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Dear Fellow Winning Edge Trader,

OUTLOOK: Still Running With the Bulls

Persistent is one word that describes this market right now, as the S&P 500 and other major indices remain able to grind higher through the first two weeks of New Year trading.  The fact that the news cycle fromEuropehas been lighter than normal has helped the underpinnings of this rally grow stronger, but the real work will start next week when earnings season truly starts.

This week, mixed earnings news and stronger than expected economic data have helped to keep investors’ interests going as the anticipation for the upcoming deluge of earnings reports grows.  From our perspective, the market is going to have to work harder to disappoint investors than it will to impress. This is the kind of market in which, more often than not, it pays to be invested..

The year ended with some signs of promise for the contrarians, as all signs are pointing to a market that has exhausted investor’s nerves, resulting in a huge stockpile of cash that is now sitting on the sidelines. 

For example, according to the Investment Company Institute (ICI), investors redeemed more than $100 billion in assets from stock mutual funds for the year of 2011. Compared to the $37.4 billion that was removed from funds in 2011, this is a display of the degree to which investors have been moving away from stocks.  Historically, the best time to buy stocks has been when everyone else is selling.  The surge in redemptions from stock mutual funds suggests that the crowd did exactly that.  If this is true, improvements in the economy, both domestic and global, have the potential to shift the momentum from selling to buying as the New Year continues.

Similarly, we see a large percentage of analysts are calling for the market to remain flat through 2012, despite the better than average seasonality from the presidential election cycle and some fairly strong improvements in the fundamental picture here at home.  This is the recipe for a much better than average year for the markets, as we all know  the best time to be bullish on stocks is when everyone else is expecting little to nothing.

The latest short interest data were released today, and they are flashing some serious buy signals at the stock and sector level.  We’ve been talking about how we favor the Regional Banks (KRE) over the large cap Financials (XLF) for months as the outlook grew much brighter for these nimble companies.  The latest short interest data show that the short sellers are making bets against the regional banks, despite the fact that these companies are leading the market’s charge higher.

According to our Component Weighted ETF Short Interest ratio, the regional banks are the most shorted of the widely traded ETFs, with a weighted short interest ratio of 11.5.  This is huge, especially given the fact that this level of shorts is higher than the micro- and small-cap sectors of the market.  These shorts will get flushed out of these bearish bets, creating a short squeeze situation for the regionals.  We continue to love the sector, and have a number of companies within the group that we’re fond of for intermediate-term positions.  We’ll cover in more detail on our blog at www.thedailystocksblog.com. 

Sectors that we’ve warned you to stay away from include technology, large financials and energy.  Not surprisingly, these are the ETFs that are at the bottom of the Weighted Short Interest Ratio list, meaning that the short sellers are relatively bullish on these stocks.  Continue to stay away from these sectors for now, as they remain market laggards and show no sign of pessimistic investor activity.

The market is flashing a lot of signals as earnings season continues.  We’re maintaining our bullish outlook, as the market is still approaching a Golden Cross technical pattern. This would provide a very bullish intermediate-term signal for stocks, and it would also do well for flushing the investors sitting in their money market funds out of cash and back into stocks.  We all know that the best time to be long the market is right before everyone else starts buying.  Given the current picture in the market, that time may be now.

EVENTS: Next Week, Earnings Season Gets Rolling

This week, the rubber will really meet the road when it comes to earnings, as we’ll see about 10% of the S&P 500 Index report their quarterly earnings results.  The brunt of the earnings activity will focus on the financials, because about half of the SPDR Financial Select Sector Fund ETF (XLF) will report earnings and about 30% of the SPDR KBW Regional Banking ETF (KRE) will report their results.  Of course, as indicated in the outlook, I love the fact that the KRE will see a large percentage of it’s companies announce earnings. This may be the catalyst needed to get the growing population of short sellers to start closing their positions.

The table below displays the ETFs that have 20 percent or more of their component companies reporting results this week.

 

Position Update

As discussed in the market update, we’re still expecting the market to move higher. This is reflected in the fact that we continue to hold calls only.  We’ve been closing out winning positions in the portfolio for the last two weeks as a result.

Let’s take a quick look at our open positions. 

Tyson Foods (TSN) Jan 19 Call (TSN 120121C00019000) – Tyson continues to wrestle with its 50-day moving average, right at the stock’s $20 mark.  The same level is significant due to the large amount of put open interest at that strike ($20).  For this reason, we’ll continue to hold the TSN calls with day-to-day evaluation.

This position is now a HOLD.

 

O’Reilly Automotive (ORLY) Jan 80 Call (ORLY 120121C00080000) – ORLY erased the 44% loss from last week by rallying right back to its recent highs.  The position now holds a slightly negative return, but is showing signs that we’ll see a plus sign in front of the return shortly.  We’ll continue to hold the calls as the stock looks to break above its $82 level.

This position is a HOLD.

 

Aggressive Portfolio –

There are currently no open aggressive positions.

Remember to keep those comments and questions coming in. We want to know what you’re thinking and what you want, rather than what we think you want, for the Winning Edgeservice.

So drop us a line at chrisandjon@winningedgeoptions.com. We appreciate it.

Also, check out our latest research and market observations at thedailystocksblog.com. And you can now follow us on Twitter - @Chris_JRG and @Jon_JRG.

Hope to hear from you soon.

Chris Johnson & Jon Lewis
Editors
The Winning Edge