Here is Some Music to the Ears of Contrarians

The Russell 2000 Index (RUT) and S&P 400 MidCap (MID) are dancing with familiar levels

by Todd Salamone

Published on Nov 29, 2014 at 9:32 AM
Updated on Jun 24, 2020 at 10:16 AM

U.S. benchmarks spent the holiday-shortened week churning to higher highs, despite a mixed bag of economic data and an end-of-week plunge in oil prices. However, as Schaeffer's Senior VP of Research Todd Salamone notes, the mood on the Street is less than euphoric -- which could signal sidelined cash to drive additional gains.

  • The pessimistic tone of some of the most influential voices
  • Evidence that equity option buyers are turning sour
  • 19 of the "most impressive" retail stocks to watch this week

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: Sentiment Remains Less than Euphoric
By Todd Salamone, Senior VP of Research

"Wilbur Ross, Jr., a shrewd investor known for turning around failed companies, went on CNBC to say that 'markets are living on borrowed time.' And an article in Street Authority profiled the cautionary views of V. Prem Watsa, the CEO of Fairfax Financial, a Toronto-based insurance holding company often compared to Berkshire Hathaway. Watsa contends that stocks could suffer as economies enter into a period of deflation which will be aided by central bank money tightening. The executive is playing this theme through derivatives that pay off should consumer prices decline. Like Watsa, Ross, in his CNBC appearance, also mentioned his concerns about deflation, as well as geopolitical risks as the catalysts that can drive stock prices downward."

-Barron's, Nov. 17, 2014

"JPMorgan Chase & Co. told investors to dump U.S. equities in favor of their European counterparts. The brokerage cut its rating on U.S. stocks to underweight, similar to a sell recommendation, from the equivalent of buy ..."

-Bloomberg, Nov. 17, 2014

"Goldman Sachs, whose ideas and actions help to set Wall Street's tone, is telling clients the Standard & Poor's 500 index will barely rise in 2015. Goldman is forecasting that the benchmark index, now around 2050, will climb to 2100 by the end of next year, implying a gain of just 2.34%, and a total return of 5%."

-Barron's, Nov. 22, 2014

"... the burden of proof is on the bears, with the SPX and Dow Jones Industrial Average (DJI - 17,810.06) continuing to carve out new all-time highs during a bullish seasonal period, and sentiment generally supportive of the bullish case ... the Russell 2000 Index (RUT - 1,172.42) and S&P 400 MidCap Index (MID - 1,444.39) have still not pushed above resistance at 1,180 and 1,450, respectively. At the very least, this would suggest that the outperforming large-caps should continue to be emphasized from the long side."

-Monday Morning Outlook, Nov. 22, 2014

The mood among most investors is not necessarily the doom and gloom that existed at the market bottom in March 2009, or even that of mid-October when the S&P 500 Index (SPX - 2,067.56) was experiencing a near-10% correction. However, the excerpts above pretty much capture the present investing environment, which is one of strong price action amid a sentiment backdrop that is not exactly euphoric with respect to the outlook for U.S equities, especially among some of the more influential voices on Wall Street.

This should be music to the ears of bulls with a contrarian investing approach, as the risk-reward environment hasn't changed a whole lot from what we have observed during the past couple of years -- in which pullbacks have been plentiful but shallow, with a heap of sideline money, corporate buybacks, and short covering powering the market to new highs, nonetheless.

Speaking of corporate buybacks, and pertinent to the upcoming month, a Reuters article published last month that we shared with you in our Nov. 15 report suggests corporate buyback activity in recent years has tended to be stronger than most other months in December, per Goldman Sachs research.

Moreover, we have indeed seen evidence of short covering, with a slight decline in SPX component short interest in the most recent report, which is data as of mid-November. Per the chart below, note that short interest on SPX component names is still relatively high, nearer the top of its range during the past couple of years, with plenty of room to fall to the low end of this range.

Short Interest on SPX Stocks Since January 2011


Like last week, a couple of other sentiment indicators that we closely monitor are again at odds with each other. For example, after reducing equity exposure two weeks ago -- a potential headwind if this were to continue -- active investment managers again increased their exposure to equities, as observed in the weekly National Association of Active Investment Managers (NAAIM) survey. Given the volatility in their reported exposure from week to week, the below chart graphs this group's exposure with a 10-week moving average to smooth the data. Note how this moving average troughed at a lower level, but is presently turning higher, indicative of a group in accumulation mode.

NAAIM Sentiment since March 2009 Trough

However, in the options market, equity option buyers have slightly soured on the market, with the customer-only, equity-only, 10-day moving average of the buy (to open) put/call volume ratio turning higher once again. Ideally, bulls would like to see this ratio continue lower from the climactic peak that occurred at the recent bottom.

But unlike the last time this ratio rolled higher, active investment managers are not in distribution mode. Plus, the pricing of out-of-the-money put options relative to call options on the SPDR S&P 500 ETF Trust (SPY - 207.20) -- as gauged by the put/call implied volatility skew -- is not nearly as high as it was before the latest pullback in the stock market (second graph below). In the absence of a technical breakdown and confirmation from other sentiment indicators, the put/call volume indicator has us on alert for a potential pullback, but not yet seeking shelter from a meaningful pullback.

Equity buy (to open) put/call volume ratio -- not a sharp uptick, but noted as a short-term risk. It is not being confirmed by other indicators as bearish in its implications.

10-day equity-only BTO put-call volume ratio with SPX since 2013

SPY implied volatility skew -- out-of-the-money put options not abnormally expensive relative to calls, a condition that has been present at recent peaks

SPY 10-day moving average on out-of-the-money put-call skew
Chart courtesy of amcharts.com

The Russell 2000 Index (RUT - 1,173.23) and S&P 400 MidCap (MID - 1,442.63) are trading at resistance levels we have discussed: 1,180 and 1,450, respectively. The MID did advance above previous 2014 highs, but the half-century 1,450 mark is still not comfortably behind it. Therefore, we continue to emphasize larger-cap stocks. If the SPX finally gives way to its presently overbought condition as optimism among equity option speculators fades, look for the 2,020-2,030 area to be potentially supportive. The 2,020 area is the approximate site of its 30-day moving average and the mid-September high, with 2,033 marking its 10% year-to-date gain.

SPX with 30-day moving average -- a trendline that was supportive in April through July, and currently around the September peak

SPX with 30-day moving average since February 2014

Indicator of the Week: The Market's Reaction to Black Friday
By Rocky White, Senior Quantitative Analyst

Foreword: Black Friday -- and a term I heard for the first time this year, Grey Thursday -- marked the unofficial beginning to the holiday shopping season. Undoubtedly, we'll see tons of reports about the length of lines at stores, and how strong or weak sales were. Those reports will surely come with commentary about what it tells us about the strength of the consumer and the economy in general. In other words, this might be a good week to use as an indicator on what to expect going forward. I've gathered some data on the returns the week after Black Friday, and how the market has done going forward.

This Week's Reaction : The table below shows how the S&P 500 Index (SPX) has done for the rest of the year, depending on how the week after Black Friday does. December is a pretty strong month, and the returns are pretty good in either case. However, the SPX has outperformed when this coming week is positive, compared to when it's negative. If the week after Black Friday is positive, then the rest of the year has averaged a gain of 1.90%, and has been positive 87% of the time. When the week after Black Friday has been negative, the average return is lower -- 0.88%, with 78% of them positive.

SPX Rest-of-Year Returns Since 1990 When the Week After Black Friday is Positive vs Negative

The difference is much more prominent when you look further out. The chart below looks at how the SPX has done from now through the end of February (about three months), depending on the week after Black Friday. When the market has been down this coming week, then the index averages a loss of 1.70%, and is positive 56% of the time. When the market is positive, then the next three months average a 4.31% gain, and are positive 80% of the time. This data does give some validity to the theory that this week provides a good forecast for next three months.

SPX Three-Month Returns Since 1990 When the Week After Black Friday is Positive vs Negative

Stocks to Watch This Week: Retailing stocks are, of course, the big focus every holiday season. I went back the last 10 years to see which retailers have a tendency to do well this coming week. Deckers Outdoor Corp (NYSE:DECK) has been the most impressive, showing gains every single year for the last 10 years in the week after Black Friday -- and averaging an increase of 9.63% for the week. The table below shows liquid retailing stocks that have been positive at least half the time over the last 10 years in the week after Black Friday. If you're looking for some short-term ideas, these stocks seem to impress investors in the immediate aftermath of Black Friday.

Best Retailing Returns in Black Friday Week

This Week's Key Events: All Eyes on Friday's Payrolls Report
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

  • Starting off the week will be the Institute for Supply Management's (ISM) manufacturing index and Markit's flash purchasing managers manufacturing index (PMI). Mattress Firm (MFRM) and Shoe Carnival (SCVL) will present earnings.

Tuesday

  • Auto sales data and construction spending make up Tuesday's docket. Bob Evans (BOBE) and OmniVision (OVTI) will dive into the earnings pool.

Wednesday

  • The Federal Reserve's Beige Book, productivity and labor costs, the monthly ADP employment report, the ISM non-manufacturing index, and the regularly scheduled crude inventories come out on Wednesday. For earnings, Abercrombie & Fitch (ANF), Aeropostale (ARO), Avago Tech (AVGO), Guess? (GES), and PVH (PVH) will report.

Thursday

  • Weekly jobless claims will come out on Thursday. American Eagle (AEO), Barnes & Noble (BKS), Dollar General (DG), Express (EXPR), Finisar (FNSR), Five Below (FIVE), Kroger (KR), and Smith & Wesson (SWHC) will step into the earnings confessional.

Friday

  • November's nonfarm payrolls report and unemployment figures, the international trade balance, and factory orders close out the week's economic news. Big Lots (BIG) will reveal its earnings.

And now a sector of note...

Semiconductors
Bullish

Tumbling oil prices are dominating headlines, and were being trumpeted late last week as a win for the consumer -- and potentially retailing stocks, which rallied impressively in November, as evidenced by the SPDR S&P Retail ETF's (XRT) 6.6% month-to-date advance. Meanwhile, semiconductors are performing even better, as measured by the Market Vectors Semiconductor ETF (SMH), which tacked on 8% this month. In fact, since gapping above the key $50 area in late October, the ETF has continued its impressive uptrend, taking out the $53.90 level this past week -- which is 20% above its mid-October closing low of $44.92 -- and tagging a 13-year high of $55.75 on Friday. What's more, on Wednesday, SMH jumped above a trendline that has connected higher highs since July.

Despite this strong technical backdrop, the average short interest-to-float ratio for the 55 names we track in the sector is a steep 8.3% -- translating into more than a week's worth of pent-up buying demand, at typical daily trading volumes. Drilling down on specific names, Analog Devices, Inc. (NASDAQ:ADI) received a positive reaction to its earnings report last week, and is now up more than 28% from its early October low. Nevertheless, it would take nearly a week to cover all of ADI's shorted shares, at average daily trading volumes. Should the sector continue to shine, a mass exodus of bears could translate into additional upside for SMH and the individual components that make up the basket.

Daily Chart of SMH since November 2013

A Schaeffer's 39th Anniversary Exclusive!

8 Top Stock Picks for 2020

Access your FREE insider report before it's too late!


  
 
 

Partnercenter