Monday Morning Outlook: Bulls Hanging by a Thread Ahead of Bernanke Speech
Is the SPX death cross a death sentence for stocks?
by Todd Salamone 8/20/2011 11:36 AM
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It was another rough ride for stocks last week, as economic anxiety jolted global markets. Europe continued to direct traffic, with traders pricing in some disappointment after German Chancellor Angela Merkel and French President Nicolas Sarkozy dismissed the notion of a jointly issued euro bond. However, the U.S. certainly produced its share of jarring headlines -- namely, a steep downturn in Mid-Atlantic manufacturing activity, an uptick in weekly jobless claims, and epic earnings disappointments from the likes of Dell (DELL) and Hewlett-Packard (HPQ). Adding insult to injury, analysts at Morgan Stanley, Goldman Sachs, and J.P. Morgan all lowered their respective economic growth forecasts. Naturally, anticipation is building ahead of Fed Chairman Ben Bernanke's speech at Jackson Hole this Friday, with many investors hoping for a reprise of last year's QE2 announcement.
Against this tense backdrop, says Todd Salamone, stocks are on the ropes. The bulls still have a few technical lines of defense to cling to, but Todd warns that we could be "just one more major sell-off" away from dire straits. Meanwhile, Rocky White eyes the latest death cross in the S&P 500 Index, in an attempt to determine whether this ominous technical indicator is the final nail in the coffin for the bullish case. Finally, we wrap up with a preview of this week's key economic and earnings events, as well as a few sectors of note.
Notes from the Trading Desk: Stocks Test Technical Lines in the Sand
By Todd Salamone, Senior VP of Research
"...what intrigues us about last week's trading is the [SPX's] low at the 1,100 century mark, which also coincides with the index's 40-month moving average. This trendline covers approximately three years, incorporating monthly closing prices going back to a few months before Lehman Brothers went under, and it capped a rally ahead of the May 2010 'flash crash.' For Fibonacci players, the pullback to 1,100 represents a 38.2% retracement of the March 2009 low and last May's peak. Additionally, as of the end of August, the 10-year breakeven price on the SPX is located at 1,133.58, which the index was able to rally above by week's end.
"... if you were to look at a daily chart of the VIX in 2008, you'll see that it took about a week for the index to finally take out 50 after its initial run at this level. If the VIX can stay below 50 in the upcoming week, a case can be made for another VIX peak, which would be music to the bulls' ears.
"The equity market is not out of the woods, despite some initial signs of stability. For example, the RUT is still below 750, and the MID remains below 900. Plus, there are no visible signs in the options market that hedge-fund managers are increasing their long equity positions. Maintain exposure to gold and Treasurys, and continue to avoid the big-cap financials."
-- Monday Morning Outlook, August 13, 2011
Last week's price action was pretty much defined by the opening hour of trading on Thursday morning and the late-afternoon skid on Friday. Stocks plummeted in reaction to growing worries that the U.S. may be entering another recession, along with concerns about the stability of European banks and the world economy.
As we have noted in recent weeks, these growing economic anxieties have motivated hedge fund managers to decrease their net long equity exposure. In fact, there are hints -- through our analysis of option activity on major exchange-traded funds (ETFs) -- that shorting activity among this group is gaining traction.
For example, as the result of a huge relative increase in call buying on major ETFs that we track, the combined buy-to-open put/call ratio on the SPDR S&P 500 ETF (SPY), iShares Russell 2000 Index Fund (IWM) and PowerShares QQQ Trust (QQQ) continues to trend lower. Declines in this ratio are usually associated with market weakness. One possibility is that the increased call buying we are seeing is the result of increased shorting activity among hedge fund managers, who can utilize calls on these broad-based ETFs to hedge short equity positions.
Unless we see a major change in the direction of this ratio, it is doubtful that equities will sustain a major turnaround. This is an indicator that we'll continue to follow closely, as it has proven to be a solid navigational tool. If there is any silver lining for the bulls, it is that this ratio is extremely low -- but the bad news is, it remains in a steep decline.
Meanwhile, the general investing public is becoming more and more disenchanted with equities. This rising risk aversion has resulted in an alarming deterioration in the technical backdrop of the major indexes, as we've noted in this space recently. The S&P 500 Index (SPX - 1,123.53), for example, is still trading below its 80-week and 80-month moving averages, currently situated in the 1,205-1,225 area. These trendlines have acted as support and resistance at major turning points during the past several years. The SPX's peak last week, in fact, occurred at its 80-week moving average.
Plus, the S&P 400 MidCap Index (MID - 787.86) remains below the 900 century mark -- its peak in 2007 -- and, like the SPX, was capped by its 80-week moving average last week. The Russell 2000 Index (RUT - 651.70) remains below its pre-"flash crash" high in the 750 area, and also failed to rally back above its 80-week moving average in last week's trading.
While many indicators we track look bleak, is it totally a lost cause for the bulls? Not necessarily.
For example, the CBOE Market Volatility Index (VIX - 43.05) comes into the week still trading below 50. As we mentioned last week, VIX rallies to the 50 area since 1997 have been buying opportunities, with the lone exception occurring in 2008. That said, we found it interesting that the VIX's Wednesday low coincided with a 50% retracement of its 2011 low and Aug. 8 peak, and the index then shot higher to close the week north of 43. We would view a move above 50 as a bearish omen, so bulls would like to see the VIX remain below this round-number level in the immediate and distant future.
In addition, various indexes remain above or around other long-term levels we are watching -- such as the 1,100-1,133 area on the SPX, which we discussed in the excerpt above from last week's column. Moreover, the 80-month moving average on the MID is situated at 764.02, and this trendline previously acted as support during major lows in both March 2003 and July 2010. Finally, the RUT remains above the historically significant 650 area, but below both its 80-month moving average and its March 2009 "double low" at 685.18. Admittedly, it will take just one more major sell-off before these "lines in the sand" are taken out.
Maintain exposure to gold and bonds, and continue to keep a tight leash on any long positions you've recently initiated, or are thinking about initiating. We have become less constructive on the consumer discretionary group, with the SPDR S&P Retail ETF (XRT) breaking below both its 80-week moving average and May 2010 high in the 45 area. Financials remain the most vulnerable sector, even after the drubbing they have taken in recent weeks.
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