Markets spent most of the week in the red, but signs of a strengthening economy eventually overcame fear surrounding the Federal Reserve's tapering timeline. Although the Dow Jones Industrial Average (DJI) and the S&P 500 Index (SPX) snapped their string of weekly wins, Friday's burst of buying power helped these major market indexes, along with the Nasdaq Composite (COMP), finish the week above their respective round-number levels. As some caution lingers, Todd Salamone insists short-term hedges are a must, but he explains why the Fed may no longer be a factor.
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: Are Round Numbers Still in Play?
By Todd Salamone, Senior VP of Research
"On the sentiment side, we remain encouraged by the build in short interest. From a technical perspective, key benchmarks such as the Dow Jones Industrial Average (DJI - 16,086.41), Russell 2000 Index (RUT - 1,142.89) and S&P MidCap 400 (MID - 1,304.18) are hitting new all-time highs and recently took out round-number levels, including Dow 16,000. Meanwhile, this past week, the Nasdaq Composite (COMP - 4,059.89) closed above 4,000 for the first time in 13 years."
"...we are at the beginning of what has historically been the strongest calendar month for stocks. The combination of bullish seasonality, a strong technical backdrop, and a still healthy short position -- driven perhaps by short fund managers and cautious long-short fund managers -- supports our bullish case. The biggest risk is that some sentiment indicators that we follow are displaying optimism."
-Monday Morning Outlook, November 30, 2013
"From 2007 through 2012 there were about $611 billion in outflows from domestic equities. In 2013, there have been $31.1 billion inflows. Inflows have been about 5.09% of outflows."
-Schaeffer's Senior Quantitative Analyst Rocky White, citing ICI.org data, December 3, 2013
"Many investors have generally accepted the fact that tapering is coming, either later this month or early next year ... Eric Augustyn, head of options at Wells Fargo Private Bank, which has $170 billion in assets under management, said clients recently haven't been asking about the potential for the Fed to soon withdraw its stimulus, or some other macro event. 'For the first time, they're not focusing on manufactured crises out of Washington or Europe,' Mr. Augustyn said. 'It's unusual, I've heard nothing on taper and everyone is more looking at general market levels.'"
-The Wall Street Journal Morning MoneyBeat, December 6, 2013
A winter storm that gripped a large part of the country last week is a reminder that December is here, but the first week of trading was not December-like, with the Dow Jones Industrial Average (DJI - 16,020.20), S&P 500 Index (SPX - 1,805.09), and Russell 2000 Index (RUT - 1,131.38) experiencing pullbacks. Meanwhile, the Nasdaq Composite (COMP - 4,062.52) and S&P MidCap 400 (MID - 1,309.68) ended the week with modest gains. The declines were attributed to stronger-than-expected economic data, stoking fears that a Fed tapering is nearing.
However, Friday's impressive rally, on the heels of a better-than-forecast employment number, likely discredits the reasons behind the Monday-through-Thursday pullback that pushed most benchmarks lower. In fact, a takeaway from Friday's rally is that a Fed tapering is now factored into the marketplace, and thus investors need to see strong economic data to justify tapering action.
Our main theme over the past few weeks has been multiple benchmarks rallying up to round numbers that could serve as speed bumps, particularly millennium marks like 4,000 and 16,000 on the COMP and DJI, respectively. Coincidentally, sentiment indicators that we closely track showed signs of increasing optimism in some corners of the market, from equity-option speculators to active investment managers to newsletter advisors. The optimism we have seen has been tempered by the fact that:
One has to wonder if these round numbers are still in play, and for how long, highlighted by the action this week, in which some benchmarks declined below their respective round numbers? For example, the MID and SPX fell back below 1,300 and 1,800, respectively, before muscling back above them by Friday's close. Meanwhile, the DJI slipped back below 16,000, and the COMP's weekly low was at 4,004.76 before rallying back to its multi-year high achieved on the last trading day of November. Retail investors, who are just now sticking their toes back in the water after years of pulling cash out of equity funds, appear to be focused on levels, as depicted by The Wall Street Journal excerpt above.
The question is whether or not multiple benchmarks can quickly leave behind their round-century marks that have acted as speed bumps during various times dating back to mid-October, when the MID first bumped up against 1,300. This was followed by the SPX's and the DJI's assault on 1,800 and 16,000, respectively, in mid-November.
The market's rally up to these multiple round-number levels appears to be driven by a combination of un-hedged, short-term traders jumping on directional trends and the retail player that continues to slowly come back into equities. As we have said many times, such momentum can persist longer than anyone might expect. Moreover, our option indicators suggest a lot of hedged money has sat out the rally that began in mid-October. This could have bullish implications, as this is a group that is capable of driving stocks higher when they grow bullish.
On the other hand, keep in mind that if un-hedged players get blindsided by unexpected negative news, they are most vulnerable to panicked sell episodes, generating bigger corrections than what we have grown accustomed to seeing. This is why it bears repeating that we think a hedge to your long portfolio makes sense, even though seasonal trends and the market's technical backdrop continue to favor the bulls.
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