Monday Morning Outlook: Taking Another Run At 1,100 on the SPX

              

The bulls proved their resilience last week. The Dow Jones Industrial Average (DJIA) gained a solid 2.5 % on the week, despite a mixed bag of earnings and economic news. Todd Salamone, Senior Vice President of Research, examines the September-November price action to date and finds an eerie replay of the May-July period. Todd also notes the stubborn resistance at the 1,100 level on the S&P 500 Index (SPX). Next, Senior Quantitative Analyst Rocky White notes the underperformance of small-cap stocks in the recent rally, and examines the relative strength of the Russell 2000 Index (RUT) vs. the DJIA. Finally, we wrap up with a look at some key economic and earnings reports slated for release this week.

Recap of the Previous Week: Corporate Earnings Fuel Bulls' Stampede
By Joseph Hargett, Senior Equities Analyst

Stocks enjoyed a serious boost last week, continuing the prior week's momentum that placed the Dow back above 10K. On Monday, the Group of 20 (G20) decided to maintain current economic stimulus measures, in order to "restore the global economy and financial system to health." Elsewhere, General Electric (GE) and Comcast (CMCSA) agreed on a fair valuation for GE's NBC Universal unit, while McDonald's (MCD) reported a 3.3% jump in same-store sales for October. The Dow Jones Industrial Average (DJIA) responded by soaring more than 2% to a new 52-week high.

A lack of catalysts on the economic calendar left Wall Street flat on Tuesday, with the Street instead digesting MBIA Inc.'s (MBI) wider-than-anticipated third-quarter loss and priceline.com inc.'s (PCLN) multi-year high following an upwardly revised fourth-quarter earnings forecast. Elsewhere, Federal Reserve officials Janet Yellen and Dennis Lockhart warned that rising unemployment levels could plague the economy for the next several years.

Low volume and a continued lack of economic data made for some boring trading activity on Veterans' Day. Traders were left with Tuesday night's comments from Federal Reserve Bank of Dallas President Richard Fisher, who argued that there's a solid case for maintaining interest rates near their current historic lows. However, Wall Street took the commentary well, sending the DJIA 0.43% higher despite dismal earnings from Macy's (M) and a Chapter 11 warning from Ambac Financial (ABK).

Thursday proved to be eventful, as the Dow finally ended a six-session winning streak amid a flood of data. On the equities front, Wal-Mart Stores (WMT) reported stronger-than-expected quarterly results and Hewlett-Packard (HPQ) announced plans to acquire 3Com Corp. (COMS). Meanwhile, a large weekly build in crude supplies sent energy issues skittering lower, eventually dragging the rest of the market along for the ride. The Dow closed Thursday with a loss of 0.91%.

Despite Thursday's pullback, stocks were determined to finish the week on a high note, and the Dow delivered by adding 0.72%. The Street cheered an upbeat outlook from The Walt Disney Co. (DIS), as well as stronger-than-anticipated results from retailers Abercrombie & Fitch (ANF), Nordstrom Inc. (JWN), and J.C. Penney (JCP). For the week, the Dow muscled 2.5% higher, notching a close above its 100-week moving average for the first time since May 2008. Elsewhere, the S&P 500 Index (SPX) added 2.3%, while the Nasdaq Composite (COMP) rose 2.6%.

What the Trader Is Expecting in the Coming Week: We're Seeing Replay of May-July Action
By Todd Salamone, Senior Vice President of Research

It is again crunch time for the broader market. The technical pattern that I pointed out two weeks ago is indeed playing itself out, as the price action that we've seen since Sept. 23 is almost a carbon copy of the S&P 500 Index's (SPX) price action from May through July.

The rally from the 80-day moving average has been impressive, but there is work to be done. The bulls must push the SPX above its October peak of 1,100 in short order if the pattern is to become a more complete carbon copy of the May through July period. In July, the SPX pushed above its prior month's high of 950 with relative ease. But last week, the 1,100 level on the SPX proved to be a strong barrier.

Technicians with a bearish bias may once again be "loading up" and shorting this market, looking to make money on a "double top" at 1,100. Moreover, the SPX's nine-day relative strength index (RSI) is showing a "bearish divergence," unlike July. In other words, as the market was hitting highs in July, the RSI was also hitting highs. However, recent highs in the SPX have been met with a series of lower highs in the RSI, which is known as a "bearish divergence."

That being said, many technicians bet against the market in July, as a bearish "head and shoulder" formation took root. They followed with another bet against the market just a couple weeks ago due to the bearish "ascending wedge" formation – discussed last week. Indeed, from strictly a technical perspective, these charts appear to be bad news for the bulls. On the other hand, to the degree that these are crowded short trades, recent history has proven that covering of these positions can provide the power boost to buoy the market through major resistance areas.

The American Association of Individual Investors' (AAII) survey, published on Nov. 12, revealed that the percentage bullish grew to 38% from only 22% the prior week. The bad news is the big pop in bulls during the week. The good news is that the last time the SPX was approaching 1,100, in mid-October, the percentage bulls in the AAII survey stood at 47%. In other words, the bullish percentage in mid-October was near the 2009 highs and was a "sell" signal. I would not exactly call the current bullish percentage a "sell" signal.

Moreover, equity call buying versus put buying on the International Securities Exchange is not as elevated as it was last month, when the SPX was also knocking on the door of 1,100. In fact, in the month of October, there were five days in which call buyers exceeded put buyers by a ratio of two to one. In November, to date, this has happened only twice, suggesting there is room for short-term sentiment to grow more optimistic before the market is vulnerable to another short-term setback.

November expiration week is imminent and has favored the bulls this decade in terms of the probability of being a winner. But bulls beware, as the average weekly return during this decade is negative. In other words, when things go wrong for the bulls during expiration week, it is very noticeable. In fact, during November 2008 expiration week, the SPX lost more than 8%. That being said, during the last 12 expiration weeks, including the November 2008 expiration-week plunge, seven of the expiration weeks have been higher, or 58.3%.

Potential resistance and support levels on the SPX could be driven in part by the expiration of options this coming week. There is considerable put open interest sitting at the 107 strike on the Standard & Poor's Depositary Receipts (SPY), which corresponds to 1,070 on the SPX. Therefore, this is a level that could hold on a pullback, with the 50-day moving average sitting just below at 1,063. Meanwhile, call open interest is heavy at the SPX's 1,100 strike and the SPY's 110 strike, and thus presents potential resistance. But, if 1,100 is taken out, look for short covering to drive stocks quickly up to 1,120, which is a 50% retracement of the October 2007 peak and the March 2009 low.

Finally, remember that CBOE Market Volatility Index (VIX) options expire this coming Wednesday. Peak put open interest in the November series is at the 22.50 strike, which could act as a floor for the VIX, at least through Wednesday.

Expiration week should again provide some excellent short-term option buying opportunities for those of you focusing on short holding periods and seeking leverage on your short-term plays.

Indicator of the Week: Relative Strength of RUT vs. Dow
By Rocky White, Senior Quantitative Analyst

Foreword: Small-cap stocks are taking a hit in the market when compared to large-cap stocks. Below is a graph of the Russell 2000 Index (RUT) since 2006. The "RUT-DOW" line on the graph shows the 21-day relative strength of the RUT to the Dow Jones Industrial Average (DJIA). The red dots mark times that the "RUT-DOW" line fell below 0.95. Right now, the relative strength of 0.92 tells us that large-cap stocks have outperformed small caps during the past month. This reading could be a signal that traders are cautious, preferring the safety of the big cap names rather than the riskier and more volatile small-cap stocks.

Analysis: Below is a table that shows return data for the RUT after the RUT/DOW relative strength falls below 0.95 (I take only one signal per month). The last row in the table shows typical returns for the RUT for comparison. The returns look quite bullish for the market (the Dow and S&P 500 Index also outperform after these signals), with the RUT averaging a return of 1.38% one month following a signal, compared to an average return of 0.38% since 2000.

However, these signals lose their bullishness when you look only at the most recent returns. The table below looks only at returns since 2003. You will notice the average returns following a signal now underperform compared to the typical returns displayed in the last row of the table.

Implications: It's hard to come to a solid conclusion from the analysis above, especially given the underwhelming performance of the more recent signals. One ominous piece of information on the RUT/Dow relationship is that since the June/July pullback, the market has been quite strong. The major indexes are all up about 20%. The more volatile small caps usually outperform the big caps during a strong market rally, but this has not been true during the current rally. If you define a strong four-month rally as an 8% move in the S&P 500 Index, then there have been 10 strong rallies since 2000. Only three of those saw the Dow outperform the RUT. Two of those happened at very bad times to be long the market (June 2000 and July 2007). The other time happened in late 2006.

This Week's Key Events: Inflation Data On Tap From Producer and Consumer Price Indexes
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 October's retail sales, September's business inventories, and the November Empire State manufacturing index. The earnings calendar remains packed, with Lowe's Companies Inc. (LOW), ReneSola Ltd. (SOL), Pacific Sunwear of California Inc. (PSUN), and SINA Corp. (SINA) reporting.

Tuesday

• The producer price index (PPI) for October, the core PPI, and October's capacity utilization and industrial production reports will arrive on Tuesday. In earnings, Canadian Solar Inc. (CSIQ), The Home Depot Inc. (HD), Saks Inc. (SKS), Target Corp. (TGT), The TJX Companies Inc. (TJX), Autodesk Inc. (ADSK), and salesforce.com inc. (CRM) are scheduled to report.

Wednesday

• October's housing starts, building permits, the consumer price index (CPI), the core CPI, and weekly U.S. petroleum supplies are on tap for Wednesday. On the earnings front, BJ's Wholesale Club Inc. (BJ), Chico's FAS Inc. (CHS), China Sunergy Co. Ltd. (CSUN), Solarfun Power Holdings Co. Ltd. (SOLF), Hot Topic Inc. (HOTT), Limited Brands Inc. (LTD), NetApp Inc. (NTAP), and PetSmart Inc. (PETM) will release their quarterly reports.

Thursday

• On Thursday, initial jobless claims will be joined by October's leading economic indicators and November's Philadelphia Fed manufacturing index are slated for release. Elsewhere, Children's Place Retail Stores Inc. (PLCE), Dick's Sporting Goods Inc. (DKS), GameStop Corp. (GME), Ross Stores Inc. (ROST), Sears Holdings Corp. (SHLD), Suntech Power Holdings Co. Ltd. (STP), Trina Solar Limited (TSL), Dell Inc. (DELL), and The Gap Inc. (GPS) will report earnings.

Friday

• There are no reports slated for release on Friday. Finally, the Street will see earnings from AnnTaylor Stores Corp. (ANN), D.R. Horton Inc. (DHI), and The J.M. Smucker Company (SJM).

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: The worst might be over for the financial sector following the massive crisis of 2008, but that doesn't mean that the forecast is sunny for this beleaguered group. In fact, a return to so-called normalcy means that major financial names could struggle going forward, as they forgo the benefits of low expectations and favorable comparisons. There are some technical concerns, too. The Financial Select Sector SPDR (XLF) exchange-traded fund (ETF) recently smacked into resistance from its 80-week moving average, and this trendline has since acted as a steadily descending ceiling for the security. 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. Overall, there are still some serious concerns lingering for the financial sector. With the XLF facing stiff technical resistance on the charts -- and garnering surprisingly complacent sentiment from investors and analysts -- this group looks poised to extend its pullback.

Sector

Oil Services Bullish

Outlook: Energy prices continue to benefit from signs that the global economy is slowing improving. Specifically, crude futures have rallied sharply off their Dec. 24 low of $35.13 per barrel, doubling in the process. The oil services sector has benefited from this jump in energy prices, with the Oil Service HOLDRS Trust (OIH) adding nearly 65% since the start of the year. Technically speaking, OIH maintains support near the site of a 38.2% Fibonacci retracement of the trust's July 2008 peak and its December 2008 low. 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. However, the trust's 50-day buy-to-open put/call volume ratio continues to roll 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.

Sector

Retail Bullish

Outlook: Consumers have started to loosen their purse strings lately – a trend that bodes very well for the retail sector heading into the holiday shopping season. In fact, sales at retail outlets open at least one year rose 2.1% last month, according to the International Council of Shopping Centers-Goldman Sachs. The results exceeded the Street's predictions for a 1% increase, and rejuvenated investors' hopes that we're on the road to an economic recovery. Echoing the optimism in the retail sector is the SPDR S&P Retail (XRT), which has advanced almost 75% since the start of 2009, with help from its ascending 10-week and 20-week moving averages. Despite the encouraging October sales report and the XRT's journey into the black, a healthy portion of the Street remains skeptical, as less than half of the 951 analyst rankings are "buy" or better on retail stocks. A fresh round of upgrades from the bearish brokerage community could help to fuel the XRT even higher up the charts. Finally, the XRT's 10-day buy-to-open put/call volume ratio on the International Securities Exchange (ISE) stands at 6.22, in the 76th annual percentile. In other words, institutional investors may be scooping up XRT puts as a way to hedge long positions on retail stocks, which could point to additional buying pressure for the ETF.