.

Earnings

Citigroup economist Steven Wieting said S&P 500 operating earnings should grow 25 percent in the second quarter, compared to the first quarter's 53 percent jump. For each of the third and fourth quarter, he expects operating earnings growth for the S&P of about 23 percent. But for 2011, his forecast is for a more normal growth rate of 7 percent.

The Dollar

Markets have had the long holiday weekend to stew over June's disappointing jobs report. In the coming week, non-manufacturing ISM is the big data point, due out Tuesday. Also important will be retailer's monthly sales reports Thursday, as well as the closely watched jobless claims data, also reported Thursday. The Bank of England and European Central Bank have rate meetings Thursday.

The dollar lost some of its safe-haven shine in the past week, as investors started to vote against it with each weak economic report. It was down 1.3 percent against the euro, which rose above $1.25 on a successful Spanish bond auction and as European banks requested less funding from the European Central Bank than expected.

David Gilmore of Foreign Exchange Analytics said the dollar could continue on its current course temporarily.

"I would say there's more downside for the dollar in the next couple of days. I would look for the euro to trade up to $1.28. I think people are going to be concerned again about Europe's banks. We have stress tests coming up at the end of July. We don't have a good idea of those stress tests. Are they credible and how do banks perform? That's something that could check enthusiasm for the euro," he said.

Let’s keep our optimism and make the most of what we have. As expressed by Larry Summers, President Obama's lead economic advisor, last week, said, "A year ago the question was about a free fall, it was about depression. Today the questions are about the pace of recovery. That's a much better kind of question to hear."

Optimism

Scary headlines, which the media loves and provides them with ratings, are also best friends with opportunity. The Dow Jones has fallen for eight of the last nine trading sessions. Is this justified? Maybe. People are terrified. Dreams are shattered. But it's presented some nice entry points. A few possibilities to consider are ExxonMobil (NYSE: XOM), Philip Morris International (NYSE: PM ), and Patriot Coal (NYSE: PCX), all three of which have been brutalized in recent months and trade for compelling, if not mouthwatering, valuations.

What should you expect out of the second half? Lots of bad news, probably. It was bound to happen. But it's that same bad news that plants the seeds of a recovery -- a real, true recovery this time. In that sense, now's the time to be optimistic.

Another great method to make your hard-earned dollar more profitable and your investments much more successful in these trying times, is to make the most of the ugly news headings and trade accordingly by options trading.

Success is simple. Do what's right, the right way, at the right time.



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