During a week that hosted the Federal Open Market Committee's (FOMC) latest meeting minutes and the monthly payrolls report -- two typically market-moving events -- major equity indexes traded in a choppy pattern. By the time the closing bell sounded on Friday, the S&P 500 Index (SPX) and the Nasdaq Composite (COMP) posted modest gains, while the Dow Jones Industrial Average (DJI) finished with a slight 0.2% loss. Despite this uninspiring price action, Todd Salamone explains that instead of panicking, longer-term bulls should "stay tuned."
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: What Hedge Funds and Short Sellers Could Mean for This Market
By Todd Salamone, Senior VP of Research
"... equities could surge in 2014's first quarter. This may be an unpopular viewpoint, but the ingredients are in place ... a short-term risk we see as we move into 2014 is the relatively tame VIX, which hit a low of 11.69 late last week ... it is not a secret that the market has struggled from a short-term perspective after the VIX has moved down to this area during the past year..."
-Monday Morning Outlook, Dec. 28, 2013
"With the SPX currently working off an overbought condition from the end of 2013 ... it would not be a major surprise for the 40-day moving average to be revisited, via a pullback or a consolidation period that lasts a couple of weeks. Meanwhile, the 1,860 area could prove to be challenging, as it is 20% above the 1,750 breakout level."
-Monday Morning Outlook, Jan. 4, 2014
"The beginning of earnings season likely won't cure the market's current malaise ... The high percentage of negative outlooks reported ahead of earnings season is a cause for concern. S&P Capital IQ reports 100 companies have already preannounced fourth-quarter results, with 80 issuing negative forecasts, 10 coming in-line and 10 exceeding estimates. The 8.0 negative-to-positive preannouncement ratio is higher than the 15-year average."
-The Wall Street Journal, Jan. 7, 2014
"$SPX $SPY lower first 3 days of year. Implications? Few samples, far from bearish for rest of month and year..."
-@ToddSalamone on Twitter, Jan. 7, 2014
The recent price action in the equities market is playing out as expected, with stocks continuing to work off an overbought condition that was evident as we entered 2014. For some, the weak start to the new year is a concern.
But, as you see in the table immediately below, the very limited sample size suggests this is not necessarily a bad omen for the rest of the year. In fact, in the two times stocks bounced back strongly over the course of the rest of the month, huge gains that matched last year's impressive performance followed. Don't panic, but stay tuned, as a repeat of last year would certainly surprise Wall Street strategists who are looking for gains of only 5-6% in 2014.
At present, however, price action has been dull. Volume is picking up after the holidays, and there have been sizeable moves among some individual stocks, but the broader market has remained locked in an extremely narrow range during the past four trading days. This, even with the Wednesday release of the minutes from the FOMC's latest meeting, and the government's monthly employment report, which was released on Friday.
The good news for bulls is that after a strong rally, the stock market seems to be holding its own, despite the following concerns:
The "too much complacency" can be debated. Is there less hedging because those that normally hedge are over-the-top bullish? Or, is there less hedging because those that typically hedge are in less need of equity protection? Said another way, if one is in cash or invested in other asset classes, such as bonds, currencies, emerging market equities and debt, or commodities, demand for equity-type hedges will decrease.
As we have mentioned in prior discussions, hedge funds, judging by their performance and our analysis of hedging activity in the options market, seem to be underweight U.S. stocks and overweight underperforming asset classes. With about $2.2 trillion in assets, this is a group that could be supportive of stocks in the future.
Other signs of complacency reside in various polls, such as Investors Intelligence, which surveys advisors each week. This opinion poll is countered by what we have seen with respect to short interest -- which has been building for quite some time -- and are real bets against the market or hedges against long positions. From the chart below, it appears that we are most vulnerable to a correction following periods of short-covering rallies and rising advisor optimism (early 2011, spring 2012). With the current rally not based on short covering and, in fact, occurring amid a build in short interest, optimism in opinion polls may not be misplaced, as short covering remains a supportive factor in this market.
The Case for Big Moves in IWM and QQQ
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