Tuesday, April 30, 2013

What sector has performed the best since March 2009?

A classic case of truth is stranger than fiction. 

Source: Stockcharts.com

Needless to say, heading into 2009, as the market was reeling and the world was coming to an end, what was clear was 1) financial stocks were decimated, with many facing extinguishment, and 2) the consumer was likewise crushed, facing years of deleveraging and severely reduced spending. That said one would've understandably believed at the time that those stocks would be must-avoids as they would very likely underperform the market for years to come.

Wrong! Since March 2009, the best performing sector has been Consumer Discretionary, and the next best relative performer has been Financials.

As always, I'm sure there are many good reasons for why this has been the case (Fed policy, unprecedented valuations, etc.). However, for me it's just another example of the old saying that the stock market will do whatever it takes to prove the most people wrong. If it was that easy to surmise a no-brainer strategy based on the past, everyone would be a Warren Buffett. And in my experience, anything that appears to be a no-brainer when it comes to allocating one's funds should be re-evaluated, more than once. Nothing comes easy in this business and all too often the seemingly "No Duh!" investment decision is a setup for future losses.

Monday, April 29, 2013

10-year Yield & Small-caps Not Confirming Recent Market Rally

For the last several weeks, the 10-year T-bond yield has been declining as the stock market (S&P 500) has been rising or working sideways: 

Source: Bloomberg

Over time, T-bond yields tend to be positively correlated with the stock market:

Source: Bloomberg

In general, as the stock market rises, so too does the 10-year yield, and vice versa. There are a few good reasons for why this correlation should hold, one being rising T-bond yields infer the economy is strengthening. Typically low government bond yields are due in large part to the Fed keeping rates low for the benefit of an anemic or ailing economy. Signs of economic growth are going to make it less necessary for the Fed to maintain such low rates, in effect framing rising yields as a bullish indication for equities. Another reason rising yields are bullish for the stock market is very simple: it implies money is getting re-allocated out of bonds (yields rise) and most likely into equities. 

And yet as you can see in the first chart above, the 10-year yield is not confirming this recent rally in the stock market, a potential red-flag.

Also note that small-cap stocks likewise have not been confirming this recent S&P 500 move:

Source: Bloomberg

The Russell 2000 Index has been trending lower since mid-March, making lower highs as the S&P 500 made a new high and is trending higher. It doesn't always hold true, but more often than not one wants to see smaller-cap stocks confirm the move of larger-caps. An index like the S&P 500 is very top-heavy, reflecting the ups and downs of several mega-caps, whereas the Russell 2000 Index is a much flatter and more equal-weighted benchmark, offering a better representation of market breadth. Based on the chart above, the average stock is not doing as well as the S&P 500 would suggest -- another potential red-flag.

Friday, April 26, 2013

Eurozone Economy and Equities Seemingly Disconnected

I wrote about this topic earlier this month and it remains perplexing. Eurozone economic indicators continue to come in under consensus expectations as reflected by the Citigroup Economic Surprise Index, which continues to decline and is now well below zero at -77. Yet in that time Eurozone equities have simply traversed sideways and even more recently have rallied by more than 5%.

Source: Bloomberg

Considering a longer-term view (below), it would appear that if anything it’s not the first time for Eurozone equities to rise in the face of continued disappointing economic data. But it would also appear that eventually equities smell the rot and likewise decline.

Source: Bloomberg

I would also point out in the above chart that 1) the Citigroup Economic Surprise Index bottomed in January 2009, two months before equities bottomed, and 2) the recent decline in the Citi index has been massive, plunging from +76 at the end of February to its current -77, further conveying severe unexpected trouble for economies in the region. One would expect investors to be more concerned and yet the Euro Stoxx Index suggests otherwise.

Note that it’s not as if the ECB is doing anything to support equities, with its balance sheet remaining in shrink mode:

Source: Bloomberg

I continue to scratch my head. Hmm, maybe this has something to do with it.

Thursday, April 25, 2013

The recent plunge in gold was very strange....

I’m not one for conspiracy theories, but the recent climactic selloff in gold looks to be very strange. 

The chart below shows the gold lease rate versus gold. 

Source: Bloomberg

Historically, any time gold has made a precipitous decline, the gold lease rate has spiked up fairly abruptly and significantly. I’ve put yellow boxes around a few past examples. 

However, note the most recent plunge in gold, one the most compressed and painful drops ever for the metal. Given such a hard decline, one would expect the gold lease rate to have shot up through the roof. Yet the lease rate barely budged. In fact, that little rise you see in the lease rate occurred before gold fell off a cliff. In other words, when gold went from 1580 to 1360 in an eye-blink, the lease rate traversed sideways to slightly down. Very odd.

Granted, it's not as if I'm showing volumes of data from various sources, but the gold lease rate generally moves based on fundamental info and events. I can only assume with this recent gold plunge that 1) not much changed fundamentally to serve as a catalyst for the selloff, and 2) more likely key technical levels were breached which triggered many computer algos to dump gold shares. Given these algos are more or less highly correlated, they all fired at roughly the same time causing mass selling, which then likely set in place a selling feedback loop as price declines continued to break key levels. Such technically-induced selling can occur abruptly and for a time within a vacuum, until the unwinding exhausts itself and price finally settles at a (much) lower level, serving as new support. 

That's my guess. It's unfortunate but price action based on technicals is no longer just human-driven. Not by a long shot. And I suspect that hasn't been the case for quite some time.

Wednesday, April 24, 2013

We're Not Out of the Woods Yet

Since its peak on April 11, the S&P 500 declined by -3.2% through April 18 and has since rallied +2.5% off that low. Good sign? Are we on our way to a new high?

Frankly it's too early to tell. The chart below helps to explain why.

Source: Bloomberg

In the past, when the S&P 500 has made new highs (green boxes) and then corrected off those highs, any ensuing rally thereafter eventually rolled over (red arrows) with further declines to follow. 

That's not to say it will happen this time, and of course there have been times when the market has corrected off new highs only to later rally to another new high. My point is we're currently at a key point where the market can go either way: this rally fails like those in the past (red arrows), or presses higher and breaks through the former April 11 high. As I've written here, I remain bearish, expecting this current rally to roll over, however if the S&P 500 were to successfully break through its prior high, my tune will likely change.

Tuesday, April 23, 2013

Is Gold Following Expected Inflation?

As I wrote last week, following the climatic-type selling we saw in gold/silver, you typically get a reflex-rally that occurs out of the vacuum left by selling exhaustion. This rally is then met by further selling and a retrace ensues to the prior extreme low -- holding above this low (higher low) for it to be a bullish sign. The rally then continues and a double-bottom (W-shaped) is formed.

Note in the hourly futures chart for gold below, it shows what looks to be a W-shaped bottom forming.

Source: Finviz.com

However looking at the daily chart for gold, you can more clearly see the extensive technical damage inflicted on the metal:

Source: Finviz.com

Based on rough approximations in the above chart, the decline from 1550 to 1350 puts the 50% retrace at 1450, the half-way point often being where a rally rolls over. But the 1550 level itself, which as you can see above was prior support, has now become resistance or another headwind.

I would add that in the Fibonacci chart below, when considering gold’s high of 1795 last year and low bid of 1320 last week, the 50% retrace is 1558, or very close to that 1550 level.

Source: Bloomberg

The bottom line is 1) what we’re seeing occurring with the price of gold over the last several days is not surprising and is often what occurs after a big selloff, and 2) gold faces much overhead resistance from here. I would expect declining retracements off any rallies as these resistance levels are met and even broken – all part of the technical mending process.

As for expected inflation, I thought the charts below were interesting. The upper inset is gold and the lower is expected inflation based on 5yr5yr forward breakeven rates. In January, future inflation expectations broke down through the 2.90% level and continued to decline below the 2.80% level. At the same time, gold weakened but then finally broke down.

Source: Bloomberg

I’m not sure of the degree of correlation between this inflation metric and gold, but looking at the multi-year chart below, they do look positively correlated. Interesting to see the recent spike in expected inflation with gold’s recent rally.

Source: Bloomberg

Judging from history, as long as this 5yr5yr inflation trend remains down or declining, it's not good for gold. However, I believe the Fed has upped its target inflation rate from 2% to 3% and as I've shown before, we know the Fed's balance sheet continues to expand. That said I have to think Bernanke is keeping a close eye on this 5yr5yr inflation chart, definitely preferring that expected inflation reverts back to the 3% level -- which would be bullish for gold. 

But -- and it's a big "but" -- expected inflation had been declining since late January in conjunction with Fed balance sheet expansion going through the roof. Question: can the Fed do enough to get expected inflation back to the 3% level, or is it pushing on a string?

Thursday, April 18, 2013

Signs of Risk-Off Prevalent

As I've written, I keep an eye on several indicators or metrics which help to gauge where we are on the risk-on/risk-off spectrum. Over the last few weeks, many of these have clearly been signaling that it's time to reign in risk and get more bearish.

The following chart shows the Russell 2000 Index versus the S&P 500 in the lower inset, and the S&P 500 in the upper inset.

Source: Stockcharts.com

When small-cap stocks begin to underperform larger-caps, it's a risk-off signal and as you can see small-cap performance has fallen off a cliff versus larger-caps.

Source: Stockcharts.com

The chart above shows high-yield "junk" bonds versus T-bonds. When high-yield bonds begin to underperform T-bonds, it's a risk-off signal and the relative performance of junk bonds broke trend last month.

Source: Stockcharts.com

I've discussed the above chart in the past. When cyclical stocks underperform staples, breaking through the 100-day moving average to the downside, it's a risk-off (sell) signal. A risk-off signal was generated late last month.

I've also discussed how mortgage REIT Annaly (NLY) has triggered a risk-off signal, and how the outperformance of health care stocks has not been a bullish sign for the market.

After being bullish since last September, color me bearish....

Wednesday, April 17, 2013

Gold is broken

Two weeks ago, I wrote, "don't count out gold just yet," as it had not yet violated key longer-term levels nor triggered longer-term sell signals. Needless to say, that all changed on Friday and Monday. 

Source: Stockcharts.com

As a reminder, a sell signal is generated when 1) gold falls below its 36-month moving average and 2) when the RSI falls below 50. Vice versa for buy signals. With Friday's close, a dual-sell signal was triggered.

You've read the reasons given for why the plunge in precious metals: Cyprus to sell its gold to raise money, which kick-started panic selling on fears of other regional countries doing the same, which set off margin calls forcing investors to sell, which continued to break key technical levels thus triggering computer algos to sell, etc. In total, lots of knock-on, cascading forced-selling, something that eventually goes too far, setting up for a decent bounce -- which we're currently witnessing.

Technically, gold is now a broken chart (and the same holds for silver, which over time is highly-correlated with gold). This current reflex-rally off the lows is a very common occurrence after a massive bout of selling. If it continues to follow the playbook, we should see a pause in this rally as remaining bruised and battered holders sell into the rally. A retrace then ensues back down towards the prior low. Hopefully we'll then see gold/silver hold at or above the prior low level, setting up what could be a double-bottom (W-shaped). It would be surprising if gold/silver were to keep rising from here, creating instead V-bottoms.

The bottom line is gold and silver now face significant headwinds to get back to prior elevated levels as there exists ample overhead resistance to get through. The charts have suffered severe technical damage which will take time to repair. It's going to be a long road ahead, it would appear.

Gold/silver will undoubtedly circulate through the bull/bear evolutionary cycle, with this recent leg down qualifying as the move from Hope to Panic. Other reasons now being suggested for gold's decline include: moderating inflation, US interest rates may go up, QE will end sooner than expected,  and investors are in risk-on mode and thus shedding safe-haven assets like gold/silver. But as the list of bearish reasons for the decline grows longer – many of them likely not based on anything that is actually causing the selloff in gold/silver – and as this list gets bigger play in the media, eventually landing on magazine covers, the closer gold/silver get to a bottom that will hold.

Monday, April 15, 2013

Is the US Dollar Indicating Imminent Danger?

The US dollar (USD) has exhibited impressive relative strength this year, rising about 3% YTD as compared to -1% for the euro and -3% for the Canadian dollar. 

The USD tends to rise when global or geopolitical fears are on the rise, serving as a safe haven, and fall when such fears subside. What to use to measure the level of fear or perceived risk in markets? There are several but I like to use the TED spread or the St. Louis Fed Reserve Financial Stress Index. More often than not, these types of sentiment measures tend to correlate so you don't need to use a bunch of them as they tend to convey the same message.

The TED spread is the difference between the 3-month LIBOR and 3-month T-bill yield. The lower the number, the less inferred risk of bank defaults and overall stress in the financial system. 

Source: Bloomberg

As you can see above, the TED spread has generally hovered around 30-50 bps, but understandably rose above 100 bps during the financial meltdown of 2007-2008. Since the start of last year, the TED spread has been in steady decline and currently resides at 22 bps, a relatively low number implying low default risk and in general a low level of investor fear and anxiety. 

As you can also see in the exhibit above, the US dollar tends to move with the TED spread. It's not a prefect correlation (what ever is?), but generally as the TED spread rises, so does the USD, and vice-versa. 

However, for the past 12+ months, the TED spread has been declining and yet the USD has been in somewhat of an uptrend.

Source: Bloomberg

It's quite a disconnect. The following chart shows it starkly, with the USD (yellow line) far above the area of the TED spread (blue).

Source: Bloomberg

I do not pretend to know the reason(s) for why this is occurring, just that it's seemingly not an ordinary occurrence. I have not been able to decipher which tends to lead the other: does the USD tend to move before the TED spread, or vice-versa? Looking at the longer-term chart going back to 2003, it appears the TED spread might lead the USD, but again nothing conclusive. Note that last year the USD rallied and yet the TED spread was declining, and from July to September the USD fell pretty hard. That would suggest the USD is elevated and should correct given the current low TED spread.

I thought I'd also show the USD versus the St. Louis Fed Stress Index, pretty much the same picture.

Source: Bloomberg

Friday, April 12, 2013

Health Care Stocks Look Bullish -- Bearish for the Market

Year-to-date, health care stocks have been the big winner. 

Source: Stockcharts.com

The XLV is up 8% (vs. S&P 500) with the next best sector, Consumer Staples, a distant second at +4.9%. 

I must say it is odd to have the S&P 500 up 12% for the year and yet as shown above, the sectors leading the way are all defensive: health care, staples and utilities. Typically these sectors have the best relative performance during down markets, and clearly YTD this market has been anything but down.

In fact, you can easily see this tendency in the chart below.

Source: Stockcharts.com

The upper inset shows the S&P 500 and the lower inset shows the RYH vs. RSP, which is the Guggenheim Equal-Weight Health Care ETF relative to the Guggenheim Equal-Weight S&P 500. I like to use the equal-weight ETFs as they help avoid distortions due to mega-caps.

You'll note that as the RYH outperforms with a rising line in the lower inset, the S&P 500 (upper inset) tends to decline and vice versa, when the S&P 500 rises, health care stocks tend to underperform. And yet we currently have the health care stocks outperforming and the S&P 500 is rising. Hmmm.

The RYH vs. RSP picture looks quite bullish to me, with it recently breaking out of a two year ascending triangle. That said, and assuming health care stocks continue to outperform, I have to think this does not bode well for the stock market. Past history suggests that eventually the market weakens when defensive sectors like health care do well.

Thursday, April 11, 2013

Airline Stocks & Crude Oil

The airline group looks like it's gone parabolic up, and also looks to be in the midst of a possible breakdown. 

Source: Bloomberg

It's still too early to tell if this recent weakness will continue, i.e. will become a breakdown in earnest. However, if it were to follow the classic script of a parabolic cycle, breakdowns off parabolic rises typically ensue in stairstep fashion. The recent weakness will be followed by an anemic rally making a lower high, only to roll over and make a lower low, followed by another rally making a lower high, etc. etc. We'll see, stay tuned.

Also, it used to be a fairly well-understood truism that when the price of crude oil rose, airline stocks would fall, and vice versa. But that relationship seems to have disappeared since the 2009 market bottom, see chart below.

Source: Bloomberg

The lower inset shows the rolling 1-year correlation between the NYSE Global Airlines Index and crude oil. If anything, airline stocks and crude oil have more of a positive relationship since 2009. Not sure why this would be the case. Odd.

Friday, April 5, 2013

Don't Count Out Gold Just Yet

Gold sentiment continues to worsen. SocGen just published a 27-page report entitled, “THE END OF THE GOLD ERA”, which reminds me a bit of the famous 1979 “Death of Equities” Businessweek cover. As is the case with most sentiment measures, it's best to go against the consensus and be contrarian, meaning all this extremely pessimistic sentiment towards gold is actually bullish.

I’ve been saying gold needs to hold at the 1550-1560 level otherwise my tune will change. Gold is now at $1566 but got as low as $1540 yesterday. It's obviously not lost on me that technically gold is in a precarious state, however a dip below 1550 is not enough to cause me to react in knee-jerk fashion. A breakdown below a key support level needs to occur in a significant way, as opposed to a brief blip.

But looking at gold's longer-term picture, I believe it's still too early to throw in the towel. I show a monthly chart for gold below. 

Source: Stockcharts.com

A sell signal is generated when 1) gold falls below its 36-month moving average and 2) when the RSI falls below 50.  Vice versa for buy signals. In the last 20 years, there’s been three signals and they've generally kept you on the right side of gold. 

A sell signal was almost triggered in 2008, and we're currently flirting with the possibility of a sell signal. However, best to wait for it to happen --  like in 2008, it may not.

UPDATE: Is A Market Top Close At Hand?

Last Thursday, I wrote regarding the market, "if this ascending triangle were to breakdown in a meaningful way, it could indicate that the tide has turned and prior built-up momentum has finally been worked off. I would then reassess my bullish stance on the market."

I already started reassessing earlier this week, believing the market was looking very dicey and vulnerable. 

The following hourly chart of the S&P 500 clearly shows a breakdown of a rising wedge, decidedly bearish action.

Source: Finviz

I track closely several risk-on/risk-off metrics (small-caps vs. large-caps, junk bonds vs. T-bonds, cyclicals vs. staples) and they've recently turned from risk-on to risk-off, suggesting we may (finally) see a meaningful correction in the market. 

Thursday, April 4, 2013

Tesla: Earnings, Smernings!

For the three fiscal years since Tesla (TSLA) has been a public company, it has yet to earn an annual profit, posting negative earnings for FY2010-2012. As a result, it's a favorite among short sellers with approximately 32 million shares short compared to the float of about 65 million shares -- a whopping 49% short as percent of float. Wow.

Looking at the charts, you'd never know Tesla has been in the red for years. 

Source: Stockcharts.com

Source: Stockcharts.com

TSLA recently hit a new 52-week high and is up 31% YTD through yesterday. (The charts above are from Monday evening). The first chart shows a bullish cup with handle formation and the second chart shows a bullish inverse head-and-shoulders formation with breakout. 

Tesla is expected to earn a profit in FY2013, so as per usual price is likely discounting the future, moving on expectations as opposed to past history. 

Some larger lessons can be learned from TSLA. For one, try to avoid shorting companies you believe will go bankrupt, or at least hold off until the chart agrees with you. Many have long felt TSLA would soon go bust, just counting the days, and yet the stock has more or less been a steady riser since debuting at $17. 

I remember in 2009-2010 it was an "easy" call that Radioshack (RSH) would go out of business, with many at the time poking fun at the company saying a business could not thrive on simply selling people batteries. Yes, RSH stock is down almost 50% in the past 12 months, but from April 2009 through June 2010 the stock rose 130%. Best to wait for the technicals to confirm future downside. 

Another lesson: do not invest according to your political bias or beliefs. TSLA has been a stock to mock by those who have high doubts about renewable energy and/or are not big fans of Obama. When it comes to your wallet & investing, try to be ideologically and politically agnostic. That can often be hard to do, but you'll be richer for it, literally. 

Tuesday, April 2, 2013

Eurozone Downturn Deepens, yet Euro Stoxx Up

The PMI numbers for Europe are out this morning and one word describes them: abysmal. All PMIs are below 50 -- any reading under 50 indicates economic contraction (above 50 = expansion). Here's the tally:

Source: Markit

Ugly indeed. 

With all PMIs below 50, it confirms widespread contraction/recession in the region, and yet the Euro Stoxx 50 is up 10% in the last six months. Huh? As I've discussed in the recent past, equities typically discount recessions by six to nine months, meaning if anything the Stoxx should be -10% not +10%. And in the past stock markets tend to be too alarmist, having more false alarms than false all-clear signals, i.e. the stock market has successfully called 20 of the last 14 recessions....

I suppose the Stoxx could be inferring that this recession(s) will be very short-lived, given that equities likewise discount the end of recessions by surging six to nine months prior to a recession's officially-declared end. The Stoxx did decline by almost 20% during March-June of last year, which is 9-12 months ago, perhaps that was the discounted heads-up for a looming recession. Since June 1st, the Stoxx is up 32%.

It's possible that we see a relatively brief recession in Europe with an imminent recovery just around the corner, but in general I remain befuddled.

Also, note the ECB balance sheet continues to shrink:

Source: Bloomberg

Monday, April 1, 2013

Using Mortgage REITs to Time the Market

With things appearing to get a bit dicey for the market, I’m becoming increasingly concerned. That said I recently reviewed one of my favorite indicators for assessing the risk-on/risk-off mode of the market. 

Mortgage REITs are double-digit dividend yielding equities that are generally regarded as risk-off investments. Given their fat dividend yield, these REITs tend to hold up quite well when the market undergoes corrections or rough times. 

For this exercise I like to focus on NLY, one of the largest mortgage REIT stocks. When the relative price chart for NLY is beginning to look bullish and turning up, 1) it’s time to buy the mortgage REITs, but more so 2) the stock market is likely headed for a correction (risk-off). And vice-versa, when relative price chart of NLY is looking bearish, sell the mortgage REITs and get long the market (risk-on).

Here is the weekly NLY relative price chart:

Source: Stockcharts.com

I use the MACD for buy & sell signals. A buy signal was recently triggered on February 21.

Here are results for the last six MACD signals (using total return):

As already mentioned, two things to notice: 1) SELL signals have NLY underperforming by double-digits, and 2) SELL signals have the S&P 500 performing quite well. Again, SELL signals mean it’s time to get out of NLY (risk-off) and go long the market (risk-on). Granted, it’s a small sample set, but through 2/21/2013 the S&P 500 is up 18% on average for SELL signals and -5.5% for BUY signals.

Since the most recent BUY signal on February 21, NLY has outperformed the S&P 500 by 3.9%.  Although the market is up in that time, we’ll see if this remains the case over the next several days/weeks.