The Dow Jones Industrial Average battled its way back above 10,000 this week, but the S&P 500 Index (SPX) found 1,100 a tougher challenge. The SPX hasn't finished a week above this round number since mid-May. Looking ahead, Todd Salamone, Senior Vice President of Research, satisfies his contrarian impulses by noting the raft of optimistic magazine cover stories that preceded the current correction. Todd is somewhat encouraged by the sober tone he has seen more recently. Next, Senior Quantitative Analyst Rocky White finds an increased demand for put options on the SPDR S&P 500 (SPY), a heavily traded exchange-traded fund (ETF) that follows the S&P 500 Index. Rocky interprets this to mean we are at or near the bottom of the current correction. Finally, we wrap up with a look at some key economic and earnings reports slated for release this week.

Recap of the Previous Week: DJIA Regained 10,000
By Jocelynn Drake, Senior Equities Analyst

The headline is that the Dow Jones Industrial Average regained the 10,000 level, thanks largely to a 273-point rally on Thursday, to record its first weekly advance in four weeks. Traders were still concerned about European debt issues, the Gulf oil spill, and the pace of the economic recovery, but for the time being at least, the correction that began in early May seemed to stabilize, if not reverse course.

As Schaeffer's Elizabeth Harrow noted in our daily Market Recap, we had "a Street-wide case of the Mondays" to open the week. The Dow fought the breakeven line much of the day, but in the end extended the previous Friday's losses. By the close of the session, the Dow Jones Industrial Average slipped 1.2%, while the S&P 500 Index (SPX) dropped 1.4%.

Federal Reserve Chairman Ben Bernanke tried his best to boost spirits Monday night, telling an interviewer that he doesn't expect a double-dip recession. "So far the news is pretty good," said the Fed chief. "My best guess is that we'll have a continued recovery [but] it won't feel terrific," citing the weak employment picture. In sort of a delayed response, stocks staged a last-minute rally on Tuesday. The Dow gained 1.26%, but remained below the 10,000 level. The SPX edged 1.1% higher.

On Wednesday, the Federal Reserve's Beige Book was relatively upbeat, with all 12 regions reporting modest improvement in economic activity. Plus, in testimony before the House Budget Committee, Fed chief Bernanke asserted, "The economy... appears to be on track to continue to expand through this year and next." But traders were still concerned about the weak euro, which backpedaled below the closely watched $1.20 level. Moreover, with oil spill worries top of mind and political pressure growing, BP plc (BP) plunged by more than 15% to $29.20, a 13-year low. In sympathy, the bulls lost conviction; the Dow finished the day down 0.4% and the SPX dropped 0.6%.

The market came back swinging on Thursday, as upbeat economic news pushed stocks sharply higher. On the home front, the Labor Department said first-time jobless claims fell by 3,000 last week, with total claims depleting by the heftiest margin in nearly a year. Elsewhere, optimists across the globe cheered China's solid surge in monthly exports, which also lent strength to the ailing euro. By the close, the Dow tacked on 2.8%, or 273 points, and the SPX jumped 3%.

The Commerce Department Friday reported a 1.2% drop in retail sales for the month of May, the first decline in eight months. Analysts had expected a small increase. Traders reacted with disappointment and stocks spent most of the day in the red. Still, U.S. consumer sentiment rose in early June, hitting the highest level since January 2008, according to the Reuters/University of Michigan index. A wave of buying in the last 30 minutes pushed the Dow into the black, ending the day on a 0.4% gain, virtually the same as the SPX's daily win. For the week, the Dow recorded a respectable 2.8% advance, while the SPX gained 2.5% for the week, and the Nasdaq Composite edged ahead 1%.

What the Trader Is Expecting in the Coming Week: Technical Backdrop Mixed
Todd Salamone, Senior Vice President of Research

In last week's Monday Morning Outlook, we concluded:

"The bottom line is that the technical backdrop and momentum continue to favor the bears. But all it takes is a spark to get the ball rolling in the opposite direction... which creates a dangerous environment for both bulls and bears. So the message stays the same: hedge your directional exposure, whether you are long or short this market."

The weak technical backdrop did indeed favor the bears last week, but the sentiment backdrop was ripe for a short-covering rally that might quickly unnerve them. Last week's price action was representative of this conclusion. Monday's trading was a continuation of the prior Friday's weakness, and Tuesday was pretty much uneventful until a surge higher in the last two hours of trading. Wednesday saw a gap higher, followed by more strength into the lunch hour, but afternoon weakness sent the S&P 500 Index (SPX) 22 points lower into the close. But Thursday saw another sharp gap higher that lasted into the closing bell. Finally, Friday's action began with a gap lower and stocks trading in the red until the last half-hour of trading, at which point they rallied to close in positive territory. The end result has been volatile movement within the 1,040 – 1,100 range, and overnight holding risk continues to be high.

Next week is the expiration of equity options, stock index options and stock futures contracts. Stock market performance during "triple-witching" expiration, which occurs during the March, June, September, and December expiration weeks, supports the "dangerous environment for bulls and bears" argument. For example, the first table below shows that in the 17 triple-witching expiration weeks since 2006, 71% have produced positive returns. However, before acting on this information, take note in the second table that June triple-witching expiration weeks have produced dismal numbers. Only 40% of the returns have been positive, with the average loss almost 2% and the average gain only about 1%.

Turning to a couple of indicators discussed last week:

1. The 10-day moving average of the International Securities Exchange's (ISE) equity-only call/put ratio turned lower once again this week. Bulls would prefer to see the ratio turn higher as a sign that fear in this cycle is finally giving way to optimism. When combining the buy-to-open call and put activity on the Chicago Board Options Exchange (CBOE) with that on the ISE, the indicator has a much less bearish undertone, although it isn't exactly flashing a "buy" signal.

Finally, magazine covers are hitting our radar screen again. In April, there were cover stories with titles that suggested a return of optimism, which came just in time for a major market decline.

The Economist, April 3, 2010 - "Hope At Last"
Bloomberg BusinessWeek, April 19, 2010 - "The Hot Hand" (accompanied by a picture of President Obama shooting a basketball and a byline suggesting "Obamanomics" is working)
Newsweek, April 19, 2010 - "America's Back"

Now, the magazine cover story tide seems to be turning toward a negative undertone, perhaps marking an important bottom. For example, covers on problems in Europe and the oil crisis in the Gulf of Mexico have hit the stands in recent weeks, while fears of a double-dip recession have returned, only weeks after there was hope.

Bloomberg BusinessWeek, May 24, 2010 – "Uh-Oh," with the "O" being a picture of the euro
The Economist, May 29, 2010 – "Fear Returns," along with advice for "How to avoid a double-dip recession"
Bloomberg BusinessWeek, June 7, 2010 – "Engulfed," with a picture of President Obama now draped in oil, after being featured with a "hot hand" in April

The sentiment landscape has taken a drastic turn since April, implying that we have moved into a low-expectation environment, which can be viewed as a positive.

The technical backdrop, however, remains mixed. For example, the Russell 2000 Index (RUT – 649.00) retreated below its 160-day and 200-day moving averages earlier this week, but rallied back to close the week above these trendlines. But the 650 area lingers just above and could present a challenge, as this level was the site of resistance in January.

Meanwhile, the SPX remains above its February and May lows in the 1,040 area, but comes into the week trading below the 1,100 century mark and its 200-day moving average, currently situated at 1,108. Last Thursday, in fact, a poll in The Wall Street Journal asked readers, "Do you expect critical support of 1,040 on the S&P 500 to hold?" While 63% of respondents said, "no," the contrarian in me would suggest 1,040 will indeed hold.

Our favorite sectors continue to be real estate and consumer discretionary names. Avoid energy-related stocks. Even if you have a strong conviction level, we recommend hedging your bets.

Are you interested in options trading but not confident about your skills? Let Ryan Detrick, Schaeffer's Senior Technical Strategist, help you. Ryan will present a free webinar called "5 Mistakes to Avoid When Trading Options" on June 22, 2010, at 1 p.m. In "5 Mistakes," Ryan talks about the common errors that rookie options traders (OK, veterans too) often make. These errors range from the inability to accept a losing streak to putting too much money into a single trade. Sign up here for this free webinar.

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: Heavy Demand for Put Options
By Rocky White, Senior Quantitative Analyst

Foreword: We've had quite a pullback since late April, but this week I have an indicator that makes a strong case that the bottom may be here, or at least near. Looking at the SPDR S&P 500 (SPY), a heavily traded exchange-traded fund (ETF) that follows the S&P 500 Index, puts are more expensive relative to calls now than they were even during the 2008 market crash. This may be the capitulation we've been looking for that indicates a market bottom.

Implied Volatility Spread: The chart below looks at 10% out-of-the-money SPY call and put options, and graphs the difference of implied volatilities. It shows that put implied volatilities recently were as high as 20 points above call implieds. That is the highest spread we've ever seen considering data back to 2005.

Interpreting the Chart: Notice that the prior two peaks happened at two completely different times in the market. The first peak, in late 2007, was the perfect time to sell everything. Then the second peak, in late 2008 to early 2009, happened shortly before the SPY stabilized and then rallied about 80%. How is this explained and what does it mean now?

SPY put options are often used as a way to hedge market risk. The early peak in 2007 came at the top of a bull market, when there was a lot of big money flowing into the market. Put options increased in price, as big players bought into the bull market and needed the put options for hedges. This was the climactic buying that ordinarily happens at the top of a bull market.

The later peak on the chart was obviously at a time of market turmoil. Again, the rise in put prices was the result of an increase in demand for put hedges. However, this time the demand was out of fear. Major losses had occurred, and despite the very high implieds at the time, managers kept bidding up the prices. This was the capitulation that signaled we were at the end of the crash.

Implications: That brings us to the current peak, which is now even higher than the previous two signals. It is plain to see that the recent market pullback has seriously spooked a lot of money managers. The indicator shows them scrambling to buy put protection on their portfolios. There is a good chance that this is signaling a culmination in selling pressure. Also, with protection in place, market pullbacks will not be as scary for these hedged players. This reduces the urgency for them to sell when bad news comes out of Europe, or when economic news comes in worse than expected. No matter how you look at it, the strong demand in puts has to be looked at as bullish for the market going forward.

This Week's Key Events: Earnings Wind Down; Inflation Data on Tap
By Jocelynn Drake, 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 website for official reporting dates.

Monday

• There are no major economic reports scheduled for Monday release, and earnings season slows to a crawl. La-Z-Boy Inc. (LZB) will step into the earnings spotlight.

Tuesday

• The Fed will release the Empire State Manufacturing Index for June on Tuesday, and we'll get May's import and export data from the Department of Labor. Meanwhile, Best Buy Co., Inc. (BBY) will post its quarterly results.

Wednesday

• Wednesday brings the release of weekly crude inventories, May housing starts, the May Producer Price Index (PPI) and core PPI, and May industrial production data. Turning to earnings, Canadian Solar Inc. (CSIQ) and FedEx Corp. (FDX) will announce their results.

Thursday

• Thursday will be chock-full of economic data. Traders will get a look at initial jobless claims, the May Consumer Price Index (CPI) and core CPI, the Conference Board's leading indicators index for May, and the Philadelphia Fed Index for June. Lining up for the earnings limelight, we find The J.M. Smucker Co. (SJM), The Kroger Co. (KR), Pier 1 Imports Inc. (PIR) and Smithfield Foods Inc. (SFD).

Friday

• There are no major economic reports or earnings scheduled for Friday release.

And now a few sectors of note...