Monday Morning Outlook

As Investor Anxiety Spikes, Risks to the Bullish Case Can't Be Ignored

Will first-quarter earnings season serve as a catalyst higher for this choppy market?

by 4/14/2012 10:55:11 AM
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Indicator of the Week: April Expiration Week
By Rocky White, Senior Quantitative Analyst

Foreword: At the end of this week, equity options are set to expire. The table below shows that expiration week has tended to be a bit bearish over the last couple of years -- averaging a slight loss, with 52% of those weeks being positive. One misconception about expiration week is that it is always highly volatile. It is assumed that traders exiting option trades and rolling new positions -- along with the hedging of new positions, or taking off hedges -- naturally leads to big market fluctuations. However, measuring volatility by standard deviation of returns, you see expiration weeks are actually less volatile than other weeks. Perhaps the potential for volatility is there, but over the last couple of years, it has not actually been realized.

S&P 500 Returns for Expiration vs. Regular Weeks

Day of the Week: So where does expiration week go wrong? Below, I show how each day has fared during expiration week. One thing that stands out is that, despite a high percentage of days being positive, the week itself averages a negative return (see table above). For example, 67% of Thursdays during expiration week have been positive, but the average return on Thursday is actually a loss of 0.11%. This tells us there were some pretty dramatic down days on Thursdays. Friday also averages a loss, although 70% of those days have been positive.

Expiration Week Breakdown by Day

This next table shows the last five expiration weeks by day, along with the return for the week. Note that in each of the last four expiration weeks, both Thursday and Friday are positive.

SPX Over Last Five Expiration Weeks

This Coming Week: These last couple of weeks have been tough for the market. The S&P 500 Index (SPX) has shed about 2% so far during the April expiration cycle. There has not been a negative cycle heading into expiration since August 2011. Looking back to 2010 again, the table below shows this is not a good omen for expiration week. When the cycle is negative heading into those last five days, expiration week has typically extended the losses, with the SPX dropping, on average, another 1.5%. The index managed a positive finish only two out of six times in those situations. If the cycle is positive, then expiration week averages a gain, and is positive over half the time.

SPX E-Week Returns since 2010

Below are the six instances when the SPX was sitting on a loss for the expiration cycle heading into its final week.

SPX E-Week Returns When Current Cycle is Negative

This Week's Key Events: Dow Earnings, Manufacturing Data Set to Move Markets
Schaeffer's Editorial Staff

Here is a brief list of some of the key events this week. All earnings dates listed below are tentative and subject to change. Please check with each company's respective website for official reporting dates.


  • The week gets started with a flurry of economic reports, including retail sales, business inventories, the Empire State manufacturing index, and the National Association of Home Builders (NAHB) housing market index. A busy week of earnings begins with quarterly results from Citigroup (C), Mattel (MAT), Charles Schwab (SCHW), and Gannett (GCI).


  • Tuesday's calendar features data on housing starts and building permits, as well as industrial production and capacity utilization. The earnings arena will see action from IBM (IBM), Intel (INTC), Johnson & Johnson (JNJ), Coca-Cola (KO), U.S. Bancorp (USB), Goldman Sachs (GS), Yahoo (YAHOO), Cree (CREE), State Street (STT), Intuitive Surgical (ISRG), Linear Technology (LLTC), and McMoRan Exploration (MMR).


  • The usual report on weekly crude inventories is due out Wednesday, and Wall Street will also hear the latest earnings from American Express (AXP), eBay (EBAY), Yum Brands (YUM), Marriott (MAR), Bank of New York Mellon (BK), BlackRock (BLK), Cubist Pharmaceuticals (CBST), F5 Networks (FFIV), Halliburton (HAL), Huntington Bancshares (HBAN), Qualcomm (QCOM), SLM Corp. (SLM), and VMware (VMW).


  • Thursday's docket includes weekly jobless claims, existing home sales, the Philadelphia Fed's manufacturing index, and the Conference Board's index of leading economic indicators. Earnings season kicks into high gear, with quarterly results due out from Bank of America (BAC), DuPont (DD), Microsoft (MSFT), Travelers (TRV), Verizon (VZ), Advanced Micro Devices (AMD), Southwest Airlines (LUV), Capital One (COF), Chipotle Mexican Grill (CMG), Freeport-McMoRan Copper & Gold (FCX), Philip Morris (PM), SanDisk (SNDK), Nokia (NOK), Peabody Energy (BTU), EMC Corp. (EMC), Morgan Stanley (MS), and New York Times (NYT).


  • There are no major economic reports scheduled for Friday, but Wall Street will mull over earnings results from General Electric (GE), McDonald's (MCD), Under Armour (UA), Honeywell (HON), Kimberly-Clark (KMB), and Schlumberger (SLB).

And now a few sectors of note...

Dissecting The Sectors

Outlook: The jobs market appears to have hit a soft patch lately, with March payrolls falling short of expectations. However, the four-week moving average of first-time jobless claims remains near a four-year low, and consumer-level inflation edged up at a slower pace last month -- pointing to an improving fundamental backdrop for shoppers, and, by proxy, consumer discretionary stocks. In fact, retailers managed a composite same-store sales gain of 6.9% for March, surpassing the 5.3% improvement predicted by analysts. On the charts, the SPDR S&P Retail ETF (XRT) is still a technical outperformer, with the fund finding a foothold above its 50-day moving average amid last week's rocky trading. For those seeking a bullish play in the retail/leisure space, we recommend focusing on stocks in solid technical uptrends that are surrounded by skepticism, which creates the potential for upside surprises. A few of our current favorites include retailers AutoZone (AZO), Advance Auto Parts (AAP), and Whole Foods Market (WFM), along with restaurateurs Chipotle Mexican Grill (CMG) and Domino's Pizza (DPZ). With skepticism still lingering toward these consumer-dependent stocks, contrarians can continue to capitalize on situations where sentiment has yet to catch up with the bullish technical performance.

Outlook: Housing data continues to come in hot-and-cold. However, a batch of coolly received reports in recent weeks gave the SPDR S&P Homebuilders ETF (XHB) a chance to fill in its bullish gap from Feb. 3. In fact, XHB on Friday notched a sixth consecutive weekly close above the $20 level, which previously marked the fund's May 2010 peak. Plus, following a recent earnings miss from KB Home (KBH), XHB found a foothold near the site of its February highs, in the $20.50 area. From here, the fund still has room to rally up to $23.25 -- which is half its all-time high, reached only three months after XHB was launched in 2006. Despite the improving price action in the sector, analysts remain overwhelmingly negative. With 82% of builders trading above their 200-day moving averages, these names have attracted only 42% "buy" ratings from brokerage firms. However, a recent preponderance of put buying on XHB suggests that hedged players are starting to dip their toes into housing stocks, which could be a boon for the group during the near term. In fact, the 50-day buy-to-open put/call volume ratio for the fund is now resting near its highest level since 2007, which indicates that big-money investors are actively acquiring shares of sector components. As further evidence, Goldman Sachs is launching a fund to buy home-loan bonds, with the investment giant asserting that "stabilization in U.S. housing fundamentals is creating an attractive investment opportunity." Some of our preferred names in the sector are Lennar (LEN), Toll Brothers (TOL), Meritage Homes (MTH), PulteGroup (PHM), and D.R. Horton (DHI), all of which sport relatively high short-to-float ratios. Going forward, these builders could benefit from upgrades or short-covering activity as the technical and fundamental performance continues to surpass the Street's low expectations. As a point of caution, Barron's just featured an optimistic cover story titled "Home Prices Ready to Rebound" -- suggesting some optimism may be priced in, and the XHB could pull back in the short term. However, a dip that is contained above $20 would be healthy, in our view, as we still believe in the potential reward in this sector. What's more, the bullish cover is not out of touch with the positive price action, making the contrarian implications less relevant.

Outlook: Lately, we've been seeing several danger signs that point to potential short-term weakness for the SPDR Gold Trust (GLD). First, as Jim Paulsen of Wells Capital Management recently observed, valuations for the underlying metal relative to stocks, bonds, and other assets have soared off the charts lately, hinting that a correction may be overdue -- particularly as gold sheds its "fear premium" in the face of recovering consumer confidence. Looking at the options markets, total buy-to-open option volume on the ETF imploded recently, and continues to decline. This occurrence has previously coincided with periods of range-bound or negative price action for GLD. Meanwhile, the fund's front-month put/call implied skew has recovered from its recent lows, but this has yet to provide any kind of meaningful bid for the shares -- marking a deviation from past trends. From a technical perspective, the outlook is similarly unsettling. The fund turned lower in late February after an unsuccessful test of resistance in the $175 area, and GLD has since plummeted through its 140-day moving average. This trendline has played a key role as both support and resistance in the past, and it's currently serving as a stubborn technical ceiling. Even more troubling, we've started to see some bullish coverage on gold in the financial media. From a contrarian perspective, this optimism in the face of deteriorating price action has distinctly bearish implications. That said, we're keeping a close eye on support from the $160 area and GLD's 320-day moving average, which could limit downside during the short term.

Prepare for the investing week ahead. Every week, Bernie Schaeffer and his staff provide you with their insight about what has happened and, more importantly, what will happen in the market. We dig deep and show you what's happening behind the scenes, and tell you which indicators are predicting major market moves. If you enjoyed this week's edition of Monday Morning Outlook, sign up here for free weekly delivery straight to your inbox.

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