Monday Morning Outlook

Dow 16,000 (and Other Levels to Watch); Plus, 3 Encouraging Sentiment Signs

Analyzing market seasonality and investor sentiment

by 11/16/2013 9:57:00 AM
Stocks quoted in this article:

Last week brought more hyperfocus on monetary policy, as Janet Yellen testified before the Senate Banking Committee. Likely the next Federal Reserve Chair, Yellen took a characteristically dovish stance, helping to quell concerns about an imminent tapering of the central bank's asset-buying efforts. Volume was nonetheless relatively light throughout expiration week, but those investors who did participate helped usher stocks to fresh historical highs. As a new week begins, Todd Salamone has a cautious eye on the charts, but remains encouraged by several sentiment readings.

  • Will these three round-number marks act as speed bumps?
  • 3 encouraging developments for the bulls to monitor.
  • Rocky White's analysis of the impact of seasonality and investor sentiment on the market.

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

Notes from the Trading Desk: The Latest in Short Interest, Bullish Sentiment, and Put Buying
By Todd Salamone, Senior VP of Research

"As we move into a period of positive seasonality, we remain bullish into the end of the year, given the strong price action and the fact that a relatively large short position exists. But there could be some hesitation in the immediate days ahead, as equity call buying relative to put buying recently hit an extreme low and the SPX finds itself in a short-term overbought condition around its half-century mark in the 1,750 area."
-Monday Morning Outlook, Oct. 26, 2013

"The SPX is no longer overbought -- but then again, it has not yet moved into an oversold condition ... For bulls, sideways price action like we saw in the March-April period, when the SPX danced around the 1,550 level, might be considered a win in the context of the currently optimistic sentiment backdrop and the index's historical price action around half-century levels ... The short term may continue to be trying for bulls in the absence of hedge fund accumulation, and as other market participants unwind long positions."
-Monday Morning Outlook, Nov. 9, 2013

"Short interest on $SPX components increased 0.28% in the 11/1 report- first reading since debt issues were moved to Jan14. I am surprised"

"AAII % bulls down from 49% to 39% from Oct. 24 to present; $SPX up 30 points in that period as bulls backtrack"

-@ToddSalamone on Twitter, Nov. 12 and 14, 2013

In late October, following a nearly 7%, two-week rally in the S&P 500 Index (SPX - 1,798.18) to all-time highs in the 1,760 area, we observed the tendency for the S&P to dance around or retreat from half-century-mark levels. As such, with short-term sentiment growing optimistic, we anticipated a consolidation or even a short-term pullback to support in the 1,725 area before a year-end rally began.

As you can see on the chart below, the SPX chopped around for about three weeks, and within a week of revisiting 1,750 on Nov. 7, the index had surpassed its late-October high-water mark of 1,775, surpassed 1,783 (its 25% year-to-date return level), and now finds itself trading within a few points of the next potential speed bump, the round-number 1,800 century mark.

Daily Chart of the SPX Since May 2013

Additionally, the Russell 2000 Index (RUT - 1,116.20) and S&P 400 MidCap Index (MID - 1,311.77) rallied above round-number resistance levels at 1,100 and 1,300, respectively. But a benchmark that everyone seems to be keying on is the NASDAQ Composite (COMP - 3,985.97), which is just below the 4,000 millennium mark, a round number that could be a speed bump. That said, bulls should find it encouraging that the COMP took out the lesser-followed 3,900 century mark, which is triple the 1,300 low in March 2009. Not to be forgotten, the Dow Jones Industrial Average (DJI - 15,961.70) is also staring up at a never-before-touched millennium level -- 16,000.

While the sentiment backdrop is not at levels that have marked important bottoms ahead of a rally like we saw last week, we do find it encouraging that:

  1. The rally in the second half of October was not driven by short covering, as we had anticipated. Short interest figures as of Nov. 1 were released last week, and short interest on components of the SPX actually ticked higher by nearly 0.3%. This is a pleasant surprise, as there is still a healthy short position, with SPX component short interest well above last year's low and closer to the top of an 18-month range (see chart immediately below).

  2. Total Short Interest for SPX Stocks, Since January 2011

  3. The consolidation frustrated some market participants, as the weekly American Association of Individual Investors (AAII) poll displayed a notable drop in the percentage of bulls from late October to the present. Moreover, the National Association of Active Investment Managers (NAAIM) weekly survey has indicated that this group has reduced equity exposure for two straight weeks, albeit exposure is not at extremely low levels.

  4. Finally, we are seeing notable put activity on a popular technology exchange-traded fund (ETF), the PowerShares QQQ Trust (QQQ - 83.96). The increase in buy (to open) put volume on this security could be indicative of speculative bets against this group, which we view as bullish as it is occurring within the context of multi-year highs. Or, the put activity hints at underperforming hedge fund managers chasing the stronger technology stocks in a year-end push, and buying cheap (30-day at-the-money implied volatility is near a 52-week low) QQQ puts to hedge their long positions exposure. If it is the latter, and to the extent this activity continues, these deep-pocketed players may be supportive in the weeks ahead.
QQQ put buying is growing while call buying is not at the levels that marked a peak earlier this year
QQQ and 20-day cumulative call and put volume

The market's momentum is supportive of the bullish case, and such momentum can last far longer than many expect, especially amid a healthy short position, which is the case today.

But as we all know, it only takes a rumor or headline to unravel things. As such, with portfolio insurance -- as measured by the CBOE Volatility Index (VIX - 12.19) -- near the lows of the year, a prudent course of action is the purchase of portfolio insurance to guard against an adverse unknown. In fact, with equity, index, and ETF options just expiring and fund managers possibly interested in replacing expired portfolio insurance cheaply, such actions could pressure the market in the near term. Once such protection is in place, however, it could mean fewer panic-selling situations down the road. Finally, with earnings season mostly over, many individual equity options are cheap as well, making it advantageous to hedge individual names with put options.

VIX near 2013 lows ... SPX historical volatility was around 12.00 coming into the month, so portfolio insurance is reasonably priced
Daily Chart of VIX Since January 2013

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