The Week Ahead in the Stock Market November 14, 2011
The Week Ahead -- Time for the Market to Focus on the US Economy – More Earnings – and a “Santa Claus rally” for Investors this winter?
Wal-Mart, Target, Dell . . . and Italy
We're currently on the cusp of options expiration week -- exchange-traded fund (ETF) options may impact the price action and levels!
The third-quarter earnings season ends this week with results from Wal-Mart, Home Depot and others. But as has happened so often recently, Europe will move markets, too. Can Italy form a new government in the week ahead?
Wall Street is stuck in a highly volatile range as investors hoping for a rally into the end of the year are browbeaten by Europe's unfolding crisis.
It was a hectic week for the major market indexes, as debt-related developments out of Europe sent stocks skittering back and forth across the breakeven line.
On the plus side, consumer sentiment seems to be climbing out of the basement with confirmation that there are still plenty of potential buyers who might find their way into the market as we head into a seasonally bullish time of year. However, with November expiration week ahead there are a few potential areas of short-term support and resistance that traders should keep on their radar.
These are exciting, scary and, admit it, exhausting times to be an investor.
It seems like every week, there's a crisis that generates lots of pronouncements that the world as we know it is a goner.
That's followed by a sense from the market that maybe a lot of people with money in a lot of places were, well, overreacting.
And lastly, there's a thrilling whiff that the world would really muddle through all its crises.
You saw it this past week when the markets went up Monday and Tuesday and utterly fell apart on Wednesday, and then rebounded solidly on Thursday and nicely again on Friday.
Bad news out of Europe reached a mid-week crescendo, as yields on Italian 10-year bonds temporarily shot above 7 percent and even France looked to be falling into the cross hairs as traders bet against its bonds. But the moves to replace the prime ministers of both Greece and Italy, plus seemingly aggressive buying of sovereign debt by the European Central Bank , helped calm markets.
The Dow Jones Industrial Average (DJIA) in the past week, gained 1.4 percent to 12,153, and the S&P 500 (SPX) was up 0.9 percent at 1263. For all its volatility, the euro finished the week down just 0.3 percent at 1.375. The U.S. 10-year finished the week, with a yield of 2.056 percent, slightly above the week earlier. Oil gained 5 percent for the week to $98.99 per barrel.
By the time Friday's closing bell rang, equities were mostly higher -- but the CBOE Market Volatility Index (VIX) also clawed out a weekly gain, and held onto its perch above 30.
With global investors still on edge, and significant technical hurdles just overhead, stocks remain stuck in limbo on the charts. Hopefully this will change in the week ahead!
Speaking of the VIX, it is interesting that the late-October low in the 24 area was half the August peak at 48, while recent peaks on Nov. 1 and Nov. 9 at the 36 area marked a 50% advance from the trough of 24. So, not only is VIX 30 significant, but so are VIX 24 and 36 as the market continues to bounce around critical technical levels. Therefore, if the VIX moves below 30 in the week ahead, we would view this as an acceptable level at which you can purchase your portfolio insurance to help ride out any sharp, overnight declines.
The higher weekly close indicates that the bulls are still in charge, and the market leading behavior of the A/D lines that track the market’s internal health suggest prices could melt up in the week ahead. Many of the charts show bull flag/pennant formations, which, if completed, project a move well above the Oct. 27 highs.
Advance/Decline Line or A/D is a technical indicator that plots changes in the value of the advance-decline index over a certain time period. Each point on the chart is calculated by taking the difference between the number of advancing/declining issues and adding the result to the previous period's value, as shown by the following formula:
A/D Line = (# of Advancing Stocks - # of Declining Stocks) + Previous Period's A/D Line Value
This indicator is used by many traders to confirm the strength of a current trend and its likelihood of reversing. If the markets are up but the A/D line is sloping downwards, it's usually a sign that the markets are losing their breadth and may be setting up to head in the other direction. If the slope of the A/D line is up and the market is trending upward then the market is said to be healthy.
Every sharp drop further convinces the bears that this is a "bull trap" that will be followed by a drop to the October or even the August lows. Certainly, if the drop last week had violated support for the Spyder Trust (SPY), it would have favored a deeper correction within the uptrend… but these levels held and may advance in the week ahead.
Past History and What Needs to Happen!!
So, maybe, for a while, things may not be as bad as everyone thinks. The trendline is telling the story.
The stock market went up nicely through April. The summer lull hit (OK, it was more like a head slap), and the fall rally began.
If all goes well, maybe it will continue. Here are two things that need to go well.
1. Italy has to form a government.
The government needs to have the strength and imagination to get its debt problems under control without sinking its economy -- continental Europe's third-largest and the eighth-largest in the world. Italian economist Mario Monti is seen as a likely candidate, with an appointment coming maybe by Sunday.
If the new government fails in this task, things could get tricky. That's because much of the sovereign debt in Europe is held by banks. If the debt goes bad, credit markets could freeze up.
2. Congress has to come up with a debt-reduction plan over the next two weeks.
It probably will take longer than that. So far, the supercommittee that is supposed to come up with a plan is deadlocked. Taxes, as usual, are the hangup.
On the Italian and U.S. issues, it's fair to be very skeptical. China's bond-rating agency is threatening another downgrade of U.S. debt. It’s possible that Moody's or Standard & Poor's could downgrade the U.S. as well.
What a downgrade would mean practically is a different question. Since S&P downgraded U.S. debt in August, interest rates have gone down.
Stocks Still Struggling Around Breakeven – Technical Perspective for the Week Ahead
“The RUT is still in the red for 2011, and the MID is barely in the green, with the index's first-half lows just overhead at 920. The fact that the MID is trading around a key round number with historical significance, which also happens to coincide with its year-to-date breakeven, is perhaps the No. 1 risk from a technical perspective. It will be of importance for the MID to make a more convincing move above 900 in order to squeeze more shorts."
“The bottom line is, the equity market's backdrop continues to improve, even as many hedge funds have been significantly underinvested and are in the red this year. With more clarity on how Europe plans to address their issues amid an improved technical backdrop, risk-taking could increase significantly and drive stocks higher in the coming months, as fund managers look to play "catch-up" with the year winding down. Risks do remain, so it's still prudent to hedge your long positions..."
- The Week Ahead for the Stock Market, October 31st, 2011
“The equity market's prospects into the week ahead and also to year-end still appears to be constructive, as it would seem that a huge build-up in pessimism is still in the early stages of unwinding.... there appears to be short-covering activity and money moving in from the sidelines as we transition out of an extreme in negative sentiment. With the major equity indexes back in the red, or still in the red, for 2011, some would-be investors may need a little more convincing, especially for the week ahead. That said, there is sufficient buying power available to push equities through the various resistance levels that have been pinpointed as we move into year-end. Hedging of long exposure is still prudent -- although premiums on portfolio insurance are 23% higher than they were the last time this recommendation was made, with the VIX moving from 24.53 to 30.16 over the course of the past week.”
- The Week Ahead for the Stock Market, November 07, 2011
It wasn't pretty, and it may not have felt like it, but headline benchmarks, such as the Dow Jones Industrial Average (DJIA - 12,153.68) and S&P 500 Index (SPX - 1,263.85), finished in the green last week, overcoming a 390-point drop in the DJIA on Wednesday. For some, it didn't feel like a "green week" -- and indeed, it was not, as the Russell 2000 Index (RUT - 744.64) and the S&P 400 MidCap Index (MID - 892.06) both settled in the red, resulting in a mixed finish. Nonetheless, Friday's rally was spearheaded by small-cap and mid-cap stocks, and so it appears that the relative out-performance in these groups that has been in place since early October remains intact, and may continue in the week ahead.
As we look back to two weeks ago, not a whole lot has changed from a technical perspective -- although it has been a choppy ride during this period. The MID goes into the week ahead, trading in the 900 area yet again, just as it has during the past couple of weeks. The 900 area has been a major speed bump, as this round-number region marked a peak in 2007, and 907 is the index's year-to-date breakeven. The good news is that pullbacks from this resistance area have been modest, with the MID finding support in the 850-860 zone -- which marked a peak ahead of the 2010 "flash crash" and brief tops in November 2010 and August/September 2011.
The Nasdaq Composite (COMP - 2,678.75) and the SPX continue to dance around their year-to-date breakeven points for the year, which are located at 2,652 and 1,257, respectively. During last week's roller-coaster ride, it was interesting that the SPX's low on Wednesday was 1,226, a resistance point in September and October. The 1,225 area was one that was flagged as being critical while the market grinded higher from its October lows, as it is the site of the SPX's historically significant 80-month moving average, and a 50% retracement of this year's May high and October low.
That said, the SPX continues to struggle in the 1,257-1,260 area, which coincides with its 2011 breakeven, its lows in March and June, and a 61.8% retracement of the calendar-year high and lows.
Meanwhile, the COMP on Friday gapped above 2,652 at the open, before pulling back to test this year-to-date breakeven in mid-morning action. The retest of and subsequent bounce from this level is interesting, but the index then peaked at 2,684 -- just shy of its weekly breakeven at 2,686.
Despite the presence of these technical speed bumps, there continues to be a belief that the sentiment backdrop is one in which equities can muster enough buying power to clear these hurdles in the week ahead. For example, as mentioned last week, put buying on equities relative to call buying recently peaked at a two and a half-year high, indicating an extreme in pessimism that could mark a major market bottom.
Moreover, there is a noticeable increase in call buying relative to put buying on the CBOE Market Volatility Index (VIX - 30.04) options, after a long period in which put buying predominated and the market fell sharply. The change in the ratio's direction suggests that market movers, such as hedge fund managers, could be using VIX calls to hedge stocks they are accumulating. Note in the chart below that when the VIX's buy-to-open call/put ratio turned higher from extremely low levels at this time last year -- just as it is doing now -- the market rallied significantly. Also refer to the chart further down in regard to XLF put/call action!
The Significance of the Cusp of Options Expiration in the Week Ahead
Finally, we're currently on the cusp of options expiration week. Therefore, exchange-traded fund (ETF) options may impact the price action and levels to watch during the course of the week ahead.
For example, the 127 and 128 areas on the SPDR S&P 500 ETF (SPY) -- which correspond to 1,270 and 1,280 on the SPX -- are the site of heavy call open interest relative to put open interest, and could act as resistance on rallies. Pullbacks to 124 or 125 -- which correspond to 1,240 and 1,250 on the SPX -- could provide support in the week ahead, as these strikes are home to heavy put open interest.
Technical speed bumps remain overhead, and headline risks linger, suggesting hedging is still a prudent strategy for the week ahead. But a breakout above resistance levels could be very rewarding for bulls, as short-covering activity and an abundance of sideline cash could provide the fuel to drive equities during a seasonal period that favors the bulls.
The Week Ahead
You may see it again in the week ahead, with Italy trying to put together a new government, earnings from Wal-Mart (NYSE: WMT), Target (NYSE: TGT), Dell (NASDAQ: DELL) and others, and reports on inflation, retail sales and housing starts.
The market started to put in a bottom in early August. Admittedly it was very choppy, but the Standard & Poor's 500 Index (SPX) wouldn't fall below 1,100 for more than a day. A breakout came in October, and the major averages are now positive for the year.
The Dow Jones industrials (The Dow Jones Industrial Average (DJIA)) and the S&P 500 (SPX) are higher so far in November. The Nasdaq Composite Index (COMP) is flat.
Most of the U.S. economic news last week was encouraging, especially the preliminary reading on the November consumer sentiment index from Reuters/University of Michigan. It came in at 64.9, up from 60.9 in October -- much better than most expected. The decline in jobless claims was also a plus.
In the week ahead, we have a full slate of economic reports, starting on Wednesday with the Producer Price Index, retail sales, the Empire State Manufacturing Survey and Business Inventories.
We get the latest reading on the Consumer Price Index on Thursday, along with industrial production and the Housing Market Index. Because of the Veterans Day holiday, the jobless claims are out Friday, along with housing starts.
Economists are particularly watching the Tuesday's October retail sales and the regional Fed surveys from Philadelphia and New York producing relatively recent readings of activity.
But Europe may still drive the markets, as Greece works to qualify for its bailout and Italy names a new prime minister to replace Silvio Berlusconi.
However, Italy can work its way out of its problems. Italy has a primary surplus. It is living within its current means. Its government expenditure is less than its government revenues.
Hedging Their Bets for the Week Ahead Using Options
Many investors picked up put options heading into the weekend to hedge against a potential downdraft in equities during the week ahead.
Options traders exchanged about 1.48 million contracts on the Financial Select Sector SPDR fund (XLF) -- 3.6 times the average daily volume -- as puts outpaced calls by a factor of more than 13 to 1, according to Trade Alert.
Technical factors are taking on greater significance as the S&P 500 hovers at the top end of its trading range and traders watch for a break either up or down, particularly in the week ahead. When that happens, it could be swift if recent volatility is anything to go by.
Technical analysts say evidence is building for a move to the downside after the index has failed for a second time since late October to push above its 200-day moving average at around 1,272 -- an area to keep an eye on!(see chart below)
It looks like it's confirming another lower high from the May peak -- a downtrend.
The 200-day moving average, a closely followed level, has emerged as a key battleground for investors this year, with successive tests to the downside over the summer eventually leading to a 13 percent cascade during five fraught trading days in August.
On the downside, analysts see support at the 50-day moving average at around 1,200. A breach of that could take the index back to around 1,100 in early 2012.
However, market technicians also say positive seasonality’s could be in stocks' favor.
'TIS THE SEASON
Is there a “Santa Claus Rally” in store for investors this winter?
Over the past 25 years, the S&P (SPX) has experienced an average 5 percent surge in stock prices from November to January.
At present there is about half of all actively managed mutual funds trailing the benchmark by at least 2.5 percent -- which lends itself to is a little bit more risk-taking and more aggressive trade – there is a reach for high beta, smaller capitalization stocks that they can actually have an effect on.
November marks the start of the "six best months of the year" when the Dow Jones Industrial Average (DJIA) has booked an average gain of 7.5 percent since 1950, compared with just 0.4 percent in the other half of the year, according to the Stock Trader's Almanac.
One reason cited for the seasonal lift, at least during the last few months of the year, is holiday spending.
Investors will look for more improvement in retail sales when data for October is released on Tuesday, especially after the Thomson Reuters/University of Michigan report on Friday showed consumer sentiment rose to a five-month high in November.
During the last major week of earnings season, some prominent retailers are set to report results and give an outlook through the end of the year. They include Wal-Mart Stores (NYSE: WMT), often seen as a barometer of U.S. consumer spending, and a niche retailer such as Abercrombie & Fitch (NYSE: ANF).
The big question is whether the holiday shopping season will be weak or OK because of a lot of discounting. IHS Global Insight is projecting a 4.2% sales gain, down slightly from a year ago's 5% gain. Discounting has already begun by many retailers. Still, a gain is better than 2008 and 2009 when sales fell.
Many of this week's reports will shed light on what retailers really expect.
Super Committee Risk
Analysts say a risk for markets in the next two weeks will be the Congressional "Super Committee," tasked with finding a minimum of $1.2 trillion in deficit reductions over 10 years.
While analysts think there's a good chance the bi-partisan committee will identify the cuts by its Nov. 23 deadline, there is also concern in the markets that it will not come to an agreement.
Some Washington insiders say it may be that the committee only finds some of the cuts. If that were to happen, an automatic "sequestration" occurs, which would generate automatic cuts across the board to total the balance of the $1.2 trillion. If no reductions are agreed, the sequestration would result in automatic cuts starting in 2013, with half the cuts coming from defense and the other half from other non defense programs.
There has also been concern that as the deadline approaches, the tone in Washington will once more become highly fractious, as it was in the summer during the debt ceiling debate.
Conclusion for the Week Ahead
The market is positioned for negative news from Europe, and stocks could benefit if investor focus shifts.
I think that despite the slate of economic news, this week will end up being a strong one for the stock market, and that the overall view of the economy will also improve.
After the flag formations are completed, we could get a retest of the breakout level in the week ahead, which would be a good buying opportunity. If you are long, move your stops up once the October highs are exceeded.
If instead, we crash to the downside and close below last week’s lows, it will invalidate the short-term outlook and favor a further decline. This is not a favorable position for the week ahead or for a very merry Christmas.
There are still some stocks that are completing their bottom formations.
While many professional investors and money managers are still in the bearish camp -- and woefully under-invested -- the AAII sentiment numbers shows that the number of bulls rose to 44.7%, quite a ways above the 25.3% reading seen in late September when the gloom and doom was thick. The number of bulls could easily rise to the 55% to 60% level by the end of the year, once the S&P closes convincingly above 1,300.
If there is a shift from bonds to stocks the rally could get exciting and by Christmas, many will regret not being more fully invested.
”Success is simple. Do what's right, the right way, at the right time.”
Option Tip for your Success!
Options traders are not successful because they win.