Amid Mixed Technical Signals, Three Reasons for Bulls to Keep the Faith

The action in VIX since earnings season began bodes well for buyers

by 4/21/2012 9:30:20 AM
Stocks quoted in this article:

April expiration week was a rather haphazard one for stocks. The Dow Jones Industrial Average (DJIA) logged its first weekly gain of the second quarter, while the S&P 500 Index (SPX) barely clawed its way onto positive ground. Meanwhile, with Apple (AAPL) still in free-fall mode, the tech-heavy Nasdaq Composite (COMP) racked up its third straight weekly loss. As the major equity indexes hover around historically significant round-number levels, Todd Salamone warns that we probably haven't seen the last of these persistent technical crosswinds. However, Todd cites a few points in the bulls' favor, which suggest this lengthy chop could eventually resolve itself to the upside. Meanwhile, Rocky White shares a list of stocks have been heavily targeted by May-dated put players, in the hopes of unearthing some potential contrarian plays for the new expiration cycle. Finally, we wrap up with a preview of the key economic and earnings events for the week ahead, as well as a few sectors of note.

Notes from the Trading Desk: Beware of Technical Crosswinds
By Todd Salamone, Senior VP of Research

"We'll leave it as follows: Some technical indications are being thrown around as corrective warnings, yet our own research on these same indicators suggests a pause could be at hand, but not necessarily a correction. Sideways, choppy action within the current uptrend would not be a surprise."
- Monday Morning Outlook, March 17, 2012

"A pullback like we saw in late February and early March would push the SPX down to the 1,370 area -- which we view as support, given it is the site of the 40-day moving average and last year's high. Potential resistance is in the 1,450-1,470 zone, the SPX target after the inverse 'head and shoulders' breakout above 1,260 and site of the May 2008 peak."

"...first-quarter earnings season is only a couple of weeks away, and it appears analysts aren't expecting much. Low analyst expectations set the stage for positive surprises."

- Monday Morning Outlook, March 31, 2012

"Quarterly earnings this round have been surprisingly strong. Of the 113 companies in the S&P 500 that had reported quarterly results as of early Friday, 92 beat expectations, while 12 matched and just 9 came up short, according to Capital IQ. Analysts are expecting overall S&P 500 first-quarter earnings to climb 6%, with revenues edging up 5%."
- CNNMoney, April 20, 2012

In mid-March, with the S&P 500 Index (SPX) at 1,404, we observed that a period of sideways, choppy action within the longer-term uptrend would not be a major surprise. Major equity benchmarks were bumping up against potential resistance, and option activity suggested professional investors were no longer in accumulation phase, with correction warnings abundant. Since that period, we have indeed experienced choppy price action, with a very mild pullback from the highs and the 1,370 area on the SPX generally being supportive.


30-Minute Chart of SPX since March 15, 2012

During the past couple of weeks, the choppy price action can be attributed to a flood of alternating negative and positive headlines -- in addition to mixed technical signals, with some indexes trading above round-number support areas, as other benchmarks trade beneath round-number levels.

The major negative headline is euro-zone sovereign debt concerns coming into play again. Worries are mounting that the European Central Bank's (ECB) emergency loans are about to run dry, even as European banks continue to utilize these funds to buy debt. As a result, yields on Spanish bonds have risen above 6%, unnerving investors. At the same time, on the domestic front, the good news is that first-quarter earnings season is off to an impressive start, thanks in part to toned-down expectations. The market is trading slightly higher since the official beginning of earnings season on April 10, which is when the CBOE Market Volatility Index (VIX - 17.44) peaked 50% above its mid-March low.

As alluded to earlier, we find it interesting that some key U.S. equity benchmarks are trading just under key round-number areas, while others trade just above key round-numbers -- creating potential crosswinds, from a technical perspective. Consider the following:

  • The Nasdaq Composite (COMP - 3000.45) has pulled back to the 3,000 millennium mark, which is also site of its 60-day moving average. In mid-March, the COMP broke above 3,000 after trading below this mark since November 2000.
  • The Russell 2000 Index (RUT - 804.05) is just above the 800 century level. This is also the site of its 80-day moving average, which was supportive during a mini-pullback in mid-December.
  • The S&P 500 Index (SPX - 1,378.53) is back below 1,400, after first crossing above this level in mid-March. Like the COMP, the 60-day moving average is just below current levels at 1,371.20, and this moving average roughly coincides with last year's high.
  • The S&P MidCap 400 Index (MID- 976.35) is trading below the key 1,000 millennium mark, which has consistently acted as a brick wall, dating back to last year's first-ever attempt to break through this level.

The above technical and fundamental crosswinds could last for several weeks, but bulls should find it encouraging that:

  1. The price action has been somewhat muted relative to previous pullbacks induced by European sovereign debt issues. We think this is due to the fact that major players, such as hedge funds, have not been as heavily exposed to stocks, and therefore there are fewer sellers. That said, a break below this month's lows would jeopardize this bullish point.
  2. The market was relatively resilient from mid-March up until last week, a period during which option activity suggested hedge fund managers -- who represent a tremendous source of buying power and support for the market -- were no longer in accumulation mode. At present, and as discussed last week by Senior Technical Strategist Ryan Detrick, the return of put buying on major equity exchange-traded funds (ETFs) and call buying on CBOE Market Volatility Index (VIX - 17.44) futures suggests these participants might be nibbling at current levels, providing support on pullbacks. In fact, on Friday, VIX call volume was more than four times VIX put volume. The VIX has plenty of room to move lower before retesting its March lows, even though Twitter sentiment suggests the VIX is "cheap."
  3. The VIX peaked at 21.06 on April 10 when earnings season began, continuing a series of lower highs in place since the beginning of the year. The peak this month was 50% above the mid-March low, continuing the uncanny behavior in which the VIX tends to peak 50% above -- or double or triple -- its previous lows, and find floors at half prior highs. If the VIX would advance comfortably above 21, though, this is another bullish point that could be invalidated. (For more on the uncanny price action in the VIX over the past couple years, see the commentary I wrote in late March.)


 Daily Chart of VIX since January 2012

If you are looking to add equity exposure, a sector we remain bullish on is homebuilding, and the pullback during the past month could be an opportune time to add exposure to this group.

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