With Euphoria Absent, Can Major Indexes Move Higher?

The S&P 500 Index (SPX), Dow Jones Industrial Average (DJIA), and other benchmarks are trading around important levels

Senior Vice President of Research
May 26, 2015 at 8:34 AM
facebook X logo linkedin

"For those who prefer keeping it simple, the knee-jerk reaction to this rally is to sell the top of the range. But one has to seriously entertain the idea of betting on a breakout, especially after many market participants have gotten used to the trading range pattern, wondering what the next catalyst is, and forgetting that the market is a discounting mechanism … [P]essimism peaked and optimism is slowly returning, and such sentiment shifts from fear to optimism are usually supportive of stocks. The current sentiment shift occurs amid a backdrop in which the COMP, DJIA, and SPX are trading back above their respective round-number resistance levels." 
-- Monday Morning Outlook, May 18, 2015

If you are a bull, the good news is that major equity indexes experienced their second consecutive weekly close above respective round-number resistance levels. Moreover, for the first time this year, there was not a single day during the week in which these equity benchmarks retreated back below these round numbers. In other words, the routine selling that has quickly followed closes above 2,100 on the S&P 500 Index (SPX - 2,126.06), 18,000 on the Dow Jones Industrial Average (DJIA - 18,232.02), and 5,000 on the Nasdaq Composite (COMP - 5,089.36) seems to be a fad that is disappearing. In fact, the SPX, DJIA, and S&P MidCap 400 Index (MID - 1,541.56) notched new all-time highs during the week, while the COMP is again within striking distance of its all-time intraday high of 5,132.

For the first time this year, the COMP went a full trading week without dipping below 5,000


While on the subject of round numbers, also of interest is how the COMP (yellow line in Google Finance graph below) is seemingly moving higher from its 20% year-over-year (YoY) return, after dancing around this area for most of this year. Furthermore, the SPX (red line) is now using its 10% YoY return as support, after dancing around this level for much of the year. For next week, this would imply support between 2,100 and 2,110.

Meanwhile, the DJIA is still getting capped at its 10% YoY return -- which is especially interesting. If the DJIA closes at 18,220 at the end of this holiday-shortened week, it would close out the month with a 10% YoY return.

But as we mentioned last week, with a rally into early July last year, these support zones will be increasing, so even if these equity benchmarks continue to hover around their respective round-number YoY percentage returns, the outlook would be "minimal downside in the immediate term to higher stock prices during the next month," which presents an attractive risk-reward environment, from this perspective.


"… [N]eutral sentiment, or expectations the market will be unchanged over the next six months, among roughly 300 retail investors set a new record. It was above 45% for the seventh consecutive week, the longest stretch in history … According to AAII, periods of unusually high neutral sentiment are typically followed by outsized returns in the equity market over the next six and 12 months. The group classifies unusually high sentiment to be one standard deviation from the historical norm, which is 31% in the case of neutral attitude."
-- The Wall Street Journal, May 22, 2015

From a seasonality perspective, the Memorial Day trading week has historically been bullish, although this has not been the case in four of the past five years. For more on this, see the recent commentary written by Rocky White, our Senior Quantitative Analyst.

Out of curiosity, we took Rocky's seasonality study one step further and measured the historical sentiment backdrop among retail investors heading into the Memorial Day trading week, as measured by the American Association of Individual Investors (AAII) weekly survey. As a contrarian trader would expect, the less enthusiasm for stocks heading into the holiday week, the better the expected returns.

With the current bullish percentage only 25%, next week could lend a helping hand in terms of producing the expected positive 6-12 month returns following a period of high neutral sentiment, as depicted in The Wall Street Journal piece last week.


Understandably, if you don't want to put a lot of weight in the opinions of 300 retail investors, there are other sentiment tools that should be at your disposal. Fortunately, these indicators continue to suggest that short-term traders and investors are shifting from extreme pessimism to a more optimistic mindset, but the optimism has not hit a euphoric extreme. Therefore, the "sentiment cycle" remains supportive. In addition to equity option players shifting out of negative sentiment extreme (discussed last week), a weekly survey from the National Association of Active Investment Managers (NAAIM) suggests these managers are increasing their equity allocations.

A risk to the bullish case, or potential headwind that we see, is the positioning of volatility players, who recently reduced their CBOE Volatility Index (VIX - 12.13) futures short exposure, according to the latest Commitment of Traders (CoT) report. This is occurring with the VIX trading around its calendar-year low. With roughly 40% of outstanding VIX call contracts expiring last week, some of which might be hedges to short VIX futures positions, the urge to cover could grow in the coming days, sending volatility higher and stocks lower.

There are a couple of observations worth noting that might mitigate the risk we just identified. First, June and July VIX futures were carving out new lows late last week, so the urge to cover a short VIX futures position is reduced. Plus, with VIX call activity robust, many short volatility players could be replacing hedges, indicating they are not looking to cover short VIX futures positions in the immediate future.

CoT Report (Large Speculators) -- VIX futures players in covering mode?



Target Effortless Triple-Digit Gains Every Sunday Evening For Life!

This is your chance to triple your profit potential on Sunday evenings, without spending all your free time watching the market.

On Sundays, as a Weekend Plus subscriber, you’ll get up to 6 trades every Sunday, each targeting gains of 200% or more.

Start targeting gains like the ones our subscribers have seen recently, including:

213.3% GAIN on AutoNation calls
100.0% GAIN on Monster Beverage calls
100.4% GAIN on Walgreens Boots Alliance puts
100.4% GAIN on ON Semiconductor calls
257.7% GAIN on Dell calls

101.0% GAIN on Apollo Global Management calls
103.6% GAIN on JP Morgan  Chase calls
105.3% GAIN on DraftKings calls
101.3% GAIN on Airbnb calls
203.0% GAIN on Shopify calls
102.0% GAIN on Cboe Global Markets calls
100.9% GAIN on Boeing calls
102.1% GAIN on Microsoft puts
102.3% GAIN on First Solar calls
101.5% GAIN on PulteGroup calls
101.0% GAIN on Apple calls
209.4% GAIN on NXP Semiconductors calls
100.8% GAIN on Uber Technologies calls
100.4% GAIN on Academy Sports and Outdoors puts
102.2% GAIN on Trade Desk calls
100.8% GAIN on DoorDash calls
100.0% GAIN on Camping World Holdings puts
100.0% GAIN on Cboe Global Markets calls
100.2% GAIN on C3.ai calls
238.5% GAIN on Oracle calls



Rainmaker Ads CGI