What should have been a quiet, holiday-shortened week quickly turned into a low-volume plunge on Wall Street, as traders reacted to several sour economic reports from around the globe. The biggest of these was Thursday's nonfarm payroll report, which has forced some economists to reassess their outlook on the potential for an economic recovery. With this as a backdrop, we kick off the second-quarter earnings season this week, with Alcoa Inc. (AA) leading the charge after the close on Wednesday. Speaking of the week ahead, Todd Salamone, Senior Vice President of Research, examines support and resistance levels for the S&P 500 Index (SPX), as well as the current impact of the CBOE Market Volatility Index (VIX). Then, Senior Quantitative Analyst Rocky White takes a closer look at quarterly seasonality, and what historical data might say about third-quarter performance for Wall Street. We wrap up with a look at some key economic and earnings reports slated for release this week.
Recap of the Previous Week: Holiday Week Spoiled by Economic Fireworks By Joseph Hargett, Senior Equities Analyst
The July 4 holiday-shortened week started off rather sleepily, with volume holding quite low on Monday. Among the major stories at the beginning of last week were a 150-year prison sentence for Ponzi schemer Bernie Madoff, and a timely return to work for Apple (AAPL) CEO Steve Jobs following his medical leave of absence. Meanwhile, the effects of end-of-quarter "window dressing" by money managers were apparent, with many equities bouncing back respectably from recent weakness. For the day, the Dow Jones Industrial Average (DJIA) added 1.08%.
However, investors hoping for a quiet retreat into holiday festivities were in for a rude awakening, as the Commerce Department's consumer confidence report experienced an unexpected drop in June, while the jobless rate in Japan hit a multi-year peak, and the U.K. economy shrank at its fastest pace in more than 50 years in the first quarter. The Dow promptly reversed course, ending Tuesday lower by 0.97%. Given hindsight from Thursday's activity, maybe investors should have paid more attention to Wednesday's ADP employment report, which arrived worse than expected. However, traders chose instead to focus on strong manufacturing data out of China and a jump in the Institute for Supply Management's manufacturing index. As a result, the DJIA added 0.68% on Wednesday.
Trading volume was notably light on Thursday, with many market participants taking a pass ahead of the long holiday weekend. Unfortunately, low volume often lends itself to drastic moves, and Thursday was no exception. The day's marquee economic report was the Labor Department's nonfarm payrolls number for June, and a virtual tsunami of selling pressure hit the Street when the figures came in worse than expected. Not only did the economy shed more jobs than predicted during the month, but the decline surpassed May's nonfarm-payrolls drop by a wide margin -- casting fresh doubt on the prospects for a meaningful recovery. Following the report, the Dow took a 223-point, or 2.63%, nosedive. For the week, the DJIA surrendered 1.9%, while the S&P 500 Index (SPX) dropped 2.4%. Finally, the normally resilient Nasdaq Composite (COMP) gave back 2.3%.
What the Trader Is Expecting in the Coming Week: Wall Street Takes a Trip on the Kiddy Coaster By Todd Salamone, Senior Vice President of Research
It is the same old story. The S&P 500 Index (SPX) has been locked in a brutal trading range since May 4 -- the day it broke out above the round-number 900 level. During this time period, whether you are long the market or short the market, you are probably not making money unless you are operating in extremely short trading periods.
With volatility eroding as the market digests the gains made during its March-through-April run, premium sellers in the options market have beamed with joy since early May. The SPX's action in 2009 reminds me of a couple of roller coaster rides at Kings Island, a theme park near Cincinnati, Ohio. There is The Beast, a wooden roller-coaster with huge hills that reaches great speeds, generates lots of excitement, and ends where it began. Then there is a coaster that I still remember as The Beastie, though the ride took on a new name in 2006, and is now called the Fairly Odd Coaster. The Beastie, a junior wooden roller coaster for the younger kids, has smaller hills, slower speeds, and much less excitement for the thrill seekers.
The January-through-April price action for the SPX was akin to a ride on The Beast: fast moving, big peaks and valleys, exciting, but an endpoint that was the same as the starting point. However, the current market activity is analogous to a ride on The Beastie: smaller peaks and valleys, slower moving, and less exciting, but also with an identical endpoint and starting point.
As we enter the first full week of trading in the third quarter, support and resistance levels are a holdover from last week. That is, the 890 area is where buyers might emerge, with the SPX's declining 200-day moving average now sitting at 887.94, while last month's low was 893.04. Resistance lies in the 930 area, site of last week's highs. The January 2009 high of 943.85 is an area that stopped the May rally dead in its tracks, and would be another area of resistance should 930 give way.
As the narrow trading range continues, the SPX's 20-day historical volatility briefly dipped below 20 last week. However, this reading moved back above 20 within the blink of an eye following Thursday's employment news. We continue to monitor this development closely, as the current level of historical (actual) volatility corresponds with similar readings heading into the market mayhem in September 2008. Is this the calm before a storm, or a continuation of the mean-reverting decline from historically high, longer-term volatility levels? Stay tuned, as we'll soon find out in the days ahead.
Should actual volatility remain at subdued levels, we'd expect the CBOE Market Volatility Index (VIX) to continue its descent, as the VIX continues to trade significantly higher than actual volatility. The VIX did hit a low of 25.00 last week, but popped significantly higher on Thursday. The 25 strike could be supportive in the days ahead, as this strike is the home of peak put open interest in the July series. Unlike equity options, VIX options expire Wednesday, July 22.
Numerous economic reports last week did nothing to help lift the market out of its trading range. The employment number did spark selling on Thursday, with the SPX closing just below the 900 level. With the employment number missing expectations, this reminded me of a question posed in the June 20 edition of Monday Morning Outlook. At the time, I mentioned that we had seen an article from Reuters stating that a net 7% of investors believed a global recession is likely in the next year, compared with a net 70% just two months prior. After seeing this surge in optimism, I posed the following question: "Are the days of stocks reacting strongly to bad economic data numbered?" Thursday's price action in response to a poor employment report may have very well answered this question. This question may also apply to corporate earnings season, which lies just around the corner.
With many of the short-term sentiment indicators that we follow near neither pessimistic nor optimistic extremes, and evidence mounting that institutional players are no longer in major accumulation mode while being hedged for downside moves, it appears that the market will trade on technical drivers for the time being. Therefore, investors may have to wait for the height of earnings season, which arrives during the last week of July, as a potential catalyst for the next major directional move. Earnings season officially begins this week, with Alcoa's (AA) earnings report due out Wednesday after the close. But AA is about the only major company due to report.
My advice from last week remains the same. If you are an option buyer, consider some premium-selling strategies in case the trading range behavior continues, which I suspect it might for the next couple of weeks. A premium-selling strategy is a nice hedge to any longer-term option buying exposure you might have. There are certain stocks in the technology area that we like, and you can hedge your long technology exposure with short positions in the energy area. We continue to think the risk-reward scenario for the bond market and the U.S. dollar shapes up nicely for bond and dollar bulls. In the meantime, have fun riding on Wall Street's version of The Beastie.
Indicator of the Week: Quarter Seasonality By Rocky White, Senior Quantitative Analyst
Foreword: The second quarter came to an end last week, and (thankfully) so has the S&P 500 Index's (SPX) streak of six straight negative quarters. That atrocious streak was blown out of the water following the SPX's gain of 15% last quarter, marking the index's best return for any quarter since 1998. This week, I will slice and dice some historical quarterly data and see what it tells us to expect as we head into the third quarter.
Third-Quarter Seasonality: Below are a couple of discouraging tables showing the SPX's average return by quarter. The table on the left shows that, since 1972, the third quarter is the only one with an average return in negative territory. The table on the right, meanwhile, shows returns since 2000. Once again, the third quarter is negative, arriving with the worst returns of the four.
Following Positive Quarters: Below are tables similar to the ones above. However, the returns in the tables below consider only quarters that followed a positive quarter. These tables are a little more encouraging, showing improved returns overall, especially for the third quarter. However, third-quarter returns following a positive second quarter are still negative, with an average loss of 0.53% since 1972, and an average loss of 2.08% since 2000.
The second quarter of this year was not an ordinary positive quarter. It showed an outsized return of slightly more than 15% -- the best since 1998. Below is a table showing quarterly returns following a quarter which gained at least 10%. The SPX's performance following such a quarter averages a return of 3.97% for the following quarter. Note that there are no fourth-quarter returns to speak of on the table below. This obviously means that since 1972, the third quarter has never had a return that reached 10%.
Finally, I mentioned earlier that we had just endured six straight negative quarters. It was only the second time since 1900 that the Dow has suffered that many consecutive quarters of negative returns (Note: we switched to looking at the Dow since there is more historical data). The last time it happened was 1970 -- you were probably expecting me to say during the Great Depression. If you think that history tends to repeat itself -- this can get you in a lot of trouble, of course -- then we are right on track to follow through with some hefty returns going forward. Last time the Dow went through six negative quarters, it broke that streak with a quarterly return of 11%, compared to last quarter's return of 15%. In the year following those six negative quarters in 1970, the Dow increased slightly more than 30%. If that happens this time, then we will see the Dow less than 100 points from 10,000 by the second quarter of next year (warning: remember, this is based off of just one data point).
This Week's Key Events: Alcoa to Kick Off Third-Quarter Earnings Season 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
The economic calendar offers up only the Institute for Supply Management's June services index. There are no major earnings reports scheduled for release on Monday.
Tuesday
There are no economic reports scheduled for release on Tuesday. Elsewhere, Ruby Tuesday Inc. (RT) is among those reporting earnings.
Wednesday
On Wednesday, the Street will be graced with the usual weekly U.S. petroleum supplies, as well as May's consumer credit report. Meanwhile, Family Dollar Stores Inc. (FDO), The Pepsi Bottling Group Inc. (PBG), and Alcoa Inc. (AA) are scheduled to report earnings.
Thursday
Weekly initial jobless claims and May's wholesale inventories reports are slated for release on Thursday. The earnings calendar includes Helen of Troy Limited (HELE) and 3Com Corp. (COMS).
Friday
The economic calendar rounds out the week with June's import/export prices, May's trade balance, and the preliminary July University of Michigan consumer sentiment index. Meanwhile, there are no major earnings reports slated for release on Friday.
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.
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