Energy ETFs In The Wake Of The OPEC Agreement

September 28, 2016

OPEC Announcement

The market had low expectations heading into this week’s OPEC meeting. The story broke Wednesday afternoon. From Bloomberg:

OPEC agreed to cut production for the first time in eight years, sending oil prices more than 6 percent higher, as Saudi Arabia and Iran wrong-footed traders who expected a continuation of the pump-at-will policy the group adopted in 2014, according to a delegate briefed on the matter.

In two days of round-the-clock talks in Algiers, the group that supplies about 40 percent of the world’s oil said that it will drop production to 32.5 million barrels a day, nearly 750,000 barrels a day lower from what it pumped in August, the delegate said, asking not to be named because the decision isn’t yet public.

How Did The Markets React?

The initial reaction in energy stocks (XLE) was positive. However, as shown in the chart below, XLE still has some hurdles to clear.

Late in Wednesday’s session, the crude oil ETF (USO) was up over 5%. However, just like energy stocks, some hurdles remain.

Broad Market Impact

The S&P 500 also gained some traction after the news regarding black gold. If energy stocks can stabilize, it would take some pressure off the credit markets. A significant amount of debt is tied to the energy complex. From Bloomberg:

The trend is most apparent in the energy sector where oil and gas companies have been deploying a raft of creative measures to stay afloat amid lower crude prices that have crimped profits and threatened their survival. Such measures have included swapping unsecured debt for secured, offering discounted buybacks of existing debt, or junior-lien debt that gets paid after other creditors.

Last 3 Spikes In The Ted Spread: Did Stocks Tank?

September 26, 2016

Ted Spread Highest Level In Seven Years

You may have seen warnings about the Ted Spread in recent days, along the lines of this blurb from The Wall Street Journal:

A measure of stress in financial markets, whose alarm bells heralded the 2008 financial crisis, just hit its highest level in over seven years.

Spikes In Ted And Stocks

The last three times the Ted Spread spiked was it better to be buying stocks or selling stocks? Recent spikes in the Ted Spread have occurred during sell-offs in the stock market. However, the peaks in the Ted Spread occurred just prior to sharp rallies in the S&P 500.

New Regulations And The Ted Spread

Another factor to consider is the regulatory impact on the ongoing utility of the Ted Spread. From The Wall Street Journal:

But don’t worry. It turns out the so-called Ted Spread might be dead, an unlikely casualty of the recent changes in U.S. money-market regulation… The U.S. Securities and Exchange Commission’s new rules for money-market funds come into effect in the middle of October. They are designed to stop rapid outflows during periods of panic and include abandoning a fixed $1 share price and allowing these funds to impose fees on shareholders who withdraw assets. Funds can also suspend redemptions temporarily.

The Bigger Picture

The recent spikes in the Ted Spread did occur during periods of increasing fear in the equity markets. Therefore, as always, we remain open to all outcomes over the coming days and weeks, including bearish outcomes. This week’s stock market video covers a very rare shift that recently occurred in the financial markets; what could have caused the shift and what does history tell us about the present day stock market?

After you click play, use the button in the lower-right corner of the video player to view in full-screen mode. Hit Esc to exit full-screen mode.

Video

Video

How Helpful Is The Ted Spread?

Indicators that have strong and consistent correlations to the S&P 500 can be helpful. As shown below, the correlation between the Ted Spread and the S&P 500 looks like an 8.0 magnitude earthquake on the Richter scale. Sometimes stocks go up when the Ted Spread goes up; sometimes stocks go down when the Ted Spread goes up.

From a long-term perspective, it is difficult to see how the Ted Spread would have been helpful in any manner for stock investors, except to confuse them. Given the look of the correlation chart above, a coin flip may be just as telling as the Ted Spread in terms of stock market odds. There are countless things to be concerned about; the recent spike in the Ted Spread is not high on the list.

Seismic Shift: What Could It Mean For Stocks?

September 23, 2016

After you click play, use the button in the lower-right corner of the video player to view in full-screen mode. Hit Esc to exit full-screen mode.

Video

Video

Will The Fed Surprise The Markets With Rate Hike?

September 20, 2016

Market Says 85% Chance Fed Makes No Move

During the trading session Tuesday, the market was pricing in a 15% chance the Fed raises rates Wednesday. Therefore, if the Fed announces a rate hike, the initial market reaction could be sharp and even exhibit characteristics of widespread panic.

91% Of Primary Dealers In No Hike Camp

According to Bloomberg, 21 of 23 primary dealers are forecasting a “no hike” outcome at 2:00 pm ET Wednesday. These figures also tell us if the Fed hikes, significant volatility may follow in a wide variety of asset classes.

An Insider’s Take

The Wall Street Journal’s Jon Hilsenrath has been covering the Fed for years. Hilsenrath’s take on this week’s meeting aligns with the markets:

“Federal Reserve officials, lacking a strong consensus for action a week before their next policy meeting, are leaning toward waiting until late in the year before raising short-term interest rates. It is a close call. But with inflation holding below the Fed’s 2% target and the unemployment rate little changed in recent months, senior officials feel little sense of urgency about moving and an inclination toward delay, according to their public comments and recent interviews.”

Our Approach Will Remain The Same

If the Fed raises rates and the markets react in a violent manner, it will not alter our approach in any way. We will make decisions based on hard data and facts. If the hard data says “do nothing”, we will ride out the volatility. If/when the math hits “volatility to respect” thresholds, we will take action as needed.

It is possible a surprise rate hike could induce a selloff similar to the plunge following the Brexit referendum. The Brexit selloff lasted two days and was quickly retraced via a sharp rally in the other direction. A “sell first ask questions later” reaction remains the lower probability outcome. However, the odds of a surprise rate hike are not zero. It is prudent to be prepared for all outcomes.

Three Charts To Assist With Fed Week

September 19, 2016

Fed And BOJ On This Week’s Docket

Three key charts are trying to hold onto “breakout followed by a retest” looks as described on September 14. Given the market is bracing for a double-dose of central banks this week (Fed and Bank Of Japan), the charts below should provide some insight into the market’s risk-reward profile over the coming days and weeks. From Reuters:

The U.S. dollar fell from Friday’s more than two-week high against a basket of major currencies on Monday on expectations that any Bank of Japan action this week would not weaken the yen and the Federal Reserve would refrain from raising rates. The BOJ is due to conduct a comprehensive review of its policy framework, which combines negative interest rates with a massive asset-buying program. The BOJ and Fed meet on Sept. 20-21.

Economically-Sensitive High Beta

The High Beta ETF (SPHB) has higher weightings in materials (XLB), energy (XLE), and financials (XLF) relative to the S&P 500’s weightings (SPY). As shown in the chart below, this economically-sensitive investment is trying to hold the recent break above an area that has acted as resistance for a year. As recently as June 28 (point C below), SPHB looked to be on the ropes.

Is Recent Volatility Waving Red Flags?

This week’s stock market video provides insight into recent market volatility via historical examples. How much volatility can occur after a bullish breakout and within the context of a bullish trend? Why is capital preservation important?

After you click play, use the button in the lower-right corner of the video player to view in full-screen mode. Hit Esc to exit full-screen mode.

Video

Video

S&P 500 Weekly

The weekly S&P 500 chart below is an updated version of the chart described on September 13. If the current weekly retest ends with the S&P 500 remaining above the long-term consolidation box, bullish probabilities would improve relative to bearish probabilities looking out weeks, months, and years.

Broad NYSE Composite

It comes as no surprise the broad stock market is hovering near a key level prior to announcements from two central banks. In October 2015, sellers thought 10,513 was relevant on the NYSE Composite. Sellers surfaced again near 10,511 in April 2016. Last Friday, the NYSE Composite closed in the same basic area at 10,532 (see chart below).

Is A Surprise Rate Hike Possible?

During the trading session Monday, the markets were pricing in an 85% probability the Fed does nothing with interest rates this week. Given the market’s near obsession with central bank liquidity, it is prudent to remain open to any and all market reactions this week. From MarketWatch:

Economists said they could not rule out a surprise rate hike this week, particularly since Yellen said “the case for an increase in the federal funds rate has strengthened in recent months.” …That said, Paul Ashworth, chief U.S. economist at Capital Economics, says that a surprise hike “just doesn’t fit Chair Yellen’s style.”

Charts And The Market’s Reaction

The longer high beta stocks, S&P 500, and NYSE Composite can stay above the levels outlined above, the better for the bullish case. Conversely, a sustained break below the key levels would increase bearish odds. We will learn something either way.

Successful Retest Or Concerning Bearish Set-Ups? [VIDEO]

September 16, 2016

Weekly Video In This Post

Weekend Update

In a September 14 post, the concept of a breakout and retest was covered in detail (see example below).

This week’s video covers the 2016 breakout and recent spike in volatility allowing us to better understand the present day market’s risk-reward profile via historical references.

After you click play, use the button in the lower-right corner of the video player to view in full-screen mode. Hit Esc to exit full-screen mode.

Video

Video

Fed Takes Center Stage…Again

Next week’s calendar features policy statements from both the Federal Reserve and Bank of Japan. From The Financial Times:

“By this time next week investors will know the outcome of the monetary policy meetings of the Bank of Japan and Federal Reserve. Yes, both decisions will be revealed on September 21, providing a quick one-two of ‘risk events’ that could provide intense market twitchery.”

Long-Term Market Signal

The video above provides an update to a rare and long-term market signal; more detail can be found in an August 20 article.

Stop Wasting Energy On The VIX

September 15, 2016

  1. The VIX Fear Index is arguably the most over-analyzed tool on Wall Street regarding its real-world predictive powers relative to the long-term path of the stock market.
  2. The common argument is when the VIX spikes, it is indicative of rising fear, and thus stocks typically drop when the VIX rises.
  3. The VIX measures “expected near-term volatility”, which is quite a bit different than fear or long-term economic concerns
  4. Can stocks go up when the VIX rises significantly from low levels? You can decide for yourself after reviewing a historical example.

Sounding The Low VIX Sirens For Stocks

If you follow the markets regularly, you have probably run across similar passages to the one shown below from a May 28, 2014 MarketWatch article:

As the VIX continues to sink closer to its historic low of 9.39, many commentators are now discussing the VIX as a “complacency index.” As the VIX falls, it signals increasing levels of investor complacency. Because economist Hyman Minsky taught us that periods of high volatility follow periods of low volatility, many investors are beginning to worry that a “Minsky moment” could be lurking around the next corner that would send volatility higher, increase the risk premium for holding stocks and cause prices to sink.

We agree with portions of the quote above, with two exceptions: (1) when the VIX rises from low levels to higher levels, it does not necessarily mean the stocks are in big trouble, especially when viewed from a longer-term perspective, and (2) low VIX readings do not necessarily align with caution-oriented “complacency”.

Retail Sales Align Nicely With The VIX Story

Having worked on Wall Street for over 20 years, we can confidently state evidence is always available that logically aligns with the bearish narrative for risk-related assets; the same can be said for a bullish narrative. The bearish case got a nice dose of weak data on Thursday, September 15. From Bloomberg:

Sales at U.S. retailers dropped more than forecast in August, indicating a pause in recent consumer-spending strength that has carried the economy.
Purchases declined 0.3 percent from July, the first drop in five months, after a revised 0.1 percent advance in the previous month, Commerce Department figures showed Thursday in Washington. The median projection of economists surveyed by Bloomberg called for a 0.1 percent decline. Excluding cars, sales unexpectedly fell 0.1 percent.

Low VIX Means Trouble For Stocks, Right?

As recently as September 8, 2016, the VIX was hovering near the low end of its long-term range dating back to the 1990s. If that means historic complacency, then logic would tell us that when the VIX rises from very low levels, it must mean rising fear and bad times ahead for stocks…right? That logic often holds in the markets, meaning the VIX can be and is a useful tool for stock investors. However, the strength of a stock market indicator lies in its consistency.

Can stocks rise as the VIX rises from low levels? History not only says “yes”, but it does so emphatically. The chart below shows a period beginning in late 1995 when the VIX started to rise from low levels. The VIX surged from 10.36 in 1995 all the way to 38.20 in late 1997, which is a major spike in the VIX. How did stocks perform over the same period? The S&P 500 gained 47%…yes, that is not a typo…stocks gained 47% during a period when the VIX more than tripled.

For those scoring at home, the 47% move in stocks began when the VIX showed “a high level of investor complacency” with a reading of 10.36. What was the recent 2016 low in the VIX? 11.02.

The VIX Is About Volatility, Not Fear

The moral of the story is there is nothing wrong with having the VIX in your stock market toolkit. However, the VIX needs to be used in the proper context to be more helpful to longer-term stock investors. From a 2014 Yahoo Finance article about the VIX:

Today the VIX sits below 11.50 and stocks are slightly higher despite weak earnings and a widely expected, but still ugly, negative print in first quarter GDP. Rather than interpreting the market action as complacency traders are generally just accepting that the VIX is lower because the market is open for business. The thing is, the VIX never measured “fear.” It measures expected volatility. If 11.5 seems like a low print that’s only because you aren’t putting it in the context of single-digit trailing volatility. The VIX is low for a reason and that reason is that stocks simply aren’t going down in large enough gaps to justify paying much for insurance.

VIX Even Less Relevant On Longer Timeframes

If we take the historical example above out even further in time, it emphasizes the two main points: (1) when the VIX rises from low levels to higher levels, it does not necessarily mean stocks are in big trouble, especially when viewed from a longer-term perspective, and (2) low VIX readings do not necessarily align with caution-oriented “complacency”. If the S&P 500 can gain over 170% during a period in which the VIX rose significantly from historically low levels, it tells us to be careful about how we interpret and use the VIX.

September Rate Hike Odds Drop

The market’s pricing mechanism has an almost infinite number of moving parts. One of the important parts is Fed policy. Thursday’s weaker than expected read on the economy makes it easier for the Fed to stay in the “do nothing” camp in September. From Reuters:

U.S. retail sales fell more than expected in August, pointing to cooling domestic demand that further diminishes expectations of a Federal Reserve interest rate increase next week…Financial markets are pricing in only a 12 percent probability of a rate hike next week, down from 15 percent before the data, according to the CME.

Investment Implications – No Need To Anticipate

Have stocks corrected after the VIX hit low levels? Yes, we can find numerous historical cases where a rising VIX occurred during a weak period for equities. Regardless of what the VIX does, we know it is highly unlikely the stock market will enter a multiple-month correction or a multiple-year bear market without seeing some evidence of deterioration on the chart of the S&P 500. How vulnerable does the broader stock market look right now? The charts below allow us to compare 2016 to a higher risk period in 2007.

This video clip explains why the charts above are helpful. Is using moving averages a perfect way to manage portfolio risk? No, but used in conjunction with other economic and technical inputs, it can help us stayed aligned with the market’s risk-reward profile.

The VIX Can Be Helpful

Before you begin composing emails or tweets about the usefulness of the VIX, our market model uses the VIX, which means we agree it can be helpful. The key point is time frames. Shorter-term traders may have found countless relevant ways to effectively use the VIX. We are investors, meaning it is important for us to understand what the VIX can and cannot do on a longer-term time horizon relative to the stock market.

Most Recent Comments Via Twitter

September 14, 2016

You can access them here (@CiovaccoCapital). You do not need to know anything about Twitter to view our comments or use the links to view charts.

S&P 500 Testing An Important Area

September 14, 2016

Retests Can Occur After Breakouts

Typically, when markets break out from long-term consolidation boxes, it tells us something has fundamentally changed. However, the fundamental drivers that kept the market contained in the consolidation box may still need one more shakeout or retest before the market can push higher.

For example, after the S&P 500 went basically nowhere between November 1993 and February 1995, the bulls finally mustered enough conviction to push price above the orange box below. After the bullish breakout from the long-term range, sellers needed one more shakeout before the market pushed higher. The retest occurred above the green arrow.

The purpose of showing the chart above is to provide a generic example of a retest. We are not making any attempt to compare 1995 to 2016. Yes, 2016 is quite different than 1995. However, that concept applies to all historical market references.

2016: Stocks Returning To Breakout Area

There are numerous ways to define a long-term market consolidation, including using a trend channel. The S&P 500 stayed contained within the two blue parallel lines below between October 2014 and July 2016 (see orange and green arrows below). After breaking out, the S&P 500 pushed higher and is now “retesting” the upper part of the blue trend channel. If the market moves back into the trend channel, the next layer of possible support falls within the orange box.

Interest Rate Expectations

Given the rather low market expectations for a September interest rate hike, recent volatility may have a “should we be getting concerned about inflation” component. From Bloomberg:

Treasuries rallied Wednesday as traders gained confidence that the Federal Reserve will keep interest rates steady at least through next week’s policy meeting. Traders are favoring shorter maturities as a Fed on hold is seen as potentially stoking inflation, which erodes the value of long-term debt. Futures signal barely a one-in-five chance that the Fed will tighten policy this month amid tepid economic growth and restrained inflation.

Monthly Levels Of Note

Weekly levels for the S&P 500 and SPY were covered on September 13. We can also learn something by examining monthly closing levels near the top of the orange consolidation box. If the market wants to drop further, something that is quite possible with inflation data and a Fed meeting on the horizon, the monthly band of possible support falls between 2,107, and 2,059.

A September 9 video clip provides additional historical examples of volatility that followed breakouts from long-term consolidation boxes.

Levels Of Note For S&P 500 And SPY

September 13, 2016

What Once Was Resistance

Given the market’s near addiction to low interest rates and recent price action, it is helpful to get some guideposts based on the expression:

“What once was resistance may now act as possible support.”

The expression above includes two key words: “may” and “possible”, meaning there is no market law bounding price to act in any particular manner at any particular level. However, we know markets often retest breakout levels or areas of past resistance.

S&P 500 Weekly

Weekly charts can help us zero in on the most important levels. The weekly chart of the S&P 500 below shows, prior to the recent bullish breakout, sellers became more active between 2,096 and 2,122. If those levels are taken out on a weekly basis, our concerns would increase with a weekly close below the Brexit low of 2,037.

Weekly charts print only one price each week. Therefore, intraweek moves are not as relevant as the close for the week.

SPY Weekly

The weekly chart of the S&P 500 ETF (SPY) below shows, prior to the recent bullish breakout, sellers became more active between 207.46 and 209.15. If those levels are taken out on a weekly basis, our concerns would increase with a weekly close below 202.91.

Prudent To Respect All Outcomes

While the longer-term outlook has not deteriorated in a significant manner yet, as outlined on September 9 and September 12, recent volatility and the near-term economic calendar tell us to respect any and all outcomes. With two economic reports (PPI and CPI) related to inflation on this week’s docket, the market will be watching closely. If there is one thing that can force the Fed’s hand on interest rates, it is a surprising pop in inflation. Our ETF scoring system tells us our positions are a bit more vulnerable, but the facts have only moved into a “pay closer attention” zone at this time.