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SCHAEFFER'S MONDAY MORNING OUTLOOK

Prepared by Shaeffer's Investment Research

DJIA Bounces Into September With A Three-Day
Back To The Future: SPX Regains 1,100

(September 6, 2010) The Dow Jones Industrial Average broke out of its three-week losing streak, and kicked off the month of September with a solid three-day rally. The Dow added 2.9% last week, and is back in positive territory for the year. Looking ahead, Todd Salamone, Senior Vice President of Research, wasn't surprised by last week's bounce, given the market's recent trading range, and he sees several factors reinforcing that trading range in the near future. However, Todd is encouraged that the CBOE Market Volatility Index (VIX) closed below its 200-day moving average for the first time since Aug. 10. Next, Senior Quantitative Analyst Rocky White examines the historical performance of the S&P 500 Index during Labor Day week and the month of September. September has a bad rep, but Rocky isn't sure that's entirely deserved. Finally, we wrap up with a look at some key economic and earnings reports slated for release this week.

Recap of the Previous Week: Bulls Recover Some Swagger
By Joseph Hargett, Senior Equities Analyst

You want the bad news first? August was awful. When the month ended on Tuesday, the Dow Jones Industrial Average (DJIA) peeked out from behind a 4.3% monthly deficit. The S&P 500 Index (SPX) fared even worse, stumbling to a 4.7% loss, while the NASDAQ Composite (COMP) lagged the pack with a groan-worthy 6.2% plunge. All three indexes turned in their worst August performance since 2001, and their first negative August in five years. Ugh. Now the good news: The Dow snapped a three-week slump amid the faintest hints that double-dip fears are overblown. We got better-than-expected reports on jobs, home prices, manufacturing and consumer confidence, along with renewed signs of strength in China and Australia. But don't break out the rally hats quite yet. The Dow is still trading well within its summer-long trading range.

The week got off to a less-than-impressive start Monday when the Commerce Department reported personal income rose only 0.2% last month, falling short of economists' estimates. Traders were also concerned about the upcoming Friday release of national jobs data. The intraday action was a long, steady, painful slide, with the Dow Jones Industrial Average finally settling on a loss of 1.39%, just barely above the 10,000 level.

Tuesday was positively schizophrenic, both in terms of market action and news. The Case-Shiller home price index increased by 1%, its third straight increase following six months of declines. The Conference Board reported that confidence among consumers rose to 53.5 in August--beating economists' predictions for a rise to 50. But Chicago-area manufacturing activity slumped in August, and the latest minutes from the Federal Open Market Committee (FOMC) revealed dissension within the policy-setting group. The Dow raced back and forth across the breakeven line day, finally settling on a tiny gain of 0.05%.

The bulls dusted themselves off on the first day of the new month and showed a little swagger. Overseas news was good: China reversed a slowdown in manufacturing activity and Australia's economy grew 1.2% in the second quarter, its fastest pace in three years. Here at home, the Institute for Supply Management (ISM) reported much better than expected manufacturing growth. The Dow raced to a more than 200-point gain by lunchtime, and closed on a gain of 255 points, or 2.54%.

Retailers cheered back-to-school shopping results on Thursday, and jobless claims declined for the second week in a row. That was enough to keep the bulls in the driver's seat. Although there was still caution ahead of Friday's employment data, the Dow added a solid 0.49% for the day.

The Labor Department reported before the opening bell on Friday that the U.S. lost 54,000 nonfarm jobs in August, versus expectations for a drop of 105,000 jobs. Excluding census workers and other government employees, nonfarm payrolls expanded by 67,000 in August, more than doubling the consensus estimate for a 30,000 gain. That was pretty much enough to insure that Dow would score its first weekly victory in a month. The Dow advanced a healthy 1.24% on the day and 2.9% for the week. Meanwhile, the S&P 500 Index scored a weekly gain of 3.8%, and the Nasdaq Composite tacked on 3.7%.

What the Trader Is Expecting in the Coming Week: More Back-and-Forth in a Trading Range?
By Todd Salamone, Senior Vice President of Research

"From a shorter-term perspective, there is a tremendous amount of put open interest just below current levels on major exchange-traded funds that we follow. If the market stabilizes during the next few days, short covering related to expiring put open interest in the next few weeks could support a rally from SPX 1,040, the lower boundary of the current trading range...If you are an options player, we have found straddles as the ideal low-risk, high-reward play given the possibilities..." - Monday Morning Outlook, Aug. 28, 2010

During the past couple of weeks, we highlighted the extreme negative sentiment on the market, with the implication being that whether one's negative bias was technically or fundamentally based, there seemed to be no shortage of sellers. This left skeptical market participants vulnerable to a sharp, short-covering rally, which we witnessed last week. We saw continued stabilization around chart support at the 1,040 level on the S&P 500 Index (SPX) before an explosion to the upside. Therefore, the short-covering possibility that we presented last week may have indeed been the scenario that played out from Tuesday's low into Friday's close.

So, where does last week's impressive advance leave the SPX heading into the holiday-shortened week? In the simplest terms, the SPX is in the upper zone of a one-year trading range, which would suggest from purely a chart perspective that short-term risk outweighs reward.

Per the chart below, since mid-September 2009, the SPX has mostly been locked in a range between 1,040 and 1,130. There have been brief periods in which it closed above and below this range, including a long period above its upper boundary in March through early May. But, for the most part, it has been all about 1,040 and 1,130. In fact, of the 248 trading days since Sept. 14, 2009, the SPX closed between 1,040 and 1,130 on 178 of those days, or 72% of the time.

Are we in for the same pattern that has been in place for the past several months, in which the SPX moves from the top to the bottom of its range, and from the bottom to the top of its range, in lightning speed? It certainly appears rallies in this period have been induced by short-covering, as they have been sharp and swift. But at the same time, in the absence of natural buyers to sustain such advances, rallies have been viewed as "selling opportunities" among equity fund managers, who are dealing with investor withdrawals on a consistent basis.

In addition, hedge funds, who bid the market higher from its trough in March 2009, have clearly become disinterested in equities at these levels, having opted for the safety of Treasury bonds.

Moreover, it appears hedge fund managers have viewed market rallies as an opportunity to buy cheap portfolio protection for long positions. A decline in the CBOE Market Volatility Index (VIX û 21.31), an approximate measure of the cost of portfolio protection, usually accompanies market advances, and the VIX retreated almost 13% last week. The collective action to purchase portfolio insurance via index puts, in the absence of simultaneous accumulation of long positions, usually has a negative coincidental impact on the market, as sellers of the puts short futures to hedge.

Above being said, the VIX closed below its 200-day moving average for the first time since Aug. 10. A declining VIX is usually associated with bullish price action, and the close below the 200-day moving average is certainly encouraging for long-term market bulls. At the same time, a short-term risk for long equity players is that the VIX rallied sharply on market weakness the last time that it was trading at these levels in early August.

Beyond 1,130 on the SPX, we are also keeping a keen eye on the 1,115 area, site of the converging 160-day and 200-day moving averages. Should a breakout above 1,130 occur, a bullish inverse "head and shoulders" pattern would be in place. We continue to believe that this technical pattern offers more upside reward than the downside risk of the various "bearish" technical patterns that have been discussed in the financial media recently.

Finally, while everyone warns of the dangers of September from a seasonality perspective, keep in mind that four of the past five September's have been positive for the market. We are off to a good start this September, mindful too that there are a lot of trading days left in the month.

From a short-term perspective, we are open to a continuation of the year-long pattern of swift moves to the top and bottom of the range, as both bulls and bears can make their case. Actions one might take would include keeping your long exposure and taking some profits, or hedging via the purchase of puts to protect long positions. Moreover, last week's pullback in the bond market could provide an attractive, low-risk entry for those of you seeking to buy pullbacks on underlying assets in a longer-term uptrend.

Indicator of the Week: Labor Day Week and September
By Rocky White, Senior Quantitative Analyst

Foreword: August is over, which may be a relief to market participants: the S&P 500 fell 4.74% during the month. That was the worst August since 2001. This week I'm looking at the seasonal patterns of the short Labor Day trading week and for the entire month of September.

Labor Day Week: Below is a summary of how the week of Labor Day played out for the market over the last 20 years, compared to all weeks. The top table summarizes the week of Labor Day, and the second table summarizes any time since 1990. The last column shows the data for the entire week. We see the short holiday week has been slightly bearish, but nothing to be too worried about.

When we focus on the individual days, we see the middle of Labor Day week to be the main reason for the week's under-performance. Wednesday is the only day that has been negative more often than positive. Both Wednesday and Thursday average a negative return. The beginning and end of Labor Day week have typically outperformed the market.

Below is a chart showing the S&P 500 performance over the last five Labor Day weeks. Last year was a good year, finishing 2.59% higher. One year prior to that, in 2008, the market tumbled 3.16%.

September: I've seen more than a few articles highlighting the historically bearish performance of September. The tables below show monthly data for the S&P 500. The numbers to the left of each table show the rank of that month's average return. Over the last 20 years, September has indeed been the worst month for the market, averaging a loss of 0.76%. However, over the last five years, September has held its own, averaging a gain of 0.24%. Also, it has been positive in four of the last five September's (actually five of the last six).

Implications: Labor Day week has a negative tendency over the last 20 years, and so does September. However, given all the articles I read highlighting September's woes, I'm a bit optimistic. If investors are as afraid of September as the articles imply, then they have probably held off on some buying and have money on the sidelines that they are waiting to deploy. This could be a positive boost for the market. Maybe the fear of September is the reason five of the last six have been positive.

This Week's Key Events: Easy-Does-It Welcome to Autumn
By Joseph Hargett, Senior Equities Analyst

It's a slow week on both the economic and the earnings fronts. Here is a brief list of some of the key events for the upcoming holiday-shortened 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 market is closed for the Labor Day holiday on Monday.

Tuesday

--There are no major economic reports scheduled for release on Tuesday. Casey's General Stores Inc. (CASY), Navistar International Corp. (NAV), The Pep Boys (PBY), and Phillips-Van Heusen Corporation (PVH) are scheduled to report earnings.

Wednesday

--The Fed's Beige Book for September will be released on Wednesday, along with the usual weekly report on U.S. petroleum supplies. Ciena Corp. (CIEN), Smithfield Foods Inc. (SFD), The Talbots Inc. (TLB), The Men's Wearhouse Inc. (MW), Shanda Games Limited (GAME), and Shuffle Master Inc. (SHFL) will post their quarterly results.

Thursday

--We'll get the weekly report on new jobless claims, along with the trade balance report from the Commerce Department. National Semiconductor Corp. (NSM) and Smith & Wesson Holding Corp. (SWHC) will report earnings.

Friday

--There are no major economic reports scheduled or Friday. Brady Corp. (BRC) and lululemon athletica inc. (LULU) will round out the week's earnings.

And now a few sectors of note...

Dissecting The Sectors

Sector
Real Estate
Bullish

Outlook: The iShares Dow Jones U.S. Real Estate Index Fund (IYR) bounced off support near its 80-day moving average last week, and proceeded to rally to a multi-week high following a round of better-than-expected economic data, which included a surprise rise in pending home sales. With momentum on its side, the IYR appears poised to challenge its April highs in the 55 region. From a sentiment standpoint, the International Securities Exchange (ISE) and Chicago Board Options Exchange (CBOE) 50-day buy-to-open put/call volume ratio is rolling over. This could indicate that put traders are no longer hedging their positions on the sector, removing a potential headwind. There is also plenty of negativity from analysts. Specifically, only 39% of the 1,120 analysts covering the sector have doled out "buys." Any upgrades could provide lift for the sector.

Sector
Energy
Bearish

Outlook: While the Energy Select Sector Fund (XLE) rebounded alongside the rest of the market last week, the fund is still trading below long-term resistance in the 55 region. This area is currently home to XLE's 160-day moving average. Additional overhead resistance in the form of the fund's 200-day moving average is also looming overhead. Making matters worse, the recent strength in the U.S. dollar and rising U.S. inventories continue to hold crude oil prices below $75 per barrel. Meanwhile, the buy-to-open 50-day put/call volume ratio on XLE has been in decline since November 2009, which means stocks in this group are not likely under accumulation. In fact, they could be in distribution mode. Negative headlines in this group, along with prospects of increased regulation, have bearish implications.

Sector
Bonds
Bullish

Outlook: Bonds have soared amid heavy inflows in 2010. As a result, the iShares Barclays 20+ Year Treasury Bond Fund (TLT) has rallied more than 15% on a year-to-date basis. Currently, the exchange-traded fund (ETF) is in the midst of a pullback from August's peak just above the $109 level. What's more, Friday's low nearly filled TLT's Aug. 14 gap. This low also corresponds with support from the ETF's 50-day moving average, a 61.8% Fibonacci retracement of the TLT's late-July low and August peak, and former resistance in the $102 region. We expect this confluence of support levels to provide a springboard for TLT. On the sentiment front, there has been a wave of speculation in the financial media regarding a "bubble" in the bond market, including a recent MarketWatch piece titled "What to buy instead of bond funds." While such warnings may eventually prove true, we believe that the immediacy of these concerns is overblown and that they will take longer-than-expected to play out. That said, traders should hedge their bullish positions on the TLT, as bonds, and the market as a whole, have been quite volatile over the short-term.

September 6, 2010
Schaeffer's investment Research
1259 Kemper Meadow Drive, Cincinnati, Ohio
800-327-8833
www.schaeffersresearch.com


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