Monday Morning Outlook: Why Bulls Should Stand Pat

The November-through-April time period is historically bullish for the S&P

by Todd Salamone

Published on Nov 8, 2014 at 9:38 AM
Updated on Apr 20, 2015 at 5:32 PM

It was another solid week on Wall Street, with the major market indexes assailing new heights after Republicans swept the midterm elections -- often seen as a boon for business. In addition, stimulus hints from across the pond added fuel to equities' fire, and a mixed jobs report on Friday ultimately resulted in a wash, although both the Dow Jones Industrial Average (DJI) and S&P 500 Index (SPX) managed to eke out fresh record closing highs. However, while the sentiment backdrop remains favorable for bulls, a slew of indexes are staring up at potential speed bumps, as Schaeffer's VP of Research Todd Salamone highlights below.

  • The new millennium mark on the radar
  • The pair of sentiment indicators we're watching
  • How the last six months likely bode well for stocks through April

Finally, we close with a preview of the major economic and earnings events for the week ahead, plus our featured sector.

Notes from the Trading Desk: Key Benchmarks Prepare for Battle Against Technical Resistance
By Todd Salamone, Senior VP of Research

"... the S&P 500 Index (SPX - 2,018.05) and the related exchange-traded fund (ETF), the SPDR S&P 500 ETF Trust (SPY - 201.66), are back to their respective August-September highs that preceded the near 10% correction that unnerved many market participants ... the sentiment backdrop continues to be supportive of the equity markets, which was NOT the case when these benchmarks first rallied up to these potential resistance levels in August and September.

... it is worth mentioning that a 10% year-to-date (YTD) gain on the SPX is at 2,033, and a 10% YTD gain on the SPY is at 203.16. Remember -- and this is a topic we have observed before -- round numbers and round-number percentage gains have been extremely important in terms of identifying potential short-term pivot levels."

-Monday Morning Outlook, Nov. 1, 2014

"$SPX triple '09 closing low is 2,029.59, fwiw - the exact high so far today"
-@ToddSalamone on Twitter, Nov. 6, 2014

Bulls continue to be in control, with the S&P 500 Index (SPX - 2,031.92) logging another all-time high on Friday, and advancing further above the round 2,000 millennium mark and its mid-September peak. Moreover, the Dow Jones Industrial Average (DJI - 17,573.93) distanced itself further above the 17,000 millennium mark into record-high territory. That said, the SPX is again facing potential resistance overhead, with the round-number 10%, year-to-date gain level situated at 2,033, and the 2,030 area representing triple its 2009 closing low. Moreover, the 2,050 level represents yet another layer of resistance, as it is a half-century mark that is situated 10% above last month's closing low.

Potential SPX resistance comes into play coincident with the SPX's 9-day relative strength index (RSI) climbing back into overbought territory above the 70 zone. When markets are trending, overbought and oversold indicators mean very little, but the last time this indicator reached overbought -- in late August -- the SPX traded sideways for about three weeks. But then again, the market continued to climb higher when this indicator was in "overbought" territory in May. The good news for bulls, and as you will see in our sentiment backdrop discussion later, there is a good chance that "overbought" will persist in the weeks ahead as the market grinds higher.

Daily Chart of SPX Since January 2014 with 10% YTD Breakeven and YTD Breakeven

Meanwhile, the Nasdaq Composite (COMP - 4,632.53) is slowly inching closer to the 5,000 millennium mark and its record high of 5,132.50, which occurred in March 2000. In fact, the COMP spent much of the week trading sideways in the vicinity of the 4,618 level, which is 10% below the COMP's all-time high-water mark. That said, the COMP is sitting above 4,543, which is less than 10% below its 5,048.62 all-time closing high. Moreover, this past week's low at 4,594.92 was in the vicinity of the COMP's 10% year-to-date gain level.

With the COMP eyeing the 5,000 millennium level once again, note that the current advance is not anything like the parabolic rally that generated euphoria in late 1999/early 2000, when it surged from 3,000 to 5,000 in only five months. It was back in March 2012, more than two-and-a-half years ago, that the COMP hit 3,000 for the first time since the technology bust, and we are still hundreds of points below 5,000 at present.

Monthly Chart of COMP Since January 1999

The S&P 400 MidCap Index (MID - 1,430.07) and Russell 2000 Index (RUT - 1,173.32) continue to lag larger-cap and technology names, and are also sitting in the vicinity of potential resistance -- with the RUT trading just a shade above its 2013 close at 1,163.64, but just below the January and early-September closing highs around 1,180. That said, a first layer of potential support for the RUT is at its 2013 close, with another layer at 1,150-1,155, which is an area that is 10% above the mid-October closing low. What's more, this level is the equivalent of the key 115 strike on the iShares Russell 2000 Index ETF (IWM - 116.71), where there is significant call and put open interest among options with a November expiration date, which is only two weeks away. Like other key benchmarks, the MID is set to do battle with chart resistance in the 1,450 half-century mark area, from where pullbacks in July and September began.

Daily Chart of RUT Since January 2014 With YTD Breakeven and Jan/Sept highs

As we discussed last week, with multiple broad-market indexes climbing from the depths of their respective October lows, potential short-term resistance levels have come into play along the way, but have been taken out. This is due to a sentiment backdrop among traders that continues to shift from one of extreme pessimism to less pessimism, implying short covering and/or small doses of money are moving from the sidelines and generating a bid for stocks.

For bulls, this is encouraging, as short-term indicators indicate that there is less pessimism, and not yet the optimism that tends to surface prior to short-term trading ranges and eventual pullbacks. With sentiment improving, after hitting a negative extreme a few weeks ago, it paints a bullish backdrop for stocks, even though potential speed bumps could slow the momentum off the lows -- but not necessarily stifle the advance.

A near-term risk we alluded to earlier is the short-term overbought condition of the SPX. Per the below graph, which quantifies sentiment among equity option buyers, note that pessimism is receding at present, as evidenced by the declining equity-only, buy-to-open, put/call volume ratio (purchased puts are bets against a stock, while purchased calls are bets that a stock will advance). In May, the direction of this ratio was headed lower from an extreme high, and this is a period in which the SPX ignored its short-term overbought reading and continued to trend higher.

This is in contrast to the early September period, when the SPX was overbought and trading at technical resistance. The ratio began turning higher, signaling growing pessimism, which proved to be a difficult time for the equity markets.

Equity option buyers -- growing less pessimistic, but not exactly enthusiastic, either. The current sentiment backdrop is supportive of equities.

10-day equity-only buy-to-open put-call volume ratio with SPX since 2013

Moreover, the National Association of Active Investment Managers (NAAIM) weekly survey, which summarizes the equity exposure among this group of market participants, reveals that this group is in a state of equity accumulation and not quite at an extreme, but getting there. Exposure has already moved sharply from the lows, suggesting that a continued advance won't be as sharp as observed in recent weeks. However, bulls would like to see this group stay in accumulation mode, even if this occurs at a slower pace.

We will keep a close eye on both of these sentiment indicators in the days ahead, as a change in the sentiment backdrop would likely foreshadow a change in the current direction of equities. At present, however, the sentiment backdrop continues to be supportive of equities.

NAAIM weekly survey -- Active fund managers have sharply increased equity exposure from three-year lows and appear to be in accumulation mode. An extreme in exposure has not yet been reached

NAAIM Exposure Index with SPX over past two years

Indicator of the Week: November-to-April Returns
By Rocky White, Senior Quantitative Analyst

Foreword: The S&P 500 Index (SPX) was up just over 7% in the six months ending in October. That's a pretty good return, especially considering the May-through-October six-month returns have historically been the weakest on the calendar for stocks. If stocks continue to outperform their past returns, the next six months should be great for stocks. The November-through-April six-month period has been the best for stocks over that time period.

Six-Month Returns: The table below shows how the SPX has performed during six-month periods since 1964 (past 50 years). I bolded the May-through-October returns, which have marked the worst six months of the year, averaging a return of less than 1%. As I mentioned earlier, we now head into the strongest six-month period for SPX returns, historically. November through April has averaged a gain of 6.63% over the past 50 years, and has been positive 76% of the time. Both of those stats are the best, compared to all other periods.

SPX Six-Month Returns Over Last 50 Years

The chart below compares the average six-month returns from May through October (the time frame just ended) to the average returns from November through April (the time frame just beginning). Historically, you can see the current time frame has, on average, struggled for the first few weeks of November before spiking higher the last part of the month. The average strength has continued through May, with a couple of notable weak periods, including the middle part of January and the last half of February.

SPX Average Six-Month Returns May-October vs Nov-April

Finally, below I look at how November through April has done depending on how the prior six months performed. As I mentioned earlier, over the last six months, the SPX has gained over 7%. That's good news for the upcoming six months, from a historical standpoint. When the index gains at least 5% from May through October, November through April has averaged a return of almost 10%. Furthermore, 86% of the returns have been positive.

SPX Nov-April Returns After Strong May-October

This Week's Key Events: Earnings Season Winds Down
Schaeffer's Editorial Staff

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

Monday

  • There are no notable economic reports on Monday. 3D Systems (DDD), Caesars Entertainment (CZR), Dean Foods (DF), Gogo (GOGO), Quicksilver Resources (KWK), Rackspace Hosting (RAX), and Sotheby's (BID) will present earnings.

Tuesday

  • On Tuesday, the U.S. bond market is closed for Veteran's Day. D.R. Horton (DHI) and Fossil (FOSL) will report earnings.

Wednesday

  • Wednesday's docket shows the latest wholesale inventories update. Reporting earnings will be Cisco Systems (CSCO), Canadian Solar (CSIQ), J C Penney (JCP), Macy's (M), NetApp (NTAP), Rocket Fuel (FUEL), and SeaWorld (SEAS).

Thursday

  • Weekly jobless claims come out on Thursday, along with the Labor Department's Job Openings and Labor Turnover Survey (JOLTS), the Treasury budget, and the weekly crude inventories update. Wal-Mart (WMT), Applied Materials (AMAT), Kohl's (KSS), Nordstrom (JWN), SINA (SINA), Tyco (TYC), Viacom (VIAB), Weibo (WB), and Youku Tudou (YOKU) will step into the earnings confessional.

Friday

  • Retail sales figures, import and export prices, the Thomson Reuters/University of Michigan consumer sentiment report, and business inventories make up Friday's docket. There are no notable earnings reports on the calendar.

And now a sector of note...

Semiconductors
Bullish

The semiconductor industry saw sales increase 12.6% month-over-month, and 8.1% year-over-year, in September -- better than expected -- according to the Semiconductor Industry Association. Furthermore, a slew of semiconductor names recently reported in-line or stronger-than-anticipated third-quarter earnings, underscoring solid demand for the industry. Among the 54 names under our "Semiconductor" umbrella, 57% are trading north of their 80-day moving averages. Plus, the average 52-week gain stands at 30.6% for this outperforming group. However, short interest represents 8.9% of the stocks' float, on average, translating into a week's worth of pent-up buying demand, at typical daily trading volumes. Should the sector continue to shine, a mass exodus of bears could translate into additional upside.

Reflecting the technical health of the industry, the Market Vectors Semiconductor ETF (SMH) has added roughly 28% over the past year, and is now trading north of the round-number $50 level -- which also represents half its all-time high. Ushering the shares into the black have been their 20-week and 50-week moving averages -- the former of which has ascended into the aforementioned $50 region, and the latter of which contained the exchange-traded fund's (ETF) mid-October pullback. We expect SMH to extend its journey higher, as semiconductor stocks continue to flex fundamental and technical muscle.

Chart of SMH since November 2012 with 20-Week and 50-Week Moving Averages

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