Wednesday, July 31, 2013

Market update: Patience is needed

Since the market bottomed on June 24th, the smaller the cap size, the greater the gain.

It's generally a bullish sign when smaller-cap stocks are outperforming their larger brethren, inferring "risk-on"-type investor behavior. 

However, the market has stalled out over the last five days and during this time smaller-caps have reversed course and underperformed:

Understandably, five days do not make a trend but it's certainly something to keep tabs on. 

On July 17th, when the S&P 500 was at 1675, I wrote that I "expect[ed] another run at new highs," in part due to the "good overbought" condition observed in the hourly chart. The Index did shoot higher, getting very close to 1700 before pulling back to its current 1685 level. 

But much of the extreme "good overbought" hourly momentum has been worked off and the daily chart is exhibiting declining momentum via the stochastic along with an imminent MACD sell signal.

I am also growing concerned about a few bearish divergences starting to develop, such as the percentage of NYSE stocks above their 200-day moving average.

As I show with red lines in the chart, this breadth indicator (lower inset) can very often give timely warnings before key market turning points (S&P 500, upper inset). Currently the percentage of NYSE stocks above their 200-day MA is 70%, which is well below its prior high of 80+% in May. Meanwhile, the stock market is higher since that time, creating a bearish divergence.

Other indicators I follow are not yet flashing negative signs, remaining either bullish or neutral, so I'm concerned but not alarmed. As I've mentioned in prior posts, the YTD rally has been characterized by very strong momentum, translating into very forceful thrust. Under such circumstances, the market does not typically die quickly or collapse overnight, but rather any weakness is often followed by rallies, creating a more protracted and volatile topping phase. That of course assumes we are in fact topping, which I would argue is too early to tell, but the larger point is given the degree of built-up momentum in this extended move, patience is afforded and prudent at this juncture. There's no need to panic. 

As always, I'll keep a close eye on my many indicators and report back if anything were to change. Stay tuned.
(The source for all charts above:

Monday, July 29, 2013

Apple remains a stock to avoid

For the last several months, Apple (AAPL) has been a stock to avoid, and in my opinion continues to be a short-term trading vehicle despite this recent gap higher.

That's not to say AAPL is bereft of any encouraging signs.


The daily chart above exhibits what appears to be a bottoming process occurring for AAPL. Since the gap down on high volume in January, the stock has rallied and retraced within an approximate 400-450 price range. If anything, a triangle is beginning to form starting from the low established in April. Note also the volume spikes with recent held lows, further indicative of bottoming action. Another encouraging sign is the positive divergence developing with the MACD, as it's been gradually carving out an uptrend as price has been either trending down or sideways.

However, too many negative signs remain in place to keep the weight-of-the-evidence tilting bearish. For one, the chart above shows that a bearish Death Cross occurred in December (orange circle); to reverse this bearish signal requires a bullish Golden Cross (50-day MA rising up through 200-day MA), which is still quite a ways off from occurring.

The daily chart below shows a relative chart of AAPL (vs. SPY), depicting a more bearish picture.


Despite the fact absolute price (black line) is showing some life, rallying to the levels of early last month, relative price (red line) is barely moving and remains well below its higher early-June levels -- a bearish divergence. The upper inset shows the RSI for the relative price and it continues to more or less oscillate within a lower-bounded 55-20 range. For AAPL to begin to truly exhibit bullish behavior, relative price RSI will need to meaningfully break out of this range and surpass 70. 

Below is the weekly relative chart.


Relative price broke down through a long-term rising trend line late last year, and more recently has succeeded in breaching a precipitously declining trend line. What concerns me most about the above chart is the stochastic (lower inset). As I've discussed before, not all overbought (oversold) conditions are the same. When momentum is extremely positive and remains so for an extended period of time ("good overbought"), price tends to kick into another gear and further ascend. Such conditions represent thrust and frequently have significant carry-through effects. Note in 2009, the weekly stochastic remained very elevated (80+) for much of the year, initiating what would become a multi-year relative performance run. On the flip side, the stochastic had been severely repressed from late last year into much of this year ("bad oversold"). Although the stochastic has since risen above 20 and has held above there, such downward thrust typically does not dissipate easily, meaning relative price is likely to remain under pressure in the near future.

Finally, I wanted to show money flow for AAPL.

Source: Bloomberg

In general, money flow (red line) has been negative for AAPL all year, inferring underlying distribution of the stock. Even as price has risen this month, money flow has not confirmed, remaining negative. 

A longer-term chart shows that it's been prudent to have money flow confirm price action.

Source: Bloomberg

All in all, AAPL is exhibiting some encouraging signs as it looks to put in a bottom. However, enough bearish indications exist to keep me uninvolved, for now.

Friday, July 26, 2013

A Few Words on Sentiment (and FIPIA?)

I keep tabs on sentiment figures, but I don't let them overly steer or influence my actions. While I absolutely respect the contrary warnings conveyed, sentiment can remain excessively bullish (bearish) during long protracted rallies (declines) and therefore I've never found such figures to be especially precise in their timeliness. As I said, they're definitely worth tracking and keeping in mind but should be considered only as another input amongst many in your process. I maintain a weight-of-the-evidence approach tends to work best in all environments, achieving the most consistent above-average results over time.

It's worth stating again, as with markets, sentiment can remain at very high (bullish) or low (bearish) levels for longer than you think. That said it is at historic extremes that sentiment figures become most timely, often indicating an asset or market is completely washed out on the downside or at a climatic peak to the upside. But even in these cases, it pays to use other tools and methods to assess trend, momentum and a likely turning point. More accurate calls will be the end result.

A case and point: gold (and gold miner equities for that matter). In January and February, sentiment for gold hit an extreme level of bearishness -- when the price of gold was still well above $1600. To have acted simply on the contrary call of sentiment would have been a costly mistake.

Another fact to consider is these days there are several representations of sentiment, which can often times portray differing pictures. There are surveys, polls, put/call ratios, fund manager cash levels, just to name a few. And with surveys and polls, results can vary depending on who is being asked for their opinion: traders, portfolio managers, individual investors, etc. Again, a weight-of-the-evidence approach is advisable, look to arrive at an overall consensus.

In a more macro sense given today's environment, I fully appreciate that with the market's historic YTD rally, more than a few sentiment measures have registered frothy bullish extremes, suggesting a top is nigh. Perhaps. I wrote on July 17th that for several reasons I felt the S&P 500 would successfully achieve a new high, which it did, but now what? (More to come on this subject early next week). But with regards to sentiment in general, I'm not sure I sense the elevated euphoria that at least some sentiment figures suggest is the current state of the collective investor psyche. I know market tops are established when least expected (i.e. when all is good), but apart from the stock market itself doing quite nicely, in my opinion stock prices continue to climb a wall of worry -- which is a bullish backdrop. Granted, investor concern was greater when the market was lower many months ago, but I wouldn't say that we have flipped the switch to euphoria or giddy optimism. In fact, not long ago the market was very jittery due to talk of the Fed tapering QE activity. I would argue that thanks to the Fed and our ever-recovering economy, nervousness remains the only constant for this market, which to reiterate is a bullish component for any market. If the economy was cruising along, unemployment was at or below 6.5% and the Fed was no longer needed as a necessary crutch, that is when I would become much more concerned. But we know this is far from the present reality.

So in the meantime, for lack of a better term, we have FIPIA: Fed-Induced Perma-Investor Anxiety. Yes, sentiment will rise and fall as the market rises and then retreats (nothing ascends forever), but as for a deeper and more ingrained reading on longer-term investor psychology, I believe the lasting uncertainties of our economy along with the incessant guessing games involving the Fed will continue to foster nervousness in varying degrees. And as long as that's the case, the proverbial wall of worry will remain in place for the market to presumably climb.

Wednesday, July 24, 2013

Smart(er) money betting on copper

The terrific Asbury Research recently featured how commercial hedgers have made a huge bet on copper. Although some may disagree, it's generally accepted that in the world of futures, commercial hedgers tend to be the smarter money. Granted, much of their smartness or ability to be more right than wrong comes from simply being on the other side of trades that tend to be more wrong than right. In the zero-sum game of the futures market, commercial hedgers are frequently on the opposing side of an increasingly popular trade, and as we know being contrarian is very often a winning strategy.

I would also emphasize that the timeliness of commercial hedgers greatly improves at extremes, meaning when their position size approaches levels that have rarely been attained over time. And if you read the Asbury Research piece (strongly urged), it's quite evident this is one of those times, with commercial hedgers at "their largest collective net long position for copper in the 30-year history of the contract."

The weekly futures chart of copper further illustrates the ups and downs of contract flow.

Source: Finviz

Note the red circles signifying levels where commercial hedgers established very large net long exposures -- and more often than not these levels have coincided with bottoms for copper. And vice versa, at levels where commercial hedgers have been very net short, as was the case at the start of 2011, copper has tended to be at a peak. I would also point out that the round-number of $3.00 appears to be a meaningful level of longer-term price support.

Is there a way to play copper without having to open a futures account? I would say yes and no. Yes, there is an ETF, the iPath Dow Jones UBS Copper Subindex Total Return ETN (ticker: JJC), which looks to track the price of copper. However, as with many of these ETFs that use futures contracts to replicate or track a given commodity, there does exist a "roll" problem. As the futures contracts age and expire, the ETF must roll its assets into new contracts and in so doing, the ETF price may gradually diverge from the price of the commodity due to contango. This effect is not a big problem in the short-term, but over many months the shortfall can become quite pronounced.

Notice in the chart above how over time the ETF (JJC, red line) gradually falls short of the commodity (copper, black line). Again, this is not a major issue for those who wish to trade the JJC within a shorter-term horizon. However, it seems clear that such ETFs are not for buy-and-hold purposes.

As for my opinion on copper, as much as I fully respect what is being inferred by the outsized net long position by commercial hedgers, I prefer to wait for the price of copper to exhibit a more bullish behavior. Currently copper appears to be holding at the $3 support level, but as shown in the weekly futures chart above, my inclination is to wait for price to successfully break through the triangle formation at about $3.50. Otherwise copper could continue to base or consolidate sideways, effectively tying up assets in dead money. As always, stay tuned!

Friday, July 19, 2013

Gold at (another) key price point

On April 17th, I wrote about how gold was broken, and on June 20th I wrote about how gold was broken, again. On June 20th, gold plunged from 1350 to near 1280. It continued to erode to about a 1200 low and has since climbed back to the 1280-1300 range. 

What now?


The daily chart above shows gold's descent since late last year. A downward trendline had been in place heading into April and with gold's abrupt breakdown in that month, a steeper descending trendline has since been established. This recent rally back towards 1300 is about to meet that trendline, serving as resistance. 

The daily chart of gold below includes the 50-day exponential moving average (EMA) along with the RSI:


During bear markets or protracted price declines, it's common for momentum to remain subdued and range-bound. This can be observed above in the RSI, as the indicator has oscillated within its lower bound (0-50). The upper range of 50 serves as resistance (represented in the chart with a green line), keeping any rallies feeble and confined. The trend will remain down until this 50 level for RSI is breached meaningfully to the upside, getting to the 70+ level, inferring renewed thrust as buyers have overtaken control from sellers. However, RSI has instead been traversing sideways below 50, not yet exhibiting any signs of heading higher -- bearish. Note also the 50-day EMA has served as effective resistance, currently residing at 1337, and note the round-number of 1300 also is a potential level of resistance (red line).

I thought I'd also show gold versus expected inflation.

Source: Bloomberg

I've discussed here before the fairly tight relationship between the price of gold and expected inflation. The chart above shows expected inflation (5yr5yr breakeven rate) in the upper inset and gold price in the lower inset. It's my belief that the Fed ("Helicopter Ben") has tried to keep expected inflation close to the 3% level, but as shown in the upper inset the 5yr5yr rate gave way earlier this year, and not surprisingly so too did gold. Expected inflation has more recently risen to the 2.5% level, but note it's meeting up against its 50-day MA (resistance) and also note the 200-day MA has turned negative (bearish). I would also point out that gold in the lower inset had a Death Cross occur earlier this year (50-day MA crossing down through 200-day MA), this after many years of the 50-day MA remaining above the 200-day MA (bullish). Until the 50-day MA gets back above the 200-day MA, this condition remains bearish.

Bottom line: the picture continues to look ugly for gold and I would expect price to head lower at this key juncture. Stay tuned.

Wednesday, July 17, 2013

Some bullish signs....

I'm always looking for inter-market, inter-sector, inter-whatever relationships to help shed light on where we are and where we might be going. Very often this type of analysis reveals indications of investor risk appetite (risk-on vs. risk-off mode), whether it's on the rise, plateauing or waning. By picking up on clues about underlying sentiment, one can frequently gain a bit of a jump on timely inflection points or if the market is likely to continue in the current direction.

Viewing the hourly S&P 500 Index chart, the market has steadily climbed over the last several days, successfully getting through resistance levels along the way.


As shown above, recently the Index was able to breach resistance at about 1680, pulling back yesterday. Granted, it has yet to be considered what I would call a significant breakout since price hasn't risen above resistance with room to spare, but nonetheless a breakout it is. Or more specifically a breakout with a pullback, with a price retreat being a very common occurrence post-breakout and such a retrace can be considered healthy, re-energizing momentum as evidenced by the now oversold stochastic (red circle in chart above). Also note the blue circles in chart highlighting a bullish inverse head-and-shoulders formation.

The question now is will the market (Index) continue to ascend or will at this current level a double-top begin to form? Based on what I'm seeing (already mentioned a few above), the former is more likely.

It's always good to check how the Russell 2000 Index is performing versus a larger index like the S&P 500.


The hourly chart above shows the S&P 500 recently making a new high, yet the Russell 2000 had successfully made a new high several days ago -- a bullish confirmation. The smaller-cap Russell 2000 Index is a much flatter representation of the market than the S&P 500 and in effect serves as more of an A/D line. Also, small-cap stocks have a higher sensitivity to the economy compared to their larger-cap brethren and give a better indication of economic conditions.

I've discussed here many times the implication of inter-sector relative returns. The chart below shows the XLY (Consumer Discretionary) versus the XLU (Utilities).


When the XLY:XLU line (lower inset) is rising, it means the XLY is outperforming the XLU, and vice versa. XLY outperforming XLU is generally indication of risk-on mode, bullish for the market, and a declining relative return line with XLU outperforming XLY generally infers risk-off mode is taking hold, bearish for the market. As I say many times, no indicator is perfect (which is why one needs to follow many), but I show periods (blue lines) where the XLY:XLU line has diverged from the market (S&P 500, upper inset), giving ample warning for turning points. More recently, the XLY:XLU line made a new high in May and has continued to rise -- a bullish confirmation.

Another near-term bullish occurrence has been momentum. I've discussed here once before the concept of "good overbought" and "bad oversold," which in a nutshell refers to extreme, longer-duration momentum. When momentum is extreme and has been consistently so over a period of time, it suggests the trend will continue in that direction, even after a correction. We observed good or bullish overbought momentum for the market (S&P 500) in May and here we are at a new high.

Note the S&P 500 hourly chart below:


It shows the July rally with consistently extreme-positive momentum, with the stochastic and RSI indicators highly elevated over several days (red boxes). In my experience, such powerful momentum represents significant thrust which tends to have a carry-over effect. The S&P 500 has retreated from its breakout, but given the observed "good overbought" condition I would expect another run at new highs to follow.

Speaking of momentum and thrust, I would finally mention that the venerable Ned Davis of Ned Davis Research (NDR) released a report on Monday discussing this subject. According to NDR, the S&P 500 registered a BUY thrust signal in early January (1/4/13 to be exact). Since 1970, the S&P 500 has registered 16 BUY thrust signals (not counting the current one) and in every instance the market was higher a year (253 trading days) later. We'll wait and see if the record improves to 17 out of 17....

It's nice to see the market stands a good chance of finishing the year higher, but my focus above is more near-term, covering the next few weeks. I have found the best one can do in hopes of making fairly accurate market calls is to function within a rolling 3-4 week window, making adjustments as needed. Within such a time frame, things continue to look bullish to me.

Thursday, July 11, 2013

Price discounts the news

Over the years, I've developed and used an investment process that effectively combines fundamental and quantitative research with technical analysis. It can be a tricky endeavor but in my experience, when properly bringing together the three disciplines, one is able to leverage their power synergistically and achieve a 1+1+1=5 outcome. Very powerful.

However, of the three disciplines, it never fails that I get the most push back and skeptical questions when it comes to my use of technical analysis (TA). In just the last five years, thanks in large part to hedge funds, TA has made huge strides with regards to its acceptance as an alpha generator and reducer of risk. Yet naysayers and cynics remain, in droves. This despite an increasing number of academic studies showing otherwise, that TA is indeed a beneficial additive to one's investment process.

I used to engage in such debates, going back and forth with professional friends and colleagues about the merit of TA, but I've learned to temper that impulse. That's not to say I don't freely give my reasons for employing TA in my process, but rather I only spend so much time on the discussion before moving on. In this business, some are open to listening and learning new ideas that could possibly help in their efforts to beat benchmarks and put up numbers, whereas others are much more set in their ways and view the investing world more narrowly, as they choose to see it. And that's completely fine with me! Different strokes for different folks, that's what makes markets, and all those other cliches and sayings....

On several occasions, I've written here about how price tends to lead the news. Unlike TA in general, I believe this tendency is more commonly accepted by investment folks, with any debate likely coming down to the length of lead time. Do prices discount the news by 6-9 months -- a frequently cited period -- or is it just days, hours, or minutes? I'm not about to settle that issue, but I will show some examples.

One of my favorites is the Egyptian ETF (EGPT) in 2011.

Source: Bloomberg

EGPT had been in a very nice uptrend heading into 2011. But then about mid-January the ETF gapped down, breaking its ascending trend line. Several days later, riots erupted in Egypt and the ETF gapped down again. Needless to say, price seemingly reacted before the news, giving investors 5-6 days to assess what to do before the actual riots and unrest occurred. The first gap-down was a meaningful -8% decline, but the second gap-down was much more painful at about -15%. Also, note the first gap-down was on slightly-elevated volume, inferring some EGPT holders appeared to know something was askew and wanted out. Compare this to the volume spike during the actual event, when everyone then knew the news and rushed for the exits. Price can often be very telling, and this is just one of many examples I've observed over time.

Another example is well-documented in academic circles and it involves price action around earnings surprises.

Source: Aswath Damodaran

The chart above shows price returns above or below benchmark (excess returns) for eventual earnings surprises. I drew a vertical red line on the day of the earnings announcement (Day 0). The key takeaway is price tends to do a very good job at discounting earnings surprises. It's not perfect but the distribution of returns in the above chart is fairly monotonic, meaning the excess returns roughly align with their respective earnings surprise deciles. The most positive earnings surprise decile had the largest positive pre-announcement excess return and the most negative earnings surprise decile had the largest negative pre-announcement excess return, with the other deciles more or less falling in line. In other words, price doesn't just discount news, it also does a pretty good job at getting the extent or degree of discounting correct. 

A more obvious conclusion to be drawn from the chart is much less alpha is to be gained after the earnings announcement than before. Referring to just the most positive decile, an almost 8% excess return is produced prior to the earnings announcement with about 2% of excess return resulting after the fact. Granted, 2% alpha in about 50-60 days is nothing to dismiss, no argument there, but my larger point is by far the bulk of excess returns are attained pre-announcement of the news. 

Yes, wouldn't it be nice if we could see the future and thus capture these massive pre-announcement excess return spreads. Sure, but as I've been discussing, apart from owning a crystal ball, price may be the next best thing when it comes to offering some hints about what lies ahead.

Tuesday, July 9, 2013

Crude oil catches up with energy equities

At the end of May, I wrote about how crude oil had been lagging the performance of energy equities and in my experience, equities tended to lead their associated commodity. That said I wrote then, "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."

The updated daily chart below shows that crude oil (WTI, red line) has indeed caught up with equities (RYE) over the last several weeks. 

Energy stocks, as represented by the Guggenheim S&P 500 Equal-Weight Energy ETF (RYE, black line), remain in a nice uptrend, but how does crude oil look technically?

I've been bullish on crude for some time and it was one of my first entries for this blog. The daily chart continues to look very bullish: 

 Source: Finviz

A few weeks ago, crude made an attempt at breaking out of the ascending triangle formation only to pullback (very common occurrence). After reloading, it then made a dramatic breakout this month, driven by events in Egypt.

Early last month, I wrote about the massive triangle formation developing in crude oil's weekly chart. With this recent run-up in price, it appears a breakout of this triangle has successfully occurred:

Source: Finviz

I would expect a price retreat back to the $100 level and some consolidation before further price gains unfold. Of course, much depends on geopolitical circumstances, but I would remind the chart for crude oil has looked bullish for many months, not just of late. And this despite the steady flow of news stories reporting how we're awash in cheap oil (and gas) thanks to new methods of drilling and extraction (read: fracking). Peak oil is dead we're told. That may be true, but judging from crude oil's chart it's likely very premature to make such definitive statements.

Monday, July 8, 2013

Market update: S&P 500 at key juncture

On June 27th, I wrote about the S&P 500 Index exhibiting a bullish inverse head-and-shoulders formation in the short-term, but that "the 1620-1625 range poses as significant resistance and it will be interesting to see if the [S&P 500] Index can successfully break through this price area (and mind you, not just poke through, but get well beyond 1625)."

Judging for the S&P 500 hourly chart, it appears as if the Index has successfully broken through that 1620-1625 resistance area.

It's also interesting (and encouraging) to see price successfully breach the neckline at 1600 and then undergo the very-common pullback to the neckline, traverse sideways for a few days and then gap up. Even the recent gap up shows a very-common pullback to "close the gap" at around 1610 before resuming its ascent.

The daily chart offers another perspective, showing the S&P 500 has rallied about 50 points off its low and now faces an inflection point.

I last discussed the 50-day MA as a key support/resistance point for the Index and not that while price did close at 1632, higher than 1626 for the 50-day MA, as depicted in the chart, the most recent candle is just about dead-on with this key MA. I would argue the S&P 500 needs to get clearly above the 50-day MA and not just poke through it. Also, note the developing declining trend line (in red) which traces just below 1640; it further serves as overhead resistance. Lastly, I would also point out that volume is exhibiting a bullish pattern in that it spiked with the late June sell-off, something that frequently occurs with a blow-off or capitulation low.

At this point in the summer, it's worth taking a look at the market's seasonality:

Source: Bloomberg

The chart above shows the average price gains/losses through the year for the S&P 500. The blue line is the 5-year average, the red line is the 10-year average and the green line is the 30-year average. The brown line is the S&P 500 performance YTD, which has been quite impressive to say the least. Directionally the market has more or less followed the historic seasonal pattern, rising until the end of April and then declining through June. In general, the seasonal tendency for the market at this point in the year is for flat-to-rising prices into mid-September followed by declines through October.

So again, the S&P 500 appears to be at a key juncture, needing to get meaningfully through the 50-day MA and the declining trend line. But as the seasonal chart suggests, the next several weeks do not inherently pose any significant headwinds that would serve to short-circuit the market's attempt at new highs. However, come September it becomes quite a different story....

Tuesday, July 2, 2013

Gone fishing

Taking a break, will return next Monday. Have a wonderful July 4th!