Energy: Stocks vs. Commodity

I am always interested in tracking equities in a sector that have an associated underlying commodity. It can be revealing to observe emerging divergences.

The chart below shows light sweet crude oil (WTI) versus RYE, the Guggenheim S&P 500 Equal-Weight Energy ETF:

Source: Stockcharts.com

I prefer to use the equal-weight ETF as it allows for a less XOM-dominated depiction. As you can see, energy equities as per RYE (black line) are approaching a new high whereas crude oil (red line) remains quite subdued at around $94, creating a fairly significant divergence.

Over the years, I've often debated which tends to lead, equities or the underlying commodity. Although clearly they move more or less in tandem, I've come to conclude that equities tend to lead the commodity. Note in the chart above equities moved ahead of WTI in early 2007, the peak in 2008 and again in late 2010. 

Assuming this tendency holds up, I would expect that with the RYE flirting with new highs, the multi-month divergence between energy equities and crude oil will be closed via the commodity (WTI) rallying from here.

Market Update: Key Short-term Inflection Point

For as many years (20+) as I've been studying charts, I'm always still amazed when I see price get to a moving average or trend line and pause or react to that level as if it was a hot wire, seemingly confirming that millions of investors are all keenly aware of the same thing.

Source: Finviz.com

I wrote yesterday how the market (S&P 500) was carving out a triangle pattern on the hourly chart. Viewing the updated chart above, one day later that triangle pattern is even more clearly defined, as yesterday the index got exactly to the upper portion of the triangle (1660) only to then roll over. The S&P 500 is currently holding at the lower portion of the triangle, fast approaching the triangle's apex.

In this shorter-term time frame, we are definitely at a key inflection point with the eventual breakout from the triangle formation likely dictating the market's future direction. Stay tuned!

Market Update

Judging from the hourly S&P 500 futures chart, the market looks to be in or entering corrective mode.

Source: Finviz.com

After hitting a new high of about 1680 on May 22nd, the S&P 500 made a lower high on May 28th and has been carving out what appears to be a symmetrical triangle formation. Granted the chart is hourly, meaning very short-term, but the direction of the eventual breakout from this triangle will likely dictate the near-term trend of the market. 

Stepping much further back, I thought I'd also show a long-term sentiment chart from DecisionPoint's blog:

The chart's lower inset shows the Rydex Asset Ratio, which is derived by dividing money market and bear fund assets by bull and sector fund assets. The higher the Ratio, the more bullish and optimistic the sentiment. Note the reading hasn't been this high since the market peak of 2000. Yikes.

Time to get cautious on TSLA

When I first wrote about Tesla (TSLA) on April 4th, it was breaking out above $40.

Source: Stockcharts.com

Wow, you talk about a classic chart. After the gap-up breakout to $44 on high volume, price retreated back to the $40 level on receding volume before resuming its ascent. It's since been off to the races.

Earlier this month, the stock gapped up further on very high volume, but this time notably taking place on the heels of an already-impressive 35% move. And more recently shares have again gapped up on high volume. High-volume price gaps occurring well within a strong advance often suggest a near-term top is imminent. Note the parabolic chart pattern, the exponential rise in a fairly short time frame (150% rise in less than two months!). The recent buying looks to be climatic and emotion-driven.

This is not to say the stock is doomed or will fall off a cliff any time soon. In fact, such stellar performers typically do not die sudden deaths, but if/when they do correct it's more of a protracted, eventual decline. One reason for this is when high-flyers crack for the first time, many investors believe it's finally their time to get in, that they've been given a golden opportunity to enter before the next big move. Such buying tends to support the shares at the initial break, so again my point is these headline-grabbing stocks do not typically reverse and give up all their gains in a heartbeat. It's also too soon to tell if TSLA will even crack or meaningfully correct at this point.

Given what I've written, the stock is obviously not at a good entry point. However, for those already holding the stock, the prudent step at this point would be to establish a trailing stop-loss threshold, allowing price to dictate an exit. In the chart above, I included a few shorter-term moving averages. It appears as if the 10-day MA would offer the most conservative stop-loss limit at approximately $94, followed by the 15- and 20-day moving averages. 

Needless to say, even if you do get stopped out, one can always reassess and re-enter the stock at a later date. And who knows, maybe by then the company will have positive annual earnings....

U.S. Dollar Remains Bullish

As I've written in the past, the U.S. dollar (USD) continues to look bullish.

Source: Finviz.com

As shown in the daily chart above, the USD is exhibiting not one but two classic bullish formations. The first (in red) is a cup-and-handle formation with a recent breakout. The second (blue circles) is a double-bottom formation with the "W" pattern occurring at the 79 level.

Stepping back, the weekly chart also depicts a bullish picture.

Source: Finviz.com

Over the last several years, a triangle formation has been taking shape, and note that since 2011 a more acute triangle formation has developed. The breakout observed this year (red circle) is needless to say a bullish occurrence and I would expect the USD to approach its prior high of 88, established back in 2008, 2009 and 2010.

Assuming the USD remains in an uptrend, it does not bode well for commodities in general.

Source: Stockcharts.com

The weekly chart above illustrates quite clearly the inverse relationship that tends to hold over time between the USD and commodities (as represented by the CCI (Reuters-CRB Index)). The rolling 50-week correlation is consistently negative, meaning longer-term the bear market for commodities that appears to have started in 2011 is not likely to end anytime soon.

Is the market finally correcting? (Stocks going down -- huh??)

On the heels of Japan's stock market plunge, it appears as if the U.S. market might be hinting at a correction of its own.

Source: Finviz.com

The hourly futures chart above shows the S&P 500 down about 3% from its Wednesday peak. Granted, nothing like the near 8% plunge suffered by the Nikkei, but nonetheless the market is clearly showing near-term signs of what could develop into a corrective phase. As with the Nikkei hourly chart I discussed yesterday, note the S&P's false breakout on Wednesday followed by an abrupt reversal, with the index collapsing about 50 points before attempting to rally overnight. But as often happens, and seen in the Nikkei chart, such a recovery rally following a swift decline is frequently anemic, attaining a lower high before rolling over. Next level of support appears to be the 1615-1620 area, and after that the 1590-1600 range.

To risk sounding like a broken record (oops, CD?), many lingering divergences remain in place, including the relative performance of smaller-caps (IWM) versus larger-caps (SPY).

Source: Stockcharts.com

In the chart above, the upper inset shows the relative return of the IWM vs. SPY (red line), with the S&P 500 depicted in the background (black line). Note the declining orange line pointing out the bearish divergence as the relative performance of IWM vs. SPY has not surpassed its prior high registered in March. This divergence also occurred late last year (shown in chart) and has occurred numerous time over the years, more often than not giving a heads-up before market weakness ensues. Also note for the red relative return line both the RSI and MACD exhibiting bearish divergences of their own, with lower highs put in as the S&P 500 has climbed higher.

And referring back to the Nikkei once again, it would be worthwhile keeping an eye on this index.

Source: Stockcharts.com

As shown in the chart above, for several months now the Nikkei and S&P 500 have been highly correlated, tracking together quite closely. If the Japanese market is beginning to show indications of meaningful weakness, could this be a foreboding sign for the U.S. market?

The Nikkei 225 Cratered Overnight

As I write this the Nikkei 225 index is down about 8%, as per overnight futures.

Source: Finviz.com

You can see in the hourly chart above that after rising about 1500 points in just the last two weeks, the index lifted off yesterday in what looked to be a parabolic surge higher. But as often happens, an extreme and abrupt continuation move like that runs out of incremental buyers (demand) and the ascent stalls and even cracks. The chart above shows such a crack, also showing the very-common anemic run at a new high that follows but fails, making a lower high. And then poof -- look out below. With the Nikkei currently residing at 14,665, all gains achieved since May 10th have been wiped out.

The daily chart of the Nikkei offers more perspective.

Source: Finviz.com

It's textbook stuff, the breakout in November followed by a brief pause, then a steady climb to new heights. The index kicked into another gear in April and soared towards the 16,000 level, getting a bit parabolic as it created a sizable gap from the rising trend line. All in all, and as I've been expecting with the U.S. market, such a correction is not surprising.

I would say at this point the next level of support for the Nikkei is the 1350-1400 area, which is where price based before lifting off earlier this month and is also where the trend line currently resides. It's too early to definitively state whether or not this is the "final" parabolic blow-off top. And I would also add that given the country's fairly recent initiation of Abenomics, added volatility and extreme moves in the index could become the norm for the foreseeable future.

More concerning charts....

I continue to survey the market landscape, trying to get a better sense of just how much further this rally has to go. I've written here before that I expected a correction last month, however I obviously underestimated the magnitude of internal strength in this recent move higher, despite the many developing bearish divergences. Until a few weeks ago, I maintained a bullish outlook on the market, a stance dating back to last September. During that period, I fully detected and appreciated the impressive underlying thrust that would propel the market to new highs. But again, it's only been during these last several weeks that I've increasingly observed disturbing negative divergences, many of which I've discussed on this blog.

I will emphasize that it's very important to avoid getting seduced into a particular mindset at any point in time. Becoming "married" to a viewpoint and constantly seeking out confirmation of this view is a behavioral finance cardinal sin. I am always trying to poke holes in my current take on things, ever fearful that I might have missed something. That said I continue to uncover items that just serve to foster more concern.

For one, the market's advance as per the S&P 500 appears stretched historically:

Source: Stockcharts.com

The chart above shows the 120-day rate-of-change (ROC) in the upper inset and the S&P 500 in the lower inset. The more/less 6-month ROC is just shy of 20%, a level that in the past has identified peaks in the market.

In addition, I continue to find nagging bearish divergences.

Source: Stockcharts.com

The chart above shows the relative performance of the PowerShares S&P 500 High Beta Portfolio vs. the Power Shares S&P 500 Low Volatility Portfolio (represented by the red line), with the S&P 500 appearing behind it (black line). Admittedly, the history is short given the PowerShare funds have not been in existence all that long, but you can see that when the S&P 500 rises, higher beta stocks tend to outperform lower beta stocks as represented by the rising red line. Over the last few weeks, we have indeed seen this red line surge with the S&P 500's advance, however also note that this red line has yet to surpass its prior high achieved in February. Until the red line is able to surpass that prior high, it remains categorized as a negative divergence. You'll see I flagged such negative divergences in the past with orange lines and they do often give a decent heads-up before overall market weakness takes hold.

Finally, I found the following chart to be very interesting, and possibly alarming.

Source: Stockcharts.com

The weekly chart in the middle shows the relative performance of the TSX Venture Index versus the TSX Composite (represented by the red line), with the S&P 500 overlaid in the background (black line). The TSX Venture Index is comprised of 500 small- and micro-cap Canadian stocks, compared to Canada's TSX Composite which is primarily a large-cap index. The Canadian equity market in general is heavily natural resource-oriented as the country is dominated by energy and mining companies. As a result, Canada's economic fate is very much dependent on and sensitive to the global economy.

Over time, the return of the TSX Venture/TSX Composite ratio has tended to move in tandem with the S&P 500. If anything, the red line has frequently led moves in the S&P 500 with it rising well ahead of the S&P 500 low in late 2002, peaking in 2006 before the S&P 500 peak a year later, and bottoming in late 2008 a few months before the S&P 500 low in March 2009. And yet since the start of 2012, there has developed a massive divergence between the red and black lines. Note also that in the past, when the TSI indicator and Stochastic Oscillator have registered oversold levels -- as is the case now -- the S&P 500 has typically been at a significant low. That does not appear to be the case this time around.

I don't wish to overstate the relationship between the TSX Venture/TSX Composite and the S&P 500 as I'm certainly aware of what has occurred with smaller-cap mining stocks, no doubt severely depressing the relative performance of the TSX Venture Index. However, it is a relationship that has broken down completely over the last year or so and I felt it was worth mentioning, do with it what you will. 

As I've strongly suggested of late, I remain wary and cautious about the market's recent leg higher.

Gold is following the script

Two weeks ago, I wrote, "Gold has retraced a bit more than 50% of its recent decline. Typically we should see a retest of the prior low, with gold price retreating to the 1350-1400 level."

At $1367, gold is now just about smack-dab in the middle of that 1350-1400 range.

 Source: Finviz.com

Gold thus far has more or less followed the script when it comes to what often happens after a fairly massive and abrupt technical breakdown. Price typically rallies off the climatic low, retracing about 50% of the decline ("filling the gap"), but then rolls over and retreats back towards the prior low (a retest). 

The price of gold should hold above the prior low level of approximately 1350 for the chart to remain constructive. It should build a base within this 1350-1400 range before looking to resume its ascent. However, if gold breaches the 1350 level and hits new lows, all bets are off as the next level off support appears to be around 1200. 

Two things I'd like to point out in gold's weekly chart:

Source: Stockcharts.com

 

The first is notice the huge volume spikes. Often such extreme levels of volume can indicate climatic turning points, either to the upside or downside -- "blow-off" tops or bottoms, as they're often called. There is what appears to be a climatic, high-volume top in 2011, and more recently this year what appears to be a climatic, high-volume low. As discussed, it has yet to be determined if this low will hold, but nonetheless for now it does have much of the markings of a significant low.

The other thing I'd point out in the chart is the many hammer candlestick patterns (in green boxes). When these occur after price declines, they very often identify the likelihood of a trend reversal, a bullish indication. Note in the chart when such hammers have appeared after price retreats, more often than not the trend has reversed and a rally -- albeit widely varying in duration -- has ensued.

Again, the jury is still out on what gold will do from here, but it's clear that right now the metal is at a key juncture.

Divergences: Stock Market Advance Not Being Confirmed

As I've mentioned here before, I expected the S&P 500 to undergo more of a meaningful correction about 80 points ago -- obviously, I've been incorrect about a correction. 

It's not unusual for me to be early (vs. late) as I do typically err on the side of caution when $$$ are involved, and I prefer to be prudent rather than gutsy. That said I'm always closely tracking the charts/indicators I've grown to value and trust over time as I am vigilant about not committing the behavioral sin of getting overly-attached to an investment stance. Pay heed to your process, stay disciplined, but also remain flexible and always look for reasons why you could be wrong this time. It's a tricky balance (and why this business ain't easy).

After reviewing several such charts and indicators, I do still see some lasting divergences that are concerning, one being small-cap performance versus larger-caps.

 Source: Stockcharts.com

The chart above shows the relative return of the Russell 2000 Index (IWM) versus the S&P 500 (SPY), plotted with the S&P 500 in the background (green line). Note that despite the new all-time highs in the S&P 500, IWM performance has lagged SPY performance with a red line identifying the bearish divergence. I would also point out that the RSI of the IWM:SPY ratio exhibits a bearish divergence, and that the Aroon Oscillator of the ratio remains repressed -- further non-confirming signs of the market's latest advance.

In addition, below I present two more relative return charts, the first showing high-yield (junk) bonds (HYG) versus T-bonds (TLT) and the second chart showing cyclical stocks ($CYC, Morgan Stanley Cyclical Index) versus staples (XLP). Both have the S&P 500 (green line) in the background.

Source: Stockcharts.com

The HYG:TLT ratio has been heading in the right direction (up), however it needs to surpass its prior high set in March to confirm the S&P 500's new highs. Likewise, in the second chart, the $CYC:XLP ratio has been heading in the right direction but it appears to be rolling over at the key 100-day moving average (I've discussed this indicator in the past). Also, note the developing bearish divergence of the $CYC:XLP ratio as it looks to be making a lower high for the third time -- as it did in February-April of last year. 

I will be the first to state that by definition, divergences lag and they can eventually disappear, i.e. finally confirming a move. However, in my experience, as they develop and remain in place one would be wise not to ignore the potential implications. All in all, I continue to be wary of this recent rally in the market.

Copper/Gold Ratio at Inflection Point

I keep track of the copper/gold ratio as it relates to the market.

Source: Stockcharts.com

In many ways, the copper/gold ratio is just another version of a risk-on/risk-off metric. Copper is very sensitive to economic forces, rising in price as global economies expand and demand for copper increases (risk-on). And we know that gold represents a safe-haven asset (risk-off). Therefore whenever the copper/gold ratio is rising, it's generally bullish for the stock market and vice versa, when falling it's generally bearish for the market.

In the weekly chart above, I use the Vortex Indicator (VI) to identify when the copper/gold ratio is in an uptrend or downtrend. It's not perfect (no indicator is, which is why you need to use many), but in isolation the trend of this ratio does a fairly good job at being on the right side of the market.

The current reading is interesting, with the VI seemingly at an inflection point. I typically wait for a more definitive signal to develop from the VI, one where the green and red lines are more clearly deviating from each other. Right now the lines are too close together to conclude much of anything concerning market direction -- stay tuned.

Is It the Dawning of the Age of America?

If you follow the news, you'd think the U.S. remains in quite a bit of trouble. However, with most broad U.S. equity indices hitting new all-time highs, either investors are idiots (possible, but doubtful) or the headlines are not telling the whole story (more likely).

To some extent, one could argue the success of U.S. stocks is due to a relative game of being the "prettier pig." The U.S. may have a number of serious issues needing resolution, but compared to the problems facing the rest of the world, we're doing just fine. 

Source: Stockcharts.com

The chart above shows the S&P 500 vs. MSCI World ex-USA and as you can see, U.S. stocks have been leading the world for years now, not just in the last several months. 

Going one step further, the case can be made that we're just in the early innings of a U.S. rebirth. The chart below shows the S&P 500/gold ratio, along with gold and the US dollar (USD).

Source: Stockcharts.com

The long-term monthly chart shows that this year the S&P 500/gold ratio finally broke through its downtrend, as represented by the 40-month moving average. The last time this happened was in the early 1990s. The RSI has confirmed this move with it rising well above 50. Note also the fairly high correlation between the S&P 500/gold ratio and the USD, with the USD in a gradual uptrend for a few years now, further indicating U.S. relative strength globally. 

A rising S&P 500/gold ratio infers that investors are increasingly less concerned about, well, anything concerning, meaning they are preferring riskier assets (stocks) over a safe-haven asset like gold. Fear is subsiding and optimism is growing. 

So could this be just the beginnings of a U.S.-led secular bull market? Based on the chart above, it peaked in 2000 and has been downhill ever since -- until recently. What we've observed so far is pretty textbook stuff: a rising market in the face of continued uncertainty and doubts. Such an environment is often the norm during the start of bull markets as prices climb the proverbial wall of worry. Typically what then happens is the market transitions into multiple-expansion mode, with prices rising ever higher on less needed earnings. 

Again, all of this would be in accordance with the playbook and is often what happens with a rising S&P 500/gold ratio (multiple expansion occurring). But we'll see, I always say there are no guarantees and nothing repeats the past exactly. 

I would also remind that the observations and charts above are monthly and longer-term. In the near-term, the stock market appears stretched and I've expected it to correct for a few weeks now -- wrong! It's a testament to the underlying demand for equities, however nothing goes up forever. Better to be prudent than gutsy. Stay tuned.

Tesla Continues to Soar

I wrote about Tesla (TSLA) on April 4th, the blog post was entitled, "Tesla: Earnings, Smernings!" At the time, the stock was up 31% YTD and was hitting a new high. It had bullish cup-with-handle and inverse head-and-shoulders formations, a powerful duo. I wrote then, "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."

Fast-forward to today, with TSLA up almost 20% this morning as the company reported a better-than-expected 1Q. Deliveries and revenues surpassed consensus numbers, but more importantly TSLA reported its first-ever profit, an EPS of $0.12 versus analysts expecting breakeven to a small loss. Needless to say, the huge outstanding short interest is playing a large part in the stock's massive spike today, with a mother-of-all squeezes taking place. Shares have now almost doubled YTD.

Source: Stockcharts.com

Again, TSLA is another example of price leading the eventual news or the eventual reality. Ever since its IPO, Tesla's stock has steadily risen despite reporting red ink during those years. But now it appears that the company will most likely report a fiscal year profit very soon, to the apparent surprise of many.

As is often said, the chart "speaks" and it frequently pays (literally) to try and decipher what it's saying.

The Market Faces Seasonal Headwinds

Over the last few weeks, I know I'm not the first to mention the "Sell in May, Go Away" truism, but figured I'd give my two-cents on the subject anyway.

The following chart shows the S&P 500 for this year compared to its averages over the last 5-, 10- and 30-years:

Source: Bloomberg

As you can see from the averages, in general the stock market does tend to rise from November through April and decline from May through October. And notice so far this year the S&P 500 has performed quite well (red line), to put it lightly.

I would also mention that BofA Merrill Lynch recently published a study on the seasonal tendencies of the market (S&P 500). The study considered average 6-month returns for the S&P 500 going back to 1928. In that time, the average 6-month return was 3.6% with the May-October period returning half that number, just 1.8%. The November-April period returned 5.0%.

All of this said, I emphasize that seasonal tendencies are just that, tendencies. There are never any guarantees or certainties when it comes to investing. However, when such tendencies in the market reoccur frequently and fairly consistently for almost 100 years, perhaps it's something worth keeping in mind. 

Gold Update

Gold has retraced a bit more than 50% of its recent decline.

Source: Bloomberg

Typically we should see a retest of the prior low, with gold price retreating to the 1350-1400 level.

This recent snap-back rally has been fast and furious, with the 8-day rate of change being one of the best in years.

 Source: Bloomberg

However, note that very often such rapid rises are followed by declines (black vertical lines identify a few such past instances). 

Inflation (both actual and expected) has been declining, serving as a headwind for gold and other commodities.

 Source: Bloomberg

It's my belief that the Fed's new inflation target (5yr5yr breakeven rate) is 3%, so this decline year-to-date certainly has not gone unnoticed. And we know the last thing "Helicopter Ben" wants is deflation.

But it's not as if the Fed isn't trying to boost inflation, with QE continuing at a steady clip.

Source: Bloomberg

Is the VIX ready to pop?

Don't look now but the VIX is close to registering a daily TD Sequential 13 bottom, and has already put in a weekly TD Seq 13 bottom:

Source: Bloomberg

Also note the bullish divergence in the MACD.

And yesterday there was big volume in VIX calls, specifically at the May 16 strike with a 40K print at $0.85: