Monday Morning Outlook: Dow Reclaims 10,000

              

A 200-point rally on Thursday brought the Dow Jones Industrial Average (DJIA) back above 10,000, a level it has been flirting with since mid-October. It had every reason to tank on Friday, when unemployment figures came in worse than unexpected. Instead, the Dow held. Todd Salamone, Senior Vice President of Research, examines several technical and sentiment indicators, including the performance of the CBOE Market Volatility Index, that help explain why the market held support last week. Next, Senior Quantitative Analyst Rocky White takes a look at November seasonality for the SPX during the past 30 years, and discovers that this once tried-and-true period of positive returns isn't quite as dependable as it once was. Finally, we wrap up with a look at some key economic and earnings reports slated for release this week.

Recap of the Previous Week: Bulls Send Dow to Highest Weekly Close Since October 2008
By Joseph Hargett, Senior Equities Analyst

Driven by a flood of corporate earnings and economic data, the bulls reclaimed the leadership role on Wall Street last week. Stocks rocketed higher out of the gate on Monday, with the Dow Jones Industrial Average (DJIA) gaining 0.79% as traders savored Ford Motor's (F) souped-up earnings forecast and the Institute for Supply Management's (ISM) stronger-than-expected manufacturing index.

The Dow didn't stray too far from breakeven on Tuesday, slipping 0.18% as investors held their breath ahead of the Federal Reserve's interest rate decision. The cautious atmosphere helped mute response to Berkshire Hathaway's plans to purchase railroad issue Burlington Northern Santa Fe (BNI). Berkshire's Warren Buffett called the acquisition "an all-in wager on the economic future of the United States."

The flood of economic data led the DJIA to a gain of 0.31% on Wednesday, as ADP announced that the private sector cut 203,000 jobs in October, while the Federal Open Market Committee (FOMC) unanimously voted to keep interest rates near their current levels. The committee cited its belief that "economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period."

Stocks rallied sharply on Thursday, as the Dow soared 2.08% to close above 10K for the first time in two weeks. An upbeat forecast from Cisco Systems (CSCO) jump-started the blue chips, and retailers lent extra support by posting solid gains for the second straight month in October, according to the International Council of Shopping Centers. Elsewhere, the Labor Department reported that first-time jobless claims fell to a 10-month low of 512,000 in the prior week, declining by a wider margin than economists expected.

On Friday, traders were initially unnerved by an unemployment rate that surged to a higher-than-expected 10.2%, its highest rate in 26 years, but the bulls regained their footing and fought back to breakeven for most of the day, encouraged partly by an upgrade for General Electric Co. (GE). The Dow eventually settled on a gain of 0.2%, closing above 10,000 on a weekly basis for the first time since October 2008. For the week, the Dow added 3.2%, the S&P 500 Index also climbed 3.2%, and the Nasdaq Composite was up 3.3%.

What the Trader Is Expecting in the Coming Week: SPX Holds Support (And Go Yankees!)
By Todd Salamone, Senior Vice President of Research

The S&P 500 Index (SPX) was down seven of nine days, then rallied back to close higher five consecutive days. For those of you who remember the July 4 Monday Morning Outlook, The Beastie is back! Drama is in the headlines, drama is in the day-to-day market movement, but the end result has been a stock market with a mean-reverting tendency since mid-September.

Last week, I posed the question:

"Are we seeing a repeat of the broad-market weakness of May-June 2009, which preceded another major buying opportunity, or is this a precursor of a more serious market decline?"

In attempting to answer this question, I pointed out a technical pattern I saw developing that was (and continues to be) very similar to the May-June 2009 period. In summary, the pattern consisted of a market that ran into major intermediate- and longer-term resistance levels and experienced a mild correction that injected fear into market participants. Going into last week, the unknowns were whether or not the SPX's 80-day moving average would again provide support after a similar percentage decline, and if the CBOE Market Volatility Index (VIX – 24.19) would again top out in the 31 area, as it did in early July.

Last week's trading quickly provided us with answers to the unknowns, as the VIX indeed peaked in the 31 area and the SPX rallied powerfully from its 80-day moving average, a trendline that has been extremely important since August 2008. Moreover, the VIX quickly reversed lower, confirming that the 2009 trend remains lower. Not only did it peak just below its 200-day moving average, but it moved back below its 80-day and 160-day moving averages, trendlines that have had significance in 2009.

Should the pattern continue to play out like that of May-July, the SPX will rally above its last peak at 1,100 by the end of the month.

One encouraging sign for the bulls is that in the latest American Association of Individual Investors' Survey (AAII), published Nov. 5, only 22% of those surveyed were bullish on the market. The percentage bulls last week was the lowest since March 5 of this year, only one day ahead of the 2009 market low, when only 19% of those surveyed proclaimed they were bullish. As I've mentioned in previous Monday Morning Outlooks, those surveyed in this weekly poll have had an uncanny knack for being wrong at major market turns in 2009.

From a contrarian perspective, the short-term sentiment landscape has improved compared to a few weeks ago, when the percentage bulls in the AAII survey peaked near 2009 highs at 47%. At that time, customer-only equity option traders were buying calls (upside bets on a stock) at a rate of two to one relative to puts (downside bets on a stock) on the International Securities Exchange. This ratio has since slipped to 1.7 to one, consistent with levels that preceded the September and October rallies.

The heart of earnings season is over and the Federal Reserve meeting is behind us. Major economic reports, such as the preliminary third-quarter gross domestic product (GDP) number and the October employment report, are no longer uncertainties. Therefore, there is a good chance that technicians will drive the action during the next few weeks.

For example, one chart that was popular among technicians a couple weeks ago was the pattern below on the SPX, which is referred to as an "ascending wedge." In layman's terms, it is a bearish pattern that depicts slowing market momentum, with trendlines connecting major lows and highs. The graph is interesting in that many traders could be short the market based on this technical formation. So, there may be a certain contingent of traders looking to get short on a rally up to the trendline connecting the lows since March. In fact, I wouldn't be surprised if the bears become bolder as they foresee the potential of a "head and shoulders" top if the SPX rallies up to 1,080. Therefore, resistance could come in at 1,080. At the same time, should the SPX build on last week's strength, a move above 1,080 could create short-covering among those trading off of this formation, at which point 1,100 and 1,120 become the next resistance areas. We view support in the 1,040 area, site of the August highs.

The PowerShares QQQ Trust (QQQ) also broke below the lower trendline of an "ascending wedge." If you're looking to hedge long exposure, we view the technology area as a crowded trade and thus a sector that could underperform amid renewed market weakness. Our biggest concern is that the buy (to open) put/call volume ratio on the QQQQ continues to move lower from high levels, potentially indicating that hedged money is no longer accumulating technology stocks.

I am going to leave with you some fun facts to ponder, as illustrated in the tables below. It is research from our own Rocky White, Senior Quantitative Analyst, and Ryan Detrick, Senior Technical Strategist, on the heels of the New York Yankees winning the 2009 World Series. Shorts beware!

Indicator of the Week: Seasonality Isn't What It Used To Be
By Rocky White, Senior Quantitative Analyst

Foreword: November is here, marking the beginning of the holiday season and the start of what has historically been a bullish period for the stock market. In fact, I just read an article stating that, beginning with $10,000 in 1950, if you had bought the S&P 500 Index (SPX) at the beginning of every November, and sold at the end of every April, you would have gained about $370,000. But if you did the opposite, buying at the beginning of May and selling at the end of October, then you would have gained nothing, having only your original $10,000. This is pretty eye-opening, but I try not to get too excited (or discouraged for that matter) by seasonality patterns. As you will see from the data below, seasonality just isn't what it used to be.

Analysis: Below are a couple of tables showing SPX returns during six-month time frames over the last 30 years. The returns colored green have outperformed the average, while red signifies underperformance. Notice that the best-performing time frame is November through April, which averaged a return of 6.6%. However, as I hinted above, the outperformance for this period has not held up in recent years. If you consider data taken only from the past 20 years, the November-through-April time frame has the second-best return, falling behind December through May. Looking at the past 10 years, the November/April time frame drops to fourth place. Finally, if you look at data taken during just the prior five years, this period drops to fifth place with a negative return.

You see this same pattern when you look at November by itself. The tables below show the average monthly returns for the SPX. If you look back over the past 30 years, November averages a return of 1.6%, falling behind only April as the most bullish month. During the past five years, however, November has averaged a loss of 0.6% and ranks eighth in terms of monthly returns.

Implications: Using the analysis above, I could probably make a pretty compelling case in either the bullish direction or bearish direction for the SPX's performance during November. The bullish argument would be that it is more reasonable to look at the more abundant data set (the past 30 years) because it is less prone to be affected by a single outlier return, and is the return to which average future returns should converge. The bearish argument would be that patterns change, and we should use only more recent data to put the emphasis in the current environment on the current pattern. However, this article is not intended to make a bullish or bearish case for the market. Awareness is always good, so it was simply my intention to make you aware of the SPX's prior price action. In fact, it's a good time to reiterate the old adage, which is exposed in the above article: Past performance is not always a good indication of future results.

This Week's Key Events: The Economic Calendar Takes a Breather
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

• The economic calendar is devoid of reports until Thursday, giving Wall Street a much-needed break following the flood of the prior two weeks. The earnings calendar, meanwhile, remains packed, with DISH Network Corp. (DISH), Rockwell Automation (ROK), Tesoro Corp. (TSO), Arena Pharmaceuticals Inc. (ARNA), Electronic Arts Inc. (ERTS), Force Protection Inc. (FRPT), GT Solar International Inc. (SOLR), MBIA Inc. (MBI), priceline.com Inc. (PCLN), and Silver Wheaton Corp. (SLW).

Tuesday

• There are no economic reports slated for release on Tuesday. In earnings, Beazer Homes USA Inc. (BZH), Fossil Inc. (FOSL), JA Solar Holdings Co. Limited (JASO), Tyco International Limited (TYC), Bob Evans Farms Inc. (BOBE), Pan Am Silver Corp. (PAAS), and Weight Watchers International Inc. (WTW) are scheduled to report.

Wednesday

• There are no economic reports on tap for Wednesday. On the earnings front, we'll hear from Macy's Inc. (M), Applied Materials Inc. (AMAT), Computer Sciences Corp. (CSC), Dendreon Corp. (DNDN), and Tetra Tech Inc. (TTEK).

Thursday

• We finally get some economic data on Thursday, with weekly initial jobless claims, weekly U.S. petroleum supplies, and the October Treasury budget. Elsewhere, Kohl's Corp. (KSS), Urban Outfitters Inc. (URBN), Wal-Mart Stores Inc. (WMT), Blockbuster Inc. (BBI), Nordstrom Inc. (JWN), and The Walt Disney Company (DIS) will report earnings.

Friday

• We end the week on Friday with October's import/export prices, September's trade balance, and the preliminary University of Michigan consumer index for November. Finally, the Street will see earnings from Abercrombie & Fitch Co. (ANF), Agilent Technologies Inc. (A), J.C. Penney Company Inc. (JCP), and Yingli Green Energy Holding Co. Limited (YGE).

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 nearly 15%, the Select Sector SPDR Financial Fund (XLF) could come under pressure in the coming weeks. Technically speaking, the XLF recently peaked 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 recently tagged a fresh 52-week high, and 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 65% since the start of the year. Technically speaking, OIH maintains support near the site of a 38.2% Fibonacci retracement of the trust's July 2008 peak and its December 2008 low. What's more, the brokerage bunch has room for upgrades, as 45% 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. 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.

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 93% 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. However, pessimism is thick on the retail sector. In the financial media, the sector was recently hammered by a cover story in Barron's, titled "The Hard Sell" and subtitled "How Retailers Are Fighting For the Hearts & Minds of the New Consumer." Elsewhere, only 45% 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 15% 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).