Market Outlook
The Week Beginning Monday,
October 25, 2010


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

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

Key Events This Week

up and coming

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:-

Monday –

  • Existing home sales for September

Tuesday –

  • The Case-Shiller home price index for August, and

  • October's consumer confidence index

Wednesday –

  • Weekly report on U.S. petroleum supplies, and

  • September's durable goods orders, and

  • September's new home sales.

Thursday –

  • Weekly initial jobless claims.

Friday –

  • An advance look at third-quarter gross domestic product,

  • October's Chicago purchasing managers' index, and

  • The final reading for the October University of Michigan consumer sentiment index.

This Week’s Major Earnings Reports


Monday –

  • M/I Homes Inc. (MHO),

  • RadioShack Corp. (RSH),

  • Inc. (SOHU),

  • Atheros Communications Inc. (ATHR),

  • SL Green Realty Corp. (SLG), and

  • Texas Instruments Inc. (TXN)

Tuesday –

• AK Steel (AKS), ArcelorMittal (MT), Biogen Idec Inc. (BIIB), Bristol-Myers Squibb Co. (BMY), DuPont (DD), Johnson Controls Inc. (JCI), Kimberly-Clark Corp. (KMB), Lexmark International Inc. (LXK), U.S. Steel Corp. (X), Under Armour Inc. (UA), Valero Energy Corp. (VLO), Broadcom Corp. (BRCM), Massey Energy Co., (MEE), NetGear Inc. (NTGR), and Novellus Systems Inc. (NVLS).

Wednesday –

• Brinker International Inc. (EAT),

• ConocoPhillips (COP),

• The Procter & Gamble Co. (PG),

• P.F. Chang's China Bistro (PFCB),

• Sprint Nextel Corp. (S),

• Goldcorp Inc. (GG), and

• Visa Inc. (V).

Thursday –

• 3M Company (MMM),

• Avon Products Inc. (AVP),

• Colgate-Palmolive Co. (CL),

• Exxon Mobil Corp. (XOM),

• Motorola Inc. (MOT),

• Potash Corp. of Saskatchewan Inc. (POT), and

• Microsoft Corp. (MSFT)

Friday –

  • Arch Coal Inc. (ACI),

  • Chevron Corp. (CVX),

  • The Estee Lauder Companies Inc. (EL),

  • Merck & Co. Inc. (MRK), and

  • Sony Corp. (SNE)

the week ahead

Outlook for This Week

A third of the S&P 500 reports results in the coming week, including Procter & Gamble, Exxon Mobil and Microsoft. Key reports on the overall economy and housing are also on tap.

Stocks are enjoying a reasonably good October, maybe not as robust as September's giddy rebound from the doldrums of August, but decent nonetheless.

There will be several reports on home sales and prices. There's a big report due Thursday on gross domestic product in the third quarter. GDP is a snapshot of economic activity.

This is also one of the biggest weeks of the third-quarter earnings season, with seven members of the Dow Jones Industrial Average (INDU) reporting, including DuPont (DD), Procter & Gamble (PG) and Microsoft (MSFT). A third of the companies in the Standard & Poor's 500 ($INX) will report. Big Oil weighs in with ConocoPhillips (COP), Exxon Mobil (XOM), Chevron (CVX) and Royal Dutch Shell (RDS.A).

And there are interesting consumer companies that will help us fill out the economic picture: Lithia Motors (LAD), Panera Bread (PNRA), Whirlpool (WHR) and Ruth's Hospitality Group (RUTH), parent of the Ruth's Chris steakhouse chain.

Corporate earnings have been better than expected and helped stocks like Google (GOOG), Monsanto (MON), Delta Air Lines (DAL), Ford Motor (F) and Dell (DELL) move 10% or more.

The economic data have been better, with the rather large exceptions of housing and jobs.

But there was even a touch of good news for the construction industry. The Architecture Billing Index, a measure of activity in the architectural profession, crossed 50 in September -- above 50 means expansion -- for the first time in two years.

Airlines have been reporting rebounding business travel.

At the end of the week, the Dow was up 3.2% for the month, with the S&P 500 up 3.7% and the Nasdaq Composite Index (COMP) up 4.7%.


Lacking any big surprises, the markets may seem to be on cruise control in the coming week, as investors await the U.S. mid-term election and the Fed's November meeting.

The Dollar

The course of the dollar could be a factor for markets in the week ahead, as the stock and commodities markets typically have moved higher as the dollar falls. But any turn in the dollar could be a negative for stock prices. G-20 finance ministers were wrapping up a meeting in Korea Saturday. In a draft communique, they showed a cooperative tone on currencies and vowed to refrain from competitive devaluations.

Voting and Fed Meeting

The big events for markets are in the week after next, when voters head to the polls Nov. 2 and the Fed wraps up its meeting Nov. 3. Republicans are widely expected to gain control of the now Democratic House of Representatives, which analysts see as a positive for stocks. The Fed is expected to announce a new round of quantitative easing after its meeting Nov. 3. Some traders see the stock market in a holding pattern until then.

Citigroup chief U.S. equities strategist Tobias Levkovich said he is currently neutral on the stock market, but he thinks it will be helped by a change in Congress and it could rally into next year on that and other issues. He also expects to get more clarity on the Bush tax cuts, which are set to expire at the end of the year.

"One of the elements is not just a change in Congress...Hopefully you're going to have more bipartisan work," he said. "You've heard his pretty loudly more recently from business executives...They feel that the government has not been helpful to them and if there's a change to a Congress that's more willing to listen to those concerns, they'll be more willing to invest."

Analysts also expect the Fed to announce a new program to buy Treasurys. In theory that would add funds to system, which would push lending rates lower and help reflate asset prices. The dollar has weakened signifcantly since the Fed first started discussing easing in late August.

"People think QE2 (quantitative easing) is responsible for the rising stock market. They're thinking the elections are helping, but I think the bigger thing underneath this is the economy reaccelerating from the soft patch," said Wells Capital Management chief investment strategist James Paulsen.

The S&P 500

Levkovich said he went neutral on stocks last week when the S&P 500 hit his 2010 target of 1175. He thinks there could be a rough Paulsen, however, thinks it could race even higher before the end of the year.

"We're close enough to 1200 (on the S&P 500) that we might just go challenge it anyway, and the thing I could see that could propel it is if next week the jobless claims number dropped, and you saw that four week number significantly below 450,000, looking like it was breaking downwards. I don't think earnings reports will do it. We already have a pretty good read on what they're doing anyway, and they're not bad," he said.

"My guess is we've still got a good shot at 1300 before the end of the year. There are things I like about where we are today. The last time we were here, pushing 1200, was in April. Back then there was a breakout in optimism, too much so," he said, noting the markets were then surprised by Europe's sovereign debt issues and a batch of weak data. "Today, there is a lot of pessimism and people are talking about QE. That difference in sentiment says we still have a chance to go through the old highs because we're still climbing a wall of worry," he said.

Expectations for this Week

Bullish Symptom - Retail Investors Lacking!


"Signs Point to Swing and Miss on Earnings"

-The Wall Street Journal, Sept. 27, 2010

"Third-quarter earnings begin soon, and the primary mood on most trading desks is one of skepticism about the recent rally."

-Barron's, Sept. 27, 2010

"S&P 500 Profits Cut for First Time in Year by Analysts"

-Bloomberg, Oct. 4, 2010

The Group of 20 (G-20) talks is behind us and earnings season is accelerating, with midterm elections and a key Federal Open Market Committee (FOMC) meeting just around the corner in early November. Economic reports will dominate morning headlines throughout the upcoming week, as reports on existing and new home sales, durable goods orders, jobless claims and the third-quarter advanced gross domestic product (GDP) reading will be released.

Earnings will also be in focus, with heavyweights such as U.S. Steel Corp. (X), 3M Company (MMM), Exxon Mobil Corp. (XOM), Merck & Co. (MRK), Procter & Gamble Co. (PG), and Microsoft Corp. (MSFT) scheduled to report quarterly earnings. Traders will also get a glimpse into the state of the consumer via earnings reports from Sherwin-Williams Company (SHW), RadioShack Corp. (RSH), Coach Inc. (COH), Buffalo Wild Wings (BWLD), Panera Bread Company (PNRA), and P.F. Chang's China Bistro (PFCB).

A compelling headline on on Friday that read, "Boeing Sales Beat 'New Normal' Pessimism as Fed May Act." The "new normal" term has been tossed around quite a bit by various market commentators and analysts, with the implication that we should prepare ourselves for a long period of slower growth. Moreover, as the lead quotes suggest, there was not a lot of enthusiasm heading into earnings season, creating a lower bar for companies to hurdle. But 85% of companies reporting so far have beaten forecasts, helping support a market that has rallied strongly off the August lows.

Stock Buyers?

It certainly is not the retail investor -- not U.S. stocks, anyway -- which provides a perspective of bullishness. The Investment Company Institute reported this week that the consecutive weekly streak of net fund outflows in place since late April finally ended the week of Oct. 13th. But the streak ended because inflows into foreign equity funds were higher than the sharp decrease in net outflows from domestic equity funds.

It appears from the analysis of option activity that a strong bid for U.S. equities is still coming from hedge funds, who will buy index or exchanged-traded fund (ETF) put options to hedge long positions that they are accumulating. A clue as to when some hedge funds are in accumulation phase is when the ratio of bought-to-open puts versus bought-to-open calls increases on major exchange-traded funds, such as the SPDR S&P 500 ETF Trust (SPY), PowerShares QQQ Trust (QQQQ) and iShares Russell 2000 Index Fund (IWM).

The below graph continues to display a 20-day put/call volume ratio on the rise. The significance of who is buying is that when hedged hands are accumulating stocks, rallies tend to occur, and any sell-offs tend to be modest given they have put protection in place.


On the technical front, a bullish "golden cross" occurred on the S&P 500 Index (SPX) Friday, in which the 50-day moving average rose above the 200-day moving average. An article further in this report within “Technical Indicators”, will take you through the historical facts surrounding this development and present the implications involved.

We continue to view the 1,200 level on the SPX as a potential resistance area. Not only is it a round number, but it is the site of the 80-month moving average and the April 2010 peak. Moreover, the SPX danced around 1,200 for several months in late 2004 and most of 2005. We view support in the 1,150 area, site of the January 2010 peak. The 1,150 level on the SPX also corresponds to the 115 level on the SPY, site of peak put open interest in the November option series.



Of the third of the S&P 500 that has already reported, 83 percent have beaten earning estimates, and 64 percent have beaten revenue estimates, according to Thomson Reuters. The expectations are now that earnings for the 500 companies will increase an average 28 percent this quarter, up from a previous 24 percent, according to Thomson Reuters.

Joel Levington, managing director, corporate credit at Brookfield Investment Management, monitored about earnings calls on about 25 companies in the past week and says while earnings were good, there aren't many companies making forecasts.

"Generally, across the S&P 500, revenues came in about where expected to modestly better...There hasn't been a lot of color on looking out to 2011, which highlights that companies comfortable yet with the economic backdrop to go out that far," he said.

Levington said he did hear one common trend on a number of calls, and that had to do with rising input costs and pricing. "If you're talking about industrial companies, for Ingersoll-Rand, Caterpillar (CAT), Danaher, all the comments are around pricing to offset commodity inflation...whether you're talking about aluminum, copper, gold, anything that will go into electrical equipment or machinery, everybody's talking about raising prices. They're trying to even them out sas their raw materials go up, they want to increase pricing to offset it. We are kind of hitting the peak in operating margins," he said.

If you look at food, and I look at the notes form McDonald's (MCD), they flat out said they are going to be raising their prices in 2011. If you look at what happened, to Kellogg's, part of that was pricing, you're talking about agricultural commodities, as opposed to metals," he said. Levington also said telephone companies AT&T (T) and Verizon (VZ) were talking about increasing their average revenue per unit next year.

"You're definitely going to have this battle over inflation, and who is going to eat it...whether it's the consumer of the goods or the manufacturers. I think the next six months, that's a story that's going to play out significant for the S&P. That's a battle that's going to be waged," he said.

Economic News

Mortgage Foreclosures

The housing-related issue expected to stay in the news is the concern about mortgage foreclosures, which resulted in the freezing of some foreclosures by banks. States are investigating the banks handling of foreclosures. Another issue is that financial institutions may also increasingly be challenged by investors about the quality of the loans they wrote and sold.

In the past week, Bank of America (BAC) was asked by the New York Fed and two major asset managers to take back $47 billion in bad mortgages. Bank of America stock lost 4.5 percent for the week.

Uncertainty about the issue overhangs the banking sector. The KBW bank index did recover some ground in the past week, rising 1.5 percent. "People don't know how big it is, and the market doesn't like uncertainty. There's issues as to what it could mean to the housing market or to some banks' capital structures," said Joel Levington, managing director, corporate credit at Brookfield Investment Management.

Economic Reports

The big data point economists are watching in the week ahead is the first reading of third quarter GDP on Friday, but housing data will also be a highlight of the coming week.

Housing reports

Five reports on housing will come in during the coming week, and they're not likely to offer much cheer.


Start Monday with the National Association of Realtors' September existing-home sales report. Nomura Securities is forecasting an annualized rate of 4.35 million units, up 5% from August and 13% from their recent lows.


On Tuesday, two important reports on price trends are due:

  • The S&P/Case Shiller index for August and

  • The Federal Housing Finance Agency's Home Price Index.

Case Shiller measures prices in 20 markets. Nomura sees prices up 2.1% from a year earlier. That would feed into the theme that the economy slowed this summer.

The FHFA looks at prices nationally.

There are some who believe the Case Shiller report will paint too rosy a picture. Clear Capital, a research firm that watches real-estate trends, says prices nationally fell nearly 6% in the last two months and could be headed lower.


On Wednesday, the Commerce Department will report new-home sales for September. The consensus is for sales to come in at an annualized 300,000 rate. That's still flirting with record lows.

Other Reports Due this Week

Consumer Confidence Index

Consumer Confidence Index, due Tuesday from The Conference Board. Nomura Securities sees the index rising to 51. IHS Global Insight sees it only reaching 46, with high joblessness and fear of job losses coloring confidence.

Durable-goods Orders

Durable-goods orders, due Wednesday from the Commerce Department. This should rise, thanks to new orders for Boeing (BA). The company booked 257 new airliner orders in the last three months, the most since April 2008. Not all of those orders have been included in the orders report.

Initial Jobless Claims

Initial jobless claims, due Thursday from the Labor Department. These will probably come in at around 450,000, frustratingly high but still off 40% from peaks reached in early 2009.


The big report comes Friday when the Commerce Department reports on GDP in the third quarter.

Third quarter GDP is expected to show growth of 2.5 percent, up slightly from the 1.7 percent in the second quarter.

"I'm expecting 2.2 percent, and sort of topline big picture, that's below trend. That's below the economy's potential which is somewhere between a 2.5 percent to 3 percent," said Mark Zandi, chief economist at Moody's "At that rate of growth, the unemployment rate will continue to slowly edge higher, so it's not good enough. Some of the growth will be related to inventory accumulation, so the growth of final sales is closer to 1.5 percent, which is just not good enough. It highlights why the Federal Reserve is on the verge of doing what it's going to do."

Chicago Purchasing Managers Index

Chicago Purchasing Managers Index, due Friday from the Chicago chapter of the Institute for Supply Management. Nomura sees the index declining from 60 to 58. That still means expansion, however. Look for higher prices.

Events of Importance


Among the significant conferences next week are:

• The Federal Reserve System and Federal Deposit Insurance Corp. are co-hosting a conference Monday and Tuesday on U.S. housing and mortgage markets.

• Associates Fall Growth Stock Conference on Monday and Tuesday in San Francisco,

• Bank of America Merrill Lynch LatAm Growth Conference on Tuesday and Wednesday in New York,

• Bank of America Merrill Lynch Private Company Conference on Thursday in New York and

• JPMorgan Public Finance Transportation Conference on Thursday in New York.

Appearances by Federal Reserve Officials

Among appearances by Federal Reserve officials:

• Chairman Ben Bernanke will speak Monday in Arlington, Va.;

• New York Fed President William Dudley will speak Monday in Ithaca, N.Y.; and

• St. Louis Fed President James Bullard will speak Monday in St. Louis.

• Finance ministers and central bank governors from the Group of 20 industrial and developing nations will meet through Saturday in South Korea in advance of the meeting of G-20 leaders next month. U.S. Treasury Secretary Timothy Geithner is calling on the world's largest economies to refrain from using their exchange rates to grow at the expense of their trade partners.


This Week’s Earnings Expectations

In all, 177 S&P 500 companies will report earnings, one of the heaviest weeks of the current earnings season.

About 83% of S&P 500 companies that issued reports through Thursday had beaten analysts' earnings estimates. About 64% had been revenue estimates.

Hopefully the results will continue to be strong.


Amgen (AMGN), Lorillard (LO) and Texas Instruments (TXN). The latter is the key report, offering a glimpse on growth in the mobile phone industry.


Bristol-Myers Squibb (BMY), Cummins (CMI), DuPont, U.S. Steel (X) and Waddell & Reed Financial (WDR). )

Watch the results of Cummins, DuPont and U.S. Steel for clues on how Smokestack America is faring. Waddell & Reed may discuss how its trading may or may not have affected the May flash crash.

DuPont is the top Dow performer in 2010, up 39%. It has raised its earnings guidance three times this year.


Allstate (ALL), auto-parts maker Borg-Warner (BWA), cable operator Comcast (CWCSA), ConocoPhillips, Panera Bread, Martha Stewart Living Omnimedia (MSO), Procter & Gamble and Whirlpool.

Panera Bread, Martha Stewart Living Omnimedia and Whirlpool will all offer a sense of consumer confidence.

P&G has been struggling with price pressures as stores push their own store brands on many consumer products. Nonetheless, it is sporting a 3% dividend yield, which is higher than the 10-year Treasury yield. Shares are up 5% this year.

ConocoPhillips starts the big oil reports. Shares are up 20% in 2010, despite flat oil prices and falling natural-gas prices.


3M (MMM), Blackstone Group (BX), Dow Chemical (DOW), Lithia Motors, Exxon Mobil and Microsoft.

Blackstone is up 250% since bottoming in March 2009. But it's still 61% below $35.06, its closing price on its first day as a publicly held company.

Watch Lithia Motors to gauge the strength of auto sales.

As the world's largest oil company, Exxon will offer a feel for the global energy market. Microsoft's challenge is to show that it is rebounding from the lows of 2009.


Chevron (CVX), Merck (MRK), Estee Lauder (EL), Ruth's Hospitality Group.

Merck will be closely watched for what it says about growth and its drug pipeline. Chevron will sketch in the global energy market.

Ruth's Hospitality is the parent of the Ruth's Chris chain of steakhouses, which have always been popular among the expense-account crowd. The question is whether it is starting to see a rebound from the worst of the recession.

Further Insight to Several Companies

• Big chemical companies DuPont Co. (DD), which reports Tuesday, and Dow Chemical Co. (DOW), on Thursday, likely benefited from rising demand in the third quarter.

DuPont's results will be skewed as the prior-year period had $117 million of tax benefits from currency hedging. Operating results for Dow, the largest U.S. chemical company by revenue, should rise on higher demand and selling prices as well as its acquisition of Rohm & Haas, which helped generate increased business and cost savings.

• More U.S. defense companies will report this week after Lockheed Martin Corp. (LMT) this week said its third-quarter profit dropped 28% despite higher revenue, as a charge for an executive-buyout program weighed on the bottom line. Investors are looking for more information on the impact of slowing military budgets after the Pentagon last month detailed an overhaul of its buying process. General Dynamics Corp. (GD) and Northrop Grumman Co. (NOC) both report Wednesday, followed a day later by Raytheon Corp. (NYSE: RTN).

• Life insurers Aflac Inc. (AFL) and MetLife Inc. (MET), which report Tuesday and Thursday, respectively, both are expected to post improved results from a year earlier as they benefit from rising stock markets. The rising yen also will help Aflac, which earns most of its revenue in Japan, while MetLife, the largest U.S. life insurer, had big investment losses in the prior-year quarter.

• Results are projected to grow at software giant Microsoft Corp. (MSFT), which reports Thursday, as it continues to benefit from strong demand for its two biggest products Windows and Office. However, investors are skeptical about its push into newer consumer markets, namely Internet search and mobile phones, where rivals Google Inc. (GOOG) and Apple Inc. (AAPL) are thriving.

• Meanwhile, chip makers Texas Instruments Inc. (NYSE: TXN) and Broadcom Corp. (BRCM), which report Monday and Tuesday, respectively, are expected to post improved results. TI has reported some weakness in consumer markets, while demand for smartphone chips, Broadcom's specialty, remains strong.


The S&P 500 Index's Golden Cross


Last July we were plagued with the "death cross" on the S&P 500 Index (SPX). That's when the 50-day moving average crosses below the 200-day moving average. This is often portrayed as a bearish signal for the market. Nevertheless, the market has rallied since then and we just had a "golden cross." That, as you may have guessed, is the opposite of a death cross. It's when the 50-day crosses above the 200-day. The chart below shows the golden and death crosses on the S&P 500 since 2000. While some of the death crosses marked a mere pullback, all the golden crosses have been bullish for the market. However, history is not always a good predictor for the market and there is a more important aspect of this that I'll talk about next.


I would point out that I mentioned in last week’s “Market Outlook for Week Beginning October 18, 2010 “, that:-

Extract - “The market has continued to move higher since the S&P 500 broke a resistance level at around 1,130 in the middle of September. Some chartists are now looking at an upside target of 1,228.74, the 61.8 percent Fibonacci retracement from the 2007 high.

Next week may also see a so-called "golden cross" in the S&P 500 if the 50-day moving average rises above the 200-day -- a bullish sign for some traders. The 14-day moving average moved above the 50-day and the 200-day averages in September.”

Media Attention

I, like everyone else in the media, wrote about the death cross in July when it happened.

Extract - from the Article – “Market Outlook The Week Beginning Monday, July 05, 2010”

“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 rally happened, as the market is up almost 15% since the death cross. Now the 50-day moving average has overtaken the 200-day to complete the golden cross. Unlike the July death cross, which everyone was talking about by the time it happened, I've hardly seen anything discussing the impending golden cross. Look at the chart below using data from Google Trends. It measures the interest in the United States of the terms "golden cross" and "death cross" by comparing the number of Google searches for those words. Look at the huge spike just before July in searches for "death cross." Compare that to the number of searches for "golden cross" happening now.


Historical Data

It is interesting to note that the most important about the golden cross is the media's lack of coverage, given the mass coverage of the death cross less than four months earlier. However, let's look at the historical data following these events. Since the early 1970s, there have been 18 golden crosses and 19 death crosses (including the most recent one). The table below shows that the market is usually pretty strong after a golden cross. In the four months following a golden cross the S&P 500 increases an average of 4.22% while the market has usually only gained 1.87% over the same period. Note there is outperformance in all time frames below.

The death cross signals are mixed compared to the typical S&P 500 returns. There is outperformance after a death cross at three- and six-month time frames but underperformance at one and 12 months.


Finally, below is another way to assess the returns. It looks at how often the returns are positive following a golden cross and death cross. The conclusions are the same as the table above. The golden cross is bullish while a death cross is more mixed.



The golden cross typically signals good returns in the near future for the market. More importantly, this bullish phenomenon is being completely ignored. Four months ago, when the death cross occurred, there was a barrage of articles asserting it confirmed a looming market crash. I haven't heard a peep about the golden cross happening right now. It seems no one is pointing to this bullish news because no one believes a rally is imminent. This lack of belief has bullish implications for the market. It suggests bad news is priced into the market already so there are a lot of people standing on the sidelines. As this market continues to rally investors will come to believe or have no choice but to submit and begin buying. The inflow of sideline money can sustain this rally for a long time. Don't be late getting in.

***Further evidence of market conditions can be gleaned from the information and representations of charts below.

Options Market and the VIX

U.S. stocks could see big swings to the downside this week on any remotely "bad" news since volatility indexes are at levels considered too low.

The Chicago Board of Options Exchange (CBOE) Volatility Index, or VIX .VIX, a gauge widely used to measure investors' anxiety levels, fell 2.54 percent on Friday to close at 18.78, its lowest level since April. The VIX, which rose to near 50 in May, has been around or under 20 for the past two weeks.

Options traders note that there is a clear sign of extreme complacency in the VIX and that it is making the market more vulnerable than before.

"The 'market volatility' index will see a lot more volatility (next week) since it is at such low levels now," said Steve Claussen, chief investment strategist at online brokerage

The iPath S&P 500 VIX Short Term Futures exchange-traded note, or ETN (VXX.P) is also at a new 52-week low of 12.83. The ETN offers directional exposure to volatility and is based off of the front two-month VIX futures.

"If you look at VIX futures, investors seem to be always preparing for something to trigger the volatility to spike up again, yet there is nothing major in the immediate future that justifies that," Claussen said.

The VIX futures were traded at around 21 for November and 24 for December, but going into 2011, they were showing an increase of 40 percent, trading above 26.

The VIX, widely known as Wall Street's fear gauge, is a 30-day risk forecast of stock market volatility. The index typically has an inverse relationship with the S&P benchmark as it tracks option prices that investors are willing to pay as protection on the underlying stocks.

Earlier this week, the VIX instantly shot up nearly 12 percent when stocks suffered their steepest one-day decline since August after a surprising rate hike from China.

Tracking of SPY, DIA, IWM and QQQQ


In an options expiration week that also kicked off the first full earnings week of the season, the markets continued to inch higher and have now clearly separated themselves from the small consolidation formed in September. As recently as a month ago, many pundits were calling for a resumption of the primary bear market and a possible breach of the recent bear market lows. The current thrust from this summer’s lows has been powerful, despite relatively lackluster volume. Markets have been clearly showing strength; just look at the Nasdaq 100, which surged to new recovery highs this week.

With several high-profile tech companies reporting earnings this week it was a little surprising that the tech group, as represented by the Powershares QQQ ETF (Nasdaq:QQQQ), ended almost exactly where it started. While not much upside progress was made, bulls have to be comforted by the fact that QQQQ has not given up any ground recently. The gap down in Apple (Nasdaq:AAPL) was fairly well contained, and other components like Baidu (Nasdaq:BIDU) and (Nasdaq:AMZN) reacted well to their earnings reports. QQQQ remains above the recent resistance area near $50, which should now become support. A drop below this level would put the $49 level in play, so bulls should monitor this week's low.


The S&P 500, as represented by the S&P 500 SPDRS (NYSE:SPY) ETF, has yet to confirm the recent strength in QQQQ by rallying above its April highs. However, SPY was able to hold above some important resistance levels near $112 and $115. The financial sector has been lagging through this entire move, which has held back SPY. If the financials can gain some momentum soon, it could help push this ETF through to new highs. In the near term, traders should monitor the recent congestion near $114-$115 for possible support on weakness.


The Diamonds Trust, Series 1 (NYSE:DIA) ETF, which tracks the Dow Jones Industrial Average, continued to flirt with its April highs without actually clearing them. Despite some recent distribution days, DIA has managed to absorb most selling and remains poised just under important resistance near $112.50. This week's low serves as an important area to watch as well; a drop below it may be a sign of a deeper pullback.


The iShares Russell 2000 Index (NYSE:IWM) continued to lag the markets. IWM remains well off its April highs, but much like the other index ETFs, it has managed to hold above recent resistance levels. The recent breakout above $67 appears to be valid, and IWM should find support near this area on any weakness. The clear area to watch above is near $74, which coincides with IWM's April highs.



In the end, it was a very tame week as there was very little overall movement in the indexes. Tuesday’s gap down was easily absorbed, and the markets are basically consolidating. In essence, traders should be prepared for two scenarios. The first is a continuation move higher after this pause, which could take the other indexes to new highs. The other is a deeper pullback from this consolidation, which of course could turn into more. A drop below this week's low would serve as a warning sign that the current pause could turn into a pullback. Traders should remain cautious, as bullish sentiment is starting to increase to levels that have been associated with reversals.

Weak Stocks In A Strong Market


After what has been a near vertical rise from August lows, it looks like the general markets may be taking a break. The past few days have seen some distribution, and although the uptrend has remained firmly in place, it may be a good time to reduce long exposure. One way to do this is by increasing short exposure, and the best types of stocks to focus on in this case are stocks that have been unable to participate in the recent strength. This lack of participation shows unwillingness on the part of institutional investors to back such stocks, even at a time when risk-taking is being rewarded.

Several stocks remain under important bases despite the strength shown by the general indexes. While many traders tend to attempt picking a top in runaway stocks, the safer play is to focus on stocks already showing weakness.

Blue Nile (Nasdaq:NILE) is a perfect example of a stock that has been unable to make any progress even though many of its peers are outperforming. NILE fell under an important base in early August, and has been trading in a fairly tight range under this level since then. Every time it attempts to push back into its base, sellers step in. In fact, NILE still has an unresolved gap near $47.50 showing that sellers remain aggressive.


Urban Outfitters (Nasdaq:URBN) is another stock that has seen sellers overwhelming buyers even in a strong environment. URBN attempted to bottom after successfully holding support near $31 in September, but sellers quickly appeared near $35 and sent URBN back to the bottom of its base. The $31 level finally gave way, despite holding on several occasions over the past few months. This is now a key level to watch, as traders who were conditioned to buy this area are now under water.


Kirkland's (Nasdaq:KIRK) has been persistently showing weakness since May, despite being one of the better performers in the retail space earlier this year. Notice how sellers consistently appear as KIRK tests its declining 50-day moving average (shown in green). KIRK also broke down under an important support level in August on a high volume gap lower. Much like URBN, KIRK has been unable to make any headway back into its base or the gap. Sellers have begun to appear at even lower levels, and it appears that KIRK may be headed back to its September lows.


MEDIFAST INC Common Stock (NYSE:MED) has had a crazy ride in 2010 as it rallied from the $15s in February through the $37 level in May. Stocks that experience such a sharp run in a small time frame typically enter a wide consolidation as market participants struggle to find fair value. MED began this process in May and formed a symmetrical triangle pattern over the subsequent five months. However, rather than clearing the triangle and resuming its prior uptrend, MED has now broken under the triangle, which may be signaling a reversal. The $25 level is the area traders should focus on to see if MED can reclaim its base, or if it is in fact reversing on longer time frames.



The markets remain above support levels and continue to show strength. As such, it makes sense to focus mainly on the long side and remain aligned with the overall trend. However, traders should always be prepared for multiple scenarios, and with the markets showing a few warning signs, it remains prudent to have options in case things turn sour. Focusing on weak stocks should allow traders a larger margin for error if the recent strength continues, while still providing a great trading opportunity if the markets take a break.

tech stocks


Earnings will remain the center of attention this week. Many analysts predict that earnings will continue to support the market rally that kicked off October. If more companies report strong results, that could bolster sentiment, along with hopes for more Fed easing.

In the last week of October, 177 S&P 500 companies are due to report their balance sheets, of which seven are Dow components. Among them are energy giants Exxon (XOM.N) and Chevron (CVX.N) and technology giant Microsoft (MSFT.O).

S&P 500 earnings are expected to increase 28 percent for the third quarter from a year ago, up from a growth estimate of 24 percent last week, according to Thomson Reuters data.

"The earnings are expected to be good next week as well ... we are not expecting any bad news out of there," said Peter Cardillo, chief market economist at Avalon Partners, in New York.

But Cardillo said that negative news from economic data could spark market volatility, especially as it would come just a week before the Nov. 2-3 meeting of the Federal Open Market Committee, or FOMC, and in the week preceding the Nov. 2nd mid-term elections.

Elliot Spar, options market strategist at Stifel Nicolaus, also said a sell-off could begin as early as next week in anticipation of the Fed meeting and the mid-term elections.

"For those that are waiting for the 'sell on the news' event on Nov. 3 when the Federal Reserve Open Market Committee concludes its meeting to discuss the prospect of another round of quantitative easing, I believe that the sell-off in the market will start during the week of Oct. 25."


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

Take control of your future prosperity the Easy way. Become a member of Stock Options Made Easy today!

Back to Stock Options Made Easy from Market Outlook for Week Beginning October 25, 2010

Search Stock Options
Made Easy

Enjoy Relaxed or Fast-Paced Trading? Choose your Membership Style...

Whether you prefer to take a laid-back approach to your trading,

or to charge ahead in your options trading,

 Stock Options Made Easy Armchair Trader and Cut-to-the-Chase Trader Memberships put everything you need to succeed at your fingertips for just  $39 or $79 per month.

Search Stock Options
Made Easy


Subscribe to our FREE
newsletter for all the latest options news!

Enter Your Email Address

Enter Your First Name

Follow S_O_M_E on Twitter

Subscribe to our FREE
newsletter for all the latest options news!

Enter Your Email Address

Enter Your First Name

Follow S_O_M_E on Twitter