Monday Morning Outlook: Earnings Picture Is Rosy, but 10,000 Proves a Battle

              

The Dow Jones Industrial Average (DJIA) closed at 9,995.91 on Friday, Oct. 16, tantalizingly close to the 10,000 mark it temporarily conquered earlier in the week. Last week, earnings was the name of the game on Wall Street, and most companies acquitted themselves pretty well. How did the market react? It backpedaled, finishing Friday at 9,972.18, less than 30 points from the millennial mark. Todd Salamone, Senior Vice President of Research, revisits his discussion of the prior week, in which he forecast the likelihood of some short-term speed bumps. He sees continued churning in the weeks ahead. Todd also recommends your attention to Bernie Schaeffer's SENTIMENT magazine. Next, Senior Quantitative Analyst Rocky White takes a look at the Moving Average Convergence Divergence, a long-term market indicator better known as the MACD. Rocky finds that MACD is flashing a strong buy signal. Finally, we wrap up with a look at some key economic and earnings reports slated for release this week.

Recap of the Previous Week: Playing Tag with 10,000
By Joseph Hargett, Senior Equities Analyst

It was a fine week for earnings. Manufacturer Eaton Corp. (ETN) and newspaper publisher Gannett Co. (GCI) exceeded analysts' earnings expectations. So did Yahoo! (YHOO), Morgan Stanley (MS), and Wells Fargo (WFC). Apple Inc. (AAPL), Amazon.com Inc (AMZN) and The Travelers Companies Inc. (TRV) just killed. There were some disappointments – including DuPont (DD) and Coca-Cola Co. (KO) – but on balance, earnings and revenue were far better than expected. The Dow Jones Industrial Average (DJIA) reacted by playing tag with 10,000 all week.

Federal Reserve Chairman Ben Bernanke kicked the week off on Sunday by encouraging Uncle Sam to spend less and countries like China to spend more. A solid round of before-the-bell earnings reports on Monday bolstered equities, while crude oil futures climbed to a fresh 52-week peak. The DJIA climbed 0.96% on the day – and back above the 10,000 mark. The earnings picture was a little more mixed on Tuesday, while the Commerce Department revealed that new home construction increased by less than forecast in September. The Dow lost 0.50% on the day, although it remained above 10,000.

Wednesday initially looked like a return to form for the bulls, and the market indexes spent most of the day in the black. However, the Federal Reserve's Beige Book, which highlighted concerns about consumer spending and commercial real estate, cast a pall, as did a downbeat note from banking sector analyst Richard Bove. The Dow succumbed to a triple-digit 11th-hour sell-off, and declined 0.92% for the day, dipping below 10,000 again.

The bulls reclaimed 10,000 on Thursday. Dow divas AT&T Inc. (T) and McDonald's (MCD) surpassed the Street's expectations, with fellow blue chips The Travelers Companies (TRV) and 3M Corporation (MMM) each tagging new highs on the heels of favorable quarterly figures. Elsewhere, investors largely shrugged off a heftier-than-anticipated increase in first-time unemployment claims, instead honing in on a larger-than-forecast rise in the Conference Board's index of leading economic indicators. The Dow added 1.33% for the day.

Friday began with a peek above breakeven, but then turned south and just got worse all day, despite another good round of earnings reports and a bigger-than-forecast rise in home resales last month. By the close on Friday, the Dow fell 1.08%. For the week, the blue-chip barometer's decline was a relatively modest 0.24%, but it failed to conquer 10,000 on a weekly basis for the second week in a row. Elsewhere, the S&P 500 Index (SPX) posted a weekly loss of 0.74%, while the Nasdaq Composite (COMP) dropped only 0.11% for the week.

What the Trader Is Expecting in the Coming Week: More Speed Bumps
By Todd Salamone, Senior Vice President of Research

Last week's Monday Morning Outlook discussed the strong possibility of speed bumps ahead for the stock market in the near term. Short-term concerns included the market in the early stages of moving from an "overbought condition," the typical post-expiration broad-market weakness, an influx of equity option buyer optimism on par with levels that existed prior to a moderate pullback last month, and various broader indexes being challenged (yet again) by overhead technical resistance.

While there was a lot of drama in last week's trading action, with some noticeable advances and declines, the end of the week resulted in little movement from the week's prior close. As expected, the market finished lower, with the Dow Jones Industrial Average closing back below 10,000. Meanwhile, the S&P 500 Index (SPX) has yet to successfully make a sustainable move above the 1,080 area, which is about 61.8% above the March low.

The technical landscape of the market hasn't changed materially since last week. For example, I pointed out how key Fibonacci numbers (31.8, 50.0, 61.8), as measured by the percentage rally from the March low, have served as major hesitation points during the climb from the March trough. Specifically, I referred to the 1,080 area as mentioned above. Since first reaching the 1,080-1,085 area in the middle of this month, the SPX hasn't made any headway. If past is prologue, there will be continued churning in the weeks ahead, much like there was when the SPX hesitated at levels 38.2 % and 50% above the March nadir. We see the SPX chopping between its rising 50-day moving average, currently situated at 1,046, and the 1,100 century mark, which capped rallies last week. If these levels are taken out, there is additional support at 1,020 and resistance at 1,121.

Above being said, I thought it would be constructive to step back and explore a couple longer-term technical indicators that we are watching.

Our fall issue of SENTIMENT is hot off presses and in it I discuss the current status of the 14-month Relative Strength Index (RSI) and the 10-month historical volatility of the SPX. These indicators hit historical extremes in the spring, with the 14-month RSI triggering a "buy" signal at the end of April. Some market participants believe that we have come "too far, too fast." Is the 14-month Relative Strength Index (RSI) confirming this view? My article, which updates the status of these indicators, is on page 6.

If you aren't familiar with Bernie Schaeffer's SENTIMENT magazine, you will find it a great companion to Monday Morning Outlook. It includes educational pieces for those new to options trading, as well as advanced strategy articles to help experienced traders build their portfolios. Regular readers of this column will also notice another familiar voice in SENTIMENT. Rocky White, our Senior Quantitative Analyst, who regularly pens the Indicator of the Week column here, has some interesting thoughts on the gamma-weighted Schaeffer's put/call open interest ratio (SOIR). His article is on page 30.

Indicator of the Week: Monthly MACD
By Rocky White, Senior Quantitative Analyst

Foreword: The market has rallied quite strongly during the past several months. A couple of popular long-term technical indicators, the Stochastics and the RSI, signaled a buy at the end of April. We just had another major technical indicator give a buy signal. I'm talking about the Moving Average Convergence Divergence, better known as the MACD.

The MACD can be looked at over different time frames (for example, hourly, daily, weekly or monthly). I'm taking a long-term perspective here and looking at it monthly. In the chart below, the MACD is calculated by subtracting a 26-month moving average from a 12-month moving average of the Dow Jones Industrial Average (DJIA). I plot the difference of those moving averages (red line below), and then calculate the nine-month moving average of that line (dotted line). This dotted line is the signal line. When the signal line crosses above the MACD, it's a buy signal. The most recent buy signals are marked by the red dots (I only consider one signal every 12 months).

Historical Analysis: Going all the way back to 1900 on the Dow, this is just the 25th MACD buy signal. Below is a table showing annualized returns for the Dow following these buy signals. The second table below is for comparison, and shows typical Dow returns since 1900. In the short term, you will see the signal shows no outperformance to the market. In fact, the three-month returns following a signal have tended to underperform the market at other times. But once you get out to six months, especially at the one year mark, you see quite a bit of outperformance. The market has averaged a gain of about 14.5% in the year after a MACD buy signal. This is way better than the typical market return of less than 7%. Furthermore, the market was positive one year later 83% of the time after a signal. Compare this to 64%, which is the percentage of time the market has usually been positive a year later.

Finally, below is a table showing the last 10 signals that were generated. The last four signals were especially good buying opportunities, showing double-digit returns one year later. Also, the last seven signals all showed positive returns one year later. The summer of 1967 was the last time the MACD gave a buy signal that resulted in a loss one year later.

Implications: This market has some major momentum and technical indicators are starting to signal buy. Obviously, the past performance of the market following a MACD buy signal does not guarantee a bullish market going forward. We do, however, feel a sense of comfort having history on our side as opposed to going against historical performance.

This Week's Key Events: A First Peek at Third-Quarter GDP
By Joseph Hargett, Senior Equities Analyst

Here is a brief list of some of the key events for the upcoming week. All earnings dates listed below are tentative and subject to change. Please check with each company's respective Web site for official reporting dates.

Monday

• There are no economic reports slated for release on Monday. It's another very big week for earnings and on Monday we'll hear from Corning Incorporated (GLW), Lorillard Inc. (LO), The McGraw-Hill Companies Inc. (MHP), RadioShack Corp. (RSH), Sohu.com Inc. (SOHU), Verizon Communications Inc. (VZ), American Financial Group (AFG), Baidu Inc. (BIDU), and DryShips Inc. (DRYS).

Tuesday

• Reports on durable orders and new home sales for September, the Case-Shiller Home Price Index for August, and consumer confidence for October are due Tuesday. On the earnings front Tuesday: AK Steel Holding Corp. (AKS), BP plc (BP), Convergys Corp. (CVG), FirstEnergy Corp. (FE), L-3 Communications Holdings Inc. (LLL), TD Ameritrade Holding Corp. (AMTD), United States Steel Corporation (X) Under Armour, Inc. (UA), Valero Energy Corporation (VLO), Buffalo Wild Wings (BWLD), Cephalon, Inc. (CEPH), Chiquita Brands International, Inc. (CQB), E TRADE Financial Corporation (ETFC), Fiserv, Inc. (FISV), Massey Energy Company (MEE) and Panera Bread Company (PNRA) .

Wednesday

• On Wednesday, we'll learn about September new home sales and the weekly crude inventories report. Scheduled to report earnings are Ashland Inc. (ASH), BorgWarner Inc. (BWA), Coca-Cola Enterprises Inc. (CCE), ConocoPhillips (COP), General Dynamics Corp. (GD), The Goodyear Tire & Rubber Co. (GT), International Paper Co. (IP), Owens Corning (OC), Qwest Communications International Inc. (Q), The Southern Co. (SO), WellPoint Inc. (WLP), AFLAC Inc. (AFL), Akamai Technologies Inc. (AKAM), First Solar Inc. (FSLR), and Human Genome Sciences.

Thursday

• The advance estimate of third-quarter gross domestic product (GDP) will be released on Thursday, along with weekly initial and continuing jobless claims. Aetna Inc. (AET), American Electric Power Co. Inc. (AEP), AutoNation Inc. (AN), Avon Products Inc. (AVP), Barrick Gold Corp. (ABX), Burger King Holdings Inc. (BKC), Cincinnati Financial Corp. (CINF), Expedia Inc. (EXPE), Exxon Mobil Corp. (XOM), Kellogg Company (K), Moody's Corp. (MCO), NRG Energy Inc. (NRG), Office Depot Inc. (ODP), Monster Worldwide Inc. (MWW), PG&E Corp. (PCG), Royal Dutch Shell plc (RDSA), Sprint Nextel Corp. (S), Genworth Financial Inc. (GNW), and MetLife Inc. (MET) are expected to report earnings.

Friday

• We round out the week's economic calendar with personal income and personal spending reports for September, along with the Chicago purchasing managers' index for October. Finishing up the earnings week will be Chevron Corp. (CVX), Constellation Energy Group Inc. (CEG), Duke Energy Corp. (DUK), NYSE Euronext (NYX), Sony Corp. (SNE), ITT Corp. (ITT), Regency Centers Corp. (REG), and Weyerhaeuser Co. (WY).

Prepare for the investing week ahead. Every week, Bernie Schaeffer and his staff provide you with their insights about what has happened and, more importantly, what will happen in the market. We dig deep and show you what's happening behind the scenes, and tell you which indicators are predicting major market moves. If you enjoyed this week's edition of Monday Morning Outlook, sign up here for free weekly delivery straight to your inbox.

And now a few sectors of note...

Dissecting The Sectors

Sector

Financials Bearish

Outlook: Despite logging a year-to-date rally of more than 22%, the Select Sector SPDR Financial Fund (XLF) could come under pressure in the coming weeks. Technically speaking, the XLF peaked last week at its declining 80-week moving average. We have observed that this long-term trendline sometimes serves as important support/resistance levels. On the sentiment front, we are noticing a huge uptick in call buying on the XLF. Specifically, the XLF's buy (to open) call/put ratio has turned higher. When this ratio trended higher in 2008 and early 2009, bank stocks skidded. The current behavior in this ratio may indicate that the shorts are coming back after a wave of short covering. In other words, they're buying XLF calls to hedge short positions. If this is true, the shorting activity would have a depressive coincidental impact on the group. Elsewhere, Barron's recently had a cover featuring Bill Miller, the popular Legg Mason Value Fund manager, with the exclamation, "He's Back!" This fund manager has heavy exposure to financial names, which hurt his performance badly last year. The timing of the cover may have bearish contrarian implications for the financial sector. For those of you with call positions or with big long exposure, the XLF put acts as a hedge in the event of a market pullback.

Sector

Oil Services Bullish

Outlook: Fresh signs of an improving global economy seem to be popping up on a daily basis, and energy prices have responded by trekking higher in anticipation of rising demand. Specifically, crude futures tagged a fresh 52-week high last week, and have more than doubled from their Dec. 24 low of $35.13 per barrel. The oil services sector has wasted no time in capitalizing on this strength, with the Oil Service HOLDRS Trust (OIH) soaring more than 76% since the start of the year. Meanwhile, the trust's 50-day buy-to-open put/call volume ratio could be in the process of rolling over, which may be a concern for the sector. Typically, OIH puts are utilized by institutional investors as a way to hedge long positions on oil sector stocks or indexes. What's more, the brokerage bunch has room for upgrades, as 46% of ratings on oil service stocks are currently "buys," compared to 67% in July 2008 and 61% at the end of last year. Any upgrades from these analysts could lend additional support for the oil services sector. Technically speaking, OIH closed its second week above its 80-week moving average last week, which is coincidentally the site of a 38.2% Fibonacci retracement of the trust's July 2008 peak and its December 2008 low.

Sector

Retail Bullish

Outlook: Technically speaking, the retail sector has come on strong since the March bottom, with the S&P Retail SPDR (XRT) rallying more than 103% during this time frame. What's more, retail remains one of the strongest sectors, and is trading above its 80-week and 160-week trendlines. XRT has also closed the past two weeks above the 61.8% Fibonacci retracement of its June 2007 peak and its November 2008 low. This level is in the 34-35 region, which coincidentally posed a major challenge for the XRT from February-September 2008. However, pessimism is thick on the retail sector. In the financial media, the retail sector was recently hammered by a cover story in Barron's, titled "The Hard Sell" and subtitled "How Retailers Are Fighting For the Hearts & Minds of the New Consumer." Elsewhere, only 42% of the 951 analyst rankings on retail stocks are "buys," according to Zacks, leaving plenty of room for potential upgrades. That said, the XRT's 50-day buy-to-open put/call ratio has recently rolled over from a near-term peak, a development that could be a concern for the sector. However, the XRT is up about 20% since the rollover in this reading began. Within the sector, we see bullish opportunities for Expedia Inc. (EXPE), Whole Foods Market Inc. (WFMI), Green Mountain Coffee Roasters Inc. (GMCR), Polo Ralph Lauren (RL), AutoNation Inc. (AN), Starbucks Corp. (SBUX), Chipotle Mexican Grill Inc. (CMG), and Aeropostale Inc. (ARO).