Archive for March, 2011

Nuclear Meltdown in Japan Would Have Worldwide Implications

Saturday, March 12th, 2011

The concerns continue to mount after Japan’s devastating earthquake and subsequent tsunami, which may further heighten recent anxiety in the financial markets. An explosion near the No. 1 reactor at the Fukushima Dai-Ichi nuclear power station has industry experts talking about the possibility of a meltdown. According to Bloomberg:

“If the fuel rods are melting and this continues, a reactor meltdown is possible,” Kakizaki said. A meltdown refers to a heat buildup in the core of such intensity it melts the floor of the reactor containment housing. “If they cannot get the nuclear reactor back under control during the day, this may end up being the biggest problem of all,” said Ken Courtis, former vice chairman of Goldman Sachs Group Inc. in Asia. “A meltdown, which would cause massive immediate damage, would also set the nuclear industry back decades. This would have vast implications for the global energy equation and perforce the world economy.”

Japanese Chief Cabinet Secretary Yukio Edano said at a press conference that the blast didn’t damage the reactor container, only the structure outside it, and that there was no major radiation leakage with the explosion. The nuclear reactors are about 150 miles north of Tokyo. New reports in Japan have indicated the radioactivity at the site was rising to 20 times normal levels.

Defensive Game Plan

We would expect the nuclear energy ETF to struggle next week. From an investment perspective, we would avoid NLR in the short-term due to the uncertainties in Japan. If we owned NLR (we do not), we would consider selling some of the position with a close below 24.74, and cutting back even further with a close below 23.18.

“If the water level remains at this level, the reactor core might be damaged, but we are now pouring water into the reactor to prevent it from happening,” Dow Jones Newswires quoted a Tepco spokesman as saying.

According to Wikipedia, a nuclear meltdown:

  • Occurs when a severe failure of a nuclear power plant system prevents proper cooling of the reactor core, to the extent that the nuclear fuel assemblies overheat and melt. A meltdown is considered very serious because of the potential that radioactive materials could be released into the environment. A core meltdown will also render the reactor unusable until and unless it is repaired.
  • Within the former Soviet Union several nuclear meltdowns of differing severity have occurred. In the most serious example, the Chernobyl disaster, design flaws and operator negligence led to a power excursion that subsequently caused a meltdown.
  • A core damage accident is caused by the loss of sufficient cooling for the nuclear fuel within the reactor core. The reason may be one of several factors, including a loss of pressure control accident, a loss of coolant accident (LOCA), an uncontrolled power excursion, or in some types, a fire within the reactor core.

Hopefully over the coming days, the people of Japan can get some good news in the form of the odds being reduced relative to the possibility of a meltdown. From an investment perspective, it may contribute to an already fragile state of the markets. As we head into Monday’s open, we will continue to monitor the situation as well as the relative performance of defensive assets.

In terms of specific strategy next week:

  • We will be patient with our cash until the news from Japan calms down a little and the technical picture in the U.S. improves.
  • Since we have been raising cash for a few weeks, we are happy to hold our longs and see how the S&P 500 acts near key levels, including 1,294, 1,275, and 1,270.
  • If the market can find its footing soon, or near the levels above, we are willing to consider some minimal redeployment of cash, possibly using a broad market approach (VTI or SCHB).
  • A close below the levels mentioned above would have us consider raising some additional cash using the incremental approach. Since we have profits in energy (XLE), we may cut back further in that area should the bears continue to control the market.

A Market In Motion Tends To Stay In Motion…

Friday, March 11th, 2011

Newton’s First Law of Motion states that a body at rest will remain at rest unless an outside force acts on it, and a body in motion at a constant velocity will remain in motion in a straight line unless acted upon by an outside force. Financial markets are not immune to Newton’s First Law. The short-term “motion” in stocks is to the downside.

As of 12:45 p.m. ET, today’s stock market gains are a positive, but not all that meaningful yet. Volume is running significantly behind yesterday’s sell-off, indicative of a higher desire to sell yesterday than the desire to buy today, something that could improve before the session closes.

The advance/decline stats on the NASDAQ are running about even, and they are slightly bullish on the NYSE. The advancing and declining volume stats look much better, showing the larger market players do have some interest today. In terms of investing new cash, or redeploying cash in existing accounts, we will continue to be patient. We first presented the table below using data from March 7, 2010.

Defensive Game Plan

The basic concepts in the table above can be summed up as follows:

In the short-run, until the market can prove otherwise, we will continue to give the bears the benefit of the doubt since they have control of the very short-term trends. Big-picture-wise and longer-term, we will give the bulls and the bull market the benefit of the doubt, until proven otherwise, since they control the long-and-intermediate-term trends.

We mentioned early on Friday the technical concerns we have are starting to spill over into weekly charts, which increases the need to be skeptical and patient until the market is acted on by positive outside forces. The action in defensive investments, mentioned on March 10, has not changed significantly yet.

For now, the bull market remains firmly intact (see oil/bear post), but we have to respect how far corrections can run, especially in an environment where Fed policy (printing money) is such an important component of the market’s recent strength.

Weakening Intermediate-Term Outlook Requires Defensive Posture

Friday, March 11th, 2011

On March 11th, the markets got some more bad news in the form of higher than expected inflation in China, which will not help with the recent trend to avoid risk. According to Bloomberg:

Today’s reports signaled the central bank’s monetary tightening has been insufficient so far to contain prices, in an echo of pressures across Asia that spurred South Korea, Thailand and Vietnam to raise interest rates this week. People’s Bank of China Governor Zhou Xiaochuan said today interest rates will be used to curb inflation, and played down the role of currency gains, which U.S. officials have encouraged China to use.

On the employment front in the U.S., the Labor Department said in a statement released on Friday job openings in the U.S. decreased in January to the lowest level in four months. Job openings declined by 5.5%, caused in part by an 115,000 decline in professional and business services openings and a similar 115,000 decline in government openings.

Other concerns that warrant a continued defensive stance include:

  • According to Bloomberg, twelve lenders, including eight savings banks and the Spanish units of Deutsche Bank AG (DBK) and Barclays Plc (BARC), are among the lenders that fell short of government-set capital requirements, the Bank of Spain said yesterday.
  • This morning’s Bloomberg also states that more than two months of protests have rocked the Middle East and North Africa as citizens demand civil rights, higher living standards and the ouster of entrenched autocratic regimes. In Bahrain, a Saudi neighbor and home to the U.S. Navy’s Fifth Fleet, mainly Shiite protesters are pressing their demands for free elections and a constitutional monarchy.

On March 1st we mentioned some short-term technical indicators that were of concern on a daily chart of the S&P 500. The concerns, not helped by the news of unrest in Saudi Arabia, are now spilling over to the S&P 500’s weekly chart, which means two things from a strategy perspective:

  • The intermediate-term outlook for stocks is deteriorating and needs to be monitored closely.
  • We need to be prepared to raise additional cash if the market breaks down further.

On Thursday, we continued to migrate away from risk using the incremental approach by reducing our exposure to energy (XLE) and materials (XLB). Many, including us, question the role speculation is playing in the energy markets. CNN says

Crude oil is trading at about $99 a barrel. That really doesn’t make a heck of a lot of sense. There are no legitimate supply concerns regarding oil right now.

In recent weeks, we have cut back on our exposure to consumer discretionary (XLY), technology (QQQQ), and commodities (JJC). Our decision to cut back on energy and materials was due in part to the strong move in the U.S. dollar on Thursday. We have also been concerned about the recent moves in “flash crash” assets.

There are numerous concerns on a weekly chart of the S&P 500, including the possible bearish cross of the indicator shown below. Until the news gets better and the technicals improve, we will maintain a defensive bias.

Defensive Game Plan

Updated Charts for Our Risk Management Game Plan

Thursday, March 10th, 2011

Based on closing prices (2nd chart below), if the S&P 500 finishes today below 1,306, we would be more apt to raise additional cash. Using intraday figures (top chart below), a move below 1,294 would also increase our desire to raise/hold cash.

Defensive Game Plan

In the past, we have expressed concern about the pink trendlines below. They still concern us in the short-to-intermediate-term.

Defensive Game Plan

We have also shown the chart below highlighting 1,313 as an area that may be difficult for the S&P 500 to overtake and hold. A market close below 1,313 would also increase our desire to remain defensive for now. Please see this morning’s post for more information.

Defensive Game Plan

VIX, ‘Flash Crash’ Assets Tell Us Bears Are Gaining Traction

Thursday, March 10th, 2011

Traders, money managers, and individual investors have numerous concerns relative to the ‘risk-on’ or inflation trade:

  • QE2 is set to be completed in June.
  • Spain’s credit rating was downgraded today.
  • Unemployment remains high.
  • Ongoing unrest in the Middle East.
  • Surging oil prices threaten the economic recovery.
  • Eye-popping budget and entitlement problems in the U.S.

In order to better understand the possible impact of the completion of QE2, we are in the process of studying the ‘flash crash’ period and the period following Ben Bernanke’s August 2010 Jackson Hole speech. Our work to date may help us better understand the risks of a continuing correction in today’s markets.  As outlined on March 3, the longer-term outlook for stocks remains favorable, but the short-term outlook is cloudy.

There were very few places to hide during the flash crash correction which kicked off on April 23, 2010. The pain for investors did not end until the S&P 500 had given back 13.20% before finding some footing on August 27, 2010. The table below shows a select list of ETFs that provided defensive cover during the dark days of 2010.

Defensive ETFs  Defensive Investments

In the minds of market participants, the assets listed above were the safe havens of choice when the dial on the risk trade moved from “on” to “off”. On Valentine’s Day 2011, defensive assets began to show improving relative strength vs. the S&P 500. The flash crash winners highlighted in blue above have continued to draw increasing interest from buyers over the past four weeks (see relative strength charts below). The investments listed in the table above serve as a de facto shopping list should the current pullback morph into a full blown correction.

The relative strength lines of the VIX or the ‘fear index’ and utilities have moved higher in recent weeks, indicating increasing concerns about further downside in risk assets.

Relative Strength Defensive ETFs  Defensive Investments

While relative strength is a term from technical analysis, the concept of buyers becoming more interested in defensive assets falls under the common sense category when it comes to risk management. Based on other concerns, we already hold the highest percentage of cash since late November 2010 as a way to reduce risk until the threat of continued downside subsides somewhat. In terms of current strategy, the increasing relative strength of defensive assets tells us:

  • Market participants are becoming increasingly nervous.
  • Further downside is possible.
  • To continue to monitor defensive assets.
  • To be open to raising more cash, based on the incremental approach, should conditions deteriorate further.

Increasing interest in bonds is not good news for stock and commodity investors.

Relative Strength Defensive ETFs  Defensive Investments

For those not familiar with technical analysis, the green lines in the relative strength charts all have positive slopes, which highlight an increasing interest in defensive assets relative to the stock market in general.

Gold’s safe haven status appears to be intact.

Relative Strength Defensive ETFs  Defensive Investments

It is not time to panic relative to the possible continuation of the current correction, but we are happy we have taken some profits off the table in recent weeks. The defensive assets shown above will continue to help us monitor the risk tolerance of market participants, who ultimately determine the value of our portfolios.

Corporate bonds and stocks in Malaysia held up well during the 2010 flash crash correction. Buyers are again showing interest over the last few weeks.

Relative Strength Defensive ETFs  Defensive Investments

Most Attractive Commodities Are Benefiting From QE2

Wednesday, March 9th, 2011

Haven’t we seen this movie before? The economy enters a recession; we have a bear market, the Fed cuts interest rates drastically flooding the global financial system with cash, and commodity prices begin to soar.

In the United States, the Fed has a handy way to ignore rising commodity prices, something they call core inflation. While most of us eat, drive, and heat our homes, the Fed excludes food and energy from its core inflation reading to remove “volatile” components of the inflation equation.

A March 3 Financial Times article touched on the Fed’s current focus in terms of inflation and monetary policy – the key points related to the commodity markets are below:

  • Most members of the Fed’s rate-setting Federal Open Market Committee have remained steadfast in their preference for looking at core inflation.
  • Core consumer prices, excluding food and energy, were up by 1% vs. a year ago in January, while the headline index rose by 1.6%.
  • “The Fed remains focused on core inflation at the consumer level, which it thinks will be restrained by high unemployment, and largely dismisses higher food, energy, and commodity prices,” said John Ryding, chief economist at RDQ Economics.

The Fed carries our monetary policies, including quantitative easing, by giving freshly printed cash to the network of eighteen primary dealers in exchange for bonds in the dealer’s inventory. Since the real world implementation of monetary policy, including QE2, floods the global financial system with cash, it is easy to understand how some of this money finds its way into the global commodity markets. Since we believe the Fed’s role in today’s asset markets is more significant than even what is perceived by experienced investors, we published a series of articles on Quantitative Easing and Asset Price Inflation in October 2010. Since then, commodity prices have surged. Understanding what QE is and how it works can help you make better investment decisions.

If excess liquidity is making its way through the global financial system, it is helpful to know where the majority of funds are flowing in the commodity complex. Ciovacco Capital’s proprietary asset classing ranking models compare 220 different investment options around the globe, across market sectors, and numerous asset classes, including commodities. Using liquid ETFs as a proxy for the underlying commodities, how do commodity investments compare head-to-head in terms of their outlook for the next three-to-twelve months? The table below shows the results for our March 1 rankings.

Attractive Commodity ETFs

While we are not out of the correction woods yet relative to the short-term, as we outlined on March 3, we believe the longer-term outlook for risk and inflation-friendly assets, including commodities is postive.

From a fundamental perspective, the primary drivers of these commodity markets are related to increased demand as the global economy expands and the attractiveness as a hedge against the loss of purchasing power caused by “at-the-checkout” inflation. Below are some specifics related to each commodity or investment:

  • DBC gives investors exposure to a wide variety of commodities, from zinc to heating oil. With global GDP expected to grow in 2011 and 2012, the demand for commodities should continue to be robust.
  • Silver (SLV) is the economically-sensitive precious metal cousin to gold. Silver has more real-world uses than gold, including electrical and chemical applications.
  • Agriculture (DBA) can benefit from rising populations and migrations from the lower to middle class, which are becoming more common in Asia as people move from rural areas to cities.
  • Gold (GLD) is more attractive than silver when concerns mount related to the economy, geopolitical tensions, and the financial markets. Gold is also attractive to global central bankers and individuals who are concerned about the Fed’s overworked printing presses.
  • According to the USGS, copper (JJC) is used in building construction, power generation and transmission, electronic product manufacturing, and the production of industrial machinery and transportation vehicles. Copper wiring and plumbing are integral to the appliances, heating and cooling systems, and telecommunications links used every day in homes and businesses. Copper is an essential component in the motors, wiring, radiators, connectors, brakes, and bearings used in cars and trucks.

One of the primary fundamental drivers of the commodity markets is the Fed’s loose policies. Ten-month relative strength, where we chart a commodity’s performance relative to the S&P 500, is one of the inputs in our asset class ranking system. The ten-month relative strength charts below give us a good visual indication of which markets are benefiting most from QE2 and near-zero interest rates.

Attractive Commodity ETFs Realtive Strength

Manpower Survey Bullish, But Correction Threat Remains

Tuesday, March 8th, 2011

We have some good news on the hiring front this morning, which aligns with our longer-term bullish outlook. However, we remain concerned short-term, and will be patient in terms of redeploying the cash we have raised in recent weeks. According to Bloomberg:

More U.S. employers said they plan to boost payrolls in the second quarter, and fewer expect to reduce headcounts, a private survey found. Manpower Inc. (MAN), the world’s second-largest provider of temporary workers, said today that 16 percent plan to add workers in the April-June period, up from 14 percent in the first quarter. The share of those projecting workforce reductions fell to 6 percent from 10 percent.

The Manpower survey and the improving labor market support our strategy to maintain our current positions in energy (XLE), commodities (DBC), and precious metals (SLV, GLD). The cash we have raised recently can help us offset some of the short-term risks associated with pro-growth/inflation-friendly assets.

The CCM Bull Market Sustainability Index (BMSI) has popped back up into the low-end of an unfavorable risk-reward zone, which means we will continue to err on the defensive side until conditions improve (see table below).

Stock Market Risk Profile

Little has changed relative to the table we presented March 7 titled “Patience is a virtue”, which again supports a “wait and see” approach with cash. The updated table below shows some improvement over Monday morning’s version, but still with a decidedly concerning slant.

Stock Market Risk Profile

From a longer-term strategy perspective, we are working on some research related to the possible impact of the looming QE2 completion date of June 30, 2011. We will present our findings and possible investment scenarios in the next day or so.

Short-Term Calls For Continued Patience

Monday, March 7th, 2011

As we outlined on Friday, the long-term outlook for stocks still remains favorable. However, the short-term outlook, from our perspective, requires some patience relative to investing cash. This morning’s Wall Street Journal states, “Many investors remain skeptical about the market’s strength”, which is bullish from a contrarian perspective. Below are a few bullet points from the WSJ that tell us to remain open-minded about further upside in stocks later this year:

  • Investors are willing to pay only a bit more than 13 times expected earnings for the next 12 months, well below the 10-year average of about 15.5, according to FactSet Research Systems.
  • Thanks to brutal cost cutting, companies have returned to levels of profitability last seen before the recession. And analysts expect earnings to hit records later this year
  • Even amid turmoil in the Middle East, oil prices rising above $100 a barrel and mild disappointment in Friday’s jobs data, the Dow rose last week—and it is up in four of the past five weeks.

The last point concerning recent market action is telling. The present day market has had more than enough reasons to correct significantly in recent weeks, and yet the S&P 500 sits only 1.7% off its recent highs. The S&P 500 has gained back more than half of the recent 3.7% mini-correction. Stocks have not made a new intraday low since February 24th. We have been concerned about a pullback (see 2/15 post), but we have to understand the pullback may be nearing its completion.

Our reasons for remaining a little skeptical with our cash relate back to the technical “things we would like to see” from March 3. The table below summarizes and updates the technical conditions we are monitoring. For those not familiar with technical analysis, the orange boxes mean we are not out of the correction woods yet (as of Friday’s close). Should the conditions above improve, we will take a look at the shopping list from our March 3 outlook post.

Like to See - Investing Blog

Stock Market Outlook and Attractive Sectors

Thursday, March 3rd, 2011

As we prepare for Friday’s employment report, it is a good time to review both the market’s outlook for the next few months and our possible investment approach. For those keeping score at home, the consensus forecast for Friday’s employment number is 180,000; the range of forecasts spans from 120,000 to 255,000. Thursday saw the biggest gain in stocks thus far in 2011. According to Bloomberg:

The Institute for Supply Management’s index of non- manufacturing businesses increased to 59.7 from 59.4 in January. The median forecast of economists projected the index would fall to 59.3. Same-store sales rose 4.3 percent last month, beating an overall compilation of analysts’ estimates for a gain of 3.8 percent at the 27 chains tracked by Retail Metrics. Separate government data showed productivity climbed more than estimated and labor costs dropped more than forecast.

Market breadth was decidedly positive Thursday, especially the up/down volume stats for the NASDAQ. Trading volume was slightly higher than the previous session on both the NASDAQ and S&P 500, but a little disappointing relative to the magnitude of the gains.

This week we have updated our asset allocation models, which allowS us to compare 220 asset classes/sectors/investments head-to-head. We have a short list of possible buy candidates should it be needed on Friday. The recent strength in economic data still has energy (XLE) and numerous energy-related subsectors looking attractive, including oil & gas equipment and services (XES), oil & gas exploration and production (XOP), and oil equipment providers (IEZ).

An economy that may not have been hurt as bad as anticipated by rising oil prices also puts the broad market (VTI) and economically-sensitive semiconductor manufacturers (SMH) on our short-list of possible buy candidates. Agriculture (DBA) has been consolidating for a month and may be poised to regain traction should the market applaud the much-anticipated employment report due Friday morning at 8:30 a.m. ET.

Semiconductors Relative Strength

We would prefer to see the market’s reaction to tomorrow’s employment number before making any moves. While Thursday’s market was impressive, numerous short-term indicators, including MACD, have not crossed bullish thresholds, meaning we will remain patient with cash until we see what we want to see. For those who want more technical analysis, this post shows additional things we are looking for in terms of feeling better about the recent rally attempt.

Like to See

In terms of the market’s outlook for the coming months, the CCM 80-20 Correction Index tells us the market’s current profile has produced favorable results more often than not over a three-to-twelve month time horizon. As we mentioned on March 3, we are still concerned about corrective activity, but we are not concerned about a full-blown bear market at the present time.

Risk Reward Profile Stock Market

Similarly, the CCM Bull Market Sustainability Index (BMSI) also points to a favorable risk-reward profile for investors looking out three-to-twelve months.

Stock Market Outlook

As shown below, the S&P 500 still sits above potential support from 2008. The recent intraday low was 1,294, which was made last Thursday. As long as we hold above 1,294ish to 1,291ish, it makes sense to hold our current positions.

Stock Market Support

With Employment Report Friday, We Will Remain Patient

Thursday, March 3rd, 2011

We would prefer to see the market’s reaction to tomorrow’s employment number before making any moves. This week we have updated our asset allocation models, which compare the 220 most liquid ETFs head-to-head. We have a short list of possible buy candidates should it be needed tomorrow.

While today’s market is impressive, numerous short-term indicators have not crossed bullish thresholds. Below are some things we would still like to see from the S&P 500. We will see what tomorrow brings.

S&P 500:  Things we would like to see