Monday Morning Outlook: Dow Tags 10,000, and Technicians See Speed Bumps Ahead

              

Well, the bulls couldn't make it stick, but even so, didn't it feel a whole lot better going up than it did going down? A year after plunging through the 10,000 mark in the midst of a financial, banking and credit crisis, and seven months after bottoming at 6,547.05 on March 9, the Dow Jones Industrial Average (DJIA) regained the millennial milestone. Although it couldn't maintain that perch by the week's close, the week still went into the "W" column, and 10,000 was just a sniff away. Todd Salamone, Senior Vice President of Research, sees this rally continuing, but focuses his technical analysis on a few short-term speed bumps that could materialize within the longer-term uptrend. Next, the coming week begins a five-week expiration cycle, and Senior Quantitative Analyst Rocky White takes a look at why these weeks are often been bearish -- with the notable exception of the most recent occurrence in July. Finally, we wrap up with a look at some key economic and earnings reports slated for release this week.

Recap of the Previous Week: Dow Briefly Conquers 10,000
By Joseph Hargett, Senior Equities Analyst

After a year of unprecedented financial upheaval, it was the week the Dow Jones Industrial Average (DJIA) regained the 10,000 level, and although it ended the week less than five points below that marker, for most it was a development worth cheering. The week started quietly enough on a low-volume Columbus Day, with the bond market closed and little activity on the earnings and economic calendars. The Dow Jones Industrial Average (DJIA) set its sights on 10,000 early, powering to an intraday high of 9,931.82, but eventually settled at 9,885.80, a daily gain of 0.2%. Earnings anxiety set in on Tuesday. Dow component Johnson & Johnson (JNJ) started things off on the wrong note by falling short of analysts' consensus revenue expectations. Banking analyst Meredith Whitney added to the downbeat tone by cutting her rating on Goldman Sachs (GS) from "buy" to "hold," just as several key members of the financial sector were preparing to release their earnings reports. The Dow fell 0.2% for the day.

Breakthrough day came Wednesday when two corporate titans released well-received earnings. Banking behemoth JPMorgan Chase & Co. (JPM) blew past third-quarter profit expectations and fellow Dow component Intel (INTC) raised its fourth-quarter revenue forecast. The Dow soared 100 points right out the gate, crossed briefly above 10,000 in the early afternoon, retreated, and then climbed back above five digits in the final hour of trading. For the day, the Dow rose 1.47%, or nearly 145 points.

Stocks spent much of the day in the red on Thursday, but an eleventh-hour buying spree eventually boosted the DJIA to a 0.5% gain. Financials Citigroup (C) and Goldman Sachs (GS) exceeded quarterly earnings expectations, but the Street was evidently looking for more. Crude oil's strength, however, eventually helped bolster prices. Good-but-not-great earnings from IBM (IBM) and General Electric Co. (GE), and a disappointing report from Bank of America (BAC) dictated the early mood on Friday, and disappointing consumer confidence data confirmed the downbeat tone. The Dow fell more than 100 points in the early going, and although it fought back to the 10,000 level at several points in the afternoon, it ended less than five points shy of the mark. By the close on Friday, the Dow fell 0.7% for the session. For the week, however, the blue-chip barometer scored a gain of 1.3%. Elsewhere, the S&P 500 Index (SPX) posted a weekly gain of 1.5%, and the Nasdaq Composite (COMP) finished 0.8% higher for the week.

What the Trader Is Expecting in the Coming Week: Speed Bumps in the Uptrend
By Todd Salamone, Senior Vice President of Research

Another positive expiration week is behind us, and the market has been higher eight of the past 10 trading days. In addition to whether the Dow Jones Industrial Average can sustain a move beyond 10,000, market participants have a lot to ponder during the next few days and weeks. Third-quarter earnings reports will continue to dominate the news flow, a potential post-expiration "hangover" lingers (see Rocky White's commentary below), and the SPX is in the early phase of moving from a short-term "overbought" condition, as longer-term technical resistance again comes into play.

Indeed, amid generally poor earnings reactions from the financial sector last week, there are some potential headwinds in the short term. That being said, we are not in the camp that a major correction is just ahead, or that a retest or move below the March lows is on the horizon. "Overbought" conditions in recent months have tended to work themselves out via a consolidation or moderate pullback. We have little reason to think the future will play out any differently, given the huge amount of sideline cash waiting to buy stocks on pullbacks.

A chart that I find intriguing uses key Fibonacci numbers as a measure of the percentage gains above the Standard & Poor's Depositary Receipts (SPY) low in March to depict resistance areas within the uptrend. Specifically, I'm referring to the numbers 38.2, 50.0 and 61.8. Per the graph of the SPY below, I cannot help but notice how the market has tended to "dance around" key Fibonacci areas for lengthy periods, before the uptrend reasserts itself. In other words, these levels have acted as major hesitation areas once initially tested. The SPY is currently trying to distance itself from the 108.50 area, which is 61.8% above the early-March low. Many technicians are focusing on SPX 1,121, a 50% retracement of the 2007 peak and 2009 trough, as the next target for the SPX. But it seems there is more work that needs to be done first to escape the grip of the 1,080-1,085 area, which corresponds to 108.00-108.50 on the SPY.

In addition to the Fibonacci area mentioned above, another potential speed bump is the International Securities Exchange's (ISE) all-equity 10-day buy (to open) call/put volume ratio, which has moved higher to 1.97. This means ISE customers have bought nearly two calls for every put during the past 10 days. Such optimism among option players was present heading into post-expiration week last month and preceded a minor correction.

Meanwhile, according to the most recent American Association of Individual Investors' weekly survey, 47% of retail investors are bullish. This bullish percentage is near an annual peak, and the market has tended to struggle when the bullish percentage reaches these heights. From a bigger-picture perspective, though, the fact that less than half of retail investors polled are bullish in spite of a 60% rally from the March lows is simply amazing. It is representative of the sideline money that can eventually power this market higher.

As I said a couple months ago, expect the bull trend to remain intact, but also expect periods that test the nerves and create brief moments of joy for the bears. If you are looking to hedge your long positions, the financial group is an area that could come under pressure in the coming weeks. We are noticing a huge uptick in call buying on the Select Sector SPDR Financial Fund (XLF). Such call buying was prevalent in 2008 as the financials spiraled lower, and it is our theory that this call buying was married to shorting activity on individual stocks. Therefore, it is possible the shorts are making their way back into financials, on the heels of negative earnings reactions in the group last week. Moreover, the XLF is trading just below its 80-week moving average, which is a risk from a technical perspective. We continue to favor oil service and retail and leisure stocks.

Indicator of the Week: Beginning a Five-Week Expiration Cycle
By Rocky White, Senior Quantitative Analyst

Foreword: This coming week begins the new expiration cycle. Unlike most expiration cycles, which are usually four weeks, we have five weeks before November expiration. Bernie has previously commented that he had a gut feeling that there might be some headwinds in the beginning of a long expiration cycle, due to the added emphasis on index put accumulation. As these puts are added on the new front-month expiration, market makers, who sold the puts, will hedge their positions via short selling. The hedging by market makers due to the index put accumulation results in selling pressure on stocks. Additionally, deltas are higher on the front-month options, given that there is more time until the next expiration than usual, which will require more hedging than a four-week cycle. This week I show you what we found when we gathered the data on Bernie's hunch.

Analysis: Below is a table comparing data on the performance of the S&P 500 Index (SPX) during the first week of a five-week expiration cycle, during the first week of any expiration, and for any week since 2006. You will notice that the first week of an expiration cycle has tended to be bearish compared to other weeks. The first week of a five-week cycle is especially bearish. These five-week cycles have really underperformed in the first week showing a loss of 0.52%. Positive returns have been realized only one-third of the time. This is quite poor when compared to any week since 2006. The any week figures are positive just more than half the time, although they show an average loss of 0.05%.

Below is a table showing the 15 weeks since 2006 that started a five-week cycle. I also included the preceding week in case there is a pattern of returns depending on the expiration week performance before the long expiration cycle. I don't personally see much of a pattern, but sometimes it takes another set of eyes. The table reveals that while these weeks have a strong bearish bias, the last two occurrences have yielded market gains – including a huge weekly gain of over 4% in the most recent case in July of this year.

Implications: While I noted above that the week ahead has been historically bearish, the last two times it happened saw positive gains, including a huge week last July when the S&P 500 increased over 4%. So the potential for a big week is not lost. In fact, given the high amount of pessimism that we're seeing anecdotally, combined with the strong momentum of this market, and a whole slew of earnings coming out this week, we believe the potential of a big week lies heavily on the upside rather than the downside. In fact, a big part of the negative sentiment that we see is directed at earnings, which lowers expectations and creates the possibility of a huge upside surprise.

This Week's Key Events: Beige Book, Home Starts and Leading Indicators on Tap
By Joseph Hargett, Senior Equities Analyst

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

Monday

• There are no economic reports slated for release on Monday. It's a big week for earnings, and kicking off the action on Monday will be BB&T Corp. (BBT), Gannett Co. Inc. (GCI ), McMoRan Exploration Co. (MMR), PetMed Express Inc. (PETS), Weatherford International Ltd. (WFT), Apple Inc. (AAPL), Atheros Communications Inc. (ATHR), Boston Scientific Corp. (BSX), and Texas Instruments Inc. (TXN).

Tuesday

• Reports on building permits and home starts for September are due on Tuesday, along with the producer price index (PPI) and the core PPI for September. Elsewhere, The Bank of New York Mellon Corp. Corporation (BK), Biogen Idec Inc (BIIB), BlackRock Inc. ( BLK), Caterpillar Inc. (CAT), Coach Inc. (COH), The Coca-Cola Co. (KO ), Comerica Inc. (CMA), DuPont Co. (DD), Lockheed Martin Corp. (LMT), Regions Financial Corp. (RF), State Street Corp. (STT), UAL Corp. (UAL), United Technologies Corp. (UTX), UnitedHealth Group Inc. (UNH), STMicroelectronics N.V. (STM), and Yahoo! Inc. (YHOO) are among those reporting earnings.

Wednesday

• On Wednesday we'll see the weekly crude inventories report and the eagerly awaited Beige Book from the Federal Reserve, its most recent snapshot of economic conditions. Meanwhile, The Boeing Co. (BA), Eli Lilly & Co. (LLY), KeyCorp (KEY), Northrop Grumman Corp. (NOC), U.S. Bancorp (USB), Wells Fargo & Co. (WFC), Amgen Inc. (AMGN), eBay Inc.(EBAY), and VMware Inc. (VMW) are scheduled to report earnings.

Thursday

• Weekly initial jobless claims, continuing claims and leading economic indicators from the Conference Board are due on Thursday, along with the Federal Housing Finance Agency's Housing Price Index. The earnings calendar is chock full and includes 3M Company (MMM), AT&T Inc. (T), Bristol Myers Squibb Co. (BMY), Danaher Corp. (DHR), Delta Air Lines Inc. (DAL), The Dow Chemical Co. (DOW), Entergy Corp. (ETR), Fifth Third Bankcorp (FITB), Goodrich Corp. (GR), Kimberly-Clark Corp. (KMB), Merck & Co. Inc. (MRK), Philip Morris International Inc. (PM), PNC Financial Services (PNC), Schering-Plough Corp. (SGP), The Travelers Companies Inc. (TRV), United Parcel Service Inc. (UPS), US Airways Group Inc. (LCC), Wyeth (WYE), Xerox Corp. (XRX), Amazon.com Inc. (AMZN), American Express Co. (AXP), Broadcom Corp. (BRCM), Juniper Networks Inc. (JNPR), and Netflix Inc. (NFLX).

Friday

• We round out the week's economic calendar with just the existing home sales report from the National Association of Realtors. In earnings, we'll see Fortune Brands Inc. (FO), Honeywell International Inc. (HON), Microsoft Corp. (MSFT), and Schlumberger Limited (SLB).

Prepare for the investing week ahead. Every week, Bernie Schaeffer and his staff provide you with their insights about what has happened and, more importantly, what will happen in the market. We dig deep and show you what's happening behind the scenes, and tell you which indicators are predicting major market moves. If you enjoyed this week's edition of Monday Morning Outlook, sign up here for free weekly delivery straight to your inbox.

And now a few sectors of note...

Dissecting The Sectors

Sector

Financials Bearish

Outlook: Despite logging a year-to-date rally of more than 24%, the Select Sector SPDR Financial Fund (XLF) could come under pressure in the coming weeks. Technically speaking, the XLF peaked last week at its declining 80-week moving average. We have observed that this long-term trendline sometimes serves as important support/resistance levels. On the sentiment front, we are noticing a huge uptick in call buying on the XLF. Specifically, the XLF's buy (to open) call/put ratio has turned higher. When this ratio trended higher in 2008 and early 2009, bank stocks skidded. The current behavior in this ratio may indicate that the shorts are coming back after a wave of short covering. In other words, they're buying XLF calls to hedge short positions. If this is true, the shorting activity would have a depressive coincidental impact on the group. Elsewhere, Barron's recently had a cover featuring Bill Miller, the popular Legg Mason Value Fund manager, with the exclamation, "He's Back!" This fund manager has heavy exposure to financial names, which hurt his performance badly last year. The timing of the cover may have bearish contrarian implications for the financial sector. For those of you with call positions or with big long exposure, the XLF put acts as a hedge in the event of a market pullback.

Sector

Oil Services Bullish

Outlook: Fresh signs of an improving global economy seem to be popping up on a daily basis, and energy prices have responded by trekking higher in anticipation of rising demand. Specifically, crude futures have more than doubled from their Dec. 24 low of $35.13 per barrel. The oil services sector has wasted no time in capitalizing on this strength, with the Oil Service HOLDRS Trust (OIH) soaring more than 74% since the start of the year. The OIH has gained momentum since the market bottom in March, rallying nearly 99% off its March 6 low of $64.65. Meanwhile, the trust's 50-day buy-to-open put/call volume ratio could be in the process of rolling over, which may be a concern for the sector. Typically, OIH puts are utilized by institutional investors as a way to hedge long positions on oil sector stocks or indexes. What's more, the brokerage bunch has room for upgrades, as 46% of ratings on oil service stocks are currently "buys," compared to 67% in July 2008 and 61% at the end of last year. Any upgrades from these analysts could lend additional support for the oil services sector. Technically speaking, OIH crossed above its 80-week moving average last week, which is coincidentally the site of a 38.2% Fibonacci retracement of the trust's July 2008 peak and its December 2008 low.

Sector

Retail Bullish

Outlook: Technically speaking, the retail sector has come on strong since the March bottom, with the S&P Retail SPDR (XRT) rallying more than 103% during this time frame. What's more, retail remains one of the strongest sectors, and is trading above its 80-week and 160-week trendlines. This month, XRT crossed above the 61.8% Fibonacci retracement of its June 2007 peak and its November 2008 low. This level is at 34, which coincidentally posed a major challenge for the XRT from February-September 2008. However, pessimism is thick on the retail sector, as only 42% of the 951 analyst rankings on retail stocks are "buys," according to Zacks, leaving plenty of room for potential upgrades. That said, the XRT's 50-day buy-to-open put/call ratio has recently rolled over from a near-term peak, a development that could be a concern for the sector. However, the XRT is up about 20% since the rollover in this reading began. Within the sector, we see bullish opportunities for Expedia Inc. (EXPE), Whole Foods Market Inc. (WFMI), Green Mountain Coffee Roasters Inc. (GMCR), Polo Ralph Lauren (RL), AutoNation Inc. (AN), Starbucks Corp. (SBUX), Chipotle Mexican Grill Inc. (CMG), and Aeropostale Inc. (ARO).