The Week Ahead in the Stock Market
July 16, 2012

Week Ahead: Bernanke May Provide Direction for the Stock Market!

Wall Street: Earnings Will Make It A Busy Week!

by Ian Harvey

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July 16, 2012

There are earnings expected from dozens of major companies BUT what many traders are hoping for is talk of more Fed easing. Federal Reserve Chairman, Ben Bernanke, will likely tell members of Congress in the coming week that it’s the lawmakers who need to act.

Bernanke gives his semi-annual testimony on the economy, before a Senate panel Tuesday and a House Financial Services committee Wednesday.

Besides Bernanke, there is a busy economic calendar in the week ahead, starting with Monday’s retail sales and including consumer inflation and several housing reports.

The Past Week

Friday the 13th turned out to be a lucky day for stocks, with the Dow and S&P 500 snapping a six-day losing streak, propelled by sharp gains in financials following JPMorgan's earnings report.

With Friday's rally, the Dow and S&P 500 managed to eke out small gains for the week – with the SPX's losing streak finally coming to an end, and the Dow posting its first triple-digit gain in July.

JPMorgan (JPM) reported better-than-expected profits and revealed a $5.8 billion loss from derivatives trading in its London office. JP docked its former employees’ pay, clawing back two year’s worth. Despite the reputational damage and government interest in the losses, it managed to give the market a sense that the worst is behind it, successfully convincing the markets that this was an isolated event. Their stock was up close to 6% on Friday.

Therefore, what started out as a fairly dismal week in the stock market finished on a positive note, as financial stocks finished the week very strong -- with coal and energy stocks posting nice gains as well! This was helped by the 17% increase in earnings from Wells Fargo (WFC), which sent its stock surging over 3%.

• The Dow Jones Industrial Average (DJIA) jumped to 12,777 and recorded a 0.04% rise for the week, which effectively erased its six previous sessions in the red.

• The Standard & Poor's 500 Index (SPX) settled at 1,356, 0.15% higher for the week.
Despite a choppy second quarter, the S&P is still up 7.7 percent year to date.

• The Nasdaq Composite Index (COMP) closed at 2,908, notching a loss of approximately 1.0% for the week.

The CBOE Market Volatility Index (VIX), widely considered the best gauge of fear in the market, retreated 2.1% for the week.

The Markets Ending July 13, 2012

**For a more in-depth look at the past week…..CLICK HERE…..**

The Major ETFs in the Past Week

Many of the widely watched major ETFs broke their uptrends from the June lows in early trading Thursday, but closed back above them. This gave encouragement to the bulls, and it was rewarded with sharp gains Friday that were enough to bring most of the averages back into positive territory for the week.

**A more detailed report can be obtained by ……CLICKING HERE…..**


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The Week Ahead

While earnings news may or may not confirm the slowing economy in the week ahead, it is Bernanke’s testimony that could help set expectations for the rest of the summer.

When measuring the confidence level regarding stock market investments, Europe is number one, but the fiscal cliff is number two – which means that there are real economic issues here that need to be addressed clearly and succinctly!

Bernanke – QE or the “Fiscal Cliff”

The Fed has made it clear it has come to no agreement on further easing, and Bernanke and others have kept Quantitative Easing (QE), or QE, as an option if the economy or financial conditions deteriorate.

Still, just the idea of another round of Fed asset purchases has provided support for the stock market, and there is already speculation that Bernanke will discuss it during his Jackson Hole speech in late August, as he did two summers ago.

Bernanke has previously warned that if Congress fails to act, the economy could hit a so-called "fiscal cliff," estimated to be as much as a $720 billion hit to the economy from the combined expiration of tax breaks Dec. 31 and automatic spending cuts that will occur starting Jan. 1.

Definition of ”Fiscal Cliff”

“Fiscal cliff” is the popular shorthand term used to describe the conundrum that the U.S. government will face at the end of 2012. U.S. lawmakers have a choice: they can either let current policy go into effect at the beginning of 2013 – which features a number of tax increases and spending cuts that are expected to weigh heavily on growth and possibly drive the economy back into a recession – or cancel some or all of the scheduled tax increases and spending cuts, which would add to the deficit and increase the odds that the United States could face a crisis similar to that which is occurring in Europe.

The oncoming fiscal cliff is a concern for investors since the highly partisan nature of the current political environment could make a compromise difficult to reach. This problem isn’t new, after all: lawmakers have had three years to address this issue, but Congress – mired in political gridlock – has largely put off the search for a solution rather than seeking to solve the problem directly. Republicans want to cut spending and avoid raising taxes, while Democrats are looking for a combination of spending cuts and tax increases. Although both parties want to avoid the fiscal cliff, compromise is seen as being difficult to achieve – particularly in an election year.

But the fact that there seems to be no will in Congress to act until after the November election is making some investors nervous and economists say it is causing business leaders to hold off on spending and hiring.

If Congress fails to address the fiscal situation, pushing it off until March 31, it could trigger another downgrade of the U.S. credit rating.

The stock market is not yet fully focusing on the fiscal cliff, with Europe and earnings its immediate concerns.

One probable outcome for the fiscal cliff would not allow equities prices to be trading at today’s prices.....which is talking about a haircut to GDP growth of plus or minus 5 percent.

Analysts said investors mostly believe Congress would not allow the trigger of automatic spending cuts on defense and federal programs. The cuts are onerous and were negotiated as part of the debt ceiling pact last summer.

Rhetoric from Washington picked up in the past week as President Obama said the tax cuts should not be extended for Americans earning more than $250,000, a position opposed by Republicans.

The play (for Bernanke) is he can’t do this alone, and there could be more monetary policy to come but quantitative easing is at a point of diminishing returns – since they’re trying to keep the lending rate below the rate of inflation, and you’ve got that -- what purpose does more quantitative easing achieve, except for rallying the stock market, and will this help stimulate the economy?”

The Fed may be considering other moves for QE3 -- it doesn’t mean it has to take the form it’s already taken -- they could consider purchasing mortgage securities, while the past two QE programs have targeted Treasury securities -- ”Operation Twist”

Presidential Election Effect

The fourth year in a president’s term is typically a positive one for stocks, which cannot be ignored -- there is only one presidential election year since 1940 that has seen a double-digit decline in the Dow, and that was 2008.

Now on the flip side of the coin, if you look at how many presidential election years have seen double-digit gains since 1940, there have been seven of them -- the kind of odds that investors should pay attention to!

Economic Uncertainty

Of course, stocks typically start to move higher when the sentiment is quite negative. Worries over the so-called “fiscal cliff” are keeping many out of stocks. The spending cuts and tax increases that could start next year are increasing the level of uncertainty, and may impact the GDP this year.


The New York Times ran an interesting chart of "Uncertainty Over U.S. Policy," which shows that it picked up in May. It is still well below the all-time high from last summer that was spurred by the debt-ceiling debate and the Euro debt crisis.

Those familiar with market history will note that several peaks in this index coincided with lows in the stock market. It should not be surprising that extreme levels of pessimism coincide with market lows.

Sentiment Value in the Week Ahead

”.....Veteran market analyst and option expert Larry McMillan noted last Thursday that “a very powerful buy signal associated with the total put-call ratio is about to engage.” Mathematically, it will turn positive with Monday’s close.
- The Week Ahead in the Stock Market - June 18, 2012


There appears to be two opposing views of the stock market’s rally from the June lows – a “bull rally” or a “bear trap”. The correction from the early July highs lasted a day longer than expected, and if stocks had closed Thursday, last week, on the lows, it would have shifted the evidence slightly to the bearish camp.

Though the public’s lack of interest or trust in the stock market seems to be high enough for a market bottom, the normal sentiment numbers are mixed. The individual investors according to AAII became more negative last week, with just over 30% are bullish. The newsletter writers, on the other hand, became more encouraged -- 44.7% are now bullish, up a couple of percent from the past week.

As mentioned a few weeks ago, obvious from the excerpt above, option traders were bearish enough at the June lows to signal an important low, according to option expert Larry McMillan. His long term put-call ratio gave a buy signal on June 18.
The daily chart of the NYSE Composite and the cumulative NYSE Advance/Decline line provided clear evidence of why Friday’s rally was important for the bullish case. The lower boundary of the flag formation (line c) was broken Thursday, but not on the close.

For more details on this refer to The Past Week Stock Market Results – July 16, 2012

The Major ETFs in the Week Ahead

The stock market eventually turned higher by the end of the week, but there needs to be further strength to confirm the bullish case and maybe the election-year rally that could last until the end of the year has begun.

Last week was certainly a test of good support for the exchange-traded funds (ETFs), which allows for good risk control for those who used it as a buying opportunity. If there is confirmation of a new intermediate-term uptrend, there will be plenty of buying opportunities in the coming weeks. The financial and energy sector are looking more interesting, especially the small caps.

**.....CLICK HERE.....for more detailed information.....**


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TOP OPTIONS TRADES SINCE JUNE 01, 2012

TRADE GAIN TRADE GAIN
HLF July 47.50 Calls 53% APPL Aug 650 Calls 67%
DLTR Aug 110 Calls 32% UIS Oct 17 Calls 79%
HSY Aug 70 Calls 56% TSO Nov 25 Calls 54%
NKE Oct 92.50 Calls 49% HLF July 47.50 Calls (again) 38%

The Key Events in the Week Ahead

Investors are looking at an onslaught in the week ahead -- corporate earnings -- Ben Bernanke talking about economic issues before Congress.

With a slew of companies set to report results in the week ahead, the hope among investors is that the bad news has been factored in, but the broader picture remains lackluster. That may limit the market's gains even if companies clear a low bar.

While earnings news may or may not confirm the slowing economy, it is Bernanke’s testimony that could help set expectations for the rest of the summer.

However, at this point-of-time, expectations are nearing a low -- global slowdown being a major factor!

Data showing slower growth in Europe, China and the United States has weighed on the stock market, while U.S. companies have warned about overseas weakness and a stronger dollar hurting profits on exports.

The minutes from the Federal Reserve's June meeting suggested it is not ready to inject more monetary stimulus into the economy, but traders will be hanging on Federal Reserve Chairman Ben Bernanke's every word for mention of such a possibility and how he views the slowing economy.

Earnings in the Week Ahead

There are earnings expected from dozens of major companies such as Coca-Cola (KO), American Express, Bank of America (BAC), Microsoft (MFST), IBM, Intel (INTC) and General Electric (GE).

There might be some good news in the numbers, outside of the companies heavily impacted by Europe. On the margin, expectations for earnings in the week ahead -- and there will be 80 S&P companies reporting—are so low that there’s a real chance for some upside surprises.

Earnings estimates have already fallen sharply. S&P 500 earnings for the second quarter now are expected to rise just 5 percent from a year ago, down from an estimate of 9.2 percent at the beginning of April, according to Thomson Reuters data.

Nearly all sectors have seen estimates fall due in part to weak demand in Europe. Energy and utilities are expected to be the weakest performers this quarter after big declines in energy prices in the second quarter.

The fall in estimates could be enough so that the majority of companies end up beating expectations, as they typically do, inspiring a relief rally. That could bolster the S&P, where trading has narrowed to a range between 1,310 and 1,370 for most of a month.

Investors could see some downside surprises in high-end consumer companies, industrials and financials in the week ahead -- for example -- Bank of America Inc (BAC) is expected to report earnings of 15 cents a share on Wednesday, but Thomson Reuters StarMine's SmartEstimates put expectations at 13.5 cents per share, or a miss of about 9 percent.

The technology sector could end up being mixed --on one hand, there are very good trends on the software side. (But) there may be some disappointments among some of the hardware manufacturers -- weak PC sales.

Besides Advanced Micro Devices, a weak forecast was issued by fellow chipmaker Applied Materials (AMAT) this past week, while engine maker Cummins Inc (CMI) warned on sales. AMD reports results on Thursday.

Negative to positive earnings guidance for the second quarter is 3.3 to 1, the worst since 2008, Thomson Reuters data showed.

Among other S&P companies scheduled to report in the week ahead are Goldman Sachs (GS), Citigroup (C) and Johnson & Johnson (JNJ).

Major Earnings in the Week Ahead

Economy in the Week Ahead

Besides Bernanke, there is a busy economic calendar in the week ahead, starting with Monday’s retail sales; the Consumer Price Index (CPI) on Tuesday; housing starts on Wednesday; and existing-home sales and the Philadelphia Federal Reserve Banks's manufacturing index on Thursday.

The Fed releases its Beige Book report on Thursday.

Bernanke is due to deliver his semiannual monetary policy report to Senate and House committees on Tuesday and Wednesday, though analysts said he is not likely to divulge plans of further economic stimulus.

Stocks lost ground in the past week as minutes from the Fed's June meeting showed policymakers are open to the idea of more economic stimulus, but that conditions might need to worsen first. Investors were hoping the Fed's June minutes would suggest the central bank was getting closer to another round of stimulus.

It appears that Bernanke will not be alluding to any quantitative easing – he is more apt to urge Congress to act on fiscal policy and tackle the issues of huge budget deficits and the impact on the economy of approaching sharp cuts in government spending known as "the "fiscal cliff."

For more information and a list of key events and earnings in the week ahead.....CLICK HERE.....

Conclusion for the Week Ahead

Implications for the immediate term were the slashing of GDP forecasts by at least three major banks. After GDP forecasts were cut, JPMorgan Chase (JPM - 36.07) earnings displayed what could be a pretty decent growth story. For example, engines of the economy -- the consumer and small business -- seem to be in better shape than headlines suggest, as JPM reported accelerated credit-card spending both year-over-year and quarter-over-quarter, even as consumers carried less balances month to month. Moreover, loans to small businesses, usually a driver of employment growth, rose 35% year-over-year, and doubled loans in the first quarter.

This may allude to the fact that perhaps the slowing in economic growth is not as bad as advertised. Time will tell, but judging by the resilient stock market, there might be something to this. At the very least, a lower-expectation environment should be viewed as a good thing for stock investors. In other words, if economic growth indeed meets the lowered expectations, it will not come as a major negative shock, implying selling would be muted relative to a disappointing economic report amid higher expectations.

Turning back to what lies ahead on the immediate horizon, the week ahead brings the expiration of July options. As you can see from the chart of SPDR S&P 500 ETF (ARCA: SPY - 135.75) open interest, option sellers would love to see the SPY close above 135.00 and below 137.00, which would allow them to pocket the premiums collected from the sales of these options. Therefore, these are levels that could serve as support and resistance.

The 137 strike would correspond to the 1,370 level on the SPX, which is where the SPX recently ran into resistance, as discussed above. The risk during expiration week is a catalyst that would suddenly send stocks reeling through major put strikes. Heavily populated put strikes below the market price can act as magnets if heavy selling begins, as those that sold the puts to open must short more and more equity futures to maintain a neutral position. This is known as delta-hedging, and can magnify selling during expiration week, as we saw in May. For example, if the SPY trades below heavy put open interest at the 132 strike this week, it could set the stage for a continued downward move -- through additional layers of put open interest and all the way to the 128 strike, at which point the put open interest drops off considerably and the "magnet effect" lessens.

Further Articles Relating to the Week Ahead

1. The Economy and Earnings in the Week Ahead – July 16, 2012

2. The Past Week Stock Market Results – July 16, 2012

3. The Major ETFs in the Week Ahead – July 16, 2012


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