"...It is not a bad idea to be hedged or at least make preparations to hedge when necessary, as one risk to the market is a break of support potentially causing panic selling among unhedged longs and/or a sudden demand for portfolio protection, which could coincidentally push indexes lower than expected. And the cost of the hedge may prove to be very small in the context of the potential rally that we could witness if hedge funds begin increasing their leverage once again."
-- Monday Morning Outlook, January 24, 2015

For the first time in 2015, the S&P 500 Index (SPX - 2,096.99) experienced two consecutive closes above 2,058.90, its 2014 close. As we have pointed out in past discussions, this level has been worth keeping an eye on -- up until last week, a close at or just above this year-to-date (YTD) breakeven level was immediately met with selling. In fact, notching that second consecutive daily close in the green for 2015 wasn't an easy task for the SPX, as an intraday pullback from its highs was supported right at this YTD breakeven.

After this SPX breakout above its 2014 close, many indexes -- including the SPX -- now face another potential short-term hurdle from round-number levels, including 18,000 on the Dow Jones Industrial Average (DJIA - 18,019.35). However, the most notable is the S&P MidCap 400 Index (MID - 1,502.78), which is an area of the market that we recommend (mid-cap stocks). In fact, several weeks ago, we discussed the implications of a breakout above 1,450, which is the neckline of a bullish inverse "head and shoulders" pattern. The target remains a move to the 1,630 area by the end of June.

From a short-term perspective, however, note that the round 1,500 level is now in play for MID. Longtime readers of this column might remember how the 1,000 millennium mark acted as resistance for several months during 2011 and 2012. With the MID now at a round-number level that's also 50% above a major breakout area, it would be natural for profit taking to act as a headwind. The MID might be especially vulnerable to headwinds with other indexes nearing key round-number levels, too.

While on the round-number discussion -- quickly turning to another asset class -- note that the CBOE 10-Year Treasury Note Yield (TNX - 20.21) is bumping up against the round-number 20 level (equivalent to a 2% yield on 10-year Treasury notes). If 2% acts as a cap on yields, bonds will rally, and stocks would likely weaken. In early 2013, TNX moved back up to 20 (2%) from 15 (1.5%). It closed just barely above this level for a few weeks before yields plummeted back below 2% in March.

Turning back to equities, not to be forgotten is the Russell 2000 Index (RUT - 1,223.13), as it moved above the round 1,200 level and its YTD breakeven mark at 1,204.70. But there is work to be done, as its all-time closing high occurred in late December at 1,219.11, and the index comes into the shortened trading week around this potential resistance. Small-cap investors would like to see the RUT finally make a noticeable break above the 1,200-1,220 area, which has turned back all rallies since March 2014.

"Turmoil in Europe and an unprecedented decline in oil are complicating the guessing game around Federal Reserve rate increases, says Peter Cecchini at Cantor Fitzgerald LP...

'Investors are getting increasingly nervous about a potential selloff,' Bill Merz, a strategist on the derivatives and structured products team at U.S. Bank Wealth Management, said by phone...

Hedge funds and other large speculators have pared positions that profit should the VIX decline, increasing the balance of those betting on a higher VIX to the most since at least 2004...

'The fact you've got all these uncertainties makes you feel like there's better risk-reward to be net-long volatility than net short,' Justin Golden, a partner at Lake Hill Capital Management LLC in New York, said by phone Feb. 10."
-- Bloomberg, February 12, 2015

There has been a lot discussion in recent days about large speculators, which are usually hedge funds, moving into a net long position on CBOE Volatility Index (VIX - 14.69) futures. The Bloomberg excerpt may capture the drivers behind this, which appear to be fear and uncertainty. If this fear/uncertainty is being accurately portrayed, it would further support the notion that the drop-off in VIX futures call open interest -- which has been written about extensively in this space during the past few weeks -- could be driven by hedge funds reducing long equity exposure. During this period, the market has remained relatively resilient -- which is why we have suggested not disturbing long positions, but also maintaining a portfolio hedge in the event that continued unwinding of long equity exposure did technical damage to the market (which, thus far, has not been the case).

Something we haven't discussed, but which the excerpt from the Bloomberg article would imply, is that reducing long equity exposure might take place in the form of reversing short VIX futures positions that were put on in anticipation of lower volatility and higher stock prices. To the extent that hedge funds use VIX calls to hedge against a short VIX futures position or a long equity portfolio, it would make sense that VIX call open interest experiences a coincident drop.

Why is the fact that large speculators are net long, according to the Commitment of Traders (CoT) report, making a lot of noise? As you can see on the chart below, since the financial crisis, it has been a rare event for these investors to be net long, or looking for higher volatility. In fact, since 2011, it has happened on only three occasions, which is admittedly a small sample size.

However, our curiosity got the best of us, as to what both the SPX and the VIX did following instances when large speculators moved into a net long position. In the few instances that this has happened, volatility headed lower or rose modestly over the next two months, while stock prices (as measured by the SPX) soared. In two of the three instances, the SPX was higher and the VIX headed lower during the ensuing two-week and one-month periods, as well. Fortunately for bulls, the SPX's price action following the Jan. 20 "signal" looks more like the two-week period that followed the March 2011 and October 2014 signals, which produced healthy SPX returns. Specifically, the SPX rallied 1% in the two weeks following the recent Jan. 20 signal, and also rallied in the two weeks following the March 2011 and October 2014 signals.

In fact, those betting on volatility (as measured by the VIX) to move lower were happy to see the VIX close below 15.53, which is half its October 2014 intraday high of 31.06. The VIX's end-of-January closing low was 15.52, ahead of a nearly 50% pop into the first week of February.

The bottom line is that from a historical perspective, if large speculators move into a long position on VIX futures, it is far from a slam dunk that volatility will head higher and stocks lower. Therefore, we advise that investors continue not to disturb long positions. Traders should continue to be open to opportunities on both sides of the market, especially if you are short-term oriented, as one cannot rule out another retest of the SPX 2,050-2,060 area.

Read more:

Indicator of the Week: Why Presidents Day Could Spell Trouble for Stocks

The Week Ahead: FOMC Meeting Minutes, Wal-Mart Stores, Inc. Winds Down Earnings Season

"From a shorter-term perspective, the SPX is trading in a volatile, choppy range. Throughout January, in fact, a defined area of resistance was at the Dec. 31, 2014 close of 2,059 ... Support has been in the round number 2,000 region ... A concern for the bulls is that the SPX has spent more time in the 2,000 area, which is the bottom of the range. The risk is that buyers at this level eventually disappear, which would likely set up a test of the 10-month moving average in the 1,985 region..."

"...a review of several Commitment of Traders (CoT) reports reveals low levels of VIX, SPX and E-mini futures open interest, coincident with multi-year high levels of open interest in euro, gold, oil and copper futures contracts. This is still more evidence that suggests some hedge funds, particularly macro funds, are exiting positions in U.S. equities in favor of other assets, such as commodities and currencies."
-- Monday Morning Outlook, February 2, 2015

The technical scenario that we presented in our Feb. 2 report played out last week with respect to the S&P 500 Index (SPX - 2,055.47) breaking below the 2,000 level, setting up an intraday decline to the lowest levels of 2015. However, longer-term support came into play in the 1,985 region -- around the index's 10-month moving average -- from which a furious rally began, proving once again the significance of this trendline.

The SPX behavior that we are observing looks very similar to the beginning of the year -- a decline to the vicinity of a key round-number area and long-term moving average, followed by a sharp rally to its year-to-date breakeven point at 2,058.90 -- a volatile, choppy range. Moreover, the importance of half-century marks on the SPX (a topic we have discussed in prior reports) remains a theme, with the index for the most part stalling in this area since it was first touched in November. Bigger picture, however, the bulls are happy to see the SPX continue in a low-volatility uptrend amid volatile headlines, with support from its 10-month moving average.

In a week's time, we have moved from the SPX trading just above potential support from the round-number 2,000 area and its 10-month moving average to the SPX trading back in the vicinity of the half-century 2,050 zone and its 2014 close at 2,058.90, an area that marked peaks in early and late January. Coincidentally, as the SPX hits resistance, the Russell 2000 (RUT - 1,205.46) and the S&P MidCap 400 Index (MID - 1,476.89) are trading around round-number century marks at 1,200 and 1,500, respectively.

The MID quietly achieved new all-time highs last week, but has never touched 1,500, which we suspect will act as resistance. The 1,500 century mark is 50% above the 1,000 level that capped multiple rallies in 2011 and 2012, so those who bought the 1,000 breakout will likely reduce exposure at a 50% gain.

Meanwhile, the RUT has failed to sustain a move through 1,200 since it first touched this level in March 2014. The 1,200 level is roughly triple the 2008-2009 lows in the vicinity of 400, and looks very much like the resistance that took hold on the MID at 1,000 a few years ago.

Last week, the CBOE Volatility Index (VIX - 17.29) peaked at 22.81, right below two key levels, in our view -- 23.28, which is 50% above its 2015 low, and 23.64, representing double the late-2014 low. That said, the VIX has not moved below 15.50, its late-January low, which is also half the 2014 peak. Thus, it is too soon to declare that the higher volatility that we are witnessing in 2015 is over.

Speaking of the VIX, a theme we have discussed the past few weeks has been the extremely low call open interest. While VIX call volume picked up a little this past week, our theory has been that hedge funds that use VIX calls as portfolio protection have reduced equity exposure, and thus do not need as many VIX calls to protect their equity portfolio. We went on to suggest that these same funds may be viewing opportunities elsewhere – such as bonds, currencies, and commodities. An article in The Wall Street Journal on Friday morning, entitled "Computer-Driven, Automatic Trading Strategies Score Big," [subscription required] supports this theory:

"Hedge-fund managers who employ complicated, automatic-trading strategies made millions off the wild swings in currency and commodity markets in recent weeks, investors said."

"In many cases, they ramped up bets on the momentum against the euro and reaped a huge win when the Swiss National Bank removed its currency peg, pushing the euro down deeper. They also have capitalized on what was until recently a consistent plunge in oil prices without worrying about when they would hit a bottom. The volatility is a rare treat for automated traders, who make their livings jumping on markets moving out of sync but have been stymied by the placid markets since the crisis and years long march higher for U.S. stocks and other related assets."

The implication for the stock market is that a powerful segment of market participants is not as actively engaged in the equities market, reducing liquidity and resulting in higher volatility. Therefore, the market may face stronger headwinds relative to last year, especially when resistance areas are approached. This is not to say that this is the end of the bull market, as the latest pullback proved that there are still willing buyers -- whether this is in the form of corporate buybacks, retail inflows, short covering, or traders playing the range. In fact, from a bigger-picture perspective, equities have remained remarkably resilient amid a plunge in oil prices, plus Fed and overseas uncertainty, particularly in Europe and China. So for this reason, we advise longer-term investors to remain long, but still have those portfolio hedges in place.

Our short-term sentiment indicators are giving mixed signals at the moment, with the buy-to-open equity put/call ratio moving lower from a relatively high level, which historically has bullish implications. However, weekly data from the National Association of Active Investment Managers (NAAIM) survey shows managers reducing equity exposure from a relatively high level, which is a potential headwind.

Therefore, short-term traders should have both long and short exposure, looking to add short exposure nearer the top of the range, and continue to either lengthen or shorten your typical time frames amid this choppy, volatile range.

Read more:

Indicator of the Week: The Super Bowl and Randomness

The Week Ahead: Retail Sales, Earnings from The Coca-Cola Company, Cisco Systems, Inc., and Tesla Motors, Inc.

It was a disappointing January for bulls. In fact, for only the third time since 1979, the Russell 2000 Index (RUT - 1,165.39) did not experience a single daily close above the previous year's close for the entire month. The only two other times this occurred was in 2005, when the RUT went on to rally 7% into year-end 2005, and in 2008, when the RUT lost an additional 26% into year-end 2008.

(In January 2008, the RUT was in far worse technical condition than 2005, with the index closing below its 40-month moving average in January 2008. Today's technical backdrop is more like that of 2005.)

The January Barometer suggests that as January goes, so goes the rest of the year. Rocky White, our Senior Quantitative Analyst, discussed this subject in detail last week in a study he ran on the Dow Jones Industrial Average (DJIA - 17,164.95).

As a reminder, with the DJIA finishing with a negative return in January, historical data suggests that the probability decreases that the rest of the year will be positive relative to years when the month of January is positive. That said, despite a negative January, it is still slightly better than a coin flip that the rest of the year finishes positive, according to Rocky's research (summarized in the table immediately below). Therefore, bulls should not necessarily throw in the proverbial white towel just because January was negative -- but at the same time, the risk of a double-digit decline through year-end has increased.

Lost amid the "bearish" tone when negative Januaries occur is this: In the years in which the February-December period produced positive returns after a negative January, the average return was 13.5% -- just slightly less than the 14.1% mean return when January is positive. So, it might "bear" repeating what Rocky suggested last week, which is that the January Barometer indicator does not give one a statistical edge over a "buy and hold" strategy.

The January Barometer indicates roughly a 50/50 chance of a double-digit decline from now until year-end, and understandably, this may not sit well with most of you. But, with the S&P 500 Index (SPX - 1,994.99) still displaying a nice uptrend with support from its 10-month moving average, as well as the "coin flip" odds of a double-digit February-December advance, according to this indicator, we currently advise not disturbing long positions.

That said, the SPX is sitting just above a critical level that, if broken, could lead to additional weakness in the days ahead. If the 10-month moving average is breached, we could see a move down to at least 1,900, or the August 2014 low.

From a shorter-term perspective, the SPX is trading in a volatile, choppy range. Throughout January, in fact, a defined area of resistance was at the Dec. 31, 2014 close of 2,059, which is the top horizontal line in the chart below. Support has been in the round number 2,000 region, represented by the bottom horizontal line. The 30-minute chart, which goes back to the first trading day of January, paints this picture clearly.

A concern for the bulls is that the SPX has spent more time in the 2,000 area, which is the bottom of the range. The risk is that buyers at this level eventually disappear, which would likely set up a test of the 10-month moving average in the 1,985 region, as discussed above.

"It is not a bad idea to be hedged or at least make preparations to hedge when necessary, as one risk to the market is a break of support potentially causing panic selling among unhedged longs and/or a sudden demand for portfolio protection, which could coincidentally push indexes lower than expected."

"We don't have a definitive reason as to why VIX call open interest and SPY put open interest have plunged in recent months. Another theory could be hedge funds have chosen to play in other areas -- currencies, commodities, emerging markets, bonds, for example."
-- Monday Morning Outlook, January 24, 2015

Still on our radar is the low level of CBOE Volatility Index (VIX - 20.97) call activity and open interest, especially with the VIX closing above 20 in January and up nearly 15% year-to-date.

Moreover, a review of several Commitment of Traders (CoT) reports reveals low levels of VIX, SPX and E-mini futures open interest, coincident with multi-year high levels of open interest in euro, gold, oil and copper futures contracts. This is still more evidence that suggests some hedge funds, particularly macro funds, are exiting positions in U.S. equities in favor of other assets, such as commodities and currencies. If this trend continues, it will be a major market headwind -- especially in the absence of short-covering activity, which helped drive the market higher late last year.

Bulls would prefer to see higher stocks coincident with hedging activity as a sign that hedge funds are in equity accumulation mode. With short interest increasing on SPX and PowerShares QQQ Trust (QQQ - 101.10) components in the most recent report, an ongoing short-interest build is an additional risk if the deep-pocketed players continue moving into other assets, as we suspect is occurring at present.

If the VIX rises above the January high of 23.43, a move to 31.00 could very well be in the cards. Last month's VIX high is in the vicinity that marks a 50% advance from the mid-January VIX low of 15.52. If the January high is taken out, the 31.00 area represents double the January low and is the site of the 2014 peak. Therefore, as we've been saying for the past few weeks, owning VIX calls is not a bad idea if you have long exposure at risk, especially at a time when VIX calls are relatively unpopular.

Read more:

The Week Ahead: Jobs Data and Earnings from Exxon Mobil Corporation, Twitter, Inc., and General Motors

The Dow Jones Industrial Average (DJI) and S&P 500 Index (SPX) both ended their weekly losing streaks on Friday, despite giving back some gains from earlier in the week. Of course, the big lift came on Thursday, courtesy of the European Central Bank's (ECB) monetary stimulus decision, which powered the aforementioned benchmarks to matching 1.5% daily gains. Despite these (and other) indexes now trading near resistance, Schaeffer's Senior VP of Research Todd Salamone explains why there's reason to believe these levels could be taken out.

• One historically bullish signal from last week.
• Why long-term investors shouldn't disturb their long positions.
• Rocky White takes a look at the January Barometer theory.

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: Why It's Still Smart to Be Hedged
By Todd Salamone, Senior VP of Research

"... the SPX must break important support areas that are in play now before the October lows can be tested. For instance, the index comes into this week around the 2,000 millennium mark and its 120-day moving average -- a trendline we discussed last week as being supportive during multiple pullbacks since 2013 (exception being the October decline)."

"Additionally, SPX 1,980 could prove important as we enter the second half of the month, as it is the site of the index's 10-month moving average ... [T]he SPX has not experienced a monthly close below its 10-month moving average since January 2012 ..."

- Monday Morning Outlook, Jan. 17, 2015

"$DJIA YTD B/E = 17,823. Yesterday's close = 17,813...$COMP YTD B/E = 4,736. Yesterday's close=4,750."

"As major benchmarks, such as $SPX, $QQQ, $DJIA trade around 2015 B/E levels, $RUT getting set to do battle with round number 1,200 (again)"

-@ToddSalamone on Twitter, Jan. 23, 2015

On the heels of the European Central Bank's (ECB) decision to buy sovereign bonds on Thursday morning, world markets rallied. The S&P 500 Index (SPX - 2,051.82) began its ascent early last week -- ahead of the ECB's decision -- as buyers emerged with the index sitting on major support, which we've discussed previously.

Thursday's ECB decision propelled the SPX higher into positive territory for 2015 by Thursday's close. The move north of breakeven was short-lived, however, with the SPX moving back into the red by Friday's close. Perhaps investors are moving to the sidelines ahead of the Federal Open Market Committee's (FOMC) scheduled meeting next week -- and as indexes trade at resistance.

Moreover, the PowerShares QQQ Trust (QQQ - 104.26) and S&P 400 MidCap Index (MID - 1,455.79) rallied from round-number levels at 100 and 1,400, respectively. And the Dow Jones Industrial Average's (DJI - 17,672.60) low for the year remains barely above the 17,000 millennium mark.

Despite equities trading at resistance, there is an encouraging sign for bulls that short-term resistance levels will be taken out. Coincident with the ECB decision and subsequent market rally, the 10-day average of the equity-only, buy-to-open put/call volume ratio experienced a relatively sizable decline on Thursday. A single-day decline in this ratio of the magnitude we saw on Thursday has proven to be bullish historically. It is a sign that short-term traders are in the early innings of moving from an environment filled with caution and/or skepticism to one that is more optimistic. This transition typically lasts a few weeks and is supportive of stocks.

Specifically, the 10-day, equity-only, buy-to-open put/call volume ratio declined by 2.7% from a reading above 0.60, which is historically high. Since June 2012, it has done this 16 other times. On 14 of those occasions, the SPX was higher one week later by an average of 1.10%, or three times its anytime average over the same time period. Moreover, the SPX has advanced 88% of the time one week after this signal, more than the expected 61%.

Volatility expectations also remain on our radar. On the volatility front, the fact that single-day volatility is almost twice 2015's daily volatility is getting a lot of play on blogs and in various media.

One potential reason for the high single-day volatility could be the effects of a previous topic in this report -- extremely low SPDR S&P 500 ETF Trust (SPY - 204.97) put open interest and extremely low CBOE Volatility Index (VIX - 16.66) futures call open interest, which some investors purchase for portfolio protection.

If the low levels of VIX call open interest and SPY put open interest are indicative of market participants giving up on hedging -- after such activity proved to be a performance headwind throughout most of 2014 -- there may be more knee-jerk reactions to perceived negative headlines now, relative to last year, when portfolio protection was extremely popular. But the wide daily fluctuations have, so far, proven to be noise within the bigger picture. For example, the SPX's 10-month historical volatility is at its lowest reading since May 2013. On balance, monthly historical volatility continues to track lower since its peak in 2009.

If you are a longer-term investor, the longer-term, low-volatility trend suggests not disturbing your long positions, unless and until you see a significant break of longer-term support. After all, as the environment stands now, there is some rationale for portfolio-protection trades to lose their popularity from the perspective of a major decline in volatility during the past few years.

"Hedge funds' use of borrowed money, or leverage, to amplify the effect of their bets dropped last week to the lowest level in more than two years, Morgan Stanley told clients in a confidential memorandum. The drop in leverage signals a dwindling conviction that markets will push ever higher."

- The Wall Street Journal (subscription required), Jan. 11, 2015

We don't have a definitive reason as to why VIX call open interest and SPY put open interest have plunged in recent months. Another theory could be hedge funds have chosen to play in other areas -- currencies, commodities, emerging markets, bonds, for example. Or, as a recent Wall Street Journal article suggested (see excerpt immediately above), reduced leverage among hedge funds could be limiting demand for portfolio protection, which may ultimately prove bullish if leverage again increases.

All things considered, we reiterate what we said last week. That is, it is not a bad idea to be hedged or at least make preparations to hedge when necessary, as one risk to the market is a break of support potentially causing panic selling among unhedged longs and/or a sudden demand for portfolio protection, which could coincidentally push indexes lower than expected. And the cost of the hedge may prove to be very small in the context of the potential rally that we could witness if hedge funds begin increasing their leverage once again.

Indicator of the Week: The January Barometer
By Rocky White, Senior Quantitative Analyst

Foreword: Heading into the last week of January, the Dow Jones Industrial Average (DJIA) is right around breakeven on a month-to-date basis. Does it really matter if it finishes the month positive or negative? It might if you subscribe to the January Barometer theory. That's the idea that the direction of the market in January sets the tone for the rest of the year. This week, I'm taking a look to see if January has actually been a good predictor for the rest of the year, and if there is anything we should do knowing that information.

Is January a Barometer?: First, I wanted to see if January was in fact a decent barometer for the rest of the year. Looking back to 1950, the table below summarizes the returns of the dow depending on whether January was positive or negative. Looking at this table, the January Barometer theory does seem to have some validity. When January has been positive, then 83% of the time the index has gained points from February through the end of the year -- averaging a return of 9.68%. When January was negative, then the average return was only 2.54%, with barely half of the returns positive.

This year, January is pretty flat -- so, barring a huge move next week, this next table isn't really relevant. It's still pretty interesting. It shows the larger the move in January, the more prophetic the January Barometer. When January has gained 4% or more, then the rest of the year has averaged a gain of almost 12%. When the first month of the year has been down at least 4%, then the rest of the year doesn't even average a 1% gain, and has been positive just half the time. When looking at this table and the table above, it seems January has tended to set the tone for the rest of the year.

Trading and the January Barometer: Okay, so we know that January has been a pretty good predictor for the rest of the year. Is there anything we can do? Well, knowing what we know now, let's go back to 1950 and pretend we had $100 to invest. How would we have done trading the January Barometer? The chart below shows what that $100 would be worth today using three different strategies (I begin the chart in 1990 since the lines were pretty even up to then, and it makes the chart a lot easier to read).

The first strategy (the black line) is simply buying the Dow on Jan. 1, 1950, and holding it through 2014. Today, it would be worth about $8,900. The red line is if we bought the index on Jan. 1 of each year, then sold it if January was down. Otherwise, we held it for the entire year. In that case, our $100 would have grown to just $6,300. Knowing that underperformance was coming didn't help us much. Typically, the market still gained, so we'd be better off owning it. The last strategy is based off the last table, and, in that case, we bought the index on Jan. 1, and sold it at the end of January -- only if January was down at least 4%. In that case our $100 would be worth $9,100, barely beating a simple buy-and-hold strategy.

This last table just shows the annualized return realized from each of the strategies above. I would conclude that knowing about the January Barometer would not help an investor. Using that last strategy of selling the index when January was down big gained less than half of a percent in annualized return. However, this analysis does not take into account dividends or trading costs. Add those in, and I'm sure the buy-and-hold strategy is superior.

Editor's Note: The charts and commentary above originally cited the S&P 500 Index (SPX), but the data was compiled using the Dow Jones Industrial Average (DJIA). We regret the error.

This Week's Key Events: FOMC in Focus; Blue-Chip, Tech Earnings Roll In
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

• The Dallas Fed's manufacturing survey will kick off the week. Microsoft (MSFT), Ashland (ASH), D.R. Horton (DHI), Seagate Technology (STX), Texas Instruments (TXN), and Zions Bancorporation (ZION) will release earnings.

Tuesday

• Tuesday's packed docket includes durable goods orders, the S&P/Case-Shiller home price index, new home sales, and the consumer confidence index. Additionally, the Federal Open Market Committee (FOMC) will begin its two-day policy setting meeting. 3M (MMM), AT&T (T), Caterpillar (CAT), DuPont (DD), Pfizer (PFE), Procter & Gamble (PG), United Technologies (UTX), Apple (AAPL), Yahoo (YHOO), AK Steel (AKS), American Airlines (AAL), Amgen (AMGN), Bristol-Myers Squibb (BMY), Coach (COH), Corning (GLW), Electronic Arts (EA), Freeport-McMoRan (FCX), Illumina (ILMN), Juniper Networks (JNPR), Lockheed Martin (LMT), Novartis AG (NVS), Peabody Energy (BTU), U.S. Steel (X), VMware (VMW), and Western Digital (WDC) will step under the earnings spotlight.

Wednesday

• Crude inventories and the FOMC policy announcement come out on Wednesday. Boeing (BA), Facebook (FB), AmerisourceBergen (ABC), Anthem (ANTM), Biogen Idec (BIIB), Cirrus Logic (CRUS), Citrix Systems (CTXS), EMC Corporation (EMC), Fiat Chrysler (FCAU), General Dynamics (GD), Hess (HES), International Game Technology (IGT), International Paper (IP), Las Vegas Sands (LVS), Meritor (MTOR), Progressive (PGR), QUALCOMM (QCOM), Steel Dynamics (STLD), T. Rowe Price (TROW), Tractor Supply (TSCO), and Vertex Pharmaceuticals (VRTX) will report earnings.

Thursday

• On Thursday, weekly jobless claims and pending home sales are slated for release. Visa (V), Alibaba (BABA), Amazon (AMZN), Google (GOOGL), B/E Aerospace (BEAV), Blackstone (BX), Broadcom (BRCM), Celgene (CELG), Colgate-Palmolive (CL), ConocoPhillips (COP), Deckers Outdoor (DECK), Dow Chemical (DOW), Ford (F), Gigamon (GIMO), Harley-Davidson (HOG), hhgregg (HGG), InvenSense (INVN), JDS Uniphase (JDSU), JetBlue Airways (JBLU), Microchip Technology (MCHP), NetSuite (N), Nokia (NOK), Potash Corp./Saskatchewan (POT), PulteGroup (PHM), QLogic (QLGC), Ryland (RYL), Sherwin-Williams (SHW), Stanley Black & Decker (SWK), Thermo Fisher Scientific (TMO), Time Warner Cable (TWC), and Viacom (VIAB) will step into the earnings confessional.

Friday

• Friday's economic calendar includes the advance reading on fourth-quarter gross domestic product (GDP), the employment cost index, the Chicago purchasing managers index (PMI), and the University of Michigan's consumer sentiment survey. Chevron (CVX), AbbVie (ABBV), Altria Group (MO), Eli Lilly (LLY), ImmunoGen (IMGN), Ingersoll-Rand (IR), MasterCard (MA), Mattel (MAT), Novo Nordisk (NVO), NuStar Energy (NS), Tyson Foods (TSN), Weyerhaeuser (WY), and Xerox (XRX) will release earnings.

And now a sector of note...

Utilities
Bullish

The utilities sector has been a strong performer on the charts, as evidenced by the record peak the PHLX Utility Sector (UTY) tagged just last week. Additionally, of the 10 utility stocks we follow, eight are currently trading above their 80-day moving average. Even more impressive, these securities have gained, on average, nearly 28% over the last 52 weeks. Nevertheless, just 37% of covering analysts rate these stocks a "buy." With bonds rallying in the wake of the European Central Bank's (ECB) stimulus announcement, utilities could benefit from a lower-rate environment -- and a round of upgrades could create additional tailwinds.

In a similar vein, the Utilities SPDR ETF (XLU) has advanced more than 29% over the last year -- and hit an all-time high last Thursday -- and is currently sitting atop several layers of potential support. Specifically, the exchange-traded fund (ETF) is north of the $45 level, which corresponds with its 2007 peak. Also, the same area is roughly double XLU's March 2009 low and triple its October 2002 low, hinting at possible triple-barreled technical support. If the shares can sustain their momentum, additional buying power could result from short sellers and/or option bears throwing in the towel. After all, 31.8% of XLU's float is sold short, and its SOIR of 5.14 ranks in the 92nd annual percentile.

It was another volatile week on Wall Street, with the Dow exploring a range of nearly 680 points. The blue-chip barometer suffered five straight losses until Friday's relatively modest rebound, due to plummeting crude prices, a shocker from the Swiss National Bank, and disappointing earnings out of the financial sector. Looking ahead, the European Central Bank (ECB) will take the spotlight during the holiday-shortened week, and Schaeffer's Senior VP of Research Todd Salamone expects volatility expectations to remain elevated.

• The significance of CBOE Volatility Index (VIX) options expiration.
• The support levels and moving average on our radar.
• A long-term ray of hope from the VIX futures spread?

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: The Impact of VIX Options and the ECB
By Todd Salamone, Senior VP of Research

"If what lies ahead in the immediate days for the stock market is anything like we observed this past week, expect choppiness to be the order of the day ... Like last year, indexes are respecting round numbers and year-to-date (YTD) breakeven points."

"Next week is expiration for most options ... January SPDR S&P 500 ETF Trust (SPY - 204.25) options ... expire next week. If the market advances, resistance from heavy call open interest relative to put open interest occurs at the 205 and 210 strikes ... Note the enormous put open interest at the 200 strike ... if negative news hits the market, this strike could be a magnet, as short positions would have to be re-established."

"... it appears hedged money could be parking cash elsewhere and taking a 'wait and see' approach, with the SPX trading in the 2,000 area, the official start of earnings season next week, and Federal Open Market Committee (FOMC) and European Central Bank (ECB) meetings scheduled for later this month. Regardless of the motivation for low-hedging activity, we continue to advise having a hedge or short (put) exposure in place, especially with earnings season and the FOMC and ECB meetings just around the corner."

- Monday Morning Outlook, Jan. 10, 2015

"$VIX high today 23.34 (double the 11.82 December low is 23.64)"

"$SPY $200 magnet update: 8 of past 12 30-min intraday bars touch $200 and 16 of past 25 30-min bars touch $200 $PremiumSellerDream"

-@ToddSalamone on Twitter, Jan. 14-15, 2015

Last week's trading played out as we expected -- choppy, as the SPDR S&P 500 ETF Trust (SPY - 201.63) opened the week lower and rallied strongly to the call-heavy 205 strike Tuesday morning, before declining again. The balance of the week was range-trading around the 200-strike "magnet" following the release of poor retail sales data before the market opened Wednesday morning.

Heavy call and put open interest at the January 2015 200 strike was present throughout expiration week, so adjustments by sellers of these options likely influenced this narrow range around $200 (see the SPY January open interest configuration graph below the SPY 30-minute chart).

Last week, we observed that various equity benchmarks peaked around last year's closing levels, and these are levels that we continue to watch as potential short-term resistance points. This past week can be summed up by round-number century and millennium levels coming into play as supportive. For example, the S&P 500 Index (SPX - 2,019.42), PowerShares QQQ Trust (QQQ - 100.82), S&P 400 MidCap Index (MID - 1,430.89), and Wilshire 5000 (W5000 - 21,244.68) found floors around 2,000, 100, 1,400, and 21,000, respectively.

In fact, it was in late August, or about five months ago, that the SPX first touched 2,000, which is where the index is parked now. Its peak last month was 5% above this major millennium mark, while at its trough in October, the SPX was 7% below the 2,000 area. From this vantage point, using the October and December trough and peak as reference points, there is roughly equal risk-reward.

That said, the SPX must break important support areas that are in play now before the October lows can be tested. For instance, the index comes into this week around the 2,000 millennium mark and its 120-day moving average -- a trendline we discussed last week as being supportive during multiple pullbacks since 2013 (exception being the October decline).

Additionally, SPX 1,980 could prove important as we enter the second half of the month, as it is the site of the index's 10-month moving average. Note on the graph below that the SPX has not experienced a monthly close below its 10-month moving average since January 2012, when it crossed back above this trendline. The moving average acted as a cap on rally attempts during the five months prior to the January 2012 breakout.

We expect volatility expectations to remain elevated above 20, with monetary policy decisions from the Bank of China and the European Central Bank (ECB) on the calendar next week. With last week's surprise move from Switzerland's central bank to no longer cap-tie its currency to the euro, market participants will be paying close attention to these overseas central bank meetings.

Additionally, January CBOE Volatility Index (VIX - 20.95) futures options expire Wednesday morning, which means the last day to trade January VIX options is Tuesday. Currently, the VIX is trading just below 23.64, which is double last month's low at 11.82. As you can see in the chart below, the "double low" area marked the mid-December peak and, so far, this month's peak. It is likely, especially with a major call influence at the 23 and 24 strikes (see the January VIX open interest graph below the VIX chart), that the VIX settles below 23-24 on Wednesday morning.

But what happens after Wednesday is up in the air, as the ECB meeting occurs the following day, and could have the biggest impact on world markets, given that there is a lot of speculation on whether or not more stimulus action will be announced.

Additionally, any VIX January calls that are meant to be portfolio hedges will be expired by the time the ECB meets. In fact, of the 3.7 million call contracts outstanding, 2.0 million, or 56%, are due to expire on Wednesday. VIX put open interest will also fall off a cliff, as 1.4 million VIX put contracts, or 63% of puts outstanding, will expire on Wednesday. So, unless the expired calls are immediately replaced, the amount of portfolio protection outstanding will decrease substantially.

Despite reports that market participants are concerned about rising volatility in 2015, and are subsequently buying portfolio protection via VIX calls, we are not seeing such activity. A lack of portfolio protection, either because hedged money is reducing equity exposure or because portfolio protection is viewed as wasteful, is a risk to the market. And such a risk is all the more reason to have portfolio protection in place, as we advised last week, despite equity benchmarks sitting on support levels. If you wait to buy portfolio insurance on a break of support, it will likely be even more expensive than it is currently.

Indicator of the Week: VIX Futures Spread
By Rocky White, Senior Quantitative Analyst

Foreword: The S&P 500 Index (SPX) has pulled back sharply from its peak close reached on Dec. 29. As expected, the CBOE Volatility Index (VIX), which typically moves in the opposite direction of stocks, has spiked. However, the longer-dated VIX futures contracts did not see the magnitude of the spike that the front-month futures contract saw. As a result, the front-month VIX futures contract traded above the VIX futures contract four months away.

The VIX is a measure of how expensive options are for the SPX. When markets are in turmoil and/or there's a lot of uncertainty, then options become expensive (and the VIX increases). Evidently, VIX futures traders are expecting less expensive options in four months. I would conclude from this that they are expecting markets to calm down a bit going forward. This week I'm taking a look at prior times the long-dated VIX futures fell below short-dated futures to see if VIX futures traders have had a tendency of correctly predicting calmer markets going forward.

5-Day Futures Spread Goes Negative: In the chart below, the "5-Day Spread Percent" is a five-day average of the difference in the four-month VIX futures and front-month futures as a percentage of the VIX level. When the red line falls below zero, it means the longer-dated futures contract is below the front-month contract. The yellow circles on the SPX line mark times the spread percent fell below zero, but only if it's the first reading below zero in at least a month.

Taking a quick look at the chart shows the last five signals before the one last week were all at or near short-term market bottoms. However, the market has been strong over that period and any dot you'd place on the chart since 2009 would probably be a pretty good buying opportunity. There were also some signals before 2009 that would have been terrible buying opportunities.

Quantified Results: The tables below summarize SPX results after those signals on the chart above, and then for the index anytime since 2006, for comparison. You can see the average return at two and four months after a signal is lower than typical returns, despite a higher percentage of the returns being positive.

The average negative return four months after a signal is more than 30% in four months. There are only two negative returns, but this explains why the average return is lagging. It looks as though there has been a lot more volatility after a signal, compared to normal -- especially to the downside.

With the signals occurring during different market environments, I'm not sure I would want to conclude much from the results in the tables above. Below is a table showing the returns after each of the signals. You can see the two signals that happened in 2008 led to huge losses.

I also show where the SPX was on the day of the signal, relative to its two-week high. Using this to measure the pullback, it seems the recent signal was on a very minor pullback. I bolded the five signals with the smallest pullbacks (or every one less than 5%, if that sounds better). No huge losses occurred after these particular pullbacks, and each time the SPX was positive four months later. So, at least we have that going for us.

This Week's Key Events: Blue-Chip Earnings, Housing Data 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.

Monday

• Markets will be closed on Monday in observance of Martin Luther King, Jr. Day.

Tuesday

• On Tuesday, the National Association of Home Builders will release its housing market index. IBM (IBM), Johnson & Johnson (JNJ), Halliburton (HAL), Morgan Stanley (MS), Advanced Micro Devices (AMD), Baker Hughes (BHI), Cree (CREE), Delta Air Lines (DAL), MGIC Investment Corp (MTG), Netflix (NFLX), Petmed Express (PETS), and Regions Financial (RF) will step into the earnings confessional.

Wednesday

• The report on housing starts and building permits comes out on Wednesday. American Express (AXP), UnitedHealth (UNH), eBay (EBAY), TD Ameritrade (AMTD), Discover Financial (DFS), F5 Networks (FFIV), Fifth Third (FITB), Kinder Morgan (KMI), Logitech (LOGI), Northern Trust (NTRS), Sallie Mae (SLM), SanDisk (SNDK), United Rentals (URI), U.S. Bancorp (USB), and Xilinx (XLNX) will report their earnings data.

Thursday

• Weekly jobless claims, Markit's flash purchasing managers' manufacturing index (PMI), and crude inventories come out on Thursday. Across the pond, the ECB will announce its policy decision. Verizon (VZ), Travelers (TRV), Starbucks (SBUX), Alaska Air Group (ALK), Altera (ALTR), Capital One Financial (COF), Covidien (COV), Cypress Semiconductor (CY), E*TRADE Financial (ETFC), Fairchild Semiconductor (FCS), Huntington (HBAN), Intuitive Surgical (ISRG), Janus Capital (JNS), Johnson Controls (JCI), KeyCorp (KEY), Southwest Airlines (LUV), Skyworks Solutions (SWKS), Travelzoo (TZOO), United Continental Holdings (UAL), and Union Pacific Corp (UNP) will step into the earnings spotlight.

Friday

• Friday's economic calendar includes the existing home sales report and the Conference Board's index of leading economic indicators. General Electric (GE), McDonald's (MCD), Bank of New York Mellon (BK), Honeywell (HON), Kimberly-Clark (KMB), and Rockwell Collins (COL) will release their earnings data.

And now a sector of note...

Utilities
Bullish

The utilities sector has been a strong performer on the charts over the long term. Of the 10 utility stocks we follow, eight are currently trading above their 80-day moving average. Even more impressive, these securities have gained, on average, nearly 27% over the last 52 weeks. Nevertheless, just 37% of covering analysts rate these stocks a "buy," suggesting upgrades could be in the cards. What's more, short-term put open interest outweighs call open interest, per the average Schaeffer's put/call open interest ratio (SOIR) of 1.03. A capitulation among these skeptical options bettors could create tailwinds.

In a similar vein, the Utilities SPDR ETF (XLU) has advanced more than 27% over the last year, and is currently sitting atop several layers of potential support. Specifically, the exchange-traded fund (ETF) is north of the $45 level, which corresponds with its 2007 peak. Also, the same area is roughly double XLU's March 2009 low and triple its October 2002 low, hinting at possible triple-barreled technical support. If the shares can sustain their momentum, additional buying power could result from short sellers and/or option bears throwing in the towel. After all, 31.8% of XLU's float is sold short, and its SOIR of 5.29 ranks in the 93rd annual percentile.

It was a wild week of trading on Wall Street, with markets making big moves in both directions. Although bulls gave a valiant mid-week effort amid a brief respite in oil's rout and stimulus speculation from overseas, one particular metric in Friday's jobs report unsettled investors -- and sent the major market indexes back into the red for 2015. As Schaeffer's Senior VP of Research Todd Salamone explains, there was a "method to the madness," and offers up a number of reasons why last week's volatile price action could continue heading into January options expiration.

• The short-term vulnerabilities facing the market
• The under-the-radar moving average we're keeping a close eye on
• If history is any guide, the current D.C. backdrop could bode well for bulls

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: More Evidence on the Importance of Round-Number, Half-Century, and YTD Breakeven Levels
By Todd Salamone, Senior VP of Research

"On the sentiment front, we have continued to see a lack of hedging from institutions in recent weeks. An extremely popular hedge for institutions and hedge funds are CBOE Volatility Index (VIX ) calls. The VIX 20-day buy-to-open call/put ratio is down to 1.0 -- the lowest level since April 5, 2012. In other words, there aren't a lot of people buying hedges on their portfolios right now. These low-hedging ratios could leave stocks vulnerable to headline news...

"As we enter 2015, there will be a lot of factors affecting the market. The Fed will continue to remain in focus, as investors try to glean just when exactly rates will be increased and by what amount."

- Monday Morning Outlook, Jan. 3, 2015

"$QQQ ytd b/e is $103.25- Reached this level at three hours ago and it has essentially been sideways movement since"

"$SPX YTD B/E is 2,058.90 - has stalled here for the past 1-1/2 hours"

"YTD breakeven levels on $SPY, $QQQ, $MID prove to be significant - sideways action yesterday followed by this morning's selloff"

-@ToddSalamone on Twitter, Jan. 8-9, 2015

If what lies ahead in the immediate days for the stock market is anything like we observed this past week, expect choppiness to be the order of the day. If you are a trader, this would suggest putting smaller dollars into each trade and either shortening or lengthening your time frame, whichever you prefer. Shorten your time frame to take advantage of quick, whipsaw movements. If you lengthen your time frame and put less dollars at risk, you can loosen your stops and target bigger returns, therefore reducing the risk of getting whipsawed out of trades.

From a price-level perspective, there was a method to the madness, which gives us reason to believe that more of this could lie ahead. Like last year, indexes are respecting round numbers and year-to-date (YTD) breakeven points.

For example, in just three trading days, the S&P 500 Index (SPX - 2,044.81) moved from the round-number 2,000 millennium level to its half-century mark of 2,050, which is just below the 2014 close. Long-time readers of Monday Morning Outlook are aware of the SPX's uncanny behavior around half-century levels, which tend to act as key pivot or hesitation points. Note the sideways intraday action around 2014's close that followed the "hurry up and get there" buying in the 30-minute graph below. Thursday's sideways action was promptly followed by a Friday morning sell-off.

As a side note, we found it interesting that the SPX's low last week occurred around its 120-day moving average, a trendline that is not on the radar of many technicians, but has been important nonetheless. Note on the chart below how it has marked major short-term buying opportunities in seven of the last eight pullbacks since mid-2013. All pullbacks that have been supported by this trendline have been followed by an advance to new highs. If past is prologue, the SPX will make another run at 2,100 in the coming days.

The below table gives you closing levels for 2014 for some major equity benchmarks that we follow, along with last week's closing lows and closing highs. The purpose of this table is to highlight the importance of round numbers and half-century marks, plus year-to-date breakeven levels that could be influential in the days, or even weeks and months, ahead.

Next week is expiration for most options, although the expiration of CBOE Volatility Index (VIX - 17.55) options does not occur until Wednesday, Jan. 21 -- the week after next. The below graph is the current open interest configuration for January SPDR S&P 500 ETF Trust (SPY - 204.25) options that expire next week.

Note the enormous put open interest at the 200 strike, which acted as support last week. The furious rally from this level may have been driven, in part, by the unwinding of short positions related to this put open interest. Said another way, the further the SPY was above this strike and the closer we moved to next week's expiration, sellers of those puts that desire to be hedged were able to unload some of their short positions, as the probability decreased of these puts finishing in the money. That said, if negative news hits the market, this strike could be a magnet, as short positions would have to be re-established.

If the market advances, resistance from heavy call open interest relative to put open interest occurs at the 205 and 210 strikes, which equates to roughly SPX 2,050 -- the half-century mark that is situated just below 2015's YTD breakeven -- and 2,100, a round-number level that is just above the late-December high.

As it stands currently, SPY premium sellers would love to see a pin at 205 next Friday, as this is where the maximum number of calls and puts would expire worthless, which is the aim of a premium seller. In fact, the maximum number of call and put contracts that expired worthless occurred during the expiration of standard December options last month.

Bigger picture, hedging activity remains well below the levels of 2014. As we mentioned last week, if market participants that are normally hedged have chosen to forego hedging but are still holding long equity positions, this leaves the market more vulnerable than normal to negative headlines, as a lack of portfolio protection puts the market at the mercy of panic sellers.

Per the chart below, courtesy of our friends at Trade-Alert, total call open interest on VIX options has declined sharply since the first 10 months of 2014. It might not be a huge surprise to contrarians that the VIX climbed to its second-highest and fourth-highest readings in a year during only a three-week period between mid-December and early January, coincident with VIX call buyers steadily leaving the building.

Another, albeit different, takeaway to the relatively low equity-hedging activity is that hedged players could be building cash positions or playing ball elsewhere, reducing the need for equity protection. Since the SPX hit the 2,000 level in late August, there has been a steady decrease in VIX call open interest. And, since mid-November, SPY put open interest, which is another hedging vehicle, has decreased. Could hedged players be reducing equity exposure in lieu of cash, bonds, currency, commodity, or other macro plays? If this is the case, it is a market headwind.

If indeed hedged players are reducing exposure, who or what is supporting the market? It appears the shorts have begun to throw in the towel (see the chart immediately below). If you are a bull, you want to see more of this, especially if hedged players are on the sidelines or playing elsewhere, as short covering is a supportive factor. But this supportive factor diminishes as short interest continues to decline. The good news is that short interest on SPX component names remains well above the 2011 and 2012 extreme lows, but another upturn in short interest would be ominous without hedged players looking to buy into market weakness.

So, ideally, bulls would like to see stocks move higher coincident with a buildup in portfolio protection and still-heavy short interest levels, as this would be a sign that the deep-pocketed hedged players are accumulating equities and buying protection along the way. The recent stock market advance, however, seemed to be driven by short covering. Heavy short interest keeps pullbacks in check and supports breakouts to new highs, but we are at a lower level of short interest relative to a couple of months ago.

For now, it appears hedged money could be parking cash elsewhere and taking a "wait and see" approach, with the SPX trading in the 2,000 area, the official start of earnings season next week, and Federal Open Market Committee (FOMC) and European Central Bank (ECB) meetings scheduled for later this month.

Regardless of the motivation for low-hedging activity, we continue to advise having a hedge or short (put) exposure in place, especially with earnings season and the FOMC and ECB meetings just around the corner.

Indicator of the Week: Third Year of a Presidential Cycle
By Rocky White, Senior Quantitative Analyst

Foreword: It is pretty well-documented that the third year of a four-year presidential cycle is historically bullish. That's good news for the upcoming year, as 2015 is such a year. There are a few theories as to why this is. Maybe investor confidence is increased after midterm elections when the new Congress takes office? Another possibility is that U.S. presidents begin eyeing the next election in their third year, and promote market-friendly policies to boost their chances for re-election (or their party's chance for re-election if it's the president's second term). Of course, it's also possible that it's simply random. Whatever the reason, the consistency of positive returns over the last 60 years in the president's third year is quite impressive.

Third-Year Presidential Cycle: The table below summarizes the yearly returns on the S&P 500 Index (SPX) for each of the presidential cycle years going back to 1949. The average return in the third year of the cycle is 17.1%. That outpaces any of the other years by far. The other years all average between 6% and 7% gains. Out of 16 years, the third year of the cycle was negative only one time. That was actually just four years ago, in 2011, and the SPX was just barely negative, down 0.003% that year. The Dow Jones Industrial Average (DJIA) has actually been positive all 16 years in the third year of the cycle (the Dow gained 5.5% in 2011).

The chart below emphasizes how much more bullish the third year has been compared to the others. It shows the average SPX return path for each cycle year. The third-year average returns blows away the other years right off the bat and never looks back. On average, the SPX has boasted a 15% gain in July during the third year of the cycle!

The table below quantifies the first-half and second-half returns for each of the presidential cycle years. It's good news -- at least for the next six months -- that the third year is especially bullish in the first half of the year. The SPX averages a 13% return and has been positive in each of the 16 years. The second half of the year has averaged a much tamer 3.86%.

This Week's Key Events: Alcoa Gets the Earnings Party Started
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

• The week begins with Alcoa's (AA) unofficial kickoff to earnings season.

Tuesday

• On Tuesday, the U.S. Treasury budget data and the Labor Department's Job Openings and Labor Turnover Survey (JOLTS) are scheduled for release. CSX Corporation (CSX), DragonWave (DRWI), KB Home (KBH), and Progress Software (PRGS) will step into the earnings confessional.

Wednesday

• Wednesday's packed docket includes retail sales, import and export prices, business inventories, the Energy Information Administration's (EIA) weekly stockpiles report, and the Fed's Beige Book. JPMorgan Chase (JPM) and Wells Fargo (WFC) will release their quarterly earnings data.

Thursday

• Weekly jobless claims, the producer price index (PPI), the Empire State manufacturing survey, and the Philadelphia Fed manufacturing survey come out on Thursday. Bank of America (BAC), Intel (INTC), Citigroup (C), Lennar (LEN), BlackRock (BLK), Charles Schwab (SCHW), Fastenal Company (FAST), PPG Industries (PPG), Schlumberger (SLB), and Taiwan Semiconductor (TSM) will head into the earnings spotlight.

Friday

• Friday's economic calendar includes the consumer price index (CPI), industrial production data, and the Thomson Reuters/University of Michigan consumer sentiment index. Goldman Sachs (GS), Comerica (CMA), PNC Financial Services (PNC), Private Bancorp (PVTB), SunTrust Banks (STI) will report their earnings data.

And now a sector of note...

Retail
Bullish

The consumer discretionary sector was the top-performing sector in November and December, rallying more than 6% and outperforming the broader SPX. However, as this recent column from The Wall Street Journal illustrates, pessimism remains prevalent. Despite the retail outperformance, "there is reason to believe other signs don't bode well for retail stocks" ahead of earnings season. Echoing this, of the 71 retail stocks we follow, nearly two-thirds are trading above their 80-day moving average, yet less than half of analysts offer up "buy" ratings. Plus, the average short interest-to-float ratio among these equities is 12.8%, which would take more than six sessions to cover, at average daily trading volumes. All things considered, retail stocks could be poised to run higher on potential short-covering activity and/or a round of analyst upgrades.

Meanwhile, the SPDR S&P Retail ETF (XRT) touched its all-time high of $97.15 on Thursday, and the shares are sitting atop several layers of previous resistance, including: $88, twice its 2011 lows; the round-number $90 level, roughly double its 2007 and 2010 resistance level at $45, and representing a 10% premium to XRT's mid-October closing low of $81.93; $92, roughly 20% above XRT's 2014 low; and $93, 50% above its 2013 low. Plus, the fund could find added support atop its 40-day trendline, which contained its recent dip, and it should be noted that XRT is now more than 10% higher year-over-year -- a feat that eluded XRT since mid-December.

It was an interesting -- albeit relatively quiet -- holiday-shortened week on Wall Street. The major market indexes flirted with record highs and wrapped up a stellar 2014, but ended the week and the month mostly lower. So, what's in store for 2015? Schaeffer's Senior Equity Analyst Joe Bell, CMT, outlines some potential market-moving events for the short- and long-term, while our Senior Quantitative Analyst Rocky White breaks down historical first-quarter returns.

• The technical pattern on the radar
• The sentiment stat that favors the bulls
• A closer look at a pair of bullish streaks on the SPX and Dow

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: What We're Watching at the Start of 2015
By Joe Bell, CMT, Senior Equity Analyst

After a lot of ups and downs, patient long-term investors were rewarded with a pretty nice year in 2014. The S&P 500 Index (SPX - 2,058.20) netted a profit of 11.4%, the Dow Jones Industrial Average (DJI - 17,832.99) gained 7.5%, and the tech-heavy Nasdaq Composite (COMP - 4,726.81) surged 13.4%. Small-cap underperformance was one of the big stories of 2014, with the Russell 2000 Index (RUT - 1,198.80) managing only a 3.5% profit. The other big story was the bond rally that almost no economist predicted. Higher rates were assumed to occur by almost everyone, but after a 23% gain in 2014, we once again see how dangerous it can be to blindly follow crowd sentiment.

Although the equity market had a nice year in 2014, the same can't be said for the past week. The momentum that carried us during the second half of December came to a screeching halt during this holiday-shortened week. Although volume was dreadfully low, we saw the bulk of the weekly loss occur on the final day of the year. After an early bounce to open the first day of 2015, selling gave way and the S&P ended the week with a notable 1.5% decline.

Typically, the second half of December has been bullish, and this year was no exception. Despite their underperformance during much of 2014, small-caps led the advance off the mid-December bottom. During this week's decline, it is also important to note that small-caps underperformed during the pullback as well.

After briefly making a new all-time high on Wednesday, the RUT finished Friday 1.9% off its weekly high. This retreat left the index back below the 1,200 mark, which is near the site of its March and June 2014 peaks. On a shorter-term basis, the 1,180-1,190 area is the site of former resistance in September, November, and December 2014. This could be a logical area of support from buyers who are looking for an entry point. (Click chart to enlarge.)

The S&P didn't quite make it to the 2,100 level before reversing course mid-week. The Dow briefly eclipsed the big 18,000 level this week, but finished well below this round number by Friday's close. (If you didn't catch it already, Schaeffer's Senior Quantitative Analyst Rocky White did an interesting study on the significance of round numbers in last week's Monday Morning Outlook; be sure to check it out.)

As Schaeffer's Senior VP of Research Todd Salamone discussed in last week's MMO, the S&P MidCap 400 Index (MID - 1,451.31) broke out above the 1,450-1,460 area in December, a level that represents the neckline of a bullish inverse "head and shoulders" formation. This past week, MID has pulled back to this former level of resistance, which could now be a potential level of support. This will be an area to watch in the weeks ahead. (Click chart to enlarge.)

On the sentiment front, we have continued to see a lack of hedging from institutions in recent weeks. An extremely popular hedge for institutions and hedge funds are CBOE Volatility Index (VIX - 17.79) calls. The VIX 20-day buy-to-open call/put ratio is down to 1.0 -- the lowest level since April 5, 2012. In other words, there aren't a lot of people buying hedges on their portfolios right now. These low-hedging ratios could leave stocks vulnerable to headline news, and may be somewhat related to the quick-trigger selling we experienced late last week.

Another hedging indicator we monitor is the 20-day buy-to-open put/call ratio of the SPX, SPDR S&P 500 ETF Trust (SPY - 205.43), PowerShares QQQ Trust (QQQ - 102.94), and iShares Russell 2000 ETF (IWM - 118.93). These are some of the more popular hedges on portfolios, and traditionally there are more puts than calls purchased on these exchange-traded funds (ETFs). This ratio is now at its lowest level since June 2014. June was not a short-term top in the market, but the momentum from May definitely slowed a bit around this time.

Taking a step back, the major market trend is still higher, and there is one sentiment indicator that bulls should be encouraged by: the 10-day equity-only buy-to-open put/call ratio on the SPX, which rolled over recently from a high level, and made a sizeable move downward this week. When this ratio rolls over, it has tended to coincide with strong upward price action, as bearish sentiment gives way to bullish sentiment and cash flows off the sidelines.

As we enter 2015, there will be a lot of factors affecting the market. The Fed will continue to remain in focus, as investors try to glean just when exactly rates will be increased and by what amount. Policymakers have continually stated that their decisions will be data-dependent, and most market participants are not anticipating a rate hike until at least the second half of 2015.

Oil will continue to grab the headlines, as prices have plummeted during the past several months. Russia's uncertain economy, Greece's political chaos, Europe's economic issues, and China's slowdown all could create market-moving headlines in the coming months. The strong U.S. dollar and its impact on U.S. multinational companies will also be something to keep an eye on in 2015. Finally, when will this downtrend in Treasury rates end? Just remember that sometimes trends last longer and go further than most people believe.

In the short term, the market gets back in the swing of things this week with a lot of economic data on tap. On Wednesday, the ADP employment data, crude inventories report, and Federal Open Market Committee (FOMC) meeting minutes will be released, and on Thursday comes the weekly jobs figures. We will end the week with the December monthly jobs report. All of these data points have the possibility to create volatility as participants start getting back to the market after the busy holiday season.

Indicator of the Week: Seasonality & Streaks Heading into 2015
By Rocky White, Senior Quantitative Analyst

Foreword: Happy 2015. The rally that started in 2009 continued last year, and we find ourselves in the midst of a couple of bullish streaks. There's an impressive quarterly winning streak on the S&P 500 Index (SPX) and a similarly impressive yearly streak on the Dow Jones Industrial Average (DJI). I'll talk a little about these below. First, though, I give some numbers on how stocks have typically performed in the first quarter.

First-Quarter Seasonality: This table summarizes the quarterly returns on the SPX over the past 50 years. The fourth quarter has been the best quarter when looking at the average return and the percentage positive. I would say the next-best quarter has been the first quarter, averaging a 2.31% gain and positive 60% of the time.

The chart below shows the average first-quarter path to that 2.31% return I just mentioned. According to the chart below, the best times for short-term traders to buy over the next three months is around Jan. 24, or at the very end of February (these points are marked on the chart). The market has tended to really take off around these times.

While the first quarter hasn't been too bad over the long run, recently, it has been especially good for stocks. The table below summarizes the quarterly returns over just the last five years. As you can see, the first quarter is the only quarter positive in each of the last five years, averaging a gain of 6.72%.

Streaks: While the first quarter for the SPX is on a five-year win streak, the index in general hasn't seen a negative full quarter since 2012. Specifically, the fourth quarter of 2012 is the last time the index lost points in a quarter. We have SPX data back to 1928, and this is just the fourth time we've seen eight straight positive quarters.

The table below shows some data on the past streaks. One notable point is that a streak never ended at eight quarters. In the other three occurrences, the streak lasted at least two more quarters. In two of the three prior streaks, the SPX underperformed over the next year (3.85% and 2.98% is less than the typical yearly return for the SPX). But then the last time the quarterly streak made it to eight, in 1996, stocks exploded higher with the index gaining over 30% in the next 12 months.

While the SPX has an eight-quarter winning streak, the Dow streak is only three quarters. The Dow lost points in the first quarter of 2014. However, the Dow does have a six-year winning streak to its credit, which the SPX can't boast (the SPX was down a fraction of a percent in 2011).

Going all the way back to 1900, it's only the second time the large-cap index was up six years in a row. The only other time was 1991 through 1996. That streak went on for a total of nine years, ending in 2000, the bursting of the dot-com bubble. Hopefully, when the current streak ends, it's a much softer landing.

This Week's Key Events: Fed Minutes, Payrolls On Tap
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

• The week kicks off with the motor vehicle sales report. There are no notable earnings on tap.

Tuesday

• On Tuesday, the Institute for Supply Management's (ISM) non-manufacturing index and factory orders are slated for release. Commercial Metals Company (CMC), Lindsay Corp (LNN), and Sonic (SONC) will step into the earnings confessional.

Wednesday

• ADP's national employment report, the Federal Open Market Committee's (FOMC) meeting minutes, the international trade balance, and weekly crude inventories come out on Wednesday. Micron Technology (MU), Greenbrier (GBX), Monsanto (MON), and SUPERVALU (SVU) will release their earnings.

Thursday

• Weekly jobless claims and the Fed's consumer credit report will be released on Thursday. Apollo Education Group (APOL), Bed Bath & Beyond (BBBY), Constellation Brands (STZ), Global Payments (GPN), Ruby Tuesday (RT), and Schnitzer Steel (SCHN) will announce earnings.

Friday

• The Labor Department's monthly report on nonfarm payrolls and the unemployment rate comes out on Friday, along with wholesale inventories. Infosys (INFY), Acuity Brands (AYI), and AZZ Incorporated (AZZ) will step under the earnings spotlight.

And now a sector of note...

Retail
Bullish

The retail sector has been in the headlines recently, with holiday shopping only recently concluding. While signs suggest retail sales figures will most likely meet forecasts, expectations are not exactly at euphoric levels, even as the SPDR S&P Retail ETF (XRT) carves out new all-time highs. In fact, the exchange-traded fund (ETF) notched its loftiest mark on record -- $97.15 -- this past week. What's more, the shares are currently sitting atop several layers of previous resistance, including $90.12 -- a 10% premium to XRT's mid-October closing low of $81.93. Plus, the round-number $90 level is roughly double the ETF's 2007 and 2010 resistance level at $45, and could now reverse roles to act as support. It should be noted, the $97 area could serve as a short-term speed bump, as it is 20% above multiple lows near $81 the ETF has panned since April.

On the sentiment front, two-thirds of the 69 retail stocks we follow are trading above their 80-day moving average. Nevertheless, the typical short interest-to-float ratio among these equities is nearly 13%, which would take more than five sessions to cover, given average daily trading volumes. Also, fewer than half of the brokerage firms covering these names have handed out "buy" ratings. All things considered, retail stocks could be poised to run higher on potential short-covering activity and/or a round of analyst upgrades.

December seasonality kicked into high gear this past week, with the Dow Jones Industrial Average (DJI), S&P 500 Index (SPX), and Russell 2000 Index (RUT) each notching impressive week-over-week gains, and finishing at their highest-ever levels. What's more, despite the holiday-shortened week, the Dow closed above the previously untouched 18,000 level three times. But this isn't the only key area traders should be watching, as Schaeffer's Senior VP of Research Todd Salamone explains below.

• The significant pattern we're noticing on the S&P MidCap 400 Index (MID).
• Why bulls should be encouraged by the rollover on the buy-to-open equity put/call volume ratio.
• Rocky White breaks down the historical implications of millennium levels for the Dow.

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: Inverse "Head and Shoulders" for MID?
By Todd Salamone, Senior VP of Research

"... the second half of December has historically been bullish, so while the market may not benefit from expiration-related short covering like last week, momentum players or those short individual equities may be supportive, as they throw in the white towel to get a fresh start next year ... [W]e are -- in the blink of an eye -- back in a situation like that of early December from a technical perspective, when round-number resistance areas were in play ...

"The MID is just below the 1,450 half-century area, which has acted as resistance three separate times since it was first touched in early July. That said, the neckline of an inverse "head-and-shoulder" formation is at 1,450-1,460, and a breakout would be bullish, targeting a 12% move to 1,640 in the five months after such a breakout.

"A few weeks ago, we observed the turn in the 10-day, buy (to open) put/call volume ratio as a risk to the bullish case. In hindsight, this was a risk well worth acknowledging. While this ratio is not near the July or September extremes, it is near extremes in 2013 and early this year that marked key turning points ... Our gut is a roll-over is in the cards with the 'V-bottom' the market just experienced, and with seasonality now bullish for the next few weeks, a breakout above resistance could be imminent."

- Monday Morning Outlook, Dec. 20, 2014

"Blue-chip & small-cap indices take out round number resistance in early going $RUT 1,205.38 and $DJIA 18,014- $SPX just 16 pts below 2,100"

-@ToddSalamone on Twitter, Dec. 23, 2014

We move into the last three full trading days of 2014 with stocks following the typical bullish pattern that has been persistent in the second half of December, as small-caps lead the advance off the December expiration-week bottom.

In fact, the Russell 2000 Index (RUT - 1,215.21) moved into new all-time-high territory on Friday, following a move above the 1,200 mark early in the week, and above the March and July highs in the 1,215 area.

While the Nasdaq Composite (COMP - 4,806.86) hit a new multi-year high and is now less than 200 points away from the big 5,000 millennium level that marked the beginning of the technology bust in 2000, the Dow Jones Industrial Average (DJIA - 18,053.71), S&P 500 Index (SPX - 2,088.77), and S&P MidCap 400 Index (MID - 1,467.90) broke out to new all-time highs, also. The SPX now sits just below another century mark at 2,100, but the DJI took out the 18,000 mark. For more on the implications of the new millennium level on the DJI, be sure to see Rocky White's research in the next section.

Plus, the MID finally broke out above the 1,450-1,460 area -- which has marked resistance on several occasions this year -- to new all-time highs. As we discussed briefly last week, the MID's move above the 1,450-1,460 area is important, as this is the neckline of a bullish inverse "head and shoulders" formation that now targets a move to 1,640 in the next five months, which is roughly 12% above current levels. However, in the immediate days ahead, the 1,475-1,480 area could be a speed bump, as this represents a 10% year-to-date gain for this index, and round-number percentage gains have been pivotal areas on multiple equity benchmarks this year. A stall in this area would likely coincide with other major benchmarks stalling, with the SPX staring at 2,100 just overhead and the jury being out as to whether or not DJI 18,000 and RUT 1,200 are behind us for good.

Nonetheless, bulls should be encouraged by the behavior in the 10-day, equity-only, customer-only, buy-to-open put/call volume ratio, which is now rolling over from a relatively high level, as we anticipated last week. As you can see on the chart immediately below, rollovers from a high level have typically coincided with bullish price action in equities, as pessimism gives way to optimism. This ratio is far from what might be considered a short-term optimistic extreme, which typically leaves the market vulnerable. As we mentioned last week, a risk to the bullish case is the lack of portfolio protection outstanding, with CBOE Market Volatility Index (VIX - 14.50) call open interest extremely low and SPDR S&P 500 ETF Trust (SPY - 208.44) put open interest at moderate levels. This would suggest that stocks may be more vulnerable than normal to negative headlines, if unhedged players react to negative headlines by selling long positions or suddenly demand portfolio insurance, which can have a coincidental negative impact on the market.

Portfolio insurance is a little cheaper now versus last week, which makes it a little more attractive relative to a week ago. So, if you are unhedged, and are concerned that so few have hedges in place, now is a more attractive time than a week ago to purchase portfolio insurance.

Finally, the last trading day of the month and year also marks quarterly expiration for those underlying vehicles that have options with quarterly expirations, and this is not likely on the radar screen of many traders.

The SPY is one such instrument with quarterly expirations, and the open interest configuration as of Thursday's close is pasted below. The SPY closed at 208.44 on Friday, and if volume is low next week, there might be a "push" for the SPY to close between 207 and 208, which is where the maximum number of puts and calls with a 12/31 expiration date will expire worthless -- creating another solid payday for option sellers, which likewise occurred on standard December expiration.

It was a pleasure keeping you informed and up to date throughout 2014. We wish you the best in 2015, and look forward to providing you with insight you are not likely to find anywhere else.

Indicator of the Week: Dow 18,000 & Even Levels
By Rocky White, Senior Quantitative Analyst

Foreword: A milestone was hit last Tuesday, with the Dow Jones Industrial Average (DJI) reaching 18,000 for the first time ever. It's always good to reach new highs, but does it really mean anything going forward that the fresh peak reached last week was a round 1,000-point level? A lot of people theorize that the even levels are consequential. These even levels can be popular points for investors to evaluate the index and determine whether it is expensive or cheap. In the case of today's rising market, it might be a popular point at which to take profits. Looking at the bright side, the even levels can be attention-getters for investors standing on the sidelines, who now might buy in so they don't miss 19,000 and 20,000. If that's the case, we could see a pretty quick move up to those levels.

The chart below shows the Dow over the past 10 years. The even 1,000-point intervals do look to be significant at times. This week, I'm taking a quantitative look at how the Dow has behaved after running into one of these even levels. We'll see if there's any evidence that these even levels mean anything for stocks going forward.

First Time Crossing Above Even Levels : Starting with the 10,000 level in 1999, the table below shows how the Dow performed after the first time reaching each of the 1,000-point intervals. I summarize those returns, and then the last table shows the typical Dow returns since 1999 for comparison.

Interestingly, the index has struggled over the next couple of weeks -- supporting the premise that even levels can act as short-term speed bumps. When you get to three months out, the underperformance disappears. The data suggests short-term traders might want to take note of these even levels on the major indexes.

Also notable is the number of days between each of the 1,000 point intervals. It's interesting that the two times it took less than 100 days (1999 and 2007) to get to the next level, it led almost immediately to huge declines, and then multiple years before the next level. Perhaps the ultra-fast run up from level to level is a sign of climactic buying. The 173 days between 17,000 and 18,000 is the third fewest days in the table, but comparable to some of the other lengths of time between intervals. Hopefully, it's a sign that no major decline is imminent.

This Week's Key Events: Manufacturing Data Headlines a Short Week
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

• New Year's week kicks off with the Dallas Fed manufacturing survey. There are no notable earnings on tap.

Tuesday

• On Tuesday, the S&P/Case-Shiller home price index and the consumer confidence report are slated for release. The earnings calendar is bare.

Wednesday

• With markets shuttered tomorrow, weekly jobless claims will come out on Wednesday, alongside the Chicago purchasing managers index (PMI), pending home sales, and the weekly crude inventories report. There are no noteworthy earnings scheduled.

Thursday

• Markets will be closed on Thursday for New Year's Day.

Friday

• On Friday, Markit's purchasing managers manufacturing index (PMI), the Institute for Supply Management's (ISM) manufacturing index, and construction spending data are all scheduled for release. There are no notable earnings on deck.

And now a sector of note...

Retail
Bullish

The retail sector has been in the headlines recently, as holiday shopping season wraps up. While signs suggest retail sales figures will most likely meet forecasts, expectations are not exactly at euphoric levels, even as the SPDR S&P Retail ETF (XRT) carves out new all-time highs. In fact, the exchange-traded fund (ETF) notched its loftiest mark on record -- $96.12 -- last Tuesday. What's more, the shares are currently sitting atop several layers of previous resistance, including their year-to-date breakeven mark of $88.10, and $90.12 -- a 10% premium to XRT's mid-October closing low of $81.93. Plus, the round-number $90 level is roughly double the ETF's 2007 and 2010 resistance level at $45, and could now reverse roles to act as support. It should be noted, the $97 area could serve as a short-term speed bump, as it is 20% above multiple lows near $81 the ETF has panned since April.

On the sentiment front, two-thirds of the 69 retail stocks we follow are trading above their 80-day moving average. Nevertheless, the typical short interest-to-float ratio among these equities is nearly 13%, which would take more than five sessions to cover, given average daily trading volumes. Also, fewer than half of the brokerage firms covering these names have handed out "buy" ratings. All things considered, retail stocks could be poised to run higher on potential short-covering activity and/or a round of analyst upgrades.

It was a volatile week of trading, but Wednesday's "patient" positioning by the Fed in regard to interest rates brought buyers to the table en masse -- and the Dow Jones Industrial (DJIA) within striking distance of record-high territory. With the major market indexes fresh off a major "V" rally, Schaeffer's Senior VP of Research Todd Salamone takes a good, hard look at what we can expect heading into the final two weeks of 2014.

• 5 critical technical levels that showed their might in the "V" bottom, and 3 to watch going forward
• The key role VIX open interest played in last week's price action
• Despite a rough start to the month, Rocky White offers up some encouraging words for end-of-year bulls

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: Round-Number Resistance Levels are Back In Play
By Todd Salamone, Senior VP of Research

"... the IWM's close below the put-heavy 115 and 116 strikes enhances the possibility of delta-hedge selling. That said, a strong rally off the bottom of its short-term trading range could inspire short covering related to the expiring put open interest.

"Strong price action, positive December seasonality, and recent evidence of short covering and buyback activity that is usually robust at this time of year, are reasons not to disturb long positions ... we still have not lost sight of the fact that the 'higher volatility ahead' trade -- via the purchase of CBOE Volatility Index (VIX - 11.82) calls -- has deteriorated significantly in recent weeks ... Therefore, with VIX futures relatively low -- plus major equity benchmarks around the world trading near potential millennium resistance levels -- it might be prudent to add VIX calls as a portfolio hedge before something emerges that sparks renewed interest in the once-popular volatility trade."

- Monday Morning Outlook, Dec. 6, 2014

"After consecutive months in which 90% to 99% of VIX call options expired worthless, could this be the month that the few who stuck with the higher-volatility trade are rewarded with call options that expire with significant value? ... [S]ellers of VIX call options run the risk of a continued advance in volatility, so they may be looking to hedge this risk by buying VIX futures, which could drive volatility higher and stocks lower. December VIX futures closed on Friday at 19.58, just below December's peak call open interest. If the VIX surges above 23.64 -- double its recent low and December VIX futures move above 20, we could see another sharp increase in the VIX, especially if VIX call buyers suddenly surface again.

"With an FOMC meeting this week ... [s]tay tuned -- it should be an eventful expiration week."

- Monday Morning Outlook, Dec. 13, 2014

"$VIX settlement ($VRO) is 24.09... 67% Dec call options expire in the money after several months of 90-99% expiring out of money"

"Many $VIX peaks occur 50% above, or double/triple a key low. 12/5 closing low was 11.82- 12/16 closing high was 23.57 (23.64 double low)"

"After the $DJIA beat down from 18K, 17K supportive post #Fed - $MID held round 1,400 and $QQQ held $100 - round #'s still important"

-@ToddSalamone on Twitter, Dec. 17-18, 2014

The excerpts from our past two weekly communications -- along with the various real-time tweets from last week -- should give you an excellent summary of the volatility surge that we discussed as a possibility earlier this month, and the roller-coaster ride stocks have taken.

It was indeed an eventful expiration week, with the Federal Open Market Committee (FOMC) policy statement acting as the main catalyst for back-to-back 2% S&P 500 Index (SPX - 2,070.65) advances on Wednesday and Thursday.

The catalyst was the Fed's statement that interest rates would remain low for a considerable period, which inspired an unusual amount of short covering. Some of this was related to equity index puts that were due to expire at the end of the trading week, and a relative "boat load" of in-the-money CBOE Volatility Index (VIX - 16.49) calls that expired on Wednesday morning.

Those that sold VIX calls to portfolio-protection buyers were likely short an unusual amount of S&P futures and/or had an unusual amount of volatility futures in their inventory at expiration to guard against a continued rise in pre-Fed volatility, as delta-hedge selling gripped the market in the days leading up to the meeting. When the VIX calls expired Wednesday morning -- and there was little demand from VIX buyers to quickly replace the calls -- the long volatility/short S&P futures hedge, among sellers of portfolio protection, was unwound, leading to historical equity advances in a two-day period.

The timing for last week's catalyst -- the FOMC meeting -- was impeccable. Not only was the meeting scheduled on a VIX futures options expiration day, and during expiration week of equity and index options, but key indexes and equity benchmarks that we closely monitor were situated at important, potentially pivotal, levels. Consider:

• The Dow Jones Industrial Average (DJI - 17,804.80), after getting rejected just shy of the 18,000 millennium mark earlier in the month, was trading less than 100 points above the 17,000 millennium level pre-Fed.


• The S&P 400 MidCap (MID - 1,449.73) was trading around the round 1,400 level and its 200-day moving average ahead of the Fed meeting.


• The PowerShares QQQ Trust (QQQ - 104.32) had pulled back to the 100-century mark the day before the Fed's statement.


• Not to be forgotten, the SPX was in the vicinity of the round 2,000 level.


• Finally, the VIX closed at 23.57 the evening prior to the Fed's announcement, just below 23.64, which marked a doubling of the Dec. 5 closing low of 11.82. We discussed the importance of 23.64 last week, and have on numerous occasions observed how the VIX will tend to peak at levels that are 50%, or double and triple important lows.

The graph below displays the December open interest configuration of the SPDR S&P 500 ETF (SPY - 206.52) options, which just expired. The higher the put open interest (red bars) at the respective strikes, and the closer the underlying is to that strike during an advance in the market -- not to mention the closer to expiration of the options -- the greater the short covering. With the SPY trading in the 200 area ahead of the Fed's announcement, there was major short-covering potential on a well-received announcement.

By Friday, the SPY was far above most of the put strikes, with major call open interest strikes (green bars) coming into play at 207 and above. It appears that by late Friday afternoon, the 207 strike acted as a call wall. In fact, it may have been a big pay day for SPY premium, as the $206.52 close appears to be the maximum payoff for those selling put and call options, with the goal being for these options to expire worthless, as a huge majority did.

So, now that we have an explanation to what might have been behind the massive "V" rally, where do we go from here?

First, the second half of December has historically been bullish, so while the market may not benefit from expiration-related short covering like last week, momentum players or those short individual equities may be supportive, as they throw in the white towel to get a fresh start next year.

That said, just as many key equity benchmarks were trading around round-number century and millennium levels the day ahead of the Fed meeting, we are -- in the blink of an eye -- back in a situation like that of early December from a technical perspective, when round-number resistance areas were in play. For example:

• The DJI comes into the holiday-shortened week just 200 points below the 18,000 mark, following an 800-point rally in just two days.


• The Russell 2000 Index (RUT - 1,195.94) is trading just below the 1,200 century mark, which has acted as resistance on multiple occasions since March. The good news for small-cap bulls is that the RUT gapped above the 1,180 level on Thursday, site of short-term peaks in January and September.


• The MID is just below the 1,450 half-century area, which has acted as resistance three separate times since it was first touched in early July. That said, the neckline of an inverse "head-and-shoulder" formation is at 1,450-1,460, and a breakout would be bullish, targeting a 12% move to 1,640 in the five months after such a breakout.

A few weeks ago, we observed the turn in the 10-day, buy (to open) put/call volume ratio as a risk to the bullish case. In hindsight, this was a risk well worth acknowledging. While this ratio is not near the July or September extremes, it is near extremes in 2013 and early this year that marked key turning points.

If you are a risk taker, you might forego a portfolio hedge with the VIX still considerably above its 2014 lows, suggesting portfolio insurance is relatively expensive. A roll-over in this ratio from the current high level would likely have bullish implications. Our gut is a roll-over is in the cards with the "V-bottom" the market just experienced, and with seasonality now bullish for the next few weeks, a breakout above resistance could be imminent.

That said, if you tend to be cautious, respect that round-number resistance lingers overhead and the buy (to open) put/call volume ratio (first chart below) is still rising. Moreover, an added risk to bulls is the extremely low call open interest on the VIX (see second chart below) and the fact that almost 25% of outstanding SPY puts just expired. This would imply that hedging activity remains low, which was also the case earlier this month preceding a 5% pullback. The one difference between now and early December, however, is that portfolio insurance was cheap and should have been bought, whereas now it is relatively expensive. But the bottom line is unhedged longs are more prone to panic on negative news, which is perhaps a risk worth noting.

Indicator of the Week: Holiday Weeks
By Rocky White, Senior Quantitative Analyst

Foreword: A couple of weeks ago, I showed a chart of the average S&P 500 Index (SPX) December over the past 50 years. It revealed the SPX averages a flat return through the first half of the month, but then spikes higher in the last two weeks. Below is that chart juxtaposed against this December so far.

We had a rough start to the month, but the rally last week happened right when expected. The next two weeks are holiday weeks, and as you can see in the chart, they are typically pretty strong. I'll break down these holiday weeks a little further and look into how stocks typically behave around Christmas and New Year's.

Holiday Weeks: The tables below show the SPX returns during Christmas week and New Year's week since 1950, and then over the last 20 years. As we saw in the chart above, these have typically been good weeks for the market. Since 1950, the SPX 500 has averaged a gain of 0.63% for each holiday week, with 68% of them positive. The typical week since 1950 averaged a gain of 0.14%, and was positive 56% of the time.

I also included the average positive and negative returns. Going back to 1950, Christmas week has tended to have very low volatility. The average gain and loss are smaller in magnitude when compared to other weeks, especially to the downside, with an average negative return of just 0.76%. Looking at the more recent time frame of just the past 20 years shows New Year's week was less volatile than the week of Christmas.

Surrounding Days: These next two tables show how the SPX has performed in the days immediately before and after the holidays.

The first table shows the days surrounding Christmas; the last column shows the typical return for a day. It's notable that over the past 20 years, every single day from two days before Christmas to two days after has averaged a stronger-than-usual return, and has been positive a higher percentage of the time than typical days. As you might expect, the days around the holidays show less volatility than normal, as measured by the standard deviation of returns.

Finally, below are the days surrounding New Year's Day, which aren't quite as bullish. New Year's Eve (or the last trading day of the year) has averaged a loss of 0.17%, and has been positive just 35% of the time over the past 20 years. The first trading day of the year boasts a very good average return, but has been positive just half the time. Also, it's interesting that the first two days of the new year have been more volatile than the typical day for the market, according to the standard deviation of returns.

This Week's Key Events: GDP in Focus During Holiday-Shortened Week
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

• The holiday week kicks off with existing home sales. There are no notable earnings on tap.

Tuesday

• On Tuesday, durable goods, the final reading on third-quarter gross domestic product (GDP), personal income and spending outlays, the Thomson Reuters/University of Michigan consumer sentiment index, and new home sales are all scheduled for release. Cal-Maine (CALM), CalAmp (CAMP), Walgreen (WAG), Piedmont Natural Gas (PNY), and China Finance Online (JRJC) will step into the earnings confessional.

Wednesday

• With markets shuttered Thursday for the holiday, weekly jobless claims will come out on Wednesday. Also set for release is the regularly scheduled crude inventories update. Markets will close at 1 p.m. ET for Christmas Eve. There are no major earnings reports on the docket.

Thursday

• Markets will be closed on Thursday for Christmas Day.

Friday

• Friday's economic and earnings calendars are empty.

And now a sector of note...

Retail
Bullish

The retail sector has been in the headlines recently, with holiday shopping season getting into full swing. In fact, November retail sales figures topped expectations, and the SPDR S&P Retail exchange-traded fund (ETF) (XRT) touched a record peak of $95.64 on Thursday. The shares are currently sitting atop several layers of previous resistance, including their year-to-date breakeven mark of $88.10, and $90.12 -- a 10% premium to XRT's mid-October closing low of $81.93. What's more, the round-number $90 level is significant, as it's roughly double the ETF's 2007 and 2010 resistance level at $45, and could now reverse roles to act as support.

Digging deeper, nearly two-thirds of the 72 retail stocks we follow are trading above their 80-day moving average. Nevertheless, the typical short interest-to-float ratio among these equities exceeds 12%, which would take more than a week to cover, given average daily trading volumes. Also, fewer than half of the brokerage firms covering these names have handed out "buy" ratings. All things considered, retail stocks could be poised to run higher on potential short-covering activity and/or a round of analyst upgrades. In the short term, keep an eye on November personal income and spending data -- set for release on Tuesday -- which could impact the retail sector.

It was a rough week for stocks -- the worst for the Dow, in fact, in more than three years -- but it was a banner five days for the CBOE Volatility Index (VIX). The "fear index" ripped more than 78% higher by Friday's close, while the S&P 500 Index (SPX) slipped less than 2%. As we head into December expiration week, Todd Salamone explains the market mechanics that should make this a very "interesting" week of trading.

• How a rush to hedge could keep stocks under pressure.
• Key VIX levels to watch as Wednesday's VIX expiration approaches.
• Rocky White explains how window dressing takes an unexpected turn in the fourth quarter.

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: How Hedging Activity (or the Lack Thereof) Affects Stocks
By Todd Salamone, Senior VP of Research

"... [W]e still have not lost sight of the fact that the 'higher volatility ahead' trade -- via the purchase of CBOE Volatility Index (VIX - 11.82) calls -- has deteriorated significantly in recent weeks ... But we know the market could succumb at any moment to 'known' or 'unknown' issues or events ... Nonetheless, volatility players and/or those that typically buy portfolio insurance through the purchase of VIX calls have essentially left the building ... Therefore, with VIX futures relatively low -- plus major equity benchmarks around the world trading near potential millennium resistance levels -- it might be prudent to add VIX calls as a portfolio hedge before something emerges that sparks renewed interest in the once-popular volatility trade."
- Monday Morning Outlook, Dec. 6, 2014

"$VIX up 70% from last week's close of 11.82. Double 11.82 is 23.64 and potentially a key area heading into Friday's trading. $SPX"
-@ToddSalamone on Twitter, Dec. 12, 2014

"Investors watching oil plunge day after day are growing concerned the decline will destabilize financial markets and that's boosting demand for hedges ... Signs abound that investors want to lock in equity gains or protect against sudden losses."
-Bloomberg, Dec. 12, 2014

Volatility, as measured by the CBOE Volatility Index (VIX - 21.08) and VIX futures, exploded higher last week, amid multiple headlines ranging from political uncertainty in Greece, to a continued plunge in crude, mounting worries about slowing growth in China, and speculation that the Fed might change its wording to imply a rate hike is getting closer next week.

The volatility was especially explosive considering equity benchmarks experienced only a modest retreat. For example, the VIX rose about 70% from Oct. 3 to Oct. 13 during a 4.8% S&P 500 Index (SPX - 2,002.33) decline. Similarly, the VIX rose 70% from the Dec. 8 close to Thursday's close, but the SPX decline during the same four-day period was only 1.2%.

Put open interest on the SPDR S&P 500 ETF Trust (SPY - 200.89) grew by 1.1 million contracts last week, 37% above the week prior. However, total SPY put open interest of roughly 15 million contracts is more than 15% below its September peak of 18 million contracts.

Meanwhile, VIX call open interest increased by 300,000 contracts, after traders reduced outstanding calls in the prior week. But VIX call open interest stands at only 4.25 million contracts, lower than 94% of the daily readings during the past 52 weeks, and more than 50% below the 2014 peak of more than 8 million contracts. Moreover, over half the current outstanding VIX calls will expire in the middle of this week, hours ahead of the release of the Federal Open Market Committee (FOMC) policy statement.

Put another way, even though hedging activity increased this past week, as noted in the Bloomberg excerpt above, it remains relatively low when compared to what we have observed during the past several months. As we discussed last week, those utilizing hedging activity in their portfolios might be accustomed to seeing their option hedges expire worthless month in and month out, or do not see the need for portfolio protection during a strong seasonal period for equities. Regardless of why hedging activity has dried up in recent weeks, stocks are more vulnerable than usual to panic-selling or headwinds stemming from a sudden increase in hedging activity driven by negative headlines.

Despite the shallow pullback in equities up to this point, potential short-term support levels did not hold. For example, the SPX broke below the 2,033 level, which represents a 10% year-to-date (YTD) gain. Moreover, the SPX fell below: 2,049, which is 10% above its recent closing low; its 30-day moving average, a trendline that marked support during the May-July rally earlier this year; and the 1,916 level, which is 10% above the 2014 low. The next layer of support is at the round 2,000 millennium level, site of its 80-day moving average and heavy put open interest in the standard expiration series that expires this coming week.

The Russell 2000 Index (RUT - 1,152.45) failed to sustain a move above 2014 resistance at 1,180, and at week's end fell back into negative territory for the year, with a close below 1,163.64. The YTD breakeven level on the RUT has been a magnet within the scope of a trading range this year. In fact, in 38 of the 241 trading days this year, the RUT has crossed 2013's close -- almost 16% of the trading days throughout the year. Moreover, it has crossed this mark in eight of the last 17 trading days.

The iShares Russell 2000 ETF (IWM - 114.71) enters expiration week trading at the bottom of its range since Nov. 19, but below its YTD breakeven point of $115.36 and below $114.75, which is 10% above its mid-October closing low. More importantly, the IWM is below the put-heavy 115 and 116 strikes.

As we have explained in prior reports, after a break below a major put strike in the days preceding expiration, other heavy put strikes below can act as magnets in a process called "delta-hedge selling." Delta-hedge selling occurs when an underlying approaches heavy put strikes and the options become more sensitive to the movements of the asset, forcing sellers of the puts to short futures to offset losses from the puts they sold to buyers of those options. In this case, heavy put open interest is stacked down to the 109 strike, which is coincidentally around the February and May lows.

Therefore, the IWM's close below the put-heavy 115 and 116 strikes enhances the possibility of delta-hedge selling. That said, a strong rally off the bottom of its short-term trading range could inspire short covering related to the expiring put open interest.

Finally, we are closely watching the VIX, which hit a high of 23.06 in Friday's trading, before settling at 21.08. After consecutive months in which 90% to 99% of VIX call options expired worthless, could this be the month that the few who stuck with the higher-volatility trade are rewarded with call options that expire with significant value?

As we head into expiration week, and given the recent trajectory of VIX and VIX futures, sellers of VIX call options run the risk of a continued advance in volatility, so they may be looking to hedge this risk by buying VIX futures, which could drive volatility higher and stocks lower. December VIX futures closed on Friday at 19.58, just below December's peak call open interest. If the VIX surges above 23.64 -- double its recent low -- and December VIX futures move above 20, we could see another sharp increase in the VIX, especially if VIX call buyers suddenly surface again.

But if you think past is prologue, expect to see a VIX settlement price Wednesday morning that is below 16, repeating a pattern where the vast majority of VIX call open interest expires worthless (see second graph below -- December VIX open interest configuration). For those of you not familiar with VIX options, the December series is based on December VIX futures, and the last day to trade December VIX options is Tuesday, ahead of Wednesday morning settlement.

With an FOMC meeting this week, there might be a little juice in SPX option premiums that is driving volatility expectations higher. Stay tuned -- it should be an eventful expiration week.

Indicator of the Week: Window Dressing
By Rocky White, Senior Quantitative Analyst

Foreword: It is expected that many mutual funds and other portfolio managers partake in a dubious custom called "window dressing." This is when mutual funds buy stocks that have been outperforming near the end of the quarter, just before the reporting period. This way, when they send their quarterly reports and disclose their holdings, it looks as though they had the foresight to invest in these high-flying stocks. Similarly, they sell stocks that have been underperforming to hide the fact they owned market laggards. This is done to fool those who invest or may potentially invest in their fund. It makes their portfolios look stronger than they actually have been. This week, I'm going to see if we can quantify the evidence that window dressing is, in fact, occurring. If it is prominent, then maybe we can predict which stocks will benefit and which will suffer because of this ruse.

Window Dressing Since 2010: To find evidence of window dressing, I went back to 2010 and looked at how all stocks (that met some liquidity guidelines) did in the final two weeks of each quarter. I also found out how each stock did in the preceding six months before those last two weeks. For evidence of window dressing, I determined the best 25 and worst 25 stocks each quarter, according to those six-month returns, and compared this data to the returns of those stocks in the last two weeks of the year.

If window dressing had a significant effect on the stocks, you'd see the stocks with the best six-month returns tending to outperform those with the worst six-month returns. Again, this is because portfolio managers are purchasing the outperformers and selling the underperformers just before the end-of-quarter disclosures are released.

The table below shows the results. There is clear evidence of window dressing in these numbers. The best-performing stocks in the preceding six months have averaged a gain of 0.48% over the final two weeks of the quarters since 2010. Meanwhile, the stocks doing the worst over the prior six months have averaged further losses of 1.03% over the final two weeks. Also, 54% of the best-performing stocks were positive in the last two weeks, while less than half (48%) of the worst performers were positive.

In Which Quarters is Window Dressing Most Prominent?: I wondered if window dressing was more prominent in some quarters than others. Using the same criteria as above, I found the average return of the stocks depending on the quarter. If window dressing is significant in the quarter, then for that quarter the average return in the "Best Performers" column should be better than the average in the "Worst Performers" column.

From the data below, if you're looking to profit from window dressing this quarter, you might want to reconsider and wait until 2015. During the tail end of the fourth quarter, the worst-performing stocks in the preceding six months have actually done better than the best-performing stocks. Maybe there are other considerations for portfolio managers in the final quarter of the year (tax considerations, perhaps?) that override window dressing. Whatever the reason, it's something we will revisit next March.

This Week's Key Events: All Eyes on the Fed
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

• The week starts off with a bang, with the Empire State manufacturing index, industrial production and capacity utilization, the National Association of Realtors' pending home sales index, and Treasury International Capital (TIC) all slated for release. FuelCell Energy (FCEL) and VeriFone (PAY) will release earnings.

Tuesday

• On Tuesday, the Federal Open Market Committee (FOMC) will kick off its two-day policy-setting meeting. Also on the docket is data on housing starts, plus Markit's flash purchasing managers manufacturing index (PMI). Darden Restaurants (DRI), FactSet (FDS), and Navistar (NAV) will report earnings.

Wednesday

• The latest policy announcement by the FOMC highlights Wednesday's docket, as well as the subsequent press conference from Fed Chair Janet Yellen. Also being released is the consumer price index (CPI) and the weekly crude inventories report. FedEx (FDX), General Mills (GIS), Joy Global (JOY), and Oracle (ORCL) will show their earnings power.

Thursday

• Weekly jobless claims and the Philadelphia Fed's manufacturing survey come out on Thursday. On the earnings front, Nike (NKE), Accenture (ACN), Cintas (CTAS), ConAgra (CAG), NQ Mobile (NQ), Pier 1 Imports (PIR), Red Hat (RHT), Rite Aid (RAD), and Scholastic Corp (SCHL) will report.

Friday

• There are no notable economic reports on Friday. BlackBerry (BBRY), CarMax (KMX), Finish Line (FINL), and Paychex (PAYX) will step into the earnings spotlight.

And now a sector of note...

Retail
Bullish

The retail sector has been in the headlines recently, with holiday shopping season getting into full swing. In fact, November retail sales figures topped expectations last week, helping to power a broad-market rally on Thursday. Meanwhile, the SPDR S&P Retail ETF (XRT) looks like an interesting play. The shares are currently sitting atop several layers of previous resistance, including their year-to-date breakeven mark of $88.10, and $90.12 -- a 10% premium to XRT's mid-October closing low of $81.93. What's more, the round-number $90 level is significant, as it's roughly double the exchange-traded fund (ETF)'s 2007 and 2010 resistance level at $45, and could now reverse roles to act as support. That said, this past week's pullback to the $90.50 area provides a potentially solid entry point, especially if retailers continue to benefit from lower gas prices translating into more consumer spending.

Digging deeper, two-thirds of the 73 retail stocks we follow are trading above their 80-day moving average. Nevertheless, the typical short interest-to-float ratio among these equities exceeds 12%, which would take roughly six sessions to cover, given average daily trading volumes. Also, fewer than half of the brokerage firms covering these names have handed out "buy" ratings. All things considered, retail stocks could be poised to run higher on potential short-covering activity and/or a round of analyst upgrades.

The Dow Jones Industrial Average (DJIA) and S&P 500 Index (SPX) raced to even higher highs on Friday, helped by the Labor Department's stellar payrolls report. In fact, for the seventh consecutive week, both indexes finished higher, even as commodity prices continued to sag. That said, this week, Schaeffer's Senior VP of Research Todd Salamone will look at the implications of crude's decline, and explain why the time may be right for a volatility play.

• The new macro risk that has emerged
• Why now may be a good time for a volatility trade
• Rocky White discovers whether high levels of bullish sentiment will play havoc with December's historically strong returns

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: Reasons to Reconsider a Volatility Trade
By Todd Salamone, Senior VP of Research

"... hedging activity has dried up in the past few weeks as the market has advanced. This suggests that there are a lot of un-hedged longs, which makes the market more vulnerable to bad news. Before the last correction, hedging activity dried up as well, but negative news caused a stampede into index put buying and volatility call buying, contributing to an accelerated decline as sellers of the portfolio protection had to short S&P futures to remain hedged."

- Monday Morning Outlook, Nov. 22, 2014

"... 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 ... short interest on SPX component names is still relatively high, nearer the top of its range during the past couple of years ... after reducing equity exposure two weeks ago -- a potential headwind if this were to continue -- active investment managers again increased their exposure to equities ... 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."

- Monday Morning Outlook, Nov. 29, 2014

"None of the red flags -- not tumbling oil prices, not slowing growth in China, not stagnation in Europe -- are getting a rise out of U.S. investors. Indeed, plenty of folks think U.S. stocks are benefiting, playing the role of the safe harbor in the storm."

-The Wall Street Journal, Dec. 4, 2014

"Speculators hold around the fewest options on the Chicago Board Options Exchange Volatility Index in more than two years, while trading in the contracts is the slowest since 2012, according to data compiled by Bloomberg. The Standard & Poor's 500 Index has gained 12 percent this year."

-Bloomberg, Dec. 4, 2014

"Round millennium #'s in play around world: $DJIA 18K, $NYA 11K, $DAX 10K, $NIKKEI 18K, $SHGIDX 3K"

"$VIX decent collapse this morning - suggests elevated reading ahead of employment number"

"$QQQ 20% YTD return at $105.50- this week's resistance"

-@ToddSalamone on Twitter, Dec. 5, 2014

Not a lot has changed since our discussion last week, with large caps -- as measured by the Dow Jones Industrial Average (DJI - 17,958.79) and S&P 500 Index (SPX - 2,075.37) -- continuing to carve out all-time highs (albeit barely) in an advance that has clearly lost the impressive momentum that we observed off the mid-October bottom into mid-November. Meanwhile, smaller-capitalization stocks, such as the Russell 2000 Index (RUT - 1,182.43) and S&P MidCap 400 (MID - 1,444.31), continue to chop around 2014 resistance levels in the 1,180 and 1,450 zones -- although this might be interpreted as bullish, since we have not yet observed violent rejections from this obvious chart resistance, which occurred in early September.

Meanwhile, an additional macro risk has emerged, along with several others that have already surfaced this year, including the Fed hinting at raising interest rates, slowing economic growth in China, the Russia/Ukraine conflict, and one that has been brewing for a long time -- Europe's economy. The "newest" macro risk on many radar screens is the huge descent in oil prices, especially last week, following news that the Organization of Petroleum Exporting Countries (OPEC) would keep its production quotas intact.

But so far, the only visible damage that has occurred has been confined to the energy sector, as the Energy Select Sector SPDR ETF (XLE - 80.28) is off 20% from its 2014 highs. Nonetheless, concerns range that the drop in oil prices is foreshadowing slowing economic growth, to another financial crisis.

As a side note, in 2007-2008, when oil prices were surging amid strong demand, the conventional wisdom was that the economy was vulnerable to higher oil prices, and thus lower oil prices would be necessary to sustain economic growth. However, as oil prices declined sharply amid slowing demand, the economy and the stock market suffered.

Now, some market participants view lower oil prices as a threat to economic growth, even though the retreat in oil prices is in part being driven by new and improved methods of drilling for oil, creating additional supply. That brings up an important question to ponder: Will market participants again misjudge the implications of lower oil prices?

The financial crisis concern is driven by the fact that energy junk-bond debt represents 16% of the $1.3 trillion junk-bond market, leaving banks exposed to those energy companies that lose money as a result of declining oil prices. That said, the Financial Select Sector SPDR ETF (XLF - 24.82) achieved a six-year high this past week, and the SPDR S&P Regional Banking ETF (KRE - 40.57) rallied strongly off a key longer-term moving average and its year-over-year breakeven level. However, the latter is currently trading just below multi-year highs and its year-to-date breakeven level of $40.61.

Strong price action, positive December seasonality, and recent evidence of short covering and buyback activity that is usually robust at this time of year, are reasons not to disturb long positions. That said, we still have not lost sight of the fact that the "higher volatility ahead" trade -- via the purchase of CBOE Volatility Index (VIX - 11.82) calls -- has deteriorated significantly in recent weeks. This trade has been extremely popular for the past couple of years, and the fact that many have given up on it may not be a huge surprise, as 90-99% of VIX calls have expired worthless month after month.

But we know the market could succumb at any moment to "known" or "unknown" issues or events (the Federal Open Market Committee meeting later this month, for example). Nonetheless, volatility players and/or those that typically buy portfolio insurance through the purchase of VIX calls have essentially left the building.

Therefore, with VIX futures relatively low -- plus major equity benchmarks around the world trading near potential millennium resistance levels -- it might be prudent to add VIX calls as a portfolio hedge before something emerges that sparks renewed interest in the once-popular volatility trade.

I will end with this thought-provoking question: Despite almost daily reminders that China's economy is slowing and that this is a risk to our market, what does it mean that the Shanghai Composite (SHGIDX) is up almost 40% year-to-date?

Indicator of the Week: December Seasonality
By Rocky White, Senior Quantitative Analyst

Foreword: Seasonality data for December seems especially interesting, what with it being the final month of the year and the holiday season. Simply looking at monthly data over the past 50 years on the S&P 500 Index (SPX), we see December has been a very good month for stocks.

Specifically, it's the second best month (April is first) in terms of the typical return, with an average gain of 1.51%, and it has been positive more often than any other month, at 74%. Furthermore, the standard deviation of returns is the lowest, indicating less variation in the returns. Let's break down this data even further to see when the best time to buy has been, and add in some sentiment data to make it a little more relevant to the current environment.

Wait Until Mid-Month: Don't be worried that we're already a week into the month. Historically speaking, all the gains in December happen in the second half of the month. Below is a chart that shows, on average, how December has played out. There have typically been gains in the first 10 days, but by the middle of the month, December is back at breakeven. The SPX has then spiked higher over the last part of the month.

Below, I have a table quantifying the data above. I summarize the returns from the beginning of December through the 14th, and then compare that to the rest of the year. The first half of the month has averaged a slight loss, and was positive 54% of the time. The second half has averaged an impressive gain of 1.56%, and has been positive 80% of the time.

Investors Intelligence: The Investors Intelligence (II) sentiment poll shows investors to be very bullish right now. With the market hitting all-time highs, that's not completely unexpected -- but when investors are extremely bullish, it tends to have negative implications for the market. So right now, we're at a point that is historically very bullish, but expectations are very high. Does the market tend to struggle in these scenarios, or does one factor tend to prevail over the other?

The average percentage of II bulls over the past month is about 55%. There have been 18 occurrences when the reading was above 50% heading into the last half of December. In those 18 times, the average return for the rest of the year was 1.77%, with 83% of those returns positive. In other words, the late-December seasonality is just too strong. The SPX's returns have been pretty good, no matter what the Investors Intelligence poll has showed.

This Week's Key Events: Retail Sales, Inflation Data Due Out
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. Diamond Foods (DMND), H & R Block (HRB), and Vail Resorts (MTN) will release earnings.

Tuesday

• The Labor Department's Job Openings and Labor Turnover Survey (JOLTS) hits the Street on Tuesday, along with wholesale inventories. AutoZone (AZO), Conn's (CONN), Krispy Kreme Doughnuts (KKD), Pep Boys (PBY), and UTI Worldwide (UTIW) will step into the earnings spotlight.

Wednesday

• The Treasury budget and weekly crude inventories make up Wednesday's docket. Costco (COST), Avanir Pharmaceuticals (AVNR), Hovnanian (HOV), Lands' End (LE), and Toll Brothers (TOL) will report earnings.

Thursday

• Weekly jobless claims will come out on Thursday, along with retail sales figures, import and export prices, and business inventories. On the earnings front, Adobe Systems (ADBE), Ciena (CIEN), and Lululemon Athletica (LULU) will report.

Friday

• The Thomson Reuters/University of Michigan consumer sentiment index and producer price index (PPI) come out on Friday. There are no major earnings reports on the day's schedule.

And now a sector of note...

Semiconductors
Bullish

Since gapping above the round $50 area in late October, the Market Vectors Semiconductor ETF (SMH) has continued its impressive uptrend. On Friday, in fact, the ETF rallied to a new 13-year high above $56, with its year-to-date gain of about 33% easily surpassing a roughly 20% advance in the broader PowerShares QQQ Trust (QQQ). Despite this strong technical backdrop, the average short interest-to-float ratio for the 48 names we track in the sector is a steep 8.0% -- accounting for more than a week's worth of pent-up buying demand, at typical daily trading volumes. Should the sector continue to outperform, a mass exodus of these bears could translate into additional upside for the semiconductor group. That said, with SMH exploring new multi-year highs, potential speed bumps are in the $58 area (representing a 50% retracement of the 2000 high and 2008 low) and at the $60 level (representing four times the SMH's 2008 low, and 50% above the historically significant $40 area).

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.

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.

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.

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.

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.

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.

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.

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.