It's starting to feel a lot like Groundhog Day on Wall Street, as stocks once again underwent whipsaw price action last week. The major market indexes started on a hot streak, with the Dow Jones Industrial Average (DJI) and S&P 500 Index (SPX) notching all-time highs Monday and Tuesday. However, stocks performed an about-face mid-week, with traders exiting equities to make a run on bonds. Against this backdrop, Todd Salamone and Rocky White explain why round numbers, breakeven levels, and especially small-cap stocks should be on the radar.
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: Round-Number Failures Continue
By Todd Salamone, Senior VP of Research
"... the Wilshire 5000 has experienced repeated failures to sustain a move above the 20,000 millennium level since March ... the popular PowerShares QQQ Trust (QQQ - 86.80) and Dow Jones Industrial Average (DJI)have repeatedly failed to sustain moves above their respective 2013 closing levels at $87.96 and 16,576.66 ... The bottom line is that psychologically important round numbers and 2014 breakeven marks have come into play on several benchmarks and at varying times, leading to range behavior that might persist longer than desired ..."
-Monday Morning Outlook, May 10, 2014
"Round numbers $RUT 1,100 and $COMP 4,000 in play as support after round-number failures at $SPX 1,900 and Wilshire 5000 20k this week"
"$VIX 6 consecutive closes below YTD breakeven (13.72), longest stretch since January, before it popped to 21.50. 11.25 a potential floor."
-@ToddSalamone on Twitter, May 15, 2014
The action in the equities market last week continued a theme that we have seen play out throughout 2014's range-bound market. Specifically, round numbers on a couple of benchmarks came into play after a short-term advance, acting as roadblocks again. Specifically, it was the Wilshire 5000 (W5000 - 19,863.96) that again advanced over the 20,000 millennium mark, as it has done multiple times since March. But the "hangover" following this move was the same as we have observed for weeks, as it became unstable at such heights. By Thursday, the W5000 retreated intraday below its year-to-date (YTD) breakeven level of 19,706, before closing above this potential support area.
Similarly, the S&P 500 Index (SPX - 1,877.86) retreated from a key round-number area, after moving above 1,900 and achieving an all-time high. But, this party ended in the blink of an eye, and the SPX was back below 1,880 -- a resistance area for weeks -- which is 20% above the peak level that preceded the past two bear markets. The SPX heads into next week sitting between two significant areas, characterized by 1,880 to 1,900 above, and 1,820 (last month's low) to 1,850 below. The 1,850 area is interesting, as the index's 80-day moving average sits in this vicinity, in addition to its YTD breakeven mark of 1,848.36.
In addition to the round-number failures, we also observed two other benchmarks fail to hold above their respective YTD breakeven marks -- specifically the PowerShares QQQ Trust (QQQ - 87.71), which experienced two closes above the $87.96 breakeven mark, and the Dow Jones Industrial Average (DJI - 16,491.31), which hit all-time highs two days in a row before falling back into the red for 2014, after closing below 16,576.66 on Thursday. In 2014, there have been five closes in YTD-positive territory for the DJI: the first in late April, and then four consecutive closes between Friday, May 9, and Wednesday, May 14. Just as round numbers have come into play as resistance, they have also been supportive this year. For example, DJI 16,000 has marked multiple troughs since February. The DJI's 160-day moving average is situated around the 16,000 millennium mark, which we find interesting, as this trendline acted as support on a pullback in the vicinity of the 15,000 millennium level in September 2013.
Not to be forgotten is the Nasdaq Composite (COMP - 4,090.59), which advanced above 4,000 late last year for the first time in 13 years, but has been unable to escape the shadow of this millennium mark. Coincidentally, 4,000 is now the site of its 200-day moving average, which acted as support last month and hasn't been breached since the days of the "fiscal cliff" in December 2012. As we mentioned a few weeks ago, if the 4,000 level fails to hold, prepare for the possibility of continued downside to 3,600, as this would be the target for a bearish "head and shoulders" formation that would be created amid such a break. Coincidentally, 3,600 is the site of the COMP's 80-week moving average, which acted as support in November 2012 following a breakdown below 3,000.
The action in the Russell 2000 Index (RUT - 1,102.91) is the biggest source of concern for bulls at present. After a strong rally off support at the round 1,100 level to begin the week, the advance was thwarted at 1,140, site of the index's 160-day moving average. This trendline has been significant in recent months, marking the bottom in early February ahead of a 10% rally, but acting as resistance early this month and again last week. By Thursday's close, the index found itself below the round-number 1,100 mark, though this level was reclaimed by the end of Friday's session. Some of last week's selling may have been exaggerated by delta hedging on the iShares Russell 2000 ETF (IWM - 109.57), as heavy put strikes act as magnets during expiration week -- a process we detailed last month. If this is indeed the case, small-caps should stabilize rather quickly -- but if they do not, take caution.
There continues to be an apparent lack of conviction among fresh buyers, as indexes either rally into round-number resistance, or into 2014 breakeven areas for those benchmarks that have been in the red for most of this year. Our analysis of option activity, for example, hints that hedge fund managers are showing little interest in equities now versus a few weeks ago. That said, the shorts are getting impatient, with short interest on components of the QQQ and SPX declining over the past few reporting periods, which is likely lending support on pullbacks (see graph below). The end result has been the nasty range behavior that continues to frustrate traders, except for those with a very short-term time horizon. Our message hasn't changed from prior weeks: be open to opportunities on both sides of the market, and consider shortening your time frames to position yourself for the whipsaw action that has been prevalent for weeks.
The Case for Big Moves in IWM and QQQ
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