Monday Morning Outlook: Dow, SPX Facing Major Technical Hurdles After Pullback

              

Whoops. The Dow Jones Industrial Average slipped another 1% last week, following on the heels of its 4.1% swoon the previous week. That helped add up to a 3.5% loss for the month of January, the worst performance for the blue-chip index since February 2009. Looking ahead to next week, Todd Salamone, Schaeffer's Senior Vice President of Research, is looking for bullish signs, but he concedes that the technical backdrop has weakened considerably. He notes, for example, that the S&P 500 Index has broken below its 80-day moving average for the first time since the March 2009 bottom. Next, Senior Quantitative Analyst Rocky White takes a look at the January Barometer -- whether the market's performance in January foretells the rest of the year -- and doesn't much like what he sees. Finally, we wrap up with a look at some key economic and earnings reports slated for release this week.

Recap of the Previous Week: Worst Monthly Performance for Dow Since February 2009
By Joseph Hargett, Senior Equities Analyst

After the previous week's slump, the major market indexes were content to coast sideways early last week, but uncertainty about the global economic environment sent the Dow Jones Industrial Average (DJIA) skidding to within spitting distance of 10K by the end of the week. On Monday, traders were encouraged by renewed optimism that the Senate would reconfirm Ben Bernanke as chairman of the Federal Reserve. However, a disappointing housing report from the National Association of Realtors helped to hold held the rally in check while traders waited on a plethora of key political and economic events later in the week, including a Federal Reserve policy meeting and President Obama's State of the Union address. By the close, the DJIA had added 0.23%.

The Conference Board set a positive tone on Tuesday, reporting that the consumer confidence index jumped to 55.9 in January, marking the third consecutive increase and the highest level in more than a year. Elsewhere, the International Monetary Fund lifted its global economic growth forecast for 2010 to nearly 4%, while Apple Inc. (AAPL) posted a solid quarterly report. But caution returned by the close. As a result, the Dow slipped to a loss of 0.03%.

Apple was once again in the spotlight on Wednesday, as the company announced its newest gadget, the iPad. Meanwhile, dissent was the name of the game at the Fed. While the FOMC pledged to keep interest rates at their current, rock-bottom levels for an "extended period" of time, Kansas City Fed President Thomas Hoenig disagreed with the by-now standard "extended" language. The Dow reversed early losses, and added 0.41% on the day.

Ford Motor announced its first full-year profit since 2005, but initial jobless claims came in higher than expected. The market was also concerned about slowing growth in China and debt in Greece. The Dow lost 1.1% Thursday and fell below its 20-week moving average. It had not closed below that level on weekly basis since April 2009.

Stocks initially rose Friday after the Commerce Department said gross domestic product expanded at an annual rate of 5.7% during the fourth quarter, easily topping forecasts. But the early optimism faded. The DJIA finished the day with a loss or 0.5%. The Dow shed 1% last week, and ended January with a loss of 3.5%, its worst monthly performance since February 2009. The S&P 500 Index gave up 1.6% on the week, and tumbled 3.7% for the month. Finally, the Nasdaq Composite wrapped up the week on a deficit of 2.6%, and settled the month of January on a steep loss of 5.4%.

What the Trader Is Expecting in the Coming Week: Searching for Bullish Signs as Technical Backdrop Weakens
By Todd Salamone, Senior Vice President of Research

In two weeks, the S&P 500 Index (SPX) has experienced a couple of eye-opening technical failures. First, the SPX was pushed back violently after a few attempts to overcome its important 160-month moving average, which is situated in the 1,150 area and acted as support at the 2002-2003 market bottom. As Bernie Schaeffer mentioned in a "Schaeffer's Media Outtake" commentary on our home page on Jan. 7, "A monthly close above this trend line would be a very important next step in re-establishing whether or not the market is in bull mode."

Secondly, the SPX broke below its 80-day moving average for the first time since the March 2009 bottom, which – for bulls – is a risk as we look to the future. This intermediate-term trendline acted as resistance on rally attempts during the last seven months of the 2007-2009 decline. A crossover above this trendline in March 2009 proved to be a "buy" signal, and pullbacks to this moving average in July and October 2009 were excellent buying opportunities. The SPX has now closed below its 80-day moving average for six consecutive days, and has resisted attempts to close back above it in each of the past five days.

What, if anything, might the bulls have going for them amid the weakening technical backdrop? One is the possibility of a pattern that occurred in September, October and November of last year. Explosive rallies began at the start of all three months. In each of these cases, the rallies followed roughly two weeks of declines that ranged between 4% and 6%. At present, the SPX has retreated about 6.5% from the peak highs observed a couple weeks ago.

Bulls also have something to look forward to in the coming weeks if mean-reversion continues to be the name of the game. In fact, the nine-day relative strength index (RSI), which is a short-term measure of overbought and oversold, comes into this week at 26.75. This is the most oversold the SPX has been since March 9, 2009, when the nine-day RSI reading was 23.55. Trend followers will remind you that oversold can stay oversold, and this is advice worth noting. The message here is that in a bull market, stocks should advance strongly from "oversold" conditions. To the extent that they cannot, the possibility increases that the lows have not been reached.

As long-time readers of this report know, we analyze the short-term sentiment landscape in an attempt to depict key turning points in the market. In recent months, one of our favorite indicators has been monitoring the weekly release of the American Association of Individual Investors survey. Those surveyed have been wrong at key turning points during the past several months, as relative highs in the percentage of bulls have preceded tops, while relative lows in the percentage of bulls have preceded major bottoms within the uptrend.

Once again, these investors were relatively bullish just ahead of the present pullback, as the percentage bulls reached 47% in mid-January. In the latest survey, there were more bears than bulls, as 35% of those surveyed were bullish, compared to the 37% in the bearish camp. The current percentage of bulls and bears is consistent with the percentages that existed at the September and October bottoms, but not as pessimistic as the percentages that occurred in early November, when only 22% were bullish and 56% were bearish.

There has been a bullish tone lately when flipping the calendar to a new month. Amid signs of increasing fear and an oversold condition, this combination sets the stage for a bounce into resistance around 1,100. But take note that the technical backdrop has deteriorated relative to the other pullbacks that we have witnessed during the past several months, suggesting there is more risk in the market now. Therefore, keep your long positions hedged with protective puts. Short-term resistance for the SPX is in the 1,100-1,110 range. The 1,100 century mark has been important going back to October, and the aforementioned 80-day moving average is sitting at 1,099.10. Support is in the 1,040 area, site of the 160-day moving average and the lows in October that preceded the November advance.

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.

Indicator of the Week: The January Barometer
By Rocky White, Senior Quantitative Analyst

Foreword: The market started the year off well, with the Dow Jones Industrial Average (DJIA) rallying 1.75% by the middle of January. But then the market reversed sharply, and when January was all said and done, the Dow was down about 3.5%. This is not a good omen for the rest of the year, according to the January Barometer. It is said that January sets the tone for the rest of the year, and the numbers seem to indicate that this is true.

January Barometer: Below is a table showing how accurate this indicator has been. It considers data for the Dow since 1950, and summarizes returns from February through the rest of year, depending on whether the DJIA was positive or negative for January. The results are striking. In the 39 times that January was positive, the rest of the year averaged a return of 9.76% and was positive more than 80% of the time. If January was negative, then the average return fell short of 1.5%, with positive returns occurring less than half the time.

Below is a similar table with data dating back to 1980. You can see that the indicator holds up here, as well. When there is a positive January, the rest of the year is positive over 80% of the time. Also, there is significant outperformance in the average and median returns following a positive January as compared to a negative January.

Short Term: We know that January tells us what to expect for the rest of the year, but does it tell us anything about the shorter term? To find out, I did the same routine as above, but focused instead on returns only for February. Again, January proves to be a very accurate indicator. If January is positive, then February is usually positive, with an average return of 1.20%. But if January is negative, then February is also usually negative, averaging a loss of 1.64%.

Implications: Needless to say, this has not been an analysis that inspires much optimism for the next month, or the rest of the year. But, we can find some rays of hope in the table below, which shows returns for individual years since 1980 in the wake of a negative January. Last year started off pretty poorly, with negative returns in both January and February, but the Dow finished extremely well, for a gain of 30%. This is a pattern similar to 1982 and 2003, which were the beginnings of long-term bull markets.

This Week's Key Events: January Unemployment Rate Due
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 kicks off with the release of December's personal income and spending data, as well as December's construction spending and the January Institute for Supply Management (ISM) manufacturing index. Exxon Mobil Corp. (XOM), Humana Inc. (HUM), Sohu.com Inc. (SOHU), and Tupperware Brands Corp. (TUP) will enter the earnings confessional.

Tuesday

• January's auto sales and December's pending home sales reports are scheduled for release on Tuesday. BP plc (BP), D.R. Horton Inc. (DHI), The Hershey Company (HSY), Lexmark International Inc. (LXK), United Parcel Services Inc. (UPS), Whirlpool Corp. (WHR), News Corp. (NWS), and VeriSign Inc. (VRSN) are slated to release earnings.

Wednesday

• The January ADP employment report, the ISM services index, and weekly crude inventories will hit the Street on Wednesday. Comcast Corp. (CMCSA), Pfizer Inc. (PFE), Polo Ralph Lauren Corp. (RL), Time Warner Inc. (TWX), Travelzoo Inc. (TZOO), Broadcom Corp. (BRCM), Cisco Systems Inc. (CSCO), MEMC Electronic Devices Inc. (WFR), Visa Inc. (V), and YUM! Brands Inc. (YUM) will report earnings.

Thursday

• Traders will see weekly initial jobless claims, the fourth-quarter productivity report, and December's factory orders on Thursday. Avon Products Inc. (AVP), Burger King Holdings Inc. (BKC), The Clorox Co. (CLX), Kellogg Co. (K), MasterCard Inc. (MA), Reynolds American Inc. (RAI), Royal Gold Inc. (RGLD), Sony Corp. (SNE), bebe stores inc. (BEBE), Con-way Inc. (CNW), and Sunoco Inc. (SUN) are scheduled to report earnings.

Friday

• Friday ends the week with a bang, as January's unemployment rate, nonfarm payrolls, and December's consumer credit report will hit the Street. Aetna Inc. (AET), Beazer Homes USA Inc. (BZH), Tyson Foods Inc. (TSN), and YRC Worldwide Inc. (YRCW) are releasing their earnings reports on Friday.

And now a few sectors of note...

Dissecting The Sectors

Sector

Real Estate Bullish

Outlook: From a technical perspective, the real estate sector has shown quite resilient price action amid the current economic conditions. Specifically, the iShares Dow Jones U.S. Real Estate Index Fund (IYR) has soared more than 35% during the prior 52 weeks. By comparison, the S&P 500 Index (SPX) has risen just 28% for the same time frame. Last week's continued grind lower was a minor blow to the bulls, but the IYR is clinging to support in the 43-43.50 region. Meanwhile, there is plenty of negativity levied against the real estate sector that could unwind sharply in the wake of a rebound from technical support. There have been quite a few negative pieces centering on risks to commercial real estate in the financial media, including a recent article on the front page of The Wall Street Journal. Meanwhile, Wall Street analysts have little nice to say about the group, with more than 67% of the ratings doled out on IYR holdings coming in at "holds" or worse. What's more, short sellers are also betting heavily against the sector, as the composite short-to-float ratio for IYR holdings comes in at 8.75%. With the ETF in a solid uptrend, an unwinding of this negativity should provide a serious tailwind for the sector.

Sector

Internet Bullish

Outlook: Internet stocks have been standouts within the market-leading technology sector. This impressive price action can be seen in the Internet HOLDRS Trust's (HHH) 83% surge during the past 52 weeks, a result of HHH beating a steady path higher from its November 2008 low of $23.20. What's more, the trust rebounded from solid support in the 53 region. This area capped the trust from July through September in 2008, and has switched roles to provide support, with the HHH not closing a week below it since late October. Short sellers are beginning to react to the sector's technical strength, as the number of shares sold short plunged by more than 26% during the past month. A continuation of this short-covering could provide a tailwind for the sector. The group has also put in a solid performance in the earnings confessional so far this season. Specifically, Amazon.com Inc. rocketed higher after reporting that sales spiked 42% during the most recent quarter, while Netflix (NFLX) shares soared as much as 22% after the company topped Wall Street's expectations. NFLX is of particular interest, as more than 21% of its float is sold short. From a contrarian perspective, the rampant pessimism amid HHH's technical prowess has bullish implications.

Sector

Retail Bullish

Outlook: Both the Federal Open Market Committee (FOMC) and the Commerce Department indicated strength for the American consumer in reports last week, with the Fed holding rates steady and gross domestic product rising a stronger-than-expected 5.7% in the fourth quarter. As a result, the SPDR S&P Retail (XRT) exchange-traded fund (ETF) continues to consolidate above support at the 34.50 level, which is just below the trust's 10-week and 20-week moving averages. Additionally, the ETF has support at its 120-day moving average rising into the area, a trendline that has provided support since early July. Despite the group's resilience, pessimism blankets the retail sector. BusinessWeek recently featured a negative cover on the employment outlook, while many analysts remain skeptical of the sector due to persistent doubts regarding consumer spending. What's more, a healthy portion of the Street remains skeptical, as less than half of the 965 analyst rankings on retail stocks are "buy" or better. Such fears should keep expectations low for this group, which sets the table for disappointing developments to result in only minor setbacks, while positive surprises could spark sharp rallies.