Questions You May Have Asked Yourself

April 22, 2014

Article Will Be Posted Wednesday Morning Answering:

  1. Why have stocks performed in a manner that seems to be out of step with the relatively slow pace of economic expansion?
  2. Why has the economic recovery failed to gain traction, even though the peak of the financial crisis occurred almost six years ago?
  3. Are policymakers inflating bubbles again?
  4. Will the markets revert back to the bust portion of the boom-and-bust cycle we have been in since 1997?

Uncertain Fed Plus Uncertain Economy Equals Uncertain Markets

April 21, 2014

Stocks, Bonds, and Gold Oh My!

After 111 calendar days we have established one thing about the 2014 investment landscape; it is quite a bit different than 2013. The “easy” call heading into 2014 was that bonds were going to fall in price and interest rates were going to rise. Unfortunately, there are no easy calls in the world of investing. From Bloomberg:

The surprising resilience of Treasuries has investors re-calibrating forecasts for higher borrowing costs as lackluster job growth and emerging-market turmoil push yields toward 2014 lows. That’s also made the business of trading bonds, once more predictable for dealers when the Fed was buying trillions of dollars of debt to spur the economy, less profitable as new rules limit the risks they can take with their own money. “You have an uncertain Fed, an uncertain direction of the economy and you’ve got rates moving,” Mark MacQueen, a partner at Sage Advisory Services Ltd., which oversees $10 billion, said by telephone from Austin, Texas. In the past, “calling the direction of the market and what you should be doing in it was a lot easier than it is today, particularly for the dealers.”

On a relative basis, long-term Treasuries (TLT) shot out of the starting gate in 2014. Since then, there has been no clear leadership from bonds or stocks. Early in trading Tuesday, TLT was besting SPY by 0.53%.

Earnings Push Stocks

Markets often pause when investors begin to question stock valuations. At some point corporate earnings must justify higher stock prices. Stocks have been in pause mode for most of 2014. Earnings are trying to push the play button once again. From Bloomberg:

“The few earnings that we’ve had so far have been coming in pretty well,” John Fox, director of research at Fenimore Asset Management in Cobleskill, New York, said in a phone interview. “All the fundamentals still line up that stock prices can go higher. Interest rates are still low, the economy’s getting better. All of that is still a good environment for equities.”

Short-Term Hurdles

This week’s stock market video covers numerous short-term hurdles that, if crossed, may allow stocks to take back the upper hand relative to bonds. Earnings will most likely determine the outcome.

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All That Glitters

Investor confusion has not been limited to the stock and bond markets. With tensions between Russia and Ukraine escalating early in the year, gold (GLD) appeared to be emerging as a market leader. The last month has not been kind to gold investors, putting them in a similar and still unsettled boat with stock and bond investors.

Professional money managers have been net-sellers of the yellow metal in recent weeks. From Bloomberg:

Hedge funds lowered bullish bets on gold for a fourth week, the longest streak this year. The net-long position contracted to the lowest since mid-February as speculators sold bullion on signs of accelerating U.S. economic growth. The investors more than doubled bets on lower prices in the past month while reducing wagers on a rally in six of the past seven weeks. Prices fell 7.6 percent since reaching a six-month high in March after tension in Ukraine eased and U.S. equities rallied to a record.

Investment Implications - Tying To End Yo-Yo Action

Monday’s session followed through on the gains posted in stocks last week, which is a good sign since it may be signaling the end of the market’s yo-yo action. We added to the growth side of our portfolios based on the observable improvement in the market’s tolerance for risk. Some of the concerns that were present at Friday’s close were cleared Monday. We still prefer to see the Dow make a new high above 16,576; it closed Monday at 16,448. We continue to hold a mix of stocks (SPY), bonds (TLT), and cash. While the markets would like to see some resolution in Ukraine, that appears to be little more than wishful thinking at this point. From Reuters:

An agreement reached last week to avert wider conflict in Ukraine was faltering as the new week began, with pro-Moscow separatist gunmen showing no sign of surrendering government buildings they have seized. Washington says it will hold Moscow responsible and impose new economic sanctions if the separatists do not clear out of government buildings they have occupied across swathes of eastern Ukraine over the past two weeks.

Stocks: Concerns Still In Place?

April 18, 2014

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Fed’s Low-Rate Pledge Keeps Wind At Stock Market’s Back

April 17, 2014

Don’t Fight The Fed

The longer you are involved with the financial markets, the more meaningful the expression don’t fight the Fed becomes. In the simplest terms, if the Fed keeps interest rates near zero, it is next to impossible to make money in conservative investments. As long as the low-rate pledge is in place, investment capital will tend to gravitate toward risk in the search of positive returns. From The Wall Street Journal:

Federal Reserve Chairwoman Janet Yellen left markets comforted and reassured about continued low interest rates after a speech that emphasized her focus on low inflation and economic slack. Wednesday’s remarks, coming in her third major address in the past month, followed an eventful first policy meeting in March that left some investors worried the central bank under her leadership might be inching toward higher rates sooner than expected. Ms. Yellen studiously sought to keep the central bank’s interest-rate options open in the speech before the Economic Club of New York. “Because the course of the economy is uncertain, monetary policy makers need to carefully watch for signs that it is diverging from the baseline outlook and then respond in a systematic way,” she said.

Fed Still Thinks Weather Was To Blame

As noted on April 2, stock market corrections almost invariably are kicked off by economic or geopolitical concerns. The recent bipolar activity in the stock and bond markets was due in part to a soft patch of economic data. Janet Yellen addressed that topic Wednesday. From CNBC:

“In recent months, some indicators have been notably weak, requiring us to judge whether the data are signaling a material change in the outlook,” Yellen said. “The unusually harsh winter weather in much of the nation has complicated this judgment, but my FOMC colleagues and I generally believe that a significant part of the recent softness was weather related.”

Resource Utilization Justifies Low Rates

The Federal Reserve is charged with a dual mandate, which includes “fostering maximum employment.” While unemployment has come down, so has the labor participation rate. Yellen cited economic slack and idle workers as justification to keep interest rates suppressed. From The New York Times:

Even as a number of indicators point to better economic times ahead, the chairwoman of the Federal Reserve, Janet L. Yellen, reiterated on Wednesday that she expected interest rates to remain very low until the recovery is on a more secure footing and the American economy is more fully involving available workers and other resources.

Investment Implications – Lines In The Sand

We outlined the economic rationale for monitoring the strength of industrial stocks on April 4. Investors would be showing renewed confidence in the wake of Yellen’s remarks if their buying conviction can push the Dow to a new weekly closing high. The zig-zag look of the Dow is indicative of investor confusion. During periods of low conviction and indecisiveness, it can be helpful to draw some lines in the risk-reward sand. For example, one might take a more measured approach redeploying cash as long as the Dow remains below 16,478. If and when a weekly close is printed above 16,478, redeployment confidence could be ratcheted up a notch. The weekly close printed below 16,478 at 16,408.

We entered the week with a fence-sitting mix of stocks (SPY), bonds (TLT), and cash. Given the still uncertain outlook for the economy and Fed policy, along with still shaky technicals, we made no moves this week. If the Dow pushes to a new high and the S&P 500 can clear 1,870, we will most likely increase our exposure to stocks. Possible buy candidates include dividend stocks (DVY), broad U.S. stock exposure (VTI), industrials (XLI), and energy stocks (XLE).

Frustrated By Stocks This Week?

This week was unpleasant for many investors, which prompted the strategy tweet below:

Weekends are a good time to review investment risk management strategies. On March 29 we noted if an approach or system can manage to avoid the pitfalls below, the odds of successfully navigating though the next crisis should improve:

  1. You think you know what is going to happen next.
  2. Your plan is not flexible enough.
  3. Failing to understand the strengths and weaknesses of technical analysis.
  4. Government and central bank intervention.
  5. Economic turnaround.

Heading into this week, the markets looked extremely vulnerable to additional downside. During the week, instead of correcting, stocks yo-yoed back up. The five points above applied to the past week of trading. The Fed was a big part of the turnaround in stocks (central bank intervention). We also saw some favorable economic numbers, such as the better than expected Philadelphia Fed Survey released Thursday. The five points above, especially flexibility, will be important next week as well.

Stock Rally: Will Third Time Be A Charm For Dow?

April 16, 2014

Mobile Usage Hurts Google

The easiest way for investors to become more decisive in the financial markets is for earnings to justify higher stock prices. While after-hours quotes should always be taken with a grain of salt, Google was down 2.48% after releasing some disappointing figures late Wednesday. From Bloomberg:

Google Inc.’s costs are rising as the search provider finds it harder to keep up with a broad shift to advertising on mobile phones, with sales falling short of estimates. Google’s audience is steadily migrating to smartphones, where the company gets less money for marketing spots than on desktops and tablets.

Dow Making 3rd Attempt At 16,580

After pointing out a Dow Theory non-confirmation that was in place on April 4, the S&P 500 dropped over 50 points. Has the Dow posted a new closing high during this week’s rally? Not yet. The inability to print a new high is indicative of investor doubt about earnings, the economy, and central bank policy. Janet Yellen’s remarks helped boost stocks Wednesday, but those moves can be “one day wonders”. We will see if the gains can continue on Thursday.

IBM Not Helping The New High Cause

IBM carries the third highest weight (7.7%) of any stock in the Dow Jones Industrial Average. Therefore, the reaction to Wednesday’s earnings will impact the Dow Thursday. The early reaction was not favorable for Big Blue. IBM was down over 4% in the after-hours session on revenue concerns. From MarketWatch:

Revenue slipped to $22.48 billion, below the $22.91 billion projected by analysts polled by Thomson Reuters. It was the eighth straight quarter IBM has reported weaker revenue from year-earlier levels. Though the computing and tech giant remains a key provider of computer hardware, software and services to big corporations and governments around the world, IBM is struggling to respond to technological advances such as cloud computing, which allows customers to rent computing power and software over the Internet. Slowing demand in emerging markets, especially China, is also posing a challenge for Big Blue.

Investment Implications

Janet Yellen’s stock-friendly comments helped spark a strong day in stocks Wednesday. Given the schizophrenic nature of the shifts between risk-on and risk-off in recent weeks, we prefer to see if stock gains can hold into the holiday weekend before considering any adjustments. You would think with stocks gaining ground Monday, Tuesday, and Wednesday, bonds would be getting killed. The long-term Treasury ETF (TLT) is up 0.49% this week, which indicates some ongoing economic skepticism. Both our stock (SPY) and bond positions are in the black for the week. We will see how the stock market handles the disappointing reports from Google and IBM.

Trading Range or Stock Correction Remain Most Plausible Scenarios

April 15, 2014
  1. The mixed-bag economy and mixed-bag market continue to call for defensive contingency plans.
  2. Given what we know today, a rapid and sustainable push to new highs in stocks appears to be the least likely scenario, behind consolidation/correction.
  3. Earnings have been decent so far, but Wall Street makes sure the expectation bar is set at a comfortable level.
  4. An allocation of stocks, bonds, and cash allows for needed flexibility and migration paths until a more dominant theme can emerge.

Playing The Low Estimate Game

Isn’t amazing how the majority of companies meet or beat earnings expectations quarter after quarter? Wall Street has always done a nice job of managing investor expectations. From Bloomberg:

“It’s quite likely that U.S. earnings will beat expectations because analysts have set the bar quite low,” James Butterfill, who helps oversee about $50 billion as head of global equity strategy at Coutts & Co., said by phone from London. “There probably won’t be any particular pressure on margins this quarter, so earnings momentum will continue to rise. I do expect the harsh winter to have impacted the most energy-intensive companies.”

Inflation Aligns With Ongoing Fed Taper

The good news Tuesday came on the earnings front, with Coca-Cola (KO) and Johnson & Johnson (JNJ) eliciting a bullish response. The bad news was related to inflation. From Reuters:

U.S. consumer prices rose in March, but inflation pressures remained generally benign, which should give the Federal Reserve ample scope to keep interest rates low. The Labor Department said on Tuesday its Consumer Price Index increased 0.2 percent last month as a rise in food and shelter costs offset a decline in gasoline prices. Economists polled by Reuters had expected a 0.1 percent rise.

Central bankers tend to print money until inflation forces them to slow down the presses. Today’s inflation data aligns with an ongoing Fed taper.

Ukrainian Military Action?

The unrest continues between Russia and Ukraine. It is possible the markets will have to digest some form of military action, which checks a glass half empty box. From The Wall Street Journal:

A Ukrainian military operation to wrest control of cities in the east from pro-Russian militants has begun, Ukraine’s acting president said Tuesday, as Russia’s foreign minister warned use of force could derail international talks on the crisis. Oleksandr Turchynov said that a phased “antiterrorist” operation began in the early morning hours in the northern Donetsk region, where the majority of the cities commandeered by pro-Russian forces are located. But there were no immediate reports of specific action and it was not clear how big the effort was.

Investment Implications: Mixed Bag = Mixed Allocation

From a fundamental perspective, there are many positives (earnings Tuesday) and many negatives (Fed taper). From a technical perspective, the longer-term trends remain bullish, but the intermediate-term trends shifted to a “risk-off” stance last week. Our nearly equal weights to cash, stocks (SPY), and bonds (TLT) remain appropriate for the current mixed investment climate.

Resistance Test Would Come At 1,850

Another example of a mixed picture is the chart of the S&P 500 below. The good news is the index has gained back 25 of the 49 points lost last week (early in Tuesday’s session). The bad news is various forms of prior support (green arrows below) and prior resistance (red arrows) seem to be congregating near 1,850ish. A reversal below 1,850 could bring a return to last week’s risk-off environment. A decisive break above 1,850 could open the door to a retest of the recent highs (near 1,900).

We have shown frustrating and indecisive charts in recent articles. We could produce additional examples from numerous corners of the market, including the chart of the small cap ETF (IWM) below. If investors had strong convictions about a brighter economic future, we would expect small caps to be performing well, rather than treading water for six months.

Indecisive markets are frustrating animals. If we remain patient and disciplined, the market will tip its hand. For now, a mix of stocks, bonds, and cash offers an appropriate balance between risk and reward. We questioned the sustainability of the bullish advance in stocks on April 4 with the S&P trading at 1,865. We remain concerned with the S&P trading at 1,827.

Stock Bounce Does Little To Alleviate Concerns

April 14, 2014
  1. The stock bulls got a nice fundamental trifecta Monday with good news on the economic, central bank, and geopolitical fronts.
  2. However, the rally attempt thus far has done little to alter the market’s intermediate-term risk-reward profile.

Retail Sales: Better Than Expected

After the stock market sells off significantly, any form of good fundamental news can create a fairly significant “oversold” bounce. The stock market bulls got what they wanted Monday in the form of retail sales. From Reuters:

U.S. retail sales recorded their largest gain in 1-1/2 years in March in a decisive sign the economy is bouncing back from its weather-induced slumber. Monday’s upbeat report was the latest to indicate growth was set to accelerate in the second quarter after an unusually cold and snowy winter hobbled activity early in the year.

The good news did little to alter the “economic concerns are increasing” look of the weekly chart below. Consumer discretionary stocks (XLY) still looked ugly on a relative basis as of 2:00 p.m. EDT Monday.

ECB: Good News and Bad News

Risk takers prefer easy money policies from central banks since the added liquidity has to land somewhere. The good news from the European Central Bank (ECB) Monday was they signaled a willingness to expand their stimulative measures. From Reuters:

The dollar rose against the euro on Monday after European Central Bank President Mario Draghi signaled the bank would ease monetary policy further, while strong U.S. retail sales data also boosted the dollar against the yen. Draghi said in Washington on Saturday that “a further strengthening of the exchange rate would require further stimulus”. Bank of France chief Christian Noyer hammered home the message saying: “The stronger the euro is, the more accommodative policy is needed.” “The ECB is taking the value of the euro more seriously in their approach to monetary policy,” said Thierry Albert Wizman, global interest rates and currencies strategist at Macquarie Ltd in New York. The statements marked the ECB’s strongest signal yet that it would act to head off further gains in the euro.

Given the Fed’s easy money policies have been a big driver of stocks in recent years, it is fair to say that all things being equal stock market bulls feel more secure when the U.S. greenback is weakening. The bad news Monday was comments about ECB policy helped push up the U.S. dollar.

The Big Picture

Since investors have much longer time frames than traders, looking at risk from a weekly perspective makes more sense. This week’s stock market outlook video provides numerous forms of observable evidence that point to a deteriorating outlook for equity investors.

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Ukraine: A More Peaceful Path?

There is no question the Russia-Ukraine standoff has weighed on the minds of investors in recent weeks. The bulls can make an argument that tensions eased a bit Monday. From The Wall Street Journal:

A day after threatening a full-scale military operation to drive pro-Russian militants out of a string of eastern Ukrainian cities, the country’s acting president offered an apparent olive branch Monday, saying he wasn’t opposed to a countrywide referendum on possibly granting regions greater autonomy. The move appears to signal increasing desperation from Kiev, highlighting it has few options for a real response as opponents take over further territory.

Investment Implications – Show Me

Is it possible stocks have found a bottom? Yes, but one day does not make a new trend. Last week we noted the concerning lack of progress in stocks, which is a symptom of increasing economic concerns. The “vulnerability box” was not altered in a meaningful way during Monday’s rally in equities.

We entered the week with an allocation of cash, stocks (SPY), and bonds (TLT); a mix that aligns well with an indecisive and hesitant market. As noted on March 21, discipline is the key to ending up in the right place once a period of consolidation is complete. Last week, the scales tipped toward risk-off. Depending on how the market reacts to the incoming data, including Tuesday’s report on consumer prices, we will ratchet up or ratchet down our risk exposure over the coming weeks.

Stock Market Correction Odds Increasing

April 11, 2014

This Week: (1) CCM Market Model, (2) DeMark counts on the S&P 500. DeMark charts and indicators are proprietary tools from Market Studies, LLC.

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Video Is Being Processed

April 11, 2014

Should be available here sometime around 7:30 p.m. EDT on Friday.

The End Of The Correction-Less Fantasy Land

April 11, 2014

  1. If you are relatively new to the investing world, you may not have a realistic reference point to understand how painful stock market corrections can be.
  2. A trip down the memory lane of market corrections (1982-2014) reminds us of what a typical year in the stock market can look like.
  3. On the surface, the 2014 stock market is holding up relatively well, but the picture behind the risk-reward curtain is concerning at best.
  4. Even if a corrective episode is averted in the short run, it is only a matter of time before the correction-less investment fantasy land comes to a painful end.

The Vulnerability Box

The S&P 500 closed at 1,833 on December 24, 2013. It closed at the same 1,833 on April 10, 2014, or over three months later. Common economic sense and the law of supply and demand tell us that when stocks stop making bullish progress, bullish economic conviction is losing ground to bearish economic concerns. The previous sentence also tells us the market’s risk-reward profile has been deteriorating since late December 2013.

Bank Earnings Not Helping

What can push a vulnerable market over the edge? Answer: when the net interpretation of all the new information is bearish. One piece of new data that is adding weight to the bearish side of the scale is earnings from JP Morgan Chase (JPM). From The New York Times:

JPMorgan Chase reported an 18.5 percent slump in first-quarter earnings on Friday, as the nation’s largest bank grappled with dual challenges: sluggish revenue from trading and lackluster mortgage lending. Both issues, broadly buffeting the banking industry, damped profits at JPMorgan.

A Trip Down Correction Memory Lane

Since weekends offer an opportunity to study markets and improve our approach to investing, it may be helpful to take a quick refresher course on stock market corrections. We will focus on two questions:

  1. How far can stocks drop?
  2. How long can corrections last?

Sample of Corrections 1982-2014

In 1984, stocks dropped 14.63%. Unlike the multiple-day pullbacks in 2013, this correction lasted two hundred and eighty-eight calendar days (288).

The 1987 stock market crash occurred within the context of a bull market, and the bull market resumed relatively quickly. Therefore, it is relevant to our correction study and 2014.

In 1990, stocks corrected sharply, dropping 20% over eighty-seven calendar days.

We have covered the importance of the investment landscape in 1994 numerous times, including this March 21 article.

In 1998, the correction may have felt like a bear market based on the sharp declines witnessed on brokerage and 401k statements. The 1998 correction was outlined in more detail on April 2.

The 2010 Flash Crash was quite a bit more than a one-day media event. Stocks dropped 16.71% over sixty-seven calendar days.

A political stalemate in Washington and escalating fears of the end of the euro, helped push stocks down over 21% in 2011.

Russia Still A Concern

If you know your market history, you probably remember the fundamental drivers behind the corrections in 1984, 1987, 1990, 1998, 2010, and 2011. The drivers in 2014 could be economic concerns and Russia. From Bloomberg:

Having annexed Crimea and deployed thousands of troops along the border, Russian President Vladimir Putin has been ratcheting up pressure on Ukraine, threatening yesterday to halt gas shipments. Ukraine is dominating discussions at the spring meetings of the International Monetary Fund and World Bank, which start today. U.S. Treasury Secretary Jacob J. Lew “emphasized that Russia’s ongoing occupation and purported annexation of Crimea is illegal and illegitimate,” the Treasury said in a statement after talks in Washington yesterday with his Russian counterpart, Anton Siluanov. “The United States is prepared to impose additional significant sanctions on Russia if it continues to escalate the situation in Ukraine.”

Corrections Can Be Harmful To Your Portfolio’s Health

What are the answers to our questions of how far can stocks drop and how long can corrections last? Based on the examples presented above, the average loss was 19.50% and the average duration was 114 calendar days. Can corrections be less painful? Sure, there are countless examples of more shallow pullbacks. However, understanding what is possible helps with investment contingency planning.

Investment Implications – No Problem, If You Have Contingency Plans

Why do we always reference contingency plans? It is not prudent to assume anything about what will happen next in the financial markets. Therefore, if you use an IF-THEN approach, and the bearish IF never happens, it prevents you from overreacting to vulnerable set-ups that may or may not morph into a correction. Let’s look at a simple contingency plan example for illustrative purposes only. Over the past week, we have outlined reasons to be concerned about increasing odds of a market correction in the articles below:

  1. The Case For Slower Growth, Low Rates And Income Investments
  2. Stocks: 4 Reasons To Have Defensive Contingency Plans
  3. Dow Theory Signal Questions Bullish Economic And Market Trends

If the first contingency in your simple risk-management plan was if the S&P 500 closes below 1,815, I will reduce my stock exposure by 10%. The S&P 500 closed Thursday at 1,833. Hypothetically, if the S&P 500 fails to correct and never closes below 1,815, then no action would be taken. The concept of using IF-THEN contingency plans was outlined in detail on October 18.

Our contingency plans are governed by our market model. The model entered Friday’s session with a very large allocation to cash to offset the market’s increasingly vulnerable risk-reward profile. Based on how things look at Friday’s close, our rules-based system may call for two chess moves: (a) reduce stock exposure (again), and (b) add some conservative investments to the mix. Conservative investment moves typically involve bonds (TLT) and/or currencies (FXA). As outlined in detail on March 27, contingency planning is a quadrant two activity – important, but not urgent. Weekends are a good time for getting into quadrant two.