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SPECIAL DISCOUNTED MEMBERSHIP RATES UNTIL JUNE 30, 2010
Market Outlook
The Week Beginning Monday, 31st May 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 May.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 is a slew of economic indicators are available this week, ranging from manufacturing data to the closely watched monthly unemployment report which is due on Friday. Monday – • The market is closed on Monday due to the Memorial Day holiday. Tuesday – • April's construction spending and • May's Institute for Supply Management (ISM) manufacturing index. Wednesday – • The weekly report on U.S. petroleum supplies, • April's pending homes sales and • May's auto sales. Thursday – • Weekly initial jobless claims, • The ADP employment report for May, • The revised first-quarter productivity report, • April's factory orders, and • The ISM services index for May. Friday – • May's nonfarm payrolls report and • May's unemployment rate. This Week’s Major Earnings Reports Monday – • The market is closed on Monday due to the Memorial Day holiday. Tuesday – • Collective Brands Inc. (PSS) and • Shanda Interactive Entertainment Ltd. (SNDA). Wednesday – • Canadian Solar Inc. (CSIQ), • Daktronics Inc. (DAKT), • Shoe Carnival Inc. (SCVL), • Coldwater Creek Inc. (CWTR), and • Hovnanian Enterprises Inc. (HOV). Thursday – • Charming Shoppes Inc. (CHRS), • Joy Global Inc. (JOYG), • Suntech Power Holdings Co. Ltd. (STP), and • The Cooper Companies Inc. (COO). Friday – • Blyth Inc. (BTH) and • American Woodmark Corp. (AMWD). Outlook for This Week It has been a hectic couple of weeks and recent movements have continued to leave traders wondering which direction the markets will be headed next. As you can see from the charts below, the large-cap indexes that represent the S&P 500 and the Dow Jones Industrial Average have fallen below the support of their respective 200-day moving averages. On the other hand, the smaller cap indexes that are represented by the Russell 2000 and the Nasdaq have manged to hold above the support levels and look like they could be positioned to make a move higher. SPX's 160-month moving average, has usually done a great job of defining true bull or bear markets. However, the SPX dropped back beneath this trend line in May.
But it isn't all bad news, as the SPX found technical support from its February lows.This looks like having the potential for a nice-looking double bottom. Then, considering how extremely oversold we are, this could quickly turn into more than a technical bounce.
Looking further afield, the S&P 500 Index (SPX) has been wrestling with its 200-day moving average for more than a week. This is a closely monitored moving average that has acted as both support and resistance in the past. The dots on the chart below, mark times that the SPX had been above its 200-day moving average for more than six months and then closed below it, which happened a little more than a week ago. Since then it has rallied right back up to it and that's where we stand now.
The red dots on the chart above denote when the SPX closes below its 200-day moving average for the first time after a sustained period of being above it. These would be bull market pullbacks. A summary of the results of data on the SPX following one of these bull market pullbacks is shown below.
The one-month returns are pretty unimpressive. It's possible that such a closely watched indicator causes a lot of activity around that area and therefore the market can get hung up for a bit. That's similar to what we are seeing now. It wouldn't be surprising for the market to chop a bit in the very near term.However, from two to six months out there is some very significant outperformance. Looking at three months out (putting us in mid/late August relative to the recent signal), the market was up on average by 4.3% and has been positive 82% of the time. This is notably better than the typical returns, which show an average of less than 2% and positive 64% of the time. There is outperformance at all times following the one-month returns. This means that during such a strong market a significant pullback can be upsetting, we have come too far too fast, and the upside of this is that there's potential to give back a large portion of the gains. The nervousness is healthy, and the analysis above shows the bull market pullbacks have been great times to buy. However, the 200-day moving average is still overhead and can be a major obstacle. Perhaps even more important than the SPX double bottom is that the Russell 2000 Index (RUT) found support from its upward sloping 200-day moving average. The small caps have held up the best, so far, which is a sign of strength that the bulls are still active. Also, note how the RUT recently bottomed well above its February low, yet another sign of underlying strength in the "risky" small cap world.
Here's another chart that suggests we are due for a bounce soon. This shows the percentage of stocks on the NYSE that are above their 50-day moving average. The reading recently got down near 10% (a far cry from the recent 90%), and going back three years, excluding the '08 financial crash, moves to this territory have marked short-term bottoms.
Let's now take a look at some sentiment indicators. There's little doubt that we are seeing some signs fear is once again coming into play. Remember, too much fear and worry is how bottoms form. Turning to the investor sentiment polls, the number of bears has spiked significantly higher recently. In fact, turning to the American Association of Individual Investors, the bears now make up than 50% of the poll. This is the highest number of bears since the first week of November last year. Taking a look at the Investors' Intelligence poll, the difference between the bulls and bears is only about 10% – 39% polled in the bull camp and 29% polled in the bear camp. As you can see below, this difference is close to the difference in early February and subsequent market bounce.
Many of the option traders are getting very worried as well. Below is a chart of the 10-day all-equity, customer-only buy (to open) call/put volume ratio on the International Securities Exchange (ISE). The recent rollover from a major peak was a huge warning sign of impending weakness. This ratio is now down near past major bottoms, but what is important is we need this ratio to begin to trend higher.
The ultimate fear/greed indicator is probably the CBOE Market Volatility Index (VIX). The chart below is very powerful. Going back 20 years, spikes to the 45 area have been great buying opportunities for stocks. The one exception was the recent credit crisis meltdown. If all this talk of the euro-zone debt issues has been blown out of proportion, then the recent spike higher could be a great buying opportunity for longer-term bulls.
Looking at seasonality is also important when considering market movements as June is one of the weaker months the past five and 10 years. However, considering the market conditions, at the moment, this may have an opposite reaction to normal.
Further evidence of market conditions can be seen in representations of charts below.1/ In looking at the S&P 500, as represented by the S&P 500 SPDRS (NYSE:SPY) ETF, you can see that Friday's bounce off the 200-day moving average suggests that this level of resistance might be stronger than many bulls would like to believe. If SPY is able to break above its 200 DMA then traders will quickly look to the $114-$115 levels as areas for the next wave of possible sellers. This was the early January high and an area of trading activity a few days ago.
2/ The Diamonds Trust Series 1 (NYSE:DIA) ETF, which tracks the Dow Jones Industrial Average, reacted almost in an idential fashion as SPY for another week with a strong reaction after testing its nearby 200-day moving average. While the majority of the week was spent trying to battle back from last week's losses, the DIA gave back some of its gains on Friday. There appears to be strong support near $98-$99 and this is a key level moving forward. A drop below that would surely have traders in a panic. Looking higher, the $107 area appears to be a possible area of overhead supply.
3/ The Nasdaq, as represented by the Powershares QQQ ETF (Nasdaq:QQQQ), fared a little better than SPY and DIA in that it managed to hold above its 200-day moving average. This is an important clue as it shows some leadership coming from the tech sector. Despite the fact that the QQQQ chart remains under pressure from the bears, the relative strength as compared to its peers is promising. There is still some room underneath before QQQQ tests its lows and if the markets continue to falter, it's possible that those lows will still come into play as a possible bottom.
4/ The Russell 2000, as represented by the iShares Russell 2000 Index (NYSE:IWM) ETF, is showing a very interesting story. When comparing the price action of IWM versus its larger cap peers, IWM was much stronger recently as it bounced nicely off its 200-day moving average. When looking at the larger trend, IWM remains in much better shape than its peers. Notice how the other indexes are close to their February lows, while IWM remains well above these levels. This suggests that the longer term strength in IWM is still intact, and that the Russell is still in a leadership role. As a market leader, IWM should be monitored closely to see if it begins to falter ahead of its peers.
ConclusionInvestors were certainly on edge last week as traders tried to fight back after the previous week's losses. While the reaction was positive for bulls, traders need to remain extremely cautious. While it’s tempting to rush in and start picking up bargains, relatively speaking, stocks were still showing weak performance last week based on Friday's market action. Many stocks are well under support levels and are not looking healthy. Most stocks are oversold and could continue to bounce, but there will be many traders looking to cash in on stocks they have held through the recent weakness. This is what makes this environment dangerous, as traders will be tempted with sharp rally attempts only to be met with other traders who have been anxious to get out at better prices. The markets will need to consolidate much further before a healthy trend can emerge. Until then, traders should trade on shorter time-frames, continue to hedge long positions in this very volatile market or become more involved in options trading. In conclusion, we are seeing many signs that a relief rally could happen soon. But if the recent bear market has taught us anything, it is: don't fight the market. It will do what it wants to do and trying to defend your market posture with stats or "proof" as to why you are right won't matter.
Success is simple. Do what's right, the right way, at the right time.
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Back to Stock Options Made Easy from Market Outlook for Week Beginning May 31, 2010
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