6 Reasons Bulls Are in the Driver's Seat

Are round-number speed bumps behind us for good?

by 12/21/2013 9:00:06 AM
Stocks quoted in this article:

The final Federal Open Market Committee (FOMC) meeting of the year created a textbook "sell the rumor, buy the news" scenario. The central bank's disclosure that it would begin to scale back its asset-buying efforts led to a sharp rally in stocks that quickly took the major indexes back to record highs. The resolution of the "will they or won't they" debate -- along with a two-year budget deal now on President Obama's desk -- eliminated a cloud of market uncertainty and provided some relief to wary investors. As the end of 2013 approaches, Todd Salamone has some cheerful words for the bulls, who still hold the reins in this rallying market.

  • Analyzing the market's positive reaction to the tapering news.
  • Why you should be watching the NYSE Composite as it sits near 10,000.
  • Rocky White examines Dow Jones Industrial Average returns around the Christmas and New Year's holidays.

Finally, we close with a preview of the major economic and earnings events for the week ahead, plus our featured sector.

Notes from the Trading Desk: Life After the Tapering Announcement
By Todd Salamone, Senior VP of Research

"...a Fed tapering is now factored into the marketplace, and thus investors need to see strong economic data to justify tapering action."
-Monday Morning Outlook, Dec. 7, 2013

"...bulls might be encouraged by the still-high short position in the market...the shorts remain a source of buying power, as they look to cover positions on pullbacks. The bearish view is a technical breakdown in the market, which could embolden the shorts....It sure seems that after these benchmarks surpass their respective round-number levels, a 'buyer's strike' will occur. But at the same time, pullbacks create perceived buying opportunities, with the next effect being a grueling trading range."
-Monday Morning Outlook, Dec. 14, 2013

"Add NYSE Composite to list of round-number resistance (10k)."
"400k $VIX call adds since 12/11, put OI flat. Sharp advance ahead of Fed relative to previous two Fed mtgs"
"$VIX 43% above $SPX historical vol day prior to Sept. Fed announcement, right now $VIX double $SPX historical volatility"
-@ToddSalamone on Twitter, Dec. 15, 17, 18, 2013

"Poll: U.S. Fed To Trim Monthly Bond Purchases By $10 Bln With Each FOMC Meeting Next Year"
-Reuters headline, Dec. 20, 2013

Are round-number resistance levels on multiple equity benchmarks behind us, after a lot of churning since the beginning of the quarter?

December expiration is in the rear view mirror, 2013 is winding down, holidays and shortened trading weeks are approaching, and some market uncertainty has been eliminated, due to: 1) a two-year congressional budget deal agreed upon one month ahead of schedule and 2) the announcement by the Federal Open Market Committee (FOMC) that asset purchases will be reduced by $10 billion per month, beginning in January.

The FOMC's announcement ended the guesswork as to the exact timing of that first move related to any tapering of the Fed's latest quantitative easing program ("QE3"). Two-thirds of Fed followers were expecting a reduction in these stimulus efforts to be announced at the January or March FOMC meeting, after incorrectly forecasting that this announcement would occur at the September meeting.

Regardless of the timing surrounding this announcement, the market's positive reaction to the news hammers home a point we made two weeks ago -- a reduction of Fed Treasury bond and mortgage bond purchases is factored into the market, as investors look to stronger economic data in the months ahead to justify the Fed's actions. The latter statement holds true, with Wall Street now expecting bond purchases to wrap up by the end of next year, and the market powering higher on Friday on the strength of a better-than-expected gross domestic product (GDP) reading.

As noted in the excerpts above, we were observing much caution heading into the Fed meeting -- most likely among professional investors -- after observing the CBOE Volatility Index's (VIX) behavior and the hedging and/or speculative call activity on VIX options. In fact, we noted more fear ahead of this meeting than the September meeting, when tapering was a "slam dunk," according to many market participants.

The VIX rallied sharply ahead of this Fed meeting relative to the previous two meetings (marked by "x" on chart)

Daily Chart of VIX, August 2013 through December 2013

The fear leading up to the meeting explains the huge rally after the Fed's announcement. The lifting of the taper-timing uncertainty -- coincident with the Fed saying the Fed Funds rate could remain low well past when the unemployment rate falls below 6.5% -- created a huge unwind of this caution. The market immediately gained more clarity on what is ahead with respect to QE3 and took solace in the fact that the Fed will remain accommodative with respect to monetary policy.

The good news for bulls (we think) is that major benchmarks rallied strongly off round-number support or back above round-number resistance levels that have been plaguing equities since mid-October. In addition to the Nasdaq Composite (COMP - 4,104.74), Dow Jones Industrial Average (DJI - 16,221.14), S&P 500 Index (SPX - 1,818.31), S&P 400 MidCap (MID - 1,318.91) and Russell 2000 Index (RUT - 1,146.47) trading in the vicinity of key millennium and century marks, we noted in a tweet Sunday evening that the NYSE Composite (NYA - 10,196.18) is another ticker you can add to your list of equity benchmarks currently slowed down by a key round-number area.

In the graph below, note that in mid-October, the NYA touched the 10,000 mark for the first time since the 2007 peak and, pre-Fed, it had pulled back below this millennium mark -- its third revisit of 10,000 since gapping above the level in October. But as you can see, the NYA has been unable to sustain a move above 10,000.

NYA can it put 10,000 behind it?

Daily Chart of NYA since July 2013

The bulls remain in the driver's seat, with the market hitting new highs, seasonality in their favor, a budget deal in place, more clarity on the Fed's intentions, strong employment and GDP data reported this month, and most importantly, a healthy short position among both SPX and the tech-laden PowerShares QQQ Trust (QQQ - 86.50) component names. Short covering could very well be the next driving force in the rally, assuming round-number speed bumps are behind us for good.

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