Happy Thanksgiving! Has the holiday crept up on all of us so soon? Indeed, we're in for a lightly traded, abbreviated holiday week. And thanks to a significant jump higher last Tuesday coupled with modest gains on Friday, we're able to give thanks for a positive week in the markets. The Dow Jones Industrial Average (DJIA) ended Friday 1% higher for the week, the Nasdaq Composite (COMP) gained 0.4% compared to the previous week, and the S&P 500 Index (SPX) edged up 0.3% for the week.

While things have been rough-and-tumble for the markets of late, there are still some critical support levels that have proven their worth in recent days. The S&P held above the 1,450 level, site of short-term chart support (though the index was strongly rebuffed at the 1,490-1,500 region). The Dow closed the week above the 13,000 millennium mark after Monday's dip beneath this threshold. The S&P 100 Index (OEX) has failed to breach the 670 level, which contained pullbacks in late August as well.

And most significant is the 80-week moving average on the S&P, which appears to be beckoning during the market's down days. A move to this trendline currently perched near 1,415 would basically put the index even (or slightly negative) for the year and could drastically reduce the complacency that continues to linger on some fronts. I can't shake the feeling that we might not be able to declare "rock bottom, time for a turnaround" until this trendline is paid a visit.

Additionally, there are some sentiment indicators that haven't yet reached the levels I'd hope to see at a true bottom. Aside from a brief peek above the 30 mark last Monday, the CBOE Market Volatility Index (VIX) hasn't shown the kind of panicked spike we saw in mid-August that preceded a market recovery. And in early October, the VIX never did manage a solid move below its 32-week moving average; the less than bullish implications of this phenomenon has been pretty well confirmed by the market's behavior in the past few weeks. I'll confess that it is not enjoyable for me to admit that I had not been paying too much attention to this factor, but the light of day is always better than the darkness. And with the benefit of the light of day, I wonder if we're going to need a VIX spike (and move above 30 again) before we can achieve a solid bottom.

I also imagine we may need to see more climactic levels of volume on the S&P Depositary Receipts (SPY), the likes of which we saw in August, when nearly 550 million shares changed hands on the exchange-traded fund (ETF) in one session. The largest single-day volume we've seen so far during this pullback was 374 million. Needless to say, we're not likely to manage a climactic volume level during a holiday week.

Complacency is also the reigning emotion amid some other sentiment indicators we monitor. The Investors Intelligence poll of financial newsletter professionals is still elevated, with the bullish reading at 53.8%. (On the flip side, we have seen a dramatic jump in the bearish reading at the American Association of Individual Investors, as noted last week, and another sentiment poll we follow saw its bullish percentage reading dip below the 50% water mark).

Turning from polls to investor activity, odd-lot short selling hasn't seen the same sort of increase experienced in May 2006, March 2007, and July 2007. And the call/put ratio index (for equities only) at the International Securities Exchange remained elevated for most of last week, hovering between 108 and 119. But Friday started to show a chink in the complacent armor, with the equities only call/put ratio coming in at 84, the lowest reading for any expiration Friday in the past 2 years. The all securities ratio reached 68. As my colleague Bob Becks said in an internal email communication on Sunday: "From eye-balling the (S&P) chart, it appears to me that very low readings, such as Friday's sub-70 (ISEE) score, are usually closely followed by some good, upside movements of the various indices, sometimes for extended durations."

Friday's trading also saw the CBOE Nasdaq Market Volatility Index (VXN) drop an eye-popping 12.5%, making me wonder if the "fever has broken" on the tech group. Last Monday, the VXN unlike its cousin, the VIX actually exceeded its mid-August peak. This spike occurred despite the fact that the Nasdaq 100 Index (NDX) was actually trading about 10% higher than at the August bottom.

So some key indicators are definitely starting to look up, but other indicators suggest we're not out of the woods just yet. While I see continued short-term risks to the bullish case, and am not comfortable in declaring a short-term bottom, I think the risks to the bearish case are exponentially larger. For one thing, technical support has been dependable for the major indices. Then there's the matter of the Fed, which could move in to cut rates again, even acting between meetings given the recent market action (though they continue to protest too much). On Friday, the yield on the 5-year note hit a new 52-week low, adding to the pressure to cut rates quickly. As I noted in the December edition of The Option Advisor, published last Thursday, there is no question that current Fed policy is tight relative to market rates.

The relationship between the Fed Funds and the 10-year yields has been inverted for 530 days and counting. And while we remain "recession free" and the S&P has even managed a decent positive return during this long period of curve inversion we could be in "pushing our luck" mode unless the Fed begins to get aggressive on rate cuts. A look at the sub-headline of the column in the November 19 issue of BusinessWeek by James C. Cooper, their highly respected "Business Outlook" columnist, underlines this point: "The Fed seems to think inflation-recession forces are in balance, but softening labor markets, tighter lending standards and nearly $100-a-barrel oil say otherwise."

So as I see it the biggest risk to the bulls right now is that a "tone deaf" Fed will remain inert as they emphasize "balanced risks." A massive blow-up by another bank could be a risk as well, but this sort of event could be a blessing in disguise, as it could force the Fed's collective hand into action. The bears, on the other hand, could suffer at the hands of a surprise rate cut, which could catch the Street off guard in terms of magnitude and/or in terms of timing. As such, I see the risk to the bullish case as a "slow bleed"; the bearish risk would be more like "an explosive rally to new highs," and under this scenario I want to be a bull despite some short-term concerns as discussed above.

Thanksgiving week, historically, has held gains for the market. In fact, since 2001, the S&P has been consistently positive, with the best gain occurring in 2003, which yielded a jump of 2.2%. The holiday won't keep some retailers out of the earnings spotlight, as Lowe's Companies (LOW), Nordstrom (JWN), Saks (SKS), Borders (BGP), Target (TGT), and others announce quarterly numbers, along with Hewlett-Packard (HPQ) and Deere & Co (DE). Of greatest importance to the retailers will be the sales levels on the critical day after Thanksgiving, also known as "Black Friday." Fed minutes will be released for digestion midday Tuesday, and remember it's the week after options expiration, which can go either way. Most of all, have a happy and safe holiday.

And now a few sectors of note...

Dissecting The Sectors

Sector

Metals Bullish

Outlook: We're liking copper again, as long-term futures could be forming a bottom around the $3.20-a-pound region. Two of our favorite names in the group remain Southern Copper (PCU) and BHP Billiton (BHP), both of which represent the desirable contrarian recipe of solid relative strength amid skepticism. Between the pair, there are just 4 "buy" ratings on Wall Street, and 9 "hold" ratings, leaving wide open the possibility for upgrades. Short interest is robust on PCU, at 7 times its average daily volume, and the Schaeffer's put/call open interest ratio (SOIR) for BHP is high at 1.21. Looking at gold, the nearby $800 level hangs in the balance. In 1980, gold hit an all-time high of $893.10 but there was only a single weekly close above $800 before a steep decline ensued. Currently, the yellow metal has enjoyed one recent weekly close above this century mark, but it continues to hold its own just below this level amid profit-taking activity. Another solid breach of $800 could mean a rush to $1,000 isn't too far behind. Barrick Gold (ABX) currently looks good from our methodology.

Sector

Small-Cap and Mid-Cap Momentum Bullish

Outlook: The Schaeffer's put/call open interest ratio (SOIR) for the iShares Russell 2000 Index (IWM) exchange-traded fund (ETF) took a tumble during the past week, moving to 1.79 from 1.98. Pessimism could finally be unwinding on the small caps, which bodes well for the group. In the newly front-month December series, put open interest is notably heavy between the out-of-the-money 71 and 75 levels. Over the short term, these underfoot puts could serve as options-related structural support. From the small- and mid-cap arena, we continue to like Chipotle Mexican Grill (CMG) and priceline.com (PCLN). The short-interest ratios match on both stocks, at 8.4, providing a foundation for a short-covering rally on each. The Russell 2000 Index (RUT), meanwhile, is holding above chart support at the 760 mark and perched above its 32-month moving average, which has not been violated on a closing basis since May 2003. Meanwhile, the S&P 400 MidCap Index (MID) is testing its 20-month trendline, which could serve as a springboard to launch the index higher. Continue to focus on strong momentum, high-relative-strength names within the sector for the best profit potential.

Sector

Financials Bearish

Outlook: I recently observed in an internal email that my biggest worry about the current market is investors' daily willingness to jump back into the financial fray. Given everything that has happened in this arena of late, I'm guessing the sector will have to be hated a lot before rock bottom can be judged. And I don't think we've seen the type of overwhelming negative sentiment that would coincide with a bottom. Case in point: the Schaeffer's put/call open interest ratio (SOIR) for the Select Sector SPDR Financial Fund (XLF) dipped farther last week, hitting 1.47 for yet another new annual low. Composite sector SOIR readings for savings-and-loan companies and for banks are indicative of speculator optimism as well, ranking in the 26th and 8th percentiles, respectively. We still continue to lack climactic volume typically registered at a market bottom. The XLF was smartly rejected by its overhead 20-day moving average last week, but this failed to make waves on a volume level. Overall, if the financials, in fact, haven't bottomed yet, the market itself will struggle.

Copyright Schaeffer's Investment Research http://www.schaeffersresearch.com

News powered by SchaeffersResearch.com