Monday Morning Outlook:

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Monday Morning Outlook: Short-Term Pain Could Give Way to Long-Term Gains
By Ryan Detrick



As we head deeper into the disreputable month of May, the short-term outlook has become increasingly cloudy. All-too-familiar anxieties about the Greek financial crisis rattled markets last week, and small- and mid-cap stocks seem to be retreating from their critical leadership role. Senior Technical Strategist Ryan Detrick doesn't think bulls should throw in the towel just yet, but he's definitely seeing more bearish opportunities. In fact, seasonal trends point to a trying time for the market in the weeks ahead. Senior Quantitative Analyst Rocky White offers an equally sobering short-term analysis, even as he explains why 2011 is already on pace to be a banner year for the S&P 500 Index. Finally, we wrap up with a look at the expiration week ahead, as well as a few sectors of note.

Notes from the Trading Desk: Opportunities Emerge for Both Bulls and Bears
By Ryan Detrick, Senior Technical Strategist

Todd Salamone is out this week, down at the Options Industry Conference in Savannah, so I'll be filling in.

As we've been noting for several weeks now, one key to the overall trend could be the performance of the small- and mid-cap names. With the Russell 2000 Index (RUT - 835.67) sitting just below resistance at 850, and the S&P MidCap 400 Index (MID - 993.92) trading south of resistance at 1,000, a clear breakout above these levels is probably needed to drive another thrust higher for the overall market. By the end of last week, though, both indexes once again backed down from these psychologically significant technical levels.










The bulls still have a chance, though, as the S&P 500 Index (SPX - 1,337.77) continues to find support above the 1,333 level -- which marks a double of its March 2009 lows -- and near the neckline of its continuation "head and shoulders" pattern. The one concern we have about this bullish technical pattern is that the media picked up on it. As I noted way back in July 2009, these patterns can result in very positive resolutions. We'd just prefer, from a contrarian perspective, that they fly under the radar.






Let's talk about seasonality. We all know the old saying "Sell in May and go away," but does it ring true? As it turns out, May isn't so bad after all. As you can see, the much-maligned month has held its own over the past five- and ten-year time frames. In fact, before last year's "flash crash"-related 8% pullback, May was actually one of the better-performing months for the SPX. Perhaps even more relevant, June is hands-down the worst month over both of these time frames. We aren't quite there yet, but this seasonally weak period is just over the horizon.






Speaking of selling in May and going away, the week ahead is options expiration week. Over the past two years, May expirations have been rather weak. Now, over the past 10 years, this week is still positive, but the recent softness is still worth noting. From a trader's point of view, what really stands out is the volatility -- whether up or down -- during May expiration in recent years.






OK, enough about seasonality and technicals. First-quarter earnings season is very close to wrapping up, and on balance, it was another solid quarter. Think about this: When Alcoa (AA) kicked off earnings season, consensus expectations were calling for 13% year-over-year earnings growth for S&P 500 stocks. Now that the majority of companies have topped expectations, that number has since been upwardly revised to 18% growth, according to Thomson Reuters. That is quite the beat versus expectations.

In fact, at the start of the year, overall S&P 500 earnings were expected to be $93 per share, with the most bullish economist looking for $100. As of this week, the average prognosticator is now looking for $103 per share -- which would represent a new record for earnings. I know we keep hearing all the reasons why the economy is still on shaky ground, but I continue to see more positives than negatives. These record earnings are a big plus.

Given that commodities have sold off during the past couple of weeks, the overall market has held up rather well. Nonetheless, we are seeing some signs of worry creeping back into the picture. In fact, the American Association of Individual Investors (AAII) poll showed more bears than bulls for the first time since the mid-March lows. Not to be outdone, the Investment Company Institute (ICI) reported more than $2 billion was pulled out of domestic mutual funds last week -- again, the highest since that March bottom. Finally, a recent Bloomberg survey also pointed to growing worry, as less than half of those surveyed expect the SPX to rise over the next six months. Back in January, almost two-thirds of respondents expected higher prices. Overall, it seems that fear is increasing, which is always a good sign for contrarians.

And it now appears that hedge funds are once again in accumulation mode. One indicator that Todd has been following closely is the combined 20-day buy-to-open put/call ratio on the SPDR S&P 500 ETF Trust (SPY), iShares Russell 2000 Index (IWM), and PowerShares QQQ Trust (QQQ). The ratio is currently ticking higher, which regular readers know is often a sign that hedge fund managers are accumulating equities, and buying put options on these broad-based ETFs to hedge their long positions. We'll continue to monitor this important indicator during the weeks ahead.






Along those same lines, the 50-day buy-to-open put/call volume ratio on the PowerShares QQQ Trust (QQQ) is moving higher. We have found many opportunities in the tech sector, and this increased put activity suggests that hedged buyers are moving into the group. Our only advice is that you look to trade the small- and mid-cap names in this area, and avoid the over-loved, mega-cap names like Microsoft (MSFT) and Cisco Systems (CSCO).






In the short term, I see opportunities for both the bears and the bulls. When this is the case, sometimes it helps to take a longer-term look at the charts to clear things up. From this broader perspective, I think you'll find the overall bull market is alive and well. One of our favorite bull/bear trendlines is the 80-week moving average for the SPX. This trendline has been a great gauge for overall strength or weakness since the bull market started back in 1995.






With this trendline currently near 1,175, and firmly pointing higher, it is foolish to try to pick a major top near current levels. Best of luck in your trading as we navigate the near term.



Indicator of the Week: Up Days and Down Days
By Rocky White, Senior Quantitative Analyst

Foreword: Last week, I wrote about the S&P 500 Index (SPX) starting out the month of May with four straight down days. However, down days have been relatively uncommon in 2011. After 92 total trading days this year, 59% of them have been positive. That puts us on pace for 150 up days for the full year. Since 1975, only two years saw more winning days than that (1995 with 156, and 1989 with 150). I think a stat showing this much bullish price action this year might surprise many readers.

2011 Pace: The table below shows the years that the SPX had the most positive days since 1975. If this pace continues, 2011 would rank third, with about 148 up days. You can see from the table that the market loses more on an average down day than it gains on an up day. So, you can bet the greater number of positive days was a big contributor to the fact that the market is up a healthy 6.4% so far this year.






After 92 Days: Here's another way of looking at it. This table shows the years that had at least 50 winning days through the first 92 sessions of the year. I would never have thought that last year would show up on this list -- but in 2010 at this point, the market had seen two more up days than we've seen this year. It's interesting because the market struggled early last year, and you can see that despite the large number of up days, the SPX only had a gain of 1.85% at the time. This drives home the obvious point: Along with the number of up and down days, the magnitude of the gains and losses also matters.






Finally, I summarized those rest-of-year returns and the next three-month returns in the first table below. The last table is for comparison, and shows the summary for all years since 1975. A large number of up days at this point in the year has typically led to impressive returns for the rest of the year, with positive returns almost 80% of the time. However, the next three months have typically been just mediocre when the year has started with a lot of positive days.






This Week's Key Events: Housing Data and Retail Earnings on Deck
Schaeffer's Editorial Staff

Here is a brief list of some of the key events this 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 the release of the Empire State manufacturing index for May. On the earnings front, retailers J.C. Penney (JCP), Lowe's (LOW), and Urban Outfitters (URBN) will reveal their quarterly results.

Tuesday

On Tuesday, we'll hear about new home starts, industrial production, and capacity utilization for April. Earnings are due out from a few heavy-hitters, including Dell (DELL), Home Depot (HD), Saks (SKS), and Wal-Mart Stores (WMT).

Wednesday

Wednesday features the regularly scheduled update on domestic petroleum supplies, as well as the minutes from the latest meeting of the Federal Open Market Committee (FOMC). The day's earnings calendar includes reports from Deere & Co. (DE), Hewlett-Packard (HPQ), Pan American Silver (PAAS), Staples (SPLS), and Target (TGT).

Thursday


The economic calendar wraps up early on Thursday, with a flurry of data on the docket. Traders will hear the weekly report on jobless claims, the Philly Fed index for May, April's existing home sales, and the Conference Board's index of leading economic indicators. Retailers and tech issues will share the earnings spotlight, with reports due out from Autodesk (ADSK), Dollar Tree (DLTR), GameStop (GME), Salesforce.com (CRM), Sears Holdings (SHLD), and Williams-Sonoma (WSM).

Friday

The economic calendar is bare on expiration Friday. Camelot Information Systems (CIS), Donaldson (DCI), and Yingli Green Energy (YGE) will round out the week's slate of earnings reports.

And now a few sectors of note...

Dissecting The Sectors
Sector
Leisure/Retail
Bullish

Outlook: Thanks to a later-than-usual Easter holiday, Wall Street was once again pleasantly surprised by monthly retail sales numbers. The 25 retailers tracked by Thomson Reuters saw same-store sales increase by 8.9% in April, topping expectations for a gain of 8.4%, and marking the best overall month in a year. Despite broad-market headwinds during the past couple of weeks, the SPDR S&P Retail ETF (XRT) tagged a new all-time high of $54.72 on Friday. In fact, the 50-day International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX) buy-to-open put/call volume ratio on the XRT has climbed along with the share price lately, which is indicative that hedged players are in accumulation mode on retail stocks. Concerns continue to linger about consumer spending amid high fuel prices and lingering unemployment, suggesting that select stocks in the so-called "leisure" sector could continue to benefit from low expectations. Within the group, Wynn Resorts (WYNN) and BJ's Restaurants (BJRI) impressed with their latest earnings reports, and both stocks rose to the latest in a string of new highs just last week. Chipotle Mexican Grill (CMG) appears on track to revisit its own record peaks, having rebounded smartly from support at its 80-day moving average. All three stocks combine positive price action with skeptically skewed analyst ratings, and CMG and BJRI remain heavily shorted -- suggesting there's still plenty of cash that could flow into these outperforming equities.  

Sector
Mid-Cap Tech
Bullish

Outlook: The tech sector came on strong during first-quarter earnings season, with companies both big and small showing surprising resilience, given the rampant anxiety about potential Japan-related supply disruptions. The PowerShares QQQ Trust (QQQ) now sports a year-to-date gain of 7.3%, besting the 6.4% rise collected by the S&P 500 Index (SPX) during the same time frame. The 50-day buy-to-open put/call volume ratio for QQQ is on the upswing, implying that hedged players are actively buying tech shares. However, we would advise against playing the outsized, over-loved names within the group, such as Microsoft (MSFT), Cisco Systems (CSCO), or Research In Motion Limited (RIMM). Instead, we recommend seeking out mid-cap stocks that combine positive price action with a skeptically slanted sentiment backdrop. One such example is Ciena Corp. (CIEN), which has gained about 29% for the year -- but a lofty 29% of its float is sold short. Likewise, Red Hat (RHT) has outperformed the SPX by 14 percentage points over the past 40 sessions, yet the shares have been targeted by speculative put buyers at an accelerated pace in recent weeks. From a contrarian perspective, this lingering negative sentiment represents pent-up buying pressure, which could unwind to propel these stocks higher as the technical strength continues.  
Sector
Financials
Bearish

Outlook: There's just not much to like about the financial sector at the moment. Of course, the big news this past week was all about Goldman Sachs (GS), with speculation rising about potential legal troubles amid ongoing investigations by the Commodity Futures Trading Commission (CFTC), the Financial Industry Regulatory Authority (FINRA), and Massachusetts state regulators -- not to mention the prospect of further probes by the Department of Justice and Securities and Exchange Commission (SEC). However, GS and its too-big-to-fail peers were lagging the market long before this latest round of negative headlines. Many of the best-known names within the group, such as Bank of America (BAC), Citigroup (C), and Goldman itself, are sitting on significant year-to-date losses, having failed to participate in the broader market's rally. JPMorgan Chase (JPM) is also breaking down on the charts, with its 10-week and 20-week moving averages now on the cusp of a bearish cross. Checking out the sentiment backdrop, the 50-day buy-to-open call/put volume ratio for the Financial Select Sector SPDR (XLF) has turned higher lately, which has had bearish implications for the group in the past. Plus, data from Zacks indicates that 58% of analyst ratings on bank stocks are of the "buy" or better variety, despite the dismal price action. Going forward, the financial sector looks vulnerable to additional downside as this remaining optimism is shaken out.  




Prepare for the investing week ahead. Every week, Bernie Schaeffer and his staff provide you with their insight 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.

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