Don't Be So Quick to Buy the Head-and-Shoulders Hype
Priceline.com (PCLN) will look to continue its earnings dominance this week
by Ryan Detrick, CMT 5/5/2012 9:35:10 AM
It was a rough week for U.S. stocks, as the month of May wasted no time in living up to its bearish reputation. Friday's report of weaker-than-forecast nonfarm payrolls growth was the last straw for traders, even though the unemployment rate unexpectedly backpedaled. So the market's range-bound chop continued, with equities settling near the low end of a sideways channel that has been in place since March. With Wall Street heading into a seasonally weak period, is it time to hit the panic button? Senior Technical Strategist Ryan Detrick concedes that the technical outlook remains cloudy over the near term -- but with plenty of "soldiers" still fighting the good fight on the ground, he's actually encouraged by the growing buzz over bearish chart patterns. Meanwhile, Rocky White examines a few potential earnings-related plays for May, highlighting stocks that have typically jumped -- or slumped -- on the heels of their quarterly reports. Finally, we wrap up with a preview of the notable earnings and economic events for the week ahead, as well as a few sectors of note.
Notes from the Trading Desk: Why a Surge in Selling Climaxes Could Bode Well for Stocks
By Ryan Detrick, Senior Technical Strategist
I'll be filling in for Todd Salamone this week, as he is down in New Orleans at the Options Industry Conference. Todd first pointed out in mid-March that the odds were high for choppy market action -- and that's exactly what we've seen over this time period, as the S&P 500 Index (SPX - 1,369.10) is right where it was eight weeks ago. Turning to the current outlook, we're hearing a lot of talk about how we peaked in late April in each of the past two years, followed by a very rough summer and fall, and we could see that once again. Well, in early April, I did note a couple of reasons to be wary of a pullback of some sort. However, we continue to see more positives than negatives, and don't expect a major sell-off this summer -- but more choppy action could be very possible.
As has been widely noted in the media, we are entering a generally bearish six-month period. Going back to 1950, the Dow Jones Industrial Average (DJIA -13,038.27) has been virtually flat during the May-to-October time frame, versus a more than 7% gain during the November-to-April period. Of course, that doesn't mean the next six months will be flat. We very well could see some gains, but this historical trend is something to be aware of going forward.
We wanted to take this study one step further and find out what it means if the market is trending higher coming into this historically weak season. To differentiate these returns, we looked at whether the Dow was above or below its 200-day moving average at the start of the May-October period. The average return gets a little better when the Dow is above this trendline, but it's still not much to write home about -- again, confirming how tough this timeframe has been.
On the technical front, we've been hearing a lot of talk about how various head-and-shoulders topping patterns have been forming on several indexes. These, of course, are rather bearish patterns, and can lead to significantly lower prices should the neckline be violated. Below is a current example on the iShares Russell 2000 Index Fund (IWM).
Chart courtesy of StockCharts.com
However, it's very important to remember that, while technical patterns like this can be very powerful, we've noticed over the past few years that when everyone is talking about a pattern, it rarely plays out the way it's supposed to. In fact, we've been amazed at how many times emerging bearish patterns have been picked up on and discussed by everyone, yet the bullish patterns -- which have tended to play out more reliably over the past three years -- are simply avoided. Well, here we are once again, and various technicians are noting the bearish patterns out there as reason for concern. Should the crowd be wrong again, a reversal of that skepticism could fuel the next move higher.
Speaking of technicals, one indicator I like to use looks at buying and selling climaxes. Simply put, a selling climax occurs when a stock makes a new 52-week low, then closes higher on the week. A buying climax is the opposite: a new 52-week high, and then a close lower on the week. If you see a surge in selling climaxes, it could be a sign of strong hands accumulating shares. Although it's not perfect, this indicator has done a solid job of finding some bottoms over the past year. For the week ending April 27, we noticed 65 selling climaxes out of all optionable stocks. As you can see below, this was the highest number so far this year. Although 65 doesn't sound like a lot, when you consider the overall market is still very close to multi-year highs, this development could actually be much more significant than it seems on the surface. If you're bullish, you like seeing this.
One other useful technical indicator is the number of stocks hitting new 52-week highs. I've always said that new 52-week highs are like soldiers in an army -- the more soldiers you have, the better chance you stand of winning the battle. If you have more and more stocks forming new highs, then there's a very good chance the market remains strong. With that said, the cumulative new highs versus new lows at the New York Stock Exchange (NYSE) reached yet another new high recently. Below is a three-year chart of this indicator. It's tough to get extremely bearish when you have this much underlying strength from the "soldiers".
Chart courtesy of StockCharts.com
Another positive sign is that we continue to see evidence of big-money investors moving into equities. As I mentioned last month, call volume was picking up on the CBOE Market Volatility Index (VIX - 19.16), and this has historically been bullish. Our thinking is that this activity is a sign institutions are in the process of making bullish bets on stocks, and using the VIX call options as a hedge.
Not to be outdone, the 20-day buy-to-open put/call ratio on the SPDR S&P 500 ETF (SPY), PowerShares QQQ Trust (QQQ), and iShares Russell 2000 Index (IWM) also broke out to new highs -- yet another sign of institutions looking to hedge their bullish equity positions. What I like here is that this ratio still has plenty of room to move higher before we get near past major peaks.
All in all, we think the bull market is alive and well, and will eventually resolve to the upside. In the intermediate term, though, we are definitely getting some mixed signals. As traders, we have to take what the market gives us -- and for this reason, it makes sense to be hedged, or look for both bearish and bullish setups here. We continue to like housing and consumer discretionary names as potential longs, while select big banks and materials look weak.
Best of luck in your trading.
Indicator of the Week: Quantifying Earnings Season
By Rocky White, Senior Quantitative Analyst
Foreword: We're now about half way through the April/May earnings season. Looking at optionable, liquid stocks, there were 579 companies that reported earnings in April. Below is a chart showing the average stock returns on the day of each company's earnings release (or the next trading day, if they reported after hours). It shows data for each month going back to 2011. April was a pretty tame month, as stocks averaged a slight loss of about 0.01% on the day of their earnings. This week, I'll take a look at the earnings returns from previous years during the April/May earnings season, and see whether April can tell us anything about what may lie in store for May.
Past April/May Returns: Here are a couple of tables showing how stocks have performed post-earnings during the months of April and May since 2006. The table on the left shows the average stock return, and the table on the right shows the percentage of stocks that were up on earnings. While the past two Mays show stocks averaging a loss on earnings, 2012 was the first April in the table to do so. The low percentage of positive returns for stocks the last two Mays highlight how poor those months were for stocks. In May 2011, stocks were up only 42.6% of the time on earnings, and in May 2010, only 31.5% of the time. Hopefully, this trend will change this month.
Individual Stocks: Looking for individual stock plays this upcoming week? Here's a list of interesting stocks which report earnings this week. They are all liquid and optionable, and have at least five years' worth of earnings data. This first set of tables shows bullish stocks. The table on the left is stocks with the best average return, and the table on the right are stocks with the highest percentage of positive earnings-day returns. Priceline.com (PCLN) tops both lists.
Finally, these last two tables show stocks which have a history of bearish earning reactions. These tables show stocks with the biggest average loss on their report day and the lowest percentage of positive returns.
This Week's Key Events: Checking Up on Consumer Sentiment
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 kicks off with the Federal Reserve's consumer credit report. Quarterly earnings are due out from Clean Energy Fuels (CLNE), Dendreon (DNDN), Electronic Arts (EA), Tyson Foods (TSN), Rackspace Hosting (RAX), Vivus (VVUS), DISH Network (DISH), Halozyme Therapeutics (HALO), and PetMed Express (PETS).
Tuesday
- There are no major economic reports slated for Tuesday, but earnings action continues with results from Walt Disney (DIS), Patriot Coal (PCX), Quicksilver Resources (KWK), Hecla Mining (HL), Demand Media (DMD), DirecTV (DTV), Fossil (FOSL), and Jazz Pharmaceuticals (JAZZ).
Wednesday
- Wednesday's docket features the latest wholesale inventories data, as well as the usual report on weekly crude inventories. Wall Street will also hear earnings from Cisco Systems (CSCO), AOL (AOL), Macy's (M), Priceline.com (PCLN), Activision Blizzard (ATVI), MEMC Electronic Materials (WFR), Agrium (AGU), MannKind (MNKD), Tesla Motors (TSLA), and Teva Pharmaceutical (TEVA).
Thursday
- Weekly jobless claims, import and export prices, and the monthly trade balance are on tap for Thursday. On the earnings front, we'll hear from Express Scripts (ESRX), Kohl's (KSS), Nordstrom (JWN), AMC Networks (AMCX), Canadian Solar (CSIQ), Molycorp (MCP), and Nuance Communications (NUAN).
Friday
- The week winds down with the producer price index (PPI) and the mid-May Thomson Reuters/University of Michigan consumer sentiment index. Nvidia (NVDA) and ReneSola (SOL) will step into the earnings confessional.
And now a few sectors of note...
Dissecting The Sectors
| | Sector | Leisure/Retail
Bullish |
Outlook: The jobs market appears to have hit a soft patch lately, with April payrolls falling short of expectations. However, consumer spending remains healthy, with a 2.9% uptick in this metric during the first quarter adding two percentage points to gross domestic product (GDP). In fact, retailers managed a composite same-store sales gain of 6.9% for March, surpassing the 5.3% improvement predicted by analysts. What's more, overall retail sales improved 0.8% for the month, blowing past the consensus analyst estimate of 0.3%. On the charts, the SPDR S&P Retail ETF (XRT) is still a technical outperformer, with the fund revisiting its all-time highs north of $63 at the start of last week's trading. For those seeking a bullish play in the retail/leisure space, we recommend focusing on stocks in solid technical uptrends that are surrounded by negative sentiment, which creates the potential for upside surprises. This past week, for example, Whole Foods Market (WFM) rallied to a new record high -- and scored several bullish brokerage notes -- after surpassing the Street's earnings expectations. Some of our other current favorites include AutoZone (AZO), Advance Auto Parts (AAP), Macy's (M), Chipotle Mexican Grill (CMG), and Limited Brands (LTD). With skepticism still lingering toward these consumer-dependent stocks, contrarians can continue to capitalize on situations where sentiment has yet to catch up with the bullish technical performance. | | Sector | Homebuilding
Bullish |
Outlook: The housing sector has benefited from some good news lately, with traders cheering upbeat data on pending home sales and a better-than-forecast earnings report from Ryland Group (RYL). On the heels of these positive developments, the SPDR S&P Homebuilders ETF (XHB) bounced from support at its 80-day moving average, located near the $20 level -- a round-number area that previously marked the fund's May 2010 peak. From here, the fund still has room to rally up to $23.25, which is half its all-time high, reached only three months after XHB was launched in 2006. Despite the improving price action in the sector, analysts remain overwhelmingly negative. With 91% of builders trading above their 200-day moving averages, these names have attracted only 44% "buy" ratings from brokerage firms. However, a recent preponderance of put buying on XHB suggests that hedged players are starting to dip their toes into housing stocks, which could be a boon for the group during the near term. In fact, the 50-day buy-to-open put/call volume ratio for the fund is now resting near its highest level since 2007, which indicates that big-money investors are actively acquiring shares of sector components. As further evidence, Goldman Sachs is launching a fund to buy home-loan bonds, with the investment giant asserting that "stabilization in U.S. housing fundamentals is creating an attractive investment opportunity." Some of our preferred names in the sector are Lennar (LEN), Toll Brothers (TOL), Meritage Homes (MTH), PulteGroup (PHM), and D.R. Horton (DHI), all of which sport relatively high short-to-float ratios. Going forward, these stocks could benefit from upgrades or short-covering activity as the technical and fundamental performance continues to surpass the Street's low expectations. As a point of caution, Barron's recently featured an upbeat cover story titled "Home Prices Ready to Rebound" -- suggesting some optimism may be priced in, and XHB could pull back in the short term. However, a pullback that is contained above $20 would be healthy, in our view, as we still believe in the potential reward in this sector. What's more, the bullish cover is not out of touch with the positive price action, making the contrarian implications less relevant. | | Sector | Gold
Bearish |
Outlook: Lately, we've been seeing several danger signs that point to potential short-term weakness for the SPDR Gold Trust (GLD). First, as Jim Paulsen of Wells Capital Management recently observed, valuations for the underlying metal relative to stocks, bonds, and other assets have soared off the charts lately, hinting that a correction may be overdue -- particularly as gold sheds its "fear premium" in the face of recovering consumer confidence. Looking at the options markets, total buy-to-open option volume on the ETF imploded recently, and continues to decline. This occurrence has previously coincided with periods of range-bound or negative price action for GLD. Meanwhile, the fund's front-month put/call implied skew has recovered from its recent lows, but this has yet to provide any kind of meaningful bid for the shares -- marking a deviation from past trends. From a technical perspective, the outlook is similarly unsettling. The fund turned lower in late February after an unsuccessful test of resistance in the $175 area, and GLD has since plummeted through its 140-day moving average. This trendline has played a key role as both support and resistance in the past, and it's currently serving as a stubborn technical ceiling. Even more troubling, many technicians are now betting on an inverse head-and-shoulders pattern for GLD -- interestingly enough, a formation that was not at the forefront of technical playbooks when it developed in the equities market. If this pattern doesn't play out as expected on GLD, some technical-related selling could be expected. That said, we're keeping a close eye on its 320-day moving average and the $160 area, which could limit downside during the short term. |
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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