Comments to consider from Schaeffers' technical analysts

On Mondays I like to reminder readers to check up on two sources. One is the Monday Morning Outlook commentary from Todd Salamone and Rocky White, who are great technical analysts at Schaeffers Research. The other is the weekly T Theory update from Terry Laundry. (Both of these sources are included in the "other sites of interest" listed at the right side of the page.) You can see that Terry has a partial update of his T Theory chart at his site, and will probably upload his audio commentary this afternoon.

Here are some quotes from what Todd Salamone and Rocky White have discussed this morning (check out the whole article at http://www.schaeffersresearch.com/commentary/observations.aspx?ID=91953 which is also where you can see all of their charts too):

What the Trader Is Expecting in the Coming Week: 3 Questions Regarding Last Week's Federal Reserve Announcement
By Todd Salamone, Senior Vice President of Research

Was it a "whiff?" A "bunt single?" Or was it, as some commentators labeled it, the "shot heard around the world?" I'm referring to the Fed's actions on Wednesday, when it announced that it would buy $300 billion in Treasurys on top of expanding its purchase of mortgage-backed securities. As stocks shot higher on the news, excitement grew as various market commentators claimed the Fed's move would be "unambiguously bullish" for stocks in the short term. Three questions/suspicions occurred to me as I watched these events unfold:

First, was this really a huge surprise for the market? After all, the Fed signaled 3 months ago that purchasing Treasurys was an action it would consider, and credit markets are still in terrible condition. Meanwhile, overseas central banks had taken this very path in recent days. A worry we had heading into last week's Fed meeting was that the group would stand stood pat and not take further action in the credit markets.

Second, is this really "unambiguously" bullish for stocks? The market was overbought, the S&P 500 Index (SPX) failed to take out the important 800 level, and the Dow Jones Industrial Average could not even muster a triple-digit gain following the announcement. Was the rally leading up to the Fed's announcement driven by hope? After all, it has pretty much been a constant in 2009 that investors bid stocks higher heading into major Fed and Treasury announcements. In other words, while the news might have been bullish on the surface, one has to wonder if equity players simply "bought the rumor and sold the news?"

Looking to the future, I am left wondering how the Fed's purchasing of Treasurys will be unwound, and what, if any, are the implications?

From a technical perspective, there are plenty of reasons that the bulls could take pause here, as the bears attempt to spoil yet another party. In fact, the financial sector looks especially vulnerable. Despite the recent rally being driven by numerous catalysts, many key financial names were trading at pre-Fed levels as of last Thursday. As you can see on the chart below, the Select Sector SPDR Financial Fund (XLF) rallied into its 80-day moving average and last month's high at the 10 strike. It would appear that this moving average and strike price have marked yet another top within the decline. Moreover, many financial names rallied from strikes with heavy put open interest into strikes with heavy call open interest. The heavy call open interest, in our view, represents stop signs for this sector. Should a portion of these calls be related to hedging activity among those actively shorting this sector, these calls offer protection on moves above the strike. Therefore, the shorts no longer feel as compelled to cover their positions, as the strong bid under these equities dries up in the blink of an eye. In fact, it is quite possible that the shorts begin to get bold once again at these levels.
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As we head into this week, the friendly witches of triple-witching expiration week disappear. Last week, Rocky White discussed the bullish impact of triple-witching expiration weeks, and the SPX followed through with a 1.6% advance. But the week following triple witching is one in which the wicked witches tend to emerge. For example, the SPX has advanced only 17% of the time in the week following triple expiration since 2006. ... If you go back to 2000, the week following triple witching is bearish, too. During 36 such weeks, the market has been higher in this period only 28% of the time...
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On the sentiment front, we have a couple of concerns as we move into the last full week of trading in the first quarter of 2009. For example, we saw pessimism among option speculators emerge in early March, ahead of the huge rally up to the 800 area on the SPX. We are now seeing optimism emerge, with single-day readings of the all-equity call/put ratio of 1.97 on Thursday, 1.73 on Wednesday, and 1.63 on Tuesday. As of Friday, these readings pushed the 10-day moving average up to 1.57, its highest level since Jan. 9.

Turning to the CBOE Market Volatility Index (VIX – 45.89), 2 concerns would be that the VIX is advancing from the 40 area, which is the half-high of the index's closing highs in October and November. The fact that the VIX found "support" in this area would be a strike against the bulls. The VIX also comes into the week trading slightly below the SPX's 20-day historical volatility of 46.17, indicating investors are not exactly falling all over themselves looking for portfolio protection. This could be a sign of complacency emerging again. There is some good news for the bulls regarding the VIX, as Friday's high was the site of the 80-day and 160-day moving averages. These trendlines are situated just above the 45 area, which is about half the intraday VIX high in November. A significant move above these trendlines would be bearish. We see potential support areas for the SPX at 750, which has been supportive in the past, and at 735, which would represent a 50% retracement of this month's low and high. Should the VIX decline back to the 40 area, we could see resistance emerging again in the 800 zone.


Avoid financials at this time, as we think the short-covering rally has nearly run its course. The consensus seems to believe that oil will be a major beneficiary of the weaker dollar that resulted from the Fed's actions on Wednesday. Price action in this group has been strong, but this could quickly become a crowded trade. Therefore, we urge that you hedge oil plays if you decide to play this group from the long side. We do favor some retail names, but be selective in this area. Consider names in this sector that are outperforming, have reacted well to earnings, and have strong short-covering and analyst upgrade potential.

Indicator of the Week: An Analysis of Gold Stocks
By Rocky White, Senior Quantitative Analyst
Foreword: The dollar and gold are often considered 2 safe places to put your money. Last week's announcement that the Federal Reserve was going to buy U.S. Treasurys -- in other words, print money -- sent the dollar lower and enhanced gold's appeal as the world's safe haven. Gold rallied on the news, and is not too far from $1,000 per ounce, where it has been smacked down in the past. We decided to take a look at gold stocks throughout this financial crisis and into the present and see how traders are positioning themselves for the future.

Analysis Technique: To analyze gold stocks, we aggregated the data from 7 of the most liquid gold-related companies, including Barrick Gold (ABX), Goldcorp (GG), Newmont Mining (NEM), Kinross Gold (KGC), Agnico Eagle Mines (AEM), Gold Fields (GFI), and Harmony Gold Mining (HMY). Getting a handle on the data from these companies should give us a feel on the market's sentiment toward gold-related stocks.

From these stocks, we created a Schaeffer's Gold Stock Index, which we refer to as SGS-IDX. The index is simply the value of $100 invested equally into each of these stocks at the end of 2004. We compared the performance of that index to the SPDR Gold Trust (GLD) exchange-traded fund (ETF), which tracks the price of gold. The chart shows that since 2007, the SGS-IDX has underperformed the price of gold. However, this index is quite a bit more volatile. Look at how much the stocks rallied beginning in October 2008, when the broad stock market decline accelerated and investors began to seek the safety of gold. If gold can rally above its prior $1,000 peak, then it will have little technical resistance overhead and these gold stocks will take off.
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Options Players: Below is a chart showing option data from the International Securities Exchange. It shows the number of puts and calls bought to open during the past 20 trading days. When you focus on buy-to-open data, you know that call traders are gaining exposure to the upside and put traders are gaining exposure to the downside. Notice that traders tend to buy more calls on these stocks than puts. The graph illustrates the benefits of being contrarians. Look at the number of calls purchased compared to the performance of the SGS-IDX. Gold stocks peaked in July 2008, when 20-day calls were quite low. Once gold stocks crashed, traders grew excited, and call buying accelerated on expectations for a rebound. There was a quick rally in the stocks, which was again followed by a flurry of call buying. This rally was short-lived, and the SGS-IDX tumbled further, bottoming in November of last year. The good news for these stocks is that the rally since November has not been accompanied by excitement from call buyers. The number of calls purchased is not very high considering the substantial gains. This means there is plenty of money still available to buy into these stocks.
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Analyst Ratings: The chart below shows the percentage of analysts who rank these stocks a "buy" and the percentage that rank them a "sell." Analysts were most bullish in 2007 just before the volatility picked up. Once the SGS-IDX rallied, analysts were quick to downgrade these gold stocks. The downgrades were appropriate, as we see the shares tumbled later. However, since the recent July 2008 peak in SGS-IDX, analysts were upgrading the stocks during the market's decline. They have also been downgrading the stocks during the recent rally. Contrarians who are gold bulls may be encouraged by this chart, as it is shows less than 50% of the analysts give "buy" rankings to these stocks. The analysts have proven to be wrong since the volatility has picked up in these stocks. Furthermore, it opens the door to further gains in the event that analysts begin upgrading the shares.
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Implications: Gold and the dollar are considered the main safe havens for investors amid the recent global recession. If the U.S. continues to print money, causing investors to lose confidence in the greenback, you may see a mass exodus to gold. If gold can stage a big rally, and topple the $1,000 resistance looming overhead, then the more volatile gold stocks should see a big boost. The analysis above shows optimism for these stocks is nowhere near extremes, which tells us there is plenty of room to the upside if investors once again become giddy.

I'd like to add a comment of my own to Rocky's discussion of gold: notice that he's referring to resistance at the $1,000 level. I can agree that gold and gold stocks can really move if it clears that resistance. But I personally don't want to front-run that in any serious way, in case gold isn't able to push above that resistance. I was happy to see my $999/1000 target met and after that I'm in wait-and-see mode!

Also, Todd points out that weeks following triple-witching usually underperform, but we have the other points reviewed here to suggest that strength can continue in the early part of this week. Doesn't mean that the strength continues well beyond however, and Todd's other points are worth consideration as well.

I also appreciate Todd's points about the financials. I had addressed those in a promised post about a week ago looking at trendlines and levels in the BKX and pointed out there that we cannot say a bullish outlook as been confirmed from a chart basis. Todd's points from the sentiment viewpoint helps wave a cautionary flag on this sector.