It was a week for the record books, with the Dow Jones Industrial Average (DJI) notching a fresh closing peak on Wednesday after the Federal Reserve signaled the economy is finally emerging from its winter doldrums. However, not even a better-than-expected payrolls number and a drop in the unemployment rate could overshadow escalating tensions between Russia and Ukraine, with major market indexes paring a portion of their weekly gains by Friday's close. Looking ahead, Todd Salamone explains why traders, at present, should remain open to both short- and long-term trading opportunities, despite both the Dow and the broader S&P 500 Index (SPX) dancing around record-high territory.
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: Why Bears May Be Vulnerable to a Breakout
By Todd Salamone, Senior VP of Research
"... whereas a millennium mark has served as support on the COMP, the 20,000 millennium mark on the Wilshire 5000 Index (W5000) continues to be a major speed bump, as cautioned weeks ago ... With the W5000 in a range over the past several weeks, other benchmarks continue to ping back and forth between round-number levels and YTD breakeven marks, suggesting the dance around 20,000 is likely to continue ... Traders should continue to shorten or lengthen their time frames, and be open to opportunities on both the long and short sides, as this trading range may continue into the foreseeable future."
-Monday Morning Outlook, April 26, 2014
"Dow Jones Industrials has not closed above its 12/31/13 close (16,576.66) in 2014. Will today be the day? 25 points away"
"$QQQ intraday high $87.96; 12/31/13 close = $87.96"
"20k level on Wilshire 5000 continues to come into play as major speed bump - 20 visits of this level in 45 days since 20K first touched"
-@ToddSalamone on Twitter, May 1-2, 2014
"Stocks accounted for 67% of employees' new contributions into retirement portfolios in March, according to the most-recent data from Aon Hewitt, which tracks 401(k) data for 1.3 million people at large corporations ... That is the highest percentage since March 2008, when stocks were teetering under the weight of mounting mortgage defaults, and compares with 56% in March 2009, when the market hit bottom."
-The Wall Street Journal, May 1, 2014 (subscription required)
Recent headlines have referred to record highs with respect to certain benchmarks, and indeed this is true, with the Dow Jones Industrial Average (DJI - 16,512.89) experiencing its first finish in the green for 2014 on Wednesday -- and achieving an all-time closing high. Moreover, the S&P 500 Index (SPX - 1,881.14) briefly traded above its all-time closing high of 1,890.90 on Friday, before reversing to land near the 1,880 area, which has been an important level going back to early March.
So, it is a fact that a couple of key equity benchmarks are trading in or around all-time high territory. But, as loyal readers of Monday Morning Outlook know -- and as could be inferred from various excerpts above -- stocks have been mired in a range, with year-to-date breakeven levels and/or round numbers coming into play as support and resistance levels for the past few months on several equity benchmarks. The benchmarks include those mentioned above, as well as the Russell 2000 Index (RUT - 1,128.80), S&P 400 MidCap Index (MID - 1,361.57), and the Nasdaq Composite (COMP - 4,123.90).
The RUT, for example, recently found support at the round 1,100 level and its 200-day moving average, while the MID recently found support at its 2013 close at 1,342. Meanwhile, the COMP experienced another low around the round 4,000 millennium mark in this past week's trading, but, in the week prior, the COMP was turned back from its 2013 closing level following a rally attempt.
Depending on the week and the equity benchmark, round-number century and millennium levels continue to play a significant role in marking support and resistance areas, and this has evolved into a frustrating trading range for many traders and investors. Last week was not any different, and most notable were the failures of the PowerShares QQQ Trust (QQQ - 87.49) and the DJI to hold on to advances above their respective 2013 closing levels, as you can see in the graphs below.
We also find it of interest that round-number percentage gains from important levels on a chart are also contributing to this trading range. For example, and as we observed last week:
"In May 2013, the S&P 500 Index (SPX) broke out above twin peaks that occurred in March 2000 and October 2007. The breakout above this 1,555-1,560 area likely brought in market participants that were waiting to enter the market on a breakout, instead of risking making an investment at prior tops on a chart. With that said, we find it of interest to identify points at which these new investors experienced certain profit levels, specifically 10% and 20%, as such returns might inspire some profit-taking.
"We notice that the 1,710 area, which is roughly 10% above the breakout level, acted as a major speed bump beginning in August 2013. This area was finally taken out in October, with the index pushing higher to our second point of interest on a chart, which is 1,880. As you can see, 1,880 has proven to be very significant since March, as it represents a 20% profit for those who bought the SPX breakout in May 2013. Bulls are hoping that profit-taking will gradually subside around 1,880 to set up a short-term breakout within the long-term uptrend."
The range seems to be driven by short covering and a "buy the dip" mentality among retail mutual fund investors. For example, Thursday's article in The Wall Street Journal (excerpted above) did a good job of quantifying the behavior of investors in retirement accounts, who were buyers during the weakness in March. Plus, the graph below on SPX component short interest changes from report to report suggests that shorts have been in covering mode, which is also supportive.
But, with small-caps and high-flying technology stocks significantly underperforming, and with portfolio protection trades clearly in demand -- buy-to-open call volume on CBOE Volatility Index (VIX - 12.91) futures is around record levels -- hedge funds appear to be in risk-reduction mode, creating resistance levels that have been difficult to overcome. In other words, this particular group appears to be in "sell the rally" or "put on portfolio protection" mode when such protection becomes cheap (as it is now, with the VIX going into next week around its 2014 lows).
The good news for bulls is that the more these resistance levels are tested, the more vulnerable the bears are to a breakout. The risk to bulls, however, is that to the extent un-hedged players are supporting the market, it is these players that will be the first to panic sell on negative headlines that drive the market lower. So, as we said last week, be open to opportunities on both the long and short sides of the market as this range persists.
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