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The Key to Pushing Stocks Even Higher

The sentiment backdrop is different than the last time equity benchmarks were flirting with new highs

by 8/23/2014 9:00:00 AM
Stocks quoted in this article:

It was a great week for stocks, as the major market indexes catapulted into the black. The Dow climbed back atop the 17,000 level for the first time since late July -- and stayed there despite a modest pullback on Friday -- and the S&P 500 Index and Nasdaq explored new-high territory. But is history doomed to repeat itself? As Todd Salamone notes, while the technical picture resembles that of July, the current sentiment backdrop could point to money on the sidelines.

  • The new resistance levels on the radar
  • The geopolitical and technical similarities between now and '97
  • The best days of the week to own S&P 500 stocks

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: Now vs. July
By Todd Salamone, Senior VP of Research

"If you are a contrarian and a market bull, you should be encouraged with the way that the sentiment backdrop has developed in recent days ... sentiment has finally turned negative, unlike the optimism we observed at the beginning of July, when several indices were battling round millennium marks ... the S&P 500 Index (SPX) and the Russell 2000 Index (RUT) found support late last week at round-number levels: 1,900 and 1,100, respectively. It is these same indices that recently peaked at 2,000 and 1,200 ... the short-term sentiment backdrop now suggests that there is more reward than risk over the next month."
-Monday Morning Outlook, Aug. 9, 2014

... the S&P 400 MidCap Index (MID - 1,395.50) is trading around the 1,400 mark once again, which marked a peak in April ahead of a pullback to the 1,300 level ... the Russell 2000 Index (RUT - 1,141.65) -- which has rallied impressively from the round 1,100 area -- still has work to do before taking out 1,163.64, its 2013 close ... the 1,950 half-century mark on the SPX is back in play, and we have highlighted the importance of these half-century marks in prior reports ... However, with the market rallying strongly off its lows, sentiment among short-term traders remains at pessimistic extremes, suggesting there is enough firepower to "deaden" these resistance points.
-Monday Morning Outlook, Aug. 16, 2014

$RUT struggling to get back above YTD B/E at 1,163.64, trailing $SPX and $MID today

Bunch of round numbers in play once again on key benchmarks $SPX 2k, $DJIA 17k, W5000 21k, QQQ $100, $NYA 11k
-@ToddSalamone on Twitter, Aug. 20 and 22, 2014

From a technical perspective, the situation is somewhat similar to early July, with key equity benchmarks trading around all-time or multi-year highs, but potential round-number resistance in the general vicinity (as noted immediately above).

For a couple of benchmarks, however, different types of resistance are coming into play, relative to July. For example, in early July, the PowerShares QQQ Trust (QQQ - 99.05) was situated about 5% below the round $100 level, but vulnerable to profit takers sitting on a 10% year-to-date (YTD) gain. This popular exchange-traded fund (ETF) has "powered" above its 10% YTD mark at $96.75, but is now sitting just below the round $100 level, which is also double the August-October 2011 correction low.

Moreover, in early July, the Russell 2000 Index (RUT - 1,160.34) was probing its 1,200 century mark for the second time in 2014. Now, however, the RUT is doing battle with its YTD breakeven point at 1,163.64, as small-cap investors are likely reducing exposure to this group as they think "break even" for the year as larger-cap stocks outperform.

Daily RUT Chart with YTD Breakeven

Last week, the S&P 500 Index (SPX - 1,988.40) peaked at 1,994.76, logging another all-time high. Not only was this just shy of the critical 2,000 millennium level, which also marks an exact tripling of the March 2009 low of 666.79, but the only other time the SPX had to deal with a round millennium level was roughly 17 years ago -- and, like today, investors were focused on overseas news.

In 1997, for example, the "Asian Contagion" acted as a catalyst for a correction just after the SPX climbed up to the 985 mark. The good news, if you are a bull, is that the SPX managed to slice right through the 1,000 level when it touched this level for the first time in early 1998. It went on to rally another 15% by July 1998, before ultimately revisiting 1,000 the following month (see first chart below).

Like 1997, the SPX in recent months peaked just short of a key millennium mark and pulled back on geopolitical news, but has recovered and once again has a millennium level in sight.

Daily Chart of SPX from June 1997 to March 1998

SPX at present -- like 1997, ran up a couple of times just short of a key millennium area, before pulling back. Can 2,000 get taken out as easily as 1,000?

Daily Chart of SPX since May 2014 with 120-Day Moving Average

Whereas the technical backdrop is similar to early July when equity markets were about to embark on a mild correction, the sentiment backdrop is different. The contrast in the sentiment backdrop at present versus July could be the key that pushes various equity benchmarks through their respective resistance levels.

For example, in early July, option speculators were at an optimistic extreme, as measured by the 10-day average of the all-equity, buy-to-open put/call volume ratio. At present, we are in the middle of an unwind from extreme pessimism among this group that was evident earlier in the month. This ratio has room to move lower before an optimistic extreme is reached that leaves the market vulnerable like early July (see the chart immediately below).

10-day BTO Put-Call volume ratio with SPX since 2013

Moreover, a weekly survey from the National Association of Active Investment Managers (NAAIM), which reports equity exposure among those responding, indicates that exposure is still on the low side relative to early July. In June, this group had extremely high exposure and lightened up a bit heading into July, but still had relatively high equity exposure. It wasn't until early August that this segment of the market greatly reduced its exposure, just in time for the bottom. At present, active investment managers appear to be increasing their exposure, albeit at a slow pace. Their current exposure is similar to that of February, which preceded an 8% SPX rally in only a six-week period.

The technical backdrop might imply that recent upside momentum slows, but we think the sentiment backdrop increases the probability of an upside breakout relative to the probability that existed in early July.

NAAIM -- exposure to equities is relatively low, an indication that sideline money can push equity benchmarks through resistance

NAAIM sentiment since 2013

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