It was a rather historic week on Wall Street, with the Dow Jones Industrial Average (DJI) enduring its first four-session losing streak of the year. The last time the blue-chip barometer lasted this far into the year without such a streak was 1954. If that weren't enough, a technological glitch halted the Nasdaq for three-plus hours, marking the longest intraday interruption in recent history. However, the major market indexes finished the week north of key support levels, and the sentiment backdrop suggests the longer-term uptrend could have legs.
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: Wall Street is Worried
By Ryan Detrick, CMT, Senior Technical Strategist
Todd Salamone is out this week, so I'll be filling in with what I'm seeing out there.
It took 159 days in 2013, but we finally had a four-day losing streak. This was the longest streak to start a year without four straight losses since 136 days in 1954. That tells you something could be changing. The Nasdaq being closed for over three hours on Thursday will get the headlines on the week, but under the surface there were some very interesting developments in what historically is a very slow time for the market.
As Todd noted last week, the 1,640 area on the S&P 500 Index (SPX - 1,663.50) should provide support, and it made sense to remain a buyer above that area. That was exactly the case, as the bulls stepped up right at that level. Turning to what caught my eye this week, sentiment polls showed some amazing spikes in fear on a less-than-5% pullback. As contrarians, this is exactly what you want to see. It doesn't mean the market has to bottom here and now, but it increases the odds of a lasting rally once we get moving again.
First up, the American Association of Individual Investors (AAII) poll saw bears spike 52% in just one week, from 28.2% to 42.9% -- the most bears since April 18. The bulls dropped to 29% -- the lowest since mid-April. This is significant because mid-April was a time to be accumulating stocks right in front of the surprise May rally. Lastly, the bears have actually advanced for six consecutive weeks. This has never happened since the poll started back in 1987.
The Investors Intelligence poll saw those looking for a "correction" move over the critical 35% area to 35.1%. As you'd expect, when everyone is looking for a pullback, the odds of it happening are slim. We've crossed this percentage line two other times this year, and both marked short-term buy signals.
In fact, going back to 1980, the percentage of II respondents expecting a correction has topped 35% just 28 times, and the SPX is up an average of 1.93% a month later, and up 75% of the time. The three-month return averages a very solid 3.75%, with the SPX up 70% of the time.
Another poll reflecting a huge spike in worry was the National Association of Active Investment Managers (NAAIM) survey, which asks money managers to provide a number that represents their overall equity exposure as of Wednesday's close each week. The latest poll actually suffered its biggest drop since January 2008, falling from 69.85% clear down to 34.76%. This is near the June lows and presents a nice buying opportunity. The bottom line is: Active managers have plenty of cash to put to work; the only question is, will they?
It doesn't end there, though, as investors are speaking with their actions. According to BofA-Merrill Lynch, just two weeks ago, we saw the largest outflow from U.S. equity mutual funds in over five years! Amazing what a small pullback and worry over "Fed tapering" can do to investors' psyche.
Now there are some worries -- it isn't all great. One of our biggest concerns is the 10-day moving average of the all-equity, customer-only, buy (to open) put/call volume ratio is near its lowest level since April 2011, which marked a major peak before a near-20% correction. The lower this ratio, the more optimism there is among option speculators.
The action in housing stocks is another concern. The iShares Dow Jones U.S. Home Construction Index Fund (ITB - 21.07) is in the midst of making a very bearish-looking head-and-shoulders peak. Not to mention we've seen a change in sentiment this year. Housing was one of the more hated groups the past few years when it was leading; now it's a laggard and we've seen a good deal of optimism. As long as ITB stays beneath the neckline, this is a worry. (Click chart below to enlarge.)
Meanwhile, the Dow Jones Industrial Average (DJIA - 15,010.51) has broken its uptrend line from the November lows. Other indexes have held up better, but this is another concern. (Click chart below to enlarge.)
Speaking of indexes that have held up well, you have to be impressed with small-caps here. We continually hear how "extended" they are, yet they continue to lead. In fact, the Russell 2000 Index (RUT - 1,038.24) breaking above the psychologically significant 1,000 area in July sparked one of the best July rallies in years. As long as the RUT stays above 1,000, it is tough to get overly bearish here. (Click chart below to enlarge.) To hear more about my thoughts on the Dow weakness and small cap strength, here is a CNBC interview I did on Friday tackling just that.
I found this study very interesting. Goldman Sachs did a recent survey of over 708 hedge funds (with $1.5 trillion in assets) and found that less than 5% were beating the SPX as of mid-August. In fact, the average hedge fund was up just 4%, versus the SPX's gain of 20% at the time. Incredibly, one in four hedge funds is actually lower this year. We find this rather bullish on a longer-term basis, as it suggests they'll be aggressively buying any pullbacks to play catch-up.
Historically, August and September are two of the weaker months, and so far August has lived up to that. In fact, going back 30 years, they are hands-down the two weakest months, with the dreaded September the worst.
If you look at more recent data, though, September surprisingly isn't that bad. In fact, the SPX is up seven of the past 10 Septembers, and is actually positive on average. Should we see more of a dip in stocks next week, and with a spike in worry over September looming, that could be a positive. Remember all the "Sell in May" worries? That didn't play out at all, as May saw a nice move higher. I'd say there's a chance that could happen once again in September.
Speaking of seasonality, I've noted before that this year looked a lot like 1954 and 1995 -- two of the best bull markets of all time. Sure, 2013 is its own year and anything can happen, but it is still important to look for clues as to what could happen next. First off, 2013 has dropped off the pace of the other two years. The Dow was doing better at the end of June, but has pulled back lately.
Nonetheless, if the Dow tries to continue following in the footsteps of these two previous years, there's a good chance a major low is coming soon. Turning to this chart, both 1954 and 1995 saw major lows hit in late August/early September before strong end-of-year rallies.
In conclusion, we continue to recommend buying dips here, and small-caps still look very strong. Good luck in your trading and have a great week.
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