The Week Ahead in the Stock Market
September 17, 2012
The Stock Market: Fed Feeds the Bulls—Where are the Bears?!
Week Ahead: WARNING -- Comedown May Be Waiting After Fed High!
Wall Street: Short Interest Still Says This Rally Won't Stop!
by Ian Harvey
September 15, 2012
After the frenetic reaction brought about by the announcement of the Fed's latest stimulus program - $40 billion pumped into the U.S. economy each month - the week ahead is likely to bring a more sober period for markets as investors digest what it means in the longer run and turn their attention to the remainder of the year.
That will include acrimonious U.S. elections in November, wrangling over taxes and spending cuts and a slowdown in corporate earnings.
However, through all this drama, the stock market should stay on an upward trajectory for the time being, while bruised bears sniff out the next trouble spot for markets.
For a period of time, the markets will give the central banks the benefit of the doubt -- and expect the downside to be limited over the next six weeks or so, even though there are some major questions about the effectiveness of the Fed injection, from a macroeconomic standpoint.
A lot of the market action over the coming months will depend on whether the Fed's stimulus program succeeds in boosting the economy.
Data on the housing market in the week ahead is expected to show a continuing improvement. Economists in a Reuters poll expect the National Association of Home Builders Index to tick up in September when the data is released on Tuesday. On Wednesday both housing starts and existing-home sales are expected to increase.
Early manufacturing data for September, however, is not expected to be so robust. Both the Empire State index and the Philadelphia Fed index are tipped to show contraction. That would follow the sharpest drop in U.S. manufacturing in more than three years in August, which was also the third consecutive month of contraction.
The effect on markets of the European Central Bank's plan to buy government bonds of struggling euro zone countries, then the Fed's opened-ended commitment to spur growth have been breathtaking. The Dow and the S&P 500 reached the highest closing level in nearly five years while the Nasdaq marched to new 12-year highs.
The Federal Reserve’s new round of Quantitative Easing (QE) and promise to keep policy easy, well into the future propelled stocks and other risk assets higher, putting the Dow less than five percent away from its all-time high in the past week.
Stocks ended higher for the fourth-straight session Friday, logging sharp gains for the second week, as Wall Street cheered the Federal Reserve’s decision to embark on another round of monetary stimulus.
Stocks briefly cut their gains on Friday, after ratings agency firm Egan-Jones lowered the sovereign debt rating of the United States to AA-minus from AA, but soon bounced back.
And while history indicates that September is the worst month of the year, all three major averages are so far up nearly 4 percent across the board, as was discussed would be likely, in the article “A Surprise September Rally”.
Stocks have racked up double-digit gains since June, despite prognosticators’ expectations that the market was heading for a summer sell-off.
• The Dow Jones Industrial Average (DJI) gained 2.2 percent this past week, to 13,593, its highest close since Dec. 10, 2007.
The Dow has gained 12 percent since hitting its 2012 low June 4.
Bank of America (BAC) led the Dow gainers for the week, while Intel (INTC) sagged.
• The Standard & Poor's 500 Index (SPX) this past week jumped 1.9 percent to 1465, its best close since Dec. 31, 2007.
The S&P 500 is up 16.6% for the year.
Among the key S&P sectors, energy was the best weekly performer, while utilities dragged.
• The Nasdaq Composite Index (COMP) gained 1.5 percent to 3183, its best close since March, 2000.
For the year, the Nasdaq is up 22.2%.
Even if the market pulled back from early highs, it has become quite vulnerable to a pullback, and that should surprise no one. Stocks have risen sharply since June. The Dow is up 12% since June 4, with the S&P 500 up 14.6% and the Nasdaq up 15.9%.
Plus, all three indexes look overbought. Their relative strength indexes are all above 70; a reading that high suggests a security or index is overbought.
The CBOE Market Volatility Index (VIX), widely considered the best gauge of fear in the stock market, added 0.5 point, or 3.3%, on Friday, regaining just enough ground to close back atop the 14.50 level.
**For a more in-depth look at the past week…..CLICK HERE…..**
The Major ETFs in the Past Week
The financial stock market finished the week with solid gains, as the 'European Central Bank - ECB' and Fed’s action was better than the markets expected. This had been a primary concern of many and had kept them out of stocks.
The major Exchange-Traded Funds (ETFs) have all managed to do well in the past week. The Spyder Trust (SPY) closed up 1.9%, while the SPDR Diamond Trust (DIA) gained 2.1%. Even more impressive was the Russell 2000, as the iShares Russell 2000 Index (IWM) was up 2.6%.
Technology stocks had been leading the charge for the past month, but last week the Nasdaq-100-tracking PowerShares QQQ Trust (QQQ) as was up only 1%.
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TOP OPTIONS TRADES SINCE JULY 01, 2012 | |||||||
|---|---|---|---|---|---|---|---|
| TRADE | GAIN | TRADE | GAIN | ||||
| 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% | ||||
| FB Aug 25.00 Puts | 500% | DISH Sept 30.00 Calls | 100% | ||||
| APPL Jan 13 650.00 Calls | 71% | CSTR Oct 42.50 Puts | 400% | ||||
| LNKD Aug 92.50 Puts | 30% | LNKD Aug 100.00 Calls | 250% | ||||
| SLV Nov 30.00 Calls | 114% | JCP Nov 25.00 Calls | 67% | ||||
| GLD Nov 165.00 Calls | 72% | LVS Dec 45.00 Calls | 67% | ||||
There have been several reasons to expect a summer rally as I have mentioned in articles as far back as June.
It all comes down to expectations. The reality is, when the masses are crying “pullback”, particularly if you are being bullish in a bull market, it creates a great deal of tension in the stock market. From my perspective this rally has not been a surprise – and if you have been following my articles then you will understand this statement. Being “bullish” has certainly been a profitable exercise!
As mentioned in the article “The Past Week Stock Market Results” stocks have racked up double-digit gains since June, despite prognosticators’ expectations that the market was heading for a summer sell off. The Dow, the S&P 500 and the Nasdaq have all had great advances.
The Fed has certainly added fuel to the strength of the stock market but there have been many other reasons for the multi-year highs. If all you followed were the technicals, then back in July they were screaming that we were due for new highs, and that's exactly what has happened. Too much attention to the headline noise is often mind-changing -- and yes, the Fed and QE3 is noise – but quite acceptable.
However, all that really matters is price action and sentiment. When you combine those two very powerful indicators, you can let everyone else worry about "why" this market is going higher and simply profit from it!
Short Interest to Drive the Stock Market in the Week Ahead!
Now that the stock market has hit new highs it is important to see what will drive it even higher in the week ahead and beyond – and the action in short interest suggests this rally could still have legs to make a potentially huge move. This indicator is a favorite reason to be bullish. When short interest goes lower, it is very bullish. The theory is that higher short interest is a headwind for equities, and once it rolls over, it can be quite bullish. According to research, short interest was flat in the recent period. However, it's now down 4.4% since its mid June peak – which was a good time to be bullish.
’Short Interest' is the quantity of stock shares that investors have sold short but not yet covered or closed out. Short interest is a market-sentiment indicator that tells whether investors think a stock's price is likely to fall. Short interest can also be compared over time to examine changes in investor sentiment. Investors use short interest to make predictions about the direction a particular stock is headed, and to measure the bullishness or bearishness of investors' sentiment towards the market as a whole.
Short interest can be expressed as a percentage by dividing the number of shares sold short by the total number of outstanding shares. For example, 3% short interest means that 3% of the outstanding shares are held short. Short interest can also simply be expressed as the number of shares sold short but not yet covered or closed out. Short interest data is widely and easily available online.
The last time short interest was this high and rolled over, it sparked a 30% rally in the SPX and more than 40% rise in the Russell 2000 Index (RUT). Maybe we are looking to extend the existing rally, but on a much grander scale – here is hoping!
Now to the WARNING for the Week Ahead!!!!
Even with the stock market sailing higher, risks abound for the week ahead. Traders are watching the violence in the Middle East that resulted in the death of the U.S. Ambassador to Libya and three others this past week. Oil prices surged above $100 Friday morning but gave up some gains on speculation that there would be crude stocks released from the Strategic Petroleum Reserve.
Europe will also stay in the headlines, as traders watch Spain inch toward a financial bailout. A test for Spain comes Thursday, in the week ahead, when it auctions longer duration bonds for the first time since the European Central Bank announced its bond purchase program.
What Could Stymie The Rally?
Fears of the ”fiscal cliff” — the year-end expiration of Bush-era tax cuts and automatic spending cuts — top the list of lingering concerns that could halt the market’s climb.
But there are others, including earnings slowdown. The weakening dollar, however, could help the earnings of multinationals. The rates of change should actually run more positive for the third quarter -- unless the stock market hits a profit recession. The problems that exist are more related to the dollar and weakness around the world. Domestic companies seem to be doing okay. This does not seem to present itself as a warning sign of a bear trend and should remain in a bullish uptrend, particularly for the week ahead!
Other concerns are election-related.
The key for the election basically is the Congressional outcome, particularly the Senate, because the market is focused now on what happens with tax policy on dividends and capital gains. The market is looking for a Republican outcome -- if it gets one, the rally will continue. Republicans favor keeping the lower capital gains and dividend tax rates that expire Dec. 31, unless extended, and a post-election selloff is expected if Democrats retain control of the Senate.
There will be an increase in volatility – more so if Wall Street-favored Republican presidential hopeful Mitt Romney starts to fall behind in the polls. However, there doesn’t appear to be a lot of downside risk in the next four to six weeks, unless the polls go extremely south.
Rising gasoline prices are also a concern -- if prices keep rising, that’s going to be bad for core growth, and would certainly give a very un-Merry Christmas this year.
Volatility in the Week Ahead
The latest data shows a moderate increase in short interest - bets that stocks will fall - across S&P 500 stocks during the last two weeks of August, a period when stocks were rallying on expectations of the Fed's announcement. Typically short interest inversely tracks the market. If investors were getting out of bets that stocks will fall, that would mean buying back those stocks and forcing the market higher.
That uptick in short interest could be significant. From the middle of September 2011 through the end of May this year, short interest on S&P 500 stocks fell like a stone to about 6 billion shares. During that period the S&P hit a four-year high, rising more than 20 percent from trough to peak.
One side effect of the Fed's bond-buying should be to reduce volatility in markets. That means the CBOE Market Volatility Index (VIX) should remain close to the five-year lows it hit this summer. In August it fell as low as 13.30.
Yet activity in the options market shows some very bold bets that volatility could sky rocket in the months ahead. Call option buying on the VIX - bets the index will rise - is close to a record high at 5.182 million contracts. The record is 5.249 million set in August.
The most actively traded VIX calls on the Chicago Board Options Exchange were October calls with a strike price of 60. Those also had the highest open interest. The VIX would need to rocket more than 300 percent by mid-October, hitting its highest level in about four years, for that trade to break even – a disaster on the horizon? I don’t believe so based on the facts we know!
The Major ETFs in the Week Ahead
The sector ETFs that lead the market change constantly, but right now there four have been leading the charge higher over the last month:-
• The SPDR S&P Retail (ARCA: XRT) ETF,
• The Financial Select Sector SPDR (ARCA: XLF) ETF,
• The Consumer Discreet Select Sector SPDR (ARCA: XLY) ETF, and
• The Materials Select Sector SPDR (ARCA: XLB) ETF.
All four sector ETFs have room to the upside in the week ahead, although the Financial and Materials sector ETFs are facing some significant overhead resistance. The Retail and Consumer Discreet ETFs are in strong long-term uptrends. Trends can change though, and while the short-term prospects look good for the bulls, support levels should always be monitored; if the price starts moving through support levels it could indicate an overall change in the direction of the ETF, and the stocks represented by that sector.
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”Sell in May” and Election Years
There was significant improvement in the technical picture last week, as the market internals improved sharply. Therefore, any upcoming correction should present a buying opportunity for higher prices into the end of the year.
Last spring, the media was focused on "sell in May,” which over the past few years has been an increasingly well-known mantra. As it has become more popular, many analysts have correctly pointed out the weaknesses in this approach. Nevertheless, after 2010 and 2011, many likely did sell in May, which they are likely now regretting.
These charts show what profits may have been lost for those who either sold at the end of April or at the end of May but have not reinvested. Someone who sold their position in the Spyder Trust (SPY) at the end of April would have given up around 5.4% in profits.
Those that held through May and sold at the end of the month would have done even worse, as since June 1 the SPY has gained over 12%. Experienced investors know that looking at each position is a better strategy than taking an all-in or all-out approach. Of course, stocks could drop back to the May lows but that does not look likely now.
By studying the effects of election years on the stock market it is to be concluded that buying in May of an election year did often work, unlike other years.
For example, in 1936, stocks rallied over 18% from the May lows until the end of the year. This is an especially interesting year as the stock market and economy were recovering from the depression.
A very interesting NPR article, “When a Turn Toward Austerity Turned to Disaster," explains that the drop in unemployment from 22% to under 10% and high deficits prompted an austerity push by FDR. As they noted: “Over two years, FDR slashed government spending 17%.”
From the March 1937 high of 192.77, the Dow Industrials dropped to a low in March 1938 of 97.46. This was a decline of 49.4%, and was accompanied by a sharp rise in unemployment and plunging commodity prices. Ben Bernanke is obviously aware of this history, and probably hopes that last week’s action will help avert a similar fate.
There were several other good election years, with 1982 being the standout. From the mid-May lows, the Dow was up 32% by the end of the year.
The Dow Jones Transportation Average Causes Concerns
The iShares Dow Jones Transportations (IYT) came to life last week, as it was finally able to overcome its downtrend (line a). This is the first sign that it may be ready to get back in sync with the Dow Industrials in the week ahead, which was a concern I expressed in last week’s article.
In the week ahead, U.S. home sales and manufacturing data will be the focus, plus a flurry of regional Fed presidents take to the circuit with speeches on the economy and monetary policy.
Housing data, for the economy, will take center stage following the Federal Reserve’s decision to emphasize recovery in that long-dormant sector as a way to spur broader economic growth.
The Federal Reserve in the past week placed an extraordinary amount of influence on the housing market, announcing it would buy $40 billion of mortgage backed securities each month in an effort to keep mortgage rates low and hopefully spur demand.
With its third round of quantitative easing since 2008, the Fed revealed a new strategy aimed at increasing employment by boosting the housing sector. That happens in a variety of ways given how the purchase of a single home ripples through the economy.
A couple of speeches from Federal Reserve officials in the week ahead will likely get a lot of attention given the activist role the Fed has played -- and will play -- over the next few years. Chicago Fed President Charles Evans speaks on Tuesday, while Atlanta Fed President Dennis Lockhart speaks Friday.
Earnings in the Week Ahead
FedEx Corp (FDX) and Oracle (ORCL) will be the main companies reporting their earnings in the week ahead.
It is also of interest to keep an eye on the Exchange-Traded Funds (ETFs) in the week ahead -- the SPDR Gold Trust (GLD) closed above the 61.8% resistance level last week, up $3.40. The next major target is in the $174 to $175.50 area. The bullish sentiment has picked up on gold, and the Web is now full of articles on gold—quite a change from just a month ago.
The daily studies are positive for GLD and confirming the price action, so there are no signs yet of a short-term top. One is expected in the next few weeks, and it should provide a good buying opportunity in iShares Silver Trust (SLV) as well as another buying opportunity in GLD or iShares Gold Trust (IAU).
Economy in the Week Ahead
No less than three important housing reports are due on Wednesday: the Mortgage Bankers Association Purchase Applications Index, which measures applications at mortgage lenders; housing start figures, which reflect the strength of the residential housing market; and existing home sales, which gauges overall demand in the sector.
On Tuesday, the National Association of Home Builders Housing Market Index is out. The index, using a survey of NAHB members, reflects the general mood of the home-building industry.
Manufacturing data is also due in the week ahead: the Empire State Manufacturing survey is out Monday and the Philadelphia Fed survey is out Thursday. The Purchasing Managers' Manufacturing Index is due Wednesday.
Recovery in the manufacturing sector has been patchy -- strong for long stretches with spots of weakness.
Conclusion
The stock market is facing unchartered waters now! At all stages – any pullbacks or corrections –a good buying opportunity will present itself.
There are quite a few stocks that have not participated in the rally from the June lows. Materials, financials, and retail are three sectors that are worth consideration in the week ahead.
For those who are not invested in the stock market, take a gradual approach—maybe 2% to 3% on any sharp down day—and work up to 20% invested. While this rally could last until the end of the year, next year may be very different.
Further Articles Relating to the Week Ahead
1. The Economy and Earnings in the Week Ahead – September 17, 2012
2. The Past Week Stock Market Results – September 17, 2012
3. The Major ETFs in the Week Ahead – September 17, 2012
Options traders are not successful because they win.
Options traders win because they are successful.
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