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.
Key Events This Week
Note:-All earnings dates listed below are tentative and subject to change.
This Week’s Economic Reports
There are still quite a few major economic indicators available this week, which are:-
• There are no major economic reports scheduled for release today.
• The Empire State Manufacturing Index for June,
• May's import and export data from the Department of Labor
• Weekly crude inventories,
• May housing starts, and
• May industrial production data.
• The initial jobless claims,
• The May Consumer Price Index (CPI) and core CPI,
• The Conference Board's leading indicators index for May, and
• The Philadelphia Fed Index for June.
• There are no major economic reports scheduled for release today.
This Week’s Major Earnings Reports
• La-Z-Boy Inc. (LZB)
• Best Buy Co., Inc. (BBY)
• Canadian Solar Inc. (CSIQ) and
• FedEx Corp. (FDX))
• The J.M. Smucker Co. (SJM),
• The Kroger Co. (KR),
• Pier 1 Imports Inc. (PIR) and
• Smithfield Foods Inc. (SFD).
• There are no major earnings scheduled for release.
Outlook for This Week
Last week saw the stock market end with a win, which I feel is very important to the psyche of the investor.
Picture: Wall St. moving up?
Perhaps more important, the market's performance during last week suggests that a bottom for the current market correction has been reached. The week ahead will test if that is true.
However, U.S. stock investors will still be keeping a close eye on Europe this week, looking for signs the debt crisis may be stabilizing, while industrial production, housing starts and inflation data may offer more clues on the U.S. economic outlook.
Market sentiment has been plagued for weeks by worries that European debt problems, including those in Greece, Spain and Hungary, could affect the global economy.
"We've gone through a period of extreme nervousness ... and problems haven't gone away, but I think right now, global investors are little less jittery," said Fred Dickson, chief market strategist at D.A. Davidson & Co. in Lake Oswego, Oregon.
Wall Street will keep a weather eye this week on the recovery in the U.S. housing sector, still deemed fragile with the expiration of a federal tax credit for home buyers.
U.S. housing starts and building permits for May will be released on Wednesday. Economists polled by Reuters forecast that housing starts will slip to an annual pace of 650,000 units in May from April's pace of 672,000 units.
Analysts said, however, that much of the week's economic news could be less troubling for the market.
"I think the takeaway for investors this week will be that the economy continues to expand, albeit at a very slow pace and inflation remains very benign," said Hugh Johnson, chief investment officer at Johnson Illington Advisors in Albany, New York.
The data could show "that the concerns should be about deflation, not inflation," he said.
PPI and CPI
Both the Producer Price Index and the Consumer Price Index for May are expected from the U.S. government this week.
The overall PPI for May, also due on Wednesday, is forecast to fall 0.5 percent, compared with a 0.1 percent dip in April. Core PPI, excluding volatile food and energy prices, is forecast to edge up 0.1 percent in May, compared with a gain of 0.2 percent in April.
Wednesday's data menu will include industrial production, which is forecast to rise 0.9 percent for May, compared with a gain of 0.8 percent in April.
The overall CPI for May, due on Thursday, is seen down 0.2 percent, compared with a 0.1 percent drop in April. Core CPI for May is forecast to rise just 0.1 percent, following no change in April.
Federal Reserve Chairman Ben Bernanke
Investors will pay close attention on Wednesday when Federal Reserve Chairman Ben Bernanke speaks on financial reform. Stocks got a boost last week after Bernanke said the economic recovery appeared to be on solid footing and that he expects the economy to keep growing.
Friday marks the so-called "quadruple witching" period, a term used by professional traders for the quarterly settlement and expiration of four different types of June equity futures and options contracts. This involves the expiration of equity options, stock index options and stock futures contracts. The event, which starts on Thursday, can lead to greater volume and volatility as players adjust or exercise their derivative positions.
An early look at the soon-to-expire June open interest on the S&P 500 indicates a potential pinning at the 1,100 strike price, said Scott Fullman, director of derivative investment strategy at broker-dealer WJB Capital Group, in New York.
Stock market performance during "triple-witching" expiration, which occurs during the March, June, September, and December expiration weeks, supports the "dangerous environment for bulls and bears" argument. For example, the first table below shows that in the 17 triple-witching expiration weeks since 2006, 71% have produced positive returns. However, before acting on this information, take note in the second table that June triple-witching expiration weeks have produced dismal numbers. Only 40% of the returns have been positive, with the average loss almost 2% and the average gain only about 1%.
The Energy Crisis
BP’s (BP) Chief Executive Tony Hayward is scheduled to be grilled by Congress this Thursday regarding the oil giant’s response to the massive oil spill in the Gulf of Mexico. Hayward has been asked to testify on Capitol Hill next week before the House Energy and Commerce Committee. Hayward has been criticized for his handling of the response, including for estimates about the rate at which oil was flowing from a broken undersea pipe that have turned out to be inaccurate.
"I think the hearings this week will be a stage for the kind of political fury that's been spawned by this crisis, and what will affect the tone will be whether the current containment unit (on the rig) will be seen to be working by the week," said IHS CERA Chairman Daniel Yergin.
"The rest of the industry will go on record with the fact that the production in the Gulf of Mexico has been very safe. I think what's going to come out of this is that the whole system that was in place was really set up to deal with a tanker accident and what's needed for deep water in the Gulf—for production that produces 30 percent of U.S. oil—is a safety system in place that works effectively when all other systems fail," said Yergin.
There have been suggestions that BP pay the wages of workers affected by the administration's six-month moratorium on new deepwater drilling permits. The offshore drilling industry is an important piece of the economy of Gulf Coast states. It's 13% of Louisiana's economy alone.
The British are now very concerned, because the BP dividend goes to a lot of big pensions in both the United Kingdom and the United States, as well as lots of personal retirement accounts. New British Prime Minister David Cameron is being forced to argue to limit BP's exposure.
President Barack Obama this week will visit Alabama, Florida and Mississippi for two days to survey the federal government's response to the Gulf oil disaster. It will be his fourth trip to the region since the Deepwater Horizon oil rig caught fire April 20, and it comes as he is facing mounting pressure over his response and reaction to the worst oil disaster in U.S. history.
On Wednesday, U.S. President Barack Obama will meet the Chairman of BP, Tony Hayward, for the first time since the oil spill began.
New regulations for credit rating agencies, hedge funds and insurers will likely be agreed by a House-Senate conference committee on Wall Street reform on Tuesday, which is dealing with the least controversial issues in its agenda before moving to contentious proposals on over-the-counter derivatives, bank trading and consumer protection the following week. Support among lawmakers for harsh crackdowns in these areas is building amid an increasingly hostile political climate for banks.
Traders are a keeping an eye on Europe, which is expected to be relatively quiet in the coming week but has delivered plenty of unexpected headline risk in recent weeks.
Jefferies Treasury strategist John Spinello said the markets show some signs of calming down. "The risk profile started changing in the middle of the (past) week with the stabilization of Europe and the stabilization of the stock market. You have stocks going up and the currency stable. It's going to be hard to get the fear trade into the (bond) market," said Spinello.
Treasurys have been the big beneficiaries of market turbulence in a flight-to-safety trade. Yields rose at the end of the week, as those buyers stepped back.
Forex.com's Brian Dolan said German and euro zone ZEW investor and business surveys are released Tuesday and should show a decline that will get the market's attention. He said he expects to see more euro weakness in the coming week, and the trend in general remains lower for risk assets.
"The world cup is going to be a bit of a drag," he said Friday afternoon. "Afternoons like this are going to be the norm for the next two weeks. Traders from London to Asia are just basically watching soccer games all day, every day so a lot of activity comes to a halt," he said.
Last Friday, an official said the European Union has reached agreement with Greece on how to move forward with pension reform, while Spain's economy ministry said it has not made and will not make a request for economic aid from the EU.
Germany and Opel
Economic ministers from four German states home to Opel factories will meet Tuesday to discuss how much aid they might contribute to General Motors Co.'s restructuring of the auto maker, a state official said Friday. On Wednesday, the federal government rejected Opel's request for EUR1.1 billion ($1.33 billion) in guarantees from a fund for companies hit by the financial crisis.
Spain and Labor Reform
Spanish Prime Minister Jose Luis Rodriguez Zapatero has promised that his government will approve a labor reform Wednesday after unions and employers failed to reach an agreement on a long-awaited overhaul of labor laws. The nation is facing pressure from the European Union to accelerate efforts to cut a towering budget deficit and impose economic reforms. Financial markets are watching to see whether Spain, which is grappling with a 20% unemployment rate, and other highly indebted euro zone countries have the political muscle to overcome popular resistance to painful austerity plans.
Deutsche Bank's chief U.S. equities strategist Binky Chadha said the stock market's current choppiness is probably here to stay for now and could last about two months, if history is a guide. He said episodes of risk aversion have averaged 36 days, which would be mid-July, and that would be around the time when there is a heavy rollover of debt in Europe.
"That's a risk, and the market's going to remain jittery about that. We think generally earnings could be a trigger for a move up in the market, like it has in the last few earnings seasons," he said. "...If we're going to believe what the CEOs are saying, which is they're seeing limited impact from Europe, then earnings are going to surprise again."
There aren't many earnings reports due, but two of them will be important gauges of the progress of the economic recovery: Best Buy (BBY) on Tuesday and FedEx (FDX) on Wednesday.
Best Buy is important because it sells everything from compact discs to computers and electronics to appliances. So it presents a very good sense of how U.S. consumers are feeling right now.
It has been raising its guidance consistently since September 2009. The question on its fiscal-first quarter earnings Tuesday is if it continues to maintain or even boost guidance.
Analysts are expecting 50 cents a share in earnings, up from 40 cents a year ago. The projected revenue of $10.9 billion would be up 8% from a year ago.
FedEx reports quarterly results Wednesday, with investors anxious to see if the package-delivery giant still considers the global economic recovery on track. Early indications from FedEx have been positive, because the company recently increased its dividend by 1 cent, to 12 cents a share.
The three major U.S. online brokers - TD Ameritrade Holding Corp. (AMTD), Charles Schwab Corp. (SCHW) and E*Trade Financial Corp. (ETFC) - will release their May trading data this week. Stock-market volatility spiked last month as economic fears built anew, with the market yo-yo best highlighted by the May 6 flash crash. The sector has been suffering with subdued trading volumes, so a spike in May would be a welcome sight for the companies' investors. Shares of all three are down for 2010.
For La-Z-Boy, which reports Monday, analysts polled by Thomson Reuters expect earnings to more than triple on an 8% increase in revenue. La-Z-Boy is benefiting from an improved economy, which is giving consumers more confidence to spend money again.
Microsoft (MSFT) is expected to announce on Sunday a name and launch date for its "Project Natal" controller-free system at the annual Electronic Entertainment Expo (E3) in Los Angeles.
Later in the week, Sony (SNE) will show off its competing Move motion-sensor and Nintendo will offer the first glimpse of its new 3D handheld device.
INDICATORS AND MARKET CONDITIONS
1. The 10-day moving average of the International Securities Exchange's (ISE) equity-only call/put ratio turned lower once again this week. Bulls would prefer to see the ratio turn higher as a sign that fear in this cycle is finally giving way to optimism. When combining the buy-to-open call and put activity on the Chicago Board Options Exchange (CBOE) with that on the ISE, the indicator has a much less bearish undertone, although it isn't exactly flashing a "buy" signal.
2. The CBOE Market Volatility Index (VIX – 28.79) closed below 30 last week, the first weekly close below this level since the meteoric rise above 30 last month. Moreover, the VIX is below the SPX's 20-day historical volatility of 30.48, suggesting volatility is headed lower.
3. This indicator makes a strong case that the bottom may be here, or at least near. Looking at the SPDR S&P 500 (SPY), a heavily traded exchange-traded fund (ETF) that follows the S&P 500 Index, puts are more expensive relative to calls now than they were even during the 2008 market crash. This may be the capitulation we've been looking for that indicates a market bottom.
The chart below looks at 10% out-of-the-money SPY call and put options, and graphs the difference of implied volatilities. It shows that put implied volatilities recently were as high as 20 points above call implieds. That is the highest spread we've ever seen considering data back to 2005.
Notice that the prior two peaks happened at two completely different times in the market. The first peak, in late 2007, was the perfect time to sell everything. Then the second peak, in late 2008 to early 2009, happened shortly before the SPY stabilized and then rallied about 80%. How is this explained and what does it mean now?
SPY put options are often used as a way to hedge market risk. The early peak in 2007 came at the top of a bull market, when there was a lot of big money flowing into the market. Put options increased in price, as big players bought into the bull market and needed the put options for hedges. This was the climactic buying that ordinarily happens at the top of a bull market.
The later peak on the chart was obviously at a time of market turmoil. Again, the rise in put prices was the result of an increase in demand for put hedges. However, this time the demand was out of fear. Major losses had occurred, and despite the very high implieds at the time, managers kept bidding up the prices. This was the capitulation that signaled we were at the end of the crash.
That brings us to the current peak, which is now even higher than the previous two signals. It is plain to see that the recent market pullback has seriously spooked a lot of money managers. The indicator shows them scrambling to buy put protection on their portfolios. There is a good chance that this is signaling a culmination in selling pressure. Also, with protection in place, market pullbacks will not be as scary for these hedged players. This reduces the urgency for them to sell when bad news comes out of Europe, or when economic news comes in worse than expected. No matter how you look at it, the strong demand in puts has to be looked at as bullish for the market going forward.
***Further evidence of market conditions can be seen in representations of charts below.
While last week was peppered with volatile overnight and intraday moves, in the end it can best be classified as a week of consolidation. The general indexes have been probing for support near the lows set during the “flash crash" a few weeks ago. So far support has held, but the bounces have been weaker on each attempt. Near-term resistance levels have also held on each rally attempt, and the markets will likely remain choppy until one side of the current range is breached.
The S&P 500, as represented by the S&P 500 SPDRS (SPY) ETF, has been finding support near the $105 level over the past two months. Initially, the reactions were sharp and on an increase in volume. This week began with yet another test of this level, and the initial thrust was fairly weak when compared to prior attempts. Additionally, the day following the initial test lacked any follow-through on the part of the bulls.
Ultimately, the markets did respect support again, and spent the rest of the week attempting to move back higher. The top of the current near-term trading range is approaching $111 but traders should be on alert for a failure to even reach this level on the current attempt. With how weak the current attempt is, a failure to reach the top of the range, followed by a retest of $105 could lead to a breakdown.
The Diamonds Trust, Series 1 (DIA) ETF, which tracks the Dow Jones Industrial Average, is trading in a very similar pattern to SPY. It has settled into a consolidation with $98 marking the bottom of the range and $103 marking the top. The recent bounce off support has actually been stronger than SPY, and DIA is not too far from $103. However, DIA is trapped below its 200-day moving average, and this could act as an added resistance level. DIA needs to clear the $103 level to complete a small double bottom that would confirm this area as strong support. A failure near the top of this near-term range would likely lead to a test of the bottom of the range and possibly worse.
The Nasdaq, as represented by the Powershares QQQ ETF (QQQQ), is also trading in a range, although it has continued to maintain some relative strength compared to SPY and DIA. QQQQ has reclaimed its 200-day moving average and managed to close right near its 20-day moving average. The recent high set in June near $47 is the level to watch on the upside. Near-term support on the downside will likely be found near $43.50, as this level has held the past few bouts of weakness.
The Russell 2000, as represented by the iShares Russell 2000 Index (IWM), ended up losing its 200-day moving average early this week, but managed to rebound and reclaim the average a few days later. IWM continues to follow a pattern of longer term relative strength versus some weakness near term. IWM is still well above its February low, which shows longer term strength. In the near term, IWM is sitting right in the middle of its closest support and resistance levels established by the recent trading range. The level of support to watch is near $62, with resistance looming above near $47.
Some traders have been frustrated with the increased volatility recently, as the markets have gapped in the opposite direction on several days over the past few weeks. While volatility has been higher, overall the markets have technically been consolidating in a range. On the one hand, the markets could be putting in an intermediate low that would end the recent correction, but on the other, the markets could simply be consolidating before another move down. It’s too early to know in which direction the next trending move will be, but as the days go by, the range continues to become clearer.
The sentiment landscape has taken a drastic turn since April, implying that we have moved into a low-expectation environment, which can be viewed as a positive.
The technical backdrop, however, remains mixed. For example, the Russell 2000 Index (RUT – 649.00) retreated below its 160-day and 200-day moving averages earlier this week, but rallied back to close the week above these trendlines. But the 650 area lingers just above and could present a challenge, as this level was the site of resistance in January.
Meanwhile, the SPX remains above its February and May lows in the 1,040 area, but comes into the week trading below the 1,100 century mark and its 200-day moving average, currently situated at 1,108.
Stocks will navigate choppy waters in the week ahead, but could sail a bit more smoothly—barring any nasty, new surprises from Europe.
The bottom line is that the technical backdrop and momentum are showing signs to favor the bulls but until the markets break free of the current range, traders should continue to show patience and trade cautiously or take up the challenge with options trading.
Success is simple. Do what's right, the right way, at the right time.
Success is simple. Do what's right, the right way, at the right time.
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