Why Sentiment, Buybacks Could Support the Market

A historical look at S&P 500 Index (SPX) bounces following sharp pullbacks

Senior Vice President of Research
Nov 15, 2014 at 9:38 AM
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Over the past five days, the momentum of the major market indexes has slowed compared to previous weeks. Nevertheless, the Dow Jones Industrial Average (DJIA), S&P 500 Index (SPX), and Nasdaq Composite (COMP) ended Friday north of where they sat the previous Friday -- meaning that they've each scored four straight weekly wins. Looking ahead, there's plenty on the upcoming economic calendar, including the latest minutes from the Federal Open Market Committee (FOMC) meeting, due out Wednesday afternoon; plus, November-dated options expire on Friday. However, as Schaeffer's Senior VP of Research explains below, volatility should be fairly modest compared to what we saw last month.

  • How corporate actions may factor into seasonal support
  • Why volatility should be modest next week, compared to October's expiration week
  • Rocky White analyzes a rare S&P 500 signal that could bode well for stocks

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: A Closer Look at Seasonal Support
By Todd Salamone, Senior VP of Research

"... 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 ... 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 ... 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."

"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."

-Monday Morning Outlook, Nov. 8, 2014

"The average U.S. equity mutual fund through Tuesday was down 2.3 percent on the year, according to Morningstar data, trailing the S&P, which is up a meager 0.8 percent."
-Reuters, Oct. 16, 2014

"November buybacks would by no means be a novelty. Goldman Sachs data show that in the last seven years, excluding 2008, November accounted for about 14 percent of the yearly buyback activity, the most for any month. About 8 percent of buybacks happened in October during that period and 10 percent in December."
-Reuters, Oct. 17, 2014

The market's momentum higher off the lows has visibly slowed, but nonetheless, the S&P 500 Index (SPX - 2,039.82) and Dow Jones Industrial Average (DJI - 17,634.74) carved out new highs again last week, while the Nasdaq Composite (COMP - 4,688.54) achieved another multi-year high on its march toward 5,000.

Smaller-capitalization benchmarks, such as the Russell 2000 Index (RUT - 1,173.81) and S&P 400 MidCap (MID - 1,430.85), progressed higher from last month's lows, but the MID stalled for the third time this year in the 1,450 zone, just short of all-time-high territory. The RUT rallied up to 1,180 this week, site of at least two short-term peaks this year, and still has the 1,200 century mark lingering overhead, site of its all-time high in July. While these two benchmarks continue to lag on a year-to-date basis, they led the initial rally off the October bottom and haven't been underperforming -- perhaps to the dismay of some bears, who have cautioned that underperformance in these groups points to a coming market malfunction. That said, both the RUT and the MID have yet to sustain a move above previous chart highs, which likely gives the bears hope.

Daily YTD Chart of SPX -- new all-time highs this week ... but is 2,050 half-century mark the next speed bump?

Daily Chart of SPX Since January 2014 with Potential Resistance at 2,050

Daily YTD Chart of RUT -- chart resistance and round-number 1,200 level just overhead, in the context of a major trading range in 2014

Daily Chart of RUT Since January 1999

The slowing momentum off the October low is not a major surprise, as various resistance levels have come into play on benchmarks that have become technically "overbought," and this is still true as we move into November expiration week. Last week, however, we suggested that stocks might be able to shake off overbought readings with undue harm, with sentiment continuing to shift away from the pessimistic extreme that we observed in mid-October. This sentiment shift is still supportive of equities, as the 10-day equity-only buy-to-open put/call volume ratio continues to head south and has the potential of declining further (see chart immediately below).

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

Moreover, active investment managers are still increasing their exposure to equities after exposure among this group hit a three-year low in mid-October. This bunch is not yet at an extreme in terms of long positions, but they are near an extreme, suggesting there is only a little bit left in the tank from this group to drive stocks at this particular juncture.

Seasonality continues to favor the bulls, but if it isn't short-covering or active investment managers buying stocks, what else might support the market at this juncture? Per the Reuters excerpt above, 'tis the season for corporations to buy back shares, as November and December have been popular months for such activity. This does not necessarily mean corporations will buy back shares that are trading at recent highs, but if past is prologue, it would argue that there is a pretty firm layer of support via buyback activity.

Also, with many fund managers trailing the SPX in mid-October, and likely missing out on the biggest advances off the lows, more risk-taking in an effort to produce outperformance is a scenario that could play out during the next few weeks, as fund managers try to position their portfolios for acceptable year-end results.

Finally, expiration week is next week, and as we usually do, we will take a look at the open interest configuration on the S&P 500 ETF Trust (SPY - 204.24) to shed light on what levels could be important in the upcoming week.

Unlike when we entered October expiration week, there is not the massive put open interest at strikes immediately below the current SPY level. This means there is not the short-covering potential related to put open interest that is set to expire next week. But then again, there is not as much potential for the accelerated (delta-hedge) selling that tends to occur around or during expiration week, when big put strikes are broken and other large put open interest strikes act as magnets.

In other words, from an options-related perspective, there is less probability of a sudden surge in volatility this expiration month relative to what we saw last month, when the SPY broke beneath strike prices with anywhere between 200,000 and 500,000 open put contracts -- which forced sellers of those puts to sell SPX futures to maintain a neutral position.

In fact, a more probable scenario for next week is the SPY trading between the 202 and 205 strikes, as sharp gains continue to be digested.

SPY Open Interest Configuration for 11/22 Series

Indicator of the Week: Stocks Pulled Back Sharply, Then Bounced
By Rocky White, Senior Quantitative Analyst

Foreword: Last month, the S&P 500 Index (SPX) barely missed out on the 10% correction that everyone has been waiting for (it was down 9.8% from the all-time high to the low). Less than three weeks later, it was back to all-time highs. In fact, going all the way back to 1928, it was the only time the index went from an all-time high to a six-month low and back to an all-time high in less than two months. Obviously, there are not prior instances of that exact signal, but we can look more generally at historical returns following sharp pullbacks and rallies to see if the market has tended to keep rallying or fall back to those lows.

Sharp SPX Pullback Followed by Bounce

Pullback, Then Rally: Here's one general way I defined a pullback and rally. On a closing basis, I looked at times when the SPX reached a 52-week high, then pulled back to a two-month low, and less than one month after that, overtook the recent 52-week high again. Interestingly, this signal has happened four times in 2014. It did not happen more than once in any other year since 1928, so it has been a pretty unique market environment this year.

The first table below shows how the SPX has done after these signals. These signals have preceded pretty strong market returns over the next few months. Three months after a signal, the market has gained an average of almost 5%, and is positive 82% of the time. Typically, the market gains 1.77% in three months and is positive 62% of the time.

SPX After V-Bottom vs Anytime

Here's another way I defined a pullback/rally signal, which yielded more occurrences. This time, to generate a signal, the SPX had to make a three-month high, and then fall at least 7% from there. Then, the index had to move back above recent highs. Also, the SPX had to be up at least 10% over the past year -- so these occurrences happened in an uptrending market, like we're in now.

The table below summarizes the index's returns after these signals. The average returns aren't quite as bullish as the ones above, but they still outpace typical market returns. One thing that's interesting: Because the market recently pulled back hard, you might think it would be susceptible to falling back to those lows. However, the average negative return after these signals is lesser in magnitude than the typical average negative return. That suggest stocks are less prone to sharp pullbacks after just experiencing one.

SPX After V-Bottom in Uptrending Market

This Week's Key Events: Inflation Data and Fed Minutes in Focus
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.


  • The Empire State manufacturing index, along with reports on industrial production and capacity utilization, will kick off the week. Agilent (A), JD.Com (JD), Tyson Foods (TSN), and Urban Outfitters (URBN) will report earnings.


  • On Tuesday, the producer price index (PPI) and core PPI, the National Association of Home Builders (NAHB) housing market index, and Treasury International Capital (TIC) data are on the docket. Stepping into the earnings confessional will be Home Depot (HD), Dick's Sporting Goods (DKS), JA Solar (JASO), Medtronic (MDT), and TJX Companies (TJX).


  • Wednesday's docket is highlighted by the minutes from the latest Federal Open Market Committee (FOMC) meeting, plus data on housing starts, and the regularly scheduled crude inventories report. Keurig Green Mountain (GMCR), J.M. Smucker (SJM), Lowe's (LOW), Salesforce.com (CRM), Staples (SPLS), and Target (TGT) will unveil earnings.


  • Weekly jobless claims, the consumer price index (CPI) and core CPI, the Philadelphia Fed's manufacturing survey, and existing home sales make up Thursday's docket. Companies presenting earnings will be Aruba Networks (ARUN), Best Buy (BBY), Dollar Tree (DLTR), GameStop (GME), Gap (GPS), JinkoSolar Holding (JKS), Marvell Technology (MRVL), Mobileye N.V. (MBLY), and Splunk (SPLK).


  • There are no notable economic reports on Friday. Foot Locker (FL) will announce earnings.

And now a sector of note...


The Semiconductor Industry Association reported better-than-expected September sales gains of 12.6% sequentially, and 8.1% annually. Accordingly, a bevy of semiconductor names recently reported in-line or stronger-than-anticipated third-quarter earnings, confirming solid chip demand. Despite the strong fundamentals for the group, the average short interest-to-float ratio for the 54 names we track in the sector is a steep 8.9% -- 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 27% over the past year, and is holding steady north of the round-number $50 level -- which roughly corresponds with half its all-time high. Ushering the shares into the black have been their 20-week and 50-week moving averages. The former trendline has ascended into the aforementioned $50 region, and the latter contained the exchange-traded fund's (ETF) mid-October pullback. We expect SMH to extend its journey higher during the near term, as semiconductor stocks continue to benefit from robust demand and the unwinding of skepticism among market players.

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

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