Today's in-depth look at the week ahead begins with a recap of last week's weak performance following another round of terrible economic data. Next, Schaeffer's Senior Vice President of Research, Todd Salamone, examines potential support at the 600 level for the S&P 500 Index (SPX). Then, Senior Quantitative Analyst Rocky White examines past performance of the Dow following breaks below round-number 1,000-mark levels. Finally, we wrap up with a look at some key economic and earnings reports slated for release this week.
Recap of the Previous Week: Major Market Indices Plummet to New Lows
By Jocelynn Drake, Senior Equities Analyst
It proved to be yet another rough week for the market as stocks struggled under the weight of more negative corporate and economic news. Monday kicked off with all eyes on American International Group (AIG), as the beleaguered insurance firm reported a fourth-quarter loss of $61.7 billion. As a result, the U.S. government announced plans to provide the company with an additional $30 billion in TARP funds. By the close of trading, the Dow Jones Industrial Average had plummeted below the 7,000 mark. Tuesday saw stocks hover between positive and negative territory all session, as traders keyed on testimony from Federal Reserve Chairman Ben Bernanke. The central bank bigwig, addressing the Senate Budget Committee, cautioned that the U.S. economy would remain under severe pressure in the near term, and said that a spike in government debt was a necessary evil in order to prevent "further deterioration in the fiscal situation." By the end of trading, the major broad-market indices closed with only minor losses.
Trading bounced back on Wednesday on hopes that China would issue a second stimulus effort. What's more, the anticipation that China may be showing signs of economic recovery – as well as a surprising decline in U.S. oil inventories – also helped fuel crude futures higher for a second straight session, with the April contract adding 9%. By the end of the day, the Dow logged a triple-digit gain. However, trading was back in the red by Thursday, following China's failure to announce additional stimulus measures as expected. Adding to the Street's gloom were blue chips General Motors (GM) and Citigroup (C), with the former warning of possible bankruptcy, and shares of the latter breaching the $1 mark for the first time ever. The Dow tagged a fresh 52-week low on Thursday before closing with a triple-digit loss.
The bleeding continued on Friday after the Labor Department reported a monthly job loss of 651,000 and an unemployment rate of 8.1%. The Nasdaq Composite (COMP) was finally pressured beneath its November 2008 lows. Meanwhile, the Dow Jones Industrial Average tumbled south of 6,500 for the first time since April 1997, and the S&P 500 Index (SPX) fell to a fresh annual low of its own. However, stocks managed to bounce back by the close, allowing the Dow to finish the session with a gain of 32.5 points, but with a weekly loss of 6.2%. The SPX also clawed its way to a positive finish, though the broad-market barometer closed just fractionally higher. For the week, the index gave up 7.0%. Finally, the COMP was unable to eke out a gain, settling on a loss of 5.7 points, or 0.4%, and shedding 6.1% for the week.
What the Trader Is Expecting in the Coming Week: Have We Hit the Bottom?
By Todd Salamone, Senior Vice President of Research
Well, are we there? Have we reached a bottom? I may as well ask the question, since it continues to be asked each time this bear market gains momentum to the downside. When we are asked where the bottom is, our typical response is: A bottom will occur when there is a lack of interest in attempting to call a bottom, or there is a belief that a bottom is nowhere on the horizon. Unfortunately, we are still not seeing the despair that is usually found at major market bottoms. But, what are the signposts for a potential short-term rally that begins this month? Read on, and you will find out.
The latest target number that we've seen thrown out by analysts is 600 on the S&P 500 Index (SPX). One justification for 600 is that this would represent a multiple of 12 times earnings, based on estimated earnings for the SPX of $50. One has to wonder if anyone can call the bottom based on valuations, as future earnings estimates are questionable at best. Moreover, why a multiple of 12? One technician put a price tag of 600 as the low on the SPX, citing it as roughly a 61.8% Fibonacci retracement of the all-time high. While this target is below current levels by 13%, note that this is on the heels of a 21% decline in the past month. The implication is that a move to 600 puts us nearer to the elusive bottom. We also saw a statistic this week from John Roque, which noted that in the 4 times the SPX's price-to-earnings ratio (P/E) rose above 20 since 1881, it eventually turned lower and didn't stop falling until it hit single digits. The average multiple of those troughs was 6.4.
With the president last week implying that valuations are attractive for the long-term investor and a growing chorus of market timers -- including bears that have capitulated to the bullish camp -- attempting to call a bottom, this again does not strike us as the despair that one will see at a bottom. Therefore, there is good reason to believe that 600 could very well be too high an estimate before all is said and done.
The above addresses what we are seeing anecdotally. I'd be remiss if I didn't address an article that appeared last Wednesday in the Financial Times entitled, "Subdued VIX signals investor battle fatigue." In fact, our chairman and CEO, Bernie Schaeffer, discussed his reaction to the article in a must-read piece on SchaeffersResearch.com entitled: "Schaeffer's Media Outtake: What the VIX Is Telling Us."
In addition to Bernie's comments, I'd like to address a quote that intrigued me within the article (which, by the way, reflects the significant amount of "bottom talk" that we are seeing). The article stated, "The breakdown in the relationship between the S&P and the VIX, which have historically moved in inverse proportion to each other, is a product of a number of factors and could suggest that stocks may have seen the worst of the current bear market, say traders."
As you know, during the past couple of weeks, I've discussed what I've seen as the implications of a relatively muted move in the CBOE Market Volatility Index (VIX) with respect to the gut-wrenching declines in the SPX during the past month. Certainly, the low VIX could be smart money and may have bullish implications, but we still have our doubts.
In fact, one can simply refer to the bear market of 2000 through its end in 2003 to get a glimpse into what the current VIX behavior might mean. For instance, the graph below displays the VIX and the SPX in 2000 through 2003. On one hand, the VIX didn't make a new high at the ultimate low, so this would support the case that when the bottom is made, a VIX reading of 80 or 90 is not a necessary condition for a bottom to be in place. On the other hand, the VIX was double its bear market low in March and April 2003, which was when the bottom was in and stocks were getting set to advance.
In other words, and as you can see on the chart, low VIX readings during the 2000-to-2003 bear market that occurred within the context of weak price action were far from bullish and, in fact, bearish in their implications. Note that when the VIX was approaching its bear market lows again in late 2003, the market had bottomed months prior. Should the VIX's behavior replicate that of March and April 2003, we could possibly see it at 73 (double the January lows), which would still be below the peaks of October and November.
I'll leave you with a couple of items of interest for the short term:
Short-term resistance on the SPX sits at 720, which is a trendline that connects various highs since Feb. 10, the day Treasury Secretary Timothy Geithner revealed his plan to address the financial crisis. Support on the SPX sits at 650, which is the site of major put open interest in the March series.
The Case for Big Moves in IWM and QQQ
Featured Partners: AOL DailyFinance
© 2014 Schaeffer's Investment Research, Inc. 5151 Pfeiffer Road, Suite 250, Cincinnati, Ohio 45242
Phone: (800) 448-2080 FAX: (513) 589-3810 Int'l Callers: (513) 589-3800 Email: firstname.lastname@example.org
All Rights Reserved. Unauthorized reproduction of any SIR publication is strictly prohibited.
Market Data provided by QuoteMedia.com | Data delayed 15-20 minutes unless otherwise indicated.