Wednesday, August 26, 2015

After a Down August, What Happens Next?

With equity markets going from bad to ugly in just a matter of days, one has to wonder what the near-term future has in store. So far this month the S&P 500 has plummeted -11.2%, putting this August on track to be the second worst performing month since the start of 2005. Topping the list is the month of October 2008 with a -16.9% return and currently in second place is February 2009 at -11%. The fact that performance this month is as awful as some of the worst months during the catastrophic market meltdown of 2008 into early 2009 helps to put this correction into proper perspective.

We're accustomed to thinking that September and October are typically more tumultuous months than August, but it's not true. On average over the last twenty years, August has fared worse than September or October, as have June and July. Summer months have been less than kind to investors and tends to support the "sell in May, go away" refrain.

Given this month is more than likely (!) to be negative, what has happened after down Augusts?

To answer this question, I looked at S&P 500 monthly returns for the last 30 years (1985-2014). In that time, the S&P 500 experienced 13 negative Augusts, shown below.

The average decline was -4.7% for those August months.

For the years that had a negative August, how did the rest of the year fare? Answer: quite well. Over the next four months (September-December), the S&P 500 rose by an average of 9.2%, not bad! Also note that the September-December returns were positive for all years, an impressive 13-0 hit rate.

The usual caveats apply (the sample size is limited, this time may be different, past performance does not guarantee future results, etc.), but given the painful price action and scary headlines of late, it's at least somewhat reassuring to know that the near-term future can be bright(er).

Monday, May 5, 2014

Risk Appetite Indicator Not Confirming Recent Market Move

Along with several other indicators, I use the ratio of high-yield "junk" bonds (HYG) to TLT to help gauge the risk appetite of investors, i.e. is the current market environment risk-on or risk-off? When the HYG:TLT ratio is trending down, it infers a risk-off bias is taking hold and is generally bearish for equities.


The chart above shows the S&P 500 in the upper inset and the HYG:TLT ratio in the lower inset. Note that with the market's recent attempts to make new highs, the HYG:TLT line has not confirmed this move, instead continuing to head south. 

Such a non-confirmation or divergence has proven to be something worth keeping in mind. Bearish divergences in 2007, 2010 and 2011 were quite timely as the HYG:TLT ratio did not confirm the trend in the S&P 500. Also, the bullish divergence in late 2008 / early 2009 suggested that the stock market's vicious decline was coming to an end, with the HYG:TLT bottoming in December 2008 and making a higher low in March 2009.

Friday, March 28, 2014

Will The Real US Dollar Please....

One could argue that the DXY Index is perhaps the most common representation of the US Dollar (USD). However it's not the only representation, and depending on which one is chosen can often dramatically alter one's view of the USD.

The DXY measures the performance of the USD versus a basket of six foreign currencies, deriving a geometric mean based on preset weights. Currently the currency with the largest weight (by far) in DXY is the Euro at a whopping 57.6% weight. The currency with the next largest weight is the Yen at a much more meager 13.6% figure.

An alternative measure for the USD is the Fed Reserve's trade-weighted representation (USTWBROA on Bloomberg). It offers a depiction of the USD that takes into account a much broader basket of currencies, currently comprised of 20+ regions and/or countries. And the weights are flatter with the largest weight, China's Yuan, set at 20.8% and the next largest weight, the Euro, at 16.2%.

Over time the DXY and USTWBROA have tracked fairly closely, but as shown below, that's not been the case since the latter half of last year.

Source: Bloomberg

Whereas the DXY broke down through a rising trend in the 3Q of 2013, the USTWBROA has maintained its steady ascent within the rising trend. Obviously the strength of the Euro and the variance in composition and weights of the two USD representations have much to do with this fairly recent disconnect. But depending on which measure one chooses to portray the USD, quite a different view can emerge. In the chart above, the DXY appears bearish and yet the USTWBROA appears quite the opposite. Food for thought.

Tuesday, March 11, 2014

Market Outlook and Materials vs. Consumer Cyclicals

First, apologies for the recent lack of blog posts, but I've explained in the past my current situation (ongoing job search due to my employer shutting down). With regards to the market, frankly I haven't had much to say since my posting on February 11th. On February 3rd, when the S&P 500 was around 1780, I wrote that I wanted to see at least two things occur to confirm a bottom, 1) the S&P 500 put together three consecutive up days off this low or one significant up day with a bar/candle range spanning 15-20+ points, and 2) the MACD to trigger a buy signal, i.e. for a bullish crossover to occur in the 12- and 26-day EMAs, also shown with a positive histogram. Both of these conditions were achieved on February 11th, see chart below (orange line).

Since February 11, the S&P 500 has risen 4.3% and is fast approaching the upper-bounds of an ascending channel (red lines). Longer-term the market remains in a solid uptrend, however several oscillators currently reside in overbought territory and I would expect this rally to slow down, consolidate sideways or even pullback from these levels.

The weekly S&P 500 chart below also suggests an interim peak may be at hand:

Despite the fact the S&P 500 is up YTD, attaining a new all-time high, note that the weekly MACD has yet to confirm this rise in the Index, instead remaining in a downtrend and establishing a bearish divergence. As shown in the chart above, a few negative divergences have developed over the last few years and all eventually resulted in a market pullback or correction, some more severe than others. 

One of the more interesting developments YTD is the erosion in relative performance of consumer cyclical stocks (I wrote about on January 21 and February 14) and the resurgence in what has been a longtime laggard, the materials sector.

The weekly chart above plots the relative performance of the XLB vs. XLY (or Materials SPDR vs. Consumer Discretionary SPDR). In late December, the XLB:XLY relative price successfully broke through a two year declining trend line and XLB's outperformance over XLY has continued into 2014. 

Will this trend continue? A significant factor will be the strength of the US dollar.

The weekly chart above shows the relative performance of the XLB vs. S&P 500 (lower inset) and the US dollar (USD, upper inset). It's fairly plain to see an inverse relationship exists as the relative return of material stocks tends to fare better when the USD is weak and declining. 

Regular readers know that I turned bearish on the USD last October and I have yet to see a compelling reason that warrants changing that stance. The US dollar is down since early October and the weekly chart above shows the USD has been carving out a descending triangle formation of sorts since the 2Q of last year. If the USD breaks to 79 or worse, it would signify a clear breach of support as indicated by the gradually ascending trend line. I would also point out the developing two-year bearish divergence between this modestly rising trend line (higher lows) and the downward trending MACD indicator, which also resides below zero. Finally, the Death Cross condition remains in place for the USD, i.e. the 50-day MA is below the 200-day MA.

(Source for all charts:

Wednesday, February 19, 2014

Emerging Markets Remain Relatively Submerged

Emerging markets as a whole just can't seem to get out of their own way. The MSCI Emerging Markets ETF (EEM) is down 6% YTD and has been underperforming the S&P 500 for years. What is the current outlook?

Ultimately I believe a view on emerging markets in isolation is not enough and instead should be framed emerging versus developed, or as more of an asset allocation decision. Should I be repositioning more funds out of developed (S&P 500) and into emerging markets (EEM), or vice versa?

I have found that over time the relative return of industrial metals versus a commodity index (CRB) does a very good job at leading the relative performance of the EEM vs. the S&P 500. The relationship makes sense since emerging markets tend to have a high sensitivity to global economic activity, and industrial metals tend to have a higher sensitivity to global economic activity than most other commodities.


The weekly chart above shows five signals (2 buys, 3 sells) since 1999, triggered by trend line breaks in the industrial metals vs. CRB relative return (lower inset). 

Note that a relative-return buy signal for EEM has yet to be triggered. Therefore, based on this one indicator, better to remain overweighted in developed (S&P 500) and underweighted in emerging.

Friday, February 14, 2014

Consumer Discretionary: Pain Has Been Wealth-Indifferent

A few weeks ago I asked the question, "Is the amazing run for consumer discretionary stocks coming to an end?" Based on the hourly chart below, the jury is still out on that question.

The XLY continued to decline into earlier this month, underperforming the S&P 500 as shown in the upper inset. Since February 3rd, the XLY has bottomed and risen by about 6%, however note the relative performance. Initially the ETF outperformed sharply when rallying off the low, and yet since last Thursday the relative return of the XLY has reversed course and trended downward. This trend is in stark contrast to the ascending absolute price trend, resulting in a bearish divergence. 

I would also point out that with many consumer discretionary/cyclical stocks, the relative pain suffered YTD has been income or wealth-indifferent. As shown below, several higher-end, luxury names have taken it on the chin just as badly as companies associated with middle- to lower-income consumers.

High-end, luxury stocks vs. S&P 500

Middle- to lower-income stocks vs. S&P 500

Wednesday, February 12, 2014

The January Barometer, Another Take

I know it's a bit past-due, but I wanted to offer another take on the so-called January Barometer ("as goes January, so goes the year"). Others have already weighed in on this subject, quite skeptically overall, and yet I'm not so sure that this skepticism is warranted.

From data in The Stock Trader's Almanac, I put together the following:

Since 1950, there have been 40 occasions when the S&P 500 has been up in January and 24 times when the S&P 500 has finished down in January. For the 40 years when January has been up, the S&P 500 finished the year higher 36 times and was down for the year in just three occasions (with one year finishing near exactly flat, excluded). For the 24 years when January has been down, the S&P 500 has finished those years higher in just 11 occasions, with 13 of the 24 years resulting in down years. The key column above is on the far right, "% UP," listing the percentage of up years. Overall, for the entire 1950-2013 period, the S&P 500 has been up in 47 years and down in 16 (again, excluding the one flat year) for a 73% up percentage. Compare this 73% base line figure to 90% up years for the S&P 500 when January has been up and just 46% up years for the S&P 500 when January has been down. Interesting.

The following is from Ned Davis Research:

In the period 1928-2012, there have been 54 up Januarys and 33 down. What has happened after these Januarys, for February-December, thus excluding any effect January may be having on results for the entire year? For up Januarys, the ensuing February-December period has returned 8.3% on average or a median return of 10.9% for a 78% up hit rate. Whereas for down Januarys, the February-December period returned just 2.8% on average and an anemic 2.3% median return for a 58% up hit rate or percentage.

Based on the data above, I wouldn't be so quick to dismiss the January Barometer. It appears there might be something to it.