China – Is It All Fun And Games?

July 24, 2014

On July 23, we noted some potentially bullish developments on the chart of emerging markets (EEM) relative to the S&P 500 (SPY). A few hours after the EEM charts were published China released strong manufacturing data.

China Plays A Big Part In EEM’s Play

If we are to put capital into EEM, our odds of success improve when a higher percentage of individual countries within the index look promising. China makes up almost 18% of EEM.

Know Your Timeframes

We see many reasons to keep both EEM and FXI on our investment radar, but we are also aware of possible hurdles. The dashed blue lines below show a bearish trend channel is still in play for FXI relative to SPY. That channel may be taken out in a bullish manner, but that has not occurred yet. Logically, a short-term trader may not care about longer-term charts. However, they are relevant to investors with longer holding periods.

Charts Can Help With Position Sizing

The monthly chart below also shows similar rallies that have been met with resistance in the past. For example, FXI rallied vs. SPY for four months in 2012, only to be turned back near point A.

The chart above is not necessarily a show-stopper, but it may keep us in “prove it to me mode”. As investors, we may (a) not take any position until the bearish trends are broken, or (b) take a smaller position and see how things play out. A trader may hold FXI or EEM for a few hours or a few days, meaning investors need to understand what it means when a trader says “bullish” and what it does not mean.

ETF Leadership

July 23, 2014

Today’s post can be found on Yahoo Finance.

New Highs: What Do They Mean?

July 22, 2014

Homes Sales Help Spark Rally

The S&P 500 posted a new intraday high Tuesday after encouraging housing data was released. From Reuters:

U.S. home resales hit an eight month-high in June, suggesting the housing market was gradually regaining momentum and would help the economy to stay on a higher growth path this year. The third straight month of home sales gains, reported by the National Association of Realtors on Tuesday, added to employment and retail sales data that have indicated economic growth ended the second quarter on a firmer note.

S&P Has Not Done This Yet

While the headlines referenced new highs, the S&P 500 needs to close over 1985 and change to make a new closing high. Tuesday’s close fell just short with the final print for the day coming in at 1983.

As noted on Twitter, investors can gain some short-term insight based on where stocks head next.

Earnings Playing A Big Role

Earnings have been pleasing to stock market bulls thus far. However, less than half of the companies in the S&P 500 have pulled back their quarterly curtain. From The Wall Street Journal:

Eighty three of the 116 companies in the S&P 500 that have reported earnings to date have beat expectations, according to FactSet. For the Dow, 11 companies of the 14 that have reported have topped estimates. There’s been “a really healthy earnings picture for U.S. corporations so far,” said Michael Marrale, head of research, sales and trading at brokerage firm ITG.

Investment Implications – Bulls Still In Control

As noted on July 21, recent volatility can be put into the “normal” basket. How concerned should we be about the failure of the S&P 500 to post a new closing high? At this point, it is not something to lose sleep over. Our concerns would increase if stocks have not posted a new closing mark over the next couple of weeks. The evidence in hand continues to call for U.S. equity exposure (SPY), coupled with leading sectors, such as transportation (IYT).

Is Recent Volatility Cause For Concern?

July 21, 2014

Earnings: A Big Role This Week

Before we get into the subject of recent volatility, it is important to understand the primary market driver in the days ahead – earnings. From The Wall Street Journal:

Twelve Dow industrials components and 146 S&P 500 companies are set to post earnings this week, including Apple, Microsoft and Ford, according to FactSet. “This is peak earnings season week,” said Doug Cote, chief market strategist at Voya Investment Management. “I’m expecting continued good news. My expectation is that we’re going to handily beat consensus earnings.”

Volatility To Ignore?

In the graph of the S&P 500 below, if markets moved in a linear fashion, managing risk would be much easier. It would be easy to leave our investments alone between point A and point B. It would have been easy to spot that something was changing between points B and C, and much easier to discern something had changed for the worse between points C and D.

Unfortunately, markets are volatile. Therefore, from a risk management perspective it is helpful to have tools that help discern between “volatility to ignore” and “volatility to respect. This week’s video covers the topic in the context of recent volatility in the U.S. 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.



Good Sign For The Economy?

Earnings are not just about numbers. The market is always interested in forward looking statements regarding the economy. Energy producers may be providing some insight. From Reuters:

Halliburton Co (HAL.N), North America’s top oilfield services provider, said it would add fracking equipment and crew to take advantage of higher demand in the region, signaling an industry-wide recovery after a two-year slump.

Investment Implications – Eye On Conflicts

Even with the S&P 500 down as much as 12 points in Monday’s session, support shown in the chart below remained in place.

The markets are dealing with unrest in the Middle East and Ukraine. From The New York Times:

As diplomatic pressure for a cease-fire mounted on the conflict’s 14th day, the Palestinian death toll topped 500 and the number of Israeli soldiers killed hit 25, more than twice as many as in Israel’s last Gaza ground operation in 2009. Two Israeli civilians have also died from rocket and mortar fire.

From a separate New York Times article:

After days of obstruction, Russia-backed separatists in eastern Ukraine permitted Dutch forensics experts on Monday to search the wreckage of the downed Malaysia Airlines jetliner destroyed by a surface-to-air missile, allowed bodies of the victims to be evacuated by train and agreed to give the plane’s flight recorder boxes to the Malaysian government. The movements, four days after Malaysia Airlines Flight 17 exploded and crashed in an eastern Ukraine wheat field, came as President Vladimir V. Putin of Russia faced a growing international clamor to clear the way for a full and unimpeded investigation of the disaster.

The evidence we have in hand continues to call for a prudent allocation to U.S. stocks (SPY), and leading sectors (QQQ). However, with markets nervous about the Fed, geopolitical events, and earnings, flexibility remains as important as ever.

Tuesday brings reports on inflation and housing. Never a dull moment.

Stocks: Volatility To Respect?

July 18, 2014

Still Relevant Big Picture Risk Management Articles - Weekend Reading.
More links and charts on Twitter.

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 - Check Link

July 18, 2014

YouTube is processing a little on the slow side tonight. This week’s video should be available on the CCM YouTube Channel sometime between 7:10 and 9:00 pm EDT.

Most Recent Comments Via Twitter

July 18, 2014

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.

Most Recent Comments Via Twitter

July 17, 2014

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.

New Dow Theory Signal - What Does It Mean?

July 17, 2014

Charts Monitor, Rather Than Dismiss Fundamental Data

Critics of technical analysis often mistakenly believe that using charts discounts the importance of fundamental data, such as earnings, employment, and economic growth. Charts allow investors to monitor the aggregate investor interpretation of all the fundamental data. Said another way, charts are efficient tools used to monitor vast amounts of fundamental data, which is important since fundamentals ultimately determine which assets classes will perform best. When the economy is healthy, stocks tend to beat bonds. When economic fear dominates, bonds tend to beat stocks. In this article, we will cover the latest signal from the markets that came on July 16.

Dow Theory Is Based On Economic Common Sense

Dow Theory is based on a series of Wall Street Journal articles written by Charles Dow. The basic tenets of Dow Theory are easy to understand. Charles Dow believed that:

  1. In order for industrial companies to increase their earnings, they had to produce and sell more goods.
  2. If industrial companies are selling more goods, then transportation companies must be delivering more goods to retailers and wholesalers.
  3. Therefore, in a healthy economy, both industrial companies and transportation companies should be experiencing revenue growth.
  4. If industrial and transportation companies are growing their revenues, then the industrial and transportation stocks should be attractive to investors.
  5. If industrial and transportation companies are doing well and are attractive to investors, both the Dow Jones Industrial Average and the Dow Jones Transportation Average should be making new highs in unison, serving to confirm a healthy economy.

Behind The Averages

After reviewing the companies in the industrial and transportation averages, it is easy to see why they represent logical vehicles to monitor the pulse of the U.S. economy. In 2014, our economy is driven by more than just industrial or manufacturing companies. The present day Dow Jones Industrial Average contains traditional producers, such as IBM (IBM), 3M (MMM), Boeing (BA), Chevron (CVX), and Johnson & Johnson (JNJ). However, the Dow (DIA) also contains Visa (V), Goldman Sachs (GS), and American Express (AXP), since the present day economy relies heavily on the financial sector. The Dow Jones Transportation Average (IYT) still has railroads, such as Union Pacific (UNP) and Norfolk Southern (NSC), but it also contains more modern logistics companies, such as United Parcel Service (UPS), Fed-Ex (FDX), and J.B. Hunt (JBHT).

Just Reconfirmed Primary Bull Market

If investors believe industrial and transportation stocks are healthy and thus, attractive investments, that speaks to demand. When demand is strong, stock prices rise. Despite the recent Fed/Ukraine volatility, the Dow Jones Industrial Average posted a new closing high this week. Notice the slope of the blue 50-day moving average in the chart below; you can compare it to the early stages of a 2011 correction in stocks and to the 2008-2009 bear market later in the article.

Similarly, the Dow Jones Transportation Average also posted a new high on July 16. Again, note the look of the blue 50-day moving average.

2011: How Can This Help Us Manage Risk Today?

If Dow Theory offers a way to monitor the aggregate interpretation of the economy, earnings, and central bank policy, then we would expect charts of the DJIA and DJTA to be helpful in terms of managing investment risk. Since a picture is worth a thousand words, when the Dow’s 50-day rolled over in 2011 (see orange arrows below), the index dropped an additional 16%. Notice how the Dow failed to make a new closing high before the big reversal in 2011. As of July 17, the 2014 Dow chart looks much better (slope of 50-day is up, recent higher high).

2007-2009: Economic Pessimism And Investor Fear

Similar economic warnings came in 2007 and 2008 (see orange arrows in chart below). Notice during the 39% drop in the Dow in 2008 the 50-day never gave a “things are improving” signal, meaning it was helpful from a cash-redeployment perspective. The Dow was not making new highs; instead it was making a series of lower lows, which reflected a period of economic pessimism and investor fear. The 2014 chart looks much better, which is indicative of more favorable economic expectations.

The differences are easy to see side-by-side. The stronger bullish conviction tells us even if stocks pull back in the short-run, the odds are good that buyers would step in and attempt to test the recent highs. Reversals tend to be a process rather than a one day binary event. The charts below speak to probabilities.

The Fed Still Big Part Of Fundamental Equation

Anyone that has followed the markets closely, especially over the last four years, knows that all things being equal the stock market is not fond of any Fed move that slows the printing presses. Thursday’s not too hot, nor too cold data on the economic front most likely keeps a 2015 rate hike on the probability table. From Reuters:

Rising inflation pressures could push the U.S. Federal Reserve to raise interest rates as early as the second quarter of next year, according to a Reuters poll of analysts. America’s jobless rate sank to almost a six-year low in June and consumer prices posted their largest rise in May in more than a year, bolstering the belief that the U.S. economy is turning a corner. Now many Fed watchers are bringing forward forecasts on the timing of when the central bank will raise interest rates. “All things considered, there is now an increased risk of an earlier first rate hike,” economists at Bank of America Merrill Lynch said in a report.

Investment Implications – Time To Pay Closer Attention

Does the recent Dow Theory bullish confirmation mean it is all fun and games for the economy and stock market? No, it simply tells us the market is currently healthy, and the next bout of significant weakness is more likely to be a correction, rather than a full blown bear market. Notice, a correction remains a possibility. As the godfather of technical analysis noted on Twitter, this week’s signal keeps the longer-term bullish case intact.

For Further Study

Since the markets are nervous about rising interest rates, it may be prudent to brush up on risk management strategies:

  1. How To Monitor The Risk Of A Midterm-Election-Year Stock Correction
  2. 5 Reasons Your Simple Bear Market Plans Could Backfire
  3. The 2 Most Important Questions For Investors

Sentiment: A Meaningful Shift For Stock Bulls?

July 17, 2014

Hot Off The Press

On July 16, in a review of investor sentiment, we noted the importance of keeping an eye on this week’s American Association of Individual Investors (AAII) Sentiment Survey. Last week’s decline in the S&P 500 and this week’s concern over a 2015 rate increase by the Federal Reserve, has resulted in a rational decrease in bullish sentiment and an increase in bearish sentiment. The image below is a screen shot from AAII’s website:

Sentiment Is Not At Extreme Levels

If you are new to sentiment, the basic theory is as follows…if we see excessive bullishness, it means most investors are probably close to fully invested. Conversely, if we see excessive bearishness, then most people have probably sold already. If everyone has bought, then buying power becomes weak. If everyone has sold, then selling pressure drops. Thus, theoretically, sentiment can be helpful when it reaches extreme levels since the probability of a market reversal is higher.

Bullish sentiment is currently below average (32.4% vs. 39.0%). Similarly, bearish sentiment is hovering around average, not extreme levels. Therefore, in theory, sentiment is not particularly helpful at the present time. Sentiment is certainly not at extreme levels that would suggest an imminent major peak in stocks. A correction is the more likely outcome if markets become weak.

Investment Implications – Wait For Evidence To Turn

The following tweet contains arguably the most important concept in investing and risk management:

The concept above applies to the present day market. Does the tweet contain useful information? We think so and others have agreed by voting our firm “most helpful” on Twitter. In terms of how to deal with recent volatility in the stock market, note in the tweet it says nothing about forecasting. Over the next few weeks, if we pay attention meticulously and make adjustments as needed, our allocation between stocks (SPY) and conservative assets, such as bonds (TLT) will stay prudently aligned with the stock market’s upside potential relative to the downside risks.