Today marked the second trading day in a row where market breadth was strong. There were 260 new highs made on the NYSE and only 29 new lows. We took a good portion of our cash off the sidelines today. We will remain flexible and purposely used broad-based instruments to gain additional market exposure.
Archive for May, 2011
The short-term news today is positive with hope centering around another aid package for Greece. According to Bloomberg:
Stocks rose around the world, paring their worst monthly performance since August, and the euro strengthened amid speculation nations will pledge more aid to Greece. The cost of insuring bank debt fell the most in six weeks, while U.S. index futures and commodities gained.
Mark Mobius always seems to make level-headed comments. Bloomberg talked with him and the longer-term outlook requires plans for the possibility of a volatile future:
Mark Mobius, executive chairman of Templeton Asset Management’s emerging markets group, said another financial crisis is inevitable because the causes of the previous one haven’t been resolved.
If the markets can sustain their gains today, especially on strong breadth and volume, we are happy to redeploy some of our cash. How much we redeploy (if any) will depend on what we see today. We are still concerned about this market and do not see many sources of strong leadership as of Friday’s close. As a result, if we redeploy cash, it will be done via a broad-based index, something similar to the S&P 500. We want to use vehicles that have low transaction costs to give us maximum flexibility, since it remains to be seen how long this rally attempt will hold up.
From a bullish perspective, the initial move back up after a period of consolidation can often look weak and unconvincing. Overtime, it can morph into a substantial rally, which means we have to be open to gains that are larger than one would expect at this time. As always, flexibility is very important. We should learn a lot today – what matters is how we finish the day, not how it begins. As we mentioned late in the day, market internals were much improved on Friday.
Below is an update to the congestion chart we showed before the open today. Market internals are much improved today, especially new highs vs. new lows. We are open to redeploying cash if the market can muster a convincing stand.
The dollar is weak today, which also favors bullish outcomes. An open mind and patience are in order for now.
A close above 1,336 (see below) is a good next step for the bulls if they hope to reverse the current short-term downtrend. The more important number, in terms of a trend change, is 1,344, which was the last short-term peak in the S&P 500. Three things need to happen for the bulls: (1) a close above the downward sloping blue trendline (near 1,332), (2) the subsequent low must remain above 1,311, and (3) a new high would have to follow above 1,344.
Here is an updated version of a chart we showed on May 26.
We covered a more bearish perspective earlier today. The bullish case, in the short run, is shown in the chart below. A close below 1,304, especially without bullish divergences present, would possibly open the door to a more rapid decline in stock prices. Price has held at the green and blue arrows in the recent past; those lines are coming into play soon.
Another possible bullish signal short-term could come in the form of an “inside day”. An inside day occurs when the current session’s range stays within the range of the previous day. For example, the high yesterday was 1,325.86 and the low was 1,311.80. If today’s range does not move outside the bounds of yesterday’s trade, it indicates indecision, and often is followed by a change in the short-term trend. The current short-term trend is down.
The Summation Index is a market breadth indicator that is derived from the number of advancing and declining stocks in a given market. The concept of breadth is easy to understand; healthy markets have broad participation during rallies.
We showed some wedge formations that we were concerned about on May 13. A similar wedge was recently broken in a bearish manner on the chart of the Summation Index (see purple arrow). The indicator at the bottom of the chart is known as ADX. ADX measures the strength of a trend. The green and red lines help identify the direction of the trend. The cross of the red line above the green line (see orange arrow) leans bearish for market breadth, and indirectly bearish for the stock market. The black line (red arrow) shows a “sleepy trend” that may be ready to pick up steam. If the current trend picks up steam, it would lean bearish for stocks.
It can be a bearish signal when you get a decent number of new highs and a decent number of new lows occurring at the same time. It shows a confused market. These stats can shift rather quickly during the day - so we may not finish in this manner.
IYT (transports) is one of the better looking markets right now. It is up today, but so far on relatively tame volume. Average daily volume is 1,051,310 shares. As of 1 pm only 323K shares have traded.
From a fundamental perspective there are numerous reasons to be concerned:
- Debt limit issues in United States
- Ongoing debt crisis in Europe
- Fed QE2 ending in June
- Earnings growth appears to be slowing
- Economic data has been weak recently
Our concerns became more pronounced when the technicals began to align with the weakness/concerns related to the fundamentals. Since a picture is worth a thousand words, the next two charts show (a) what we saw on May 13 as posted in Short Takes, and (b) the same chart as of the close on May 24, 2011 (2nd chart below).
The deterioration is obvious in both RSI (top of charts) and within the market itself. The short-term trends have been broken from the March 2011 lows, which is not that big a deal taken in isolation. As we will show below, the deterioration is spilling over into weekly charts and intermediate-term daily charts, which makes the short-term weakness more important.
The intermediate-term trend on a daily chart from the summer 2010 lows was recently violated (see upper-right portion of chart).
The chart below takes some of the noise out by showing only closing prices on a daily basis.
From a technical perspective, the most pressing concern is that we have yellow and red flags on weekly charts. At point A, MACD recently had a bearish cross and then failed again at the orange arrow. At point B, On-Balance-Volume (OBV) broke below the orange line and currently has a bearish divergence with price. At point C, CCI also broke below the orange line and has a bearish divergence with price. At point D, Rate-of-Change (ROC) has now crossed below the zero line for the second time, which leans bearish.
Could the market firm here and be followed by improvement in the charts? Absolutely it could, but until it does, we will err on the side of protecting hard earned capital. We are happy to redeploy cash rapidly if we see improvement that appears to be sustainable.
We raised cash in more traditional areas on Monday, including technology (QQQ), industrials (XLI), and foreign stocks (EFA). The S&P 500 closed below both the green downward-sloping trendline and the 50-day moving average (blue). We may find some buying support, at least for a time, near the horizontal green line, which sits near 1,307. A close below 1,307, especially if no short-term bullish divergences are present, would increase the odds of a more significant sell off.
Energy and commodity-related positions did have some very-short-term bullish divergences on daily charts. It may not mean much, but it is worth seeing how it plays out over the next few days. Given the problems in Europe and United States, we will maintain a bearish/defensive bias until we see some improvement.
A sharp selloff in risk and inflation protection assets may influence Fed policy in the weeks and months ahead. Opportunities, in the form of attractive risk-reward entry points, may present themselves in the not too distant future. If that is the case, our current, relatively large, cash position would allow us to do some buying after prices have come down.
We spent Sunday reviewing all our holdings and numerous markets using monthly, weekly, and daily charts. Based on the bearish signs in numerous markets and time frames, we also prepared for the next possible round of defensive moves.
The recent declines in commodities were caused in part by the approaching end of QE2 and rising inflation expectations. Bloomberg noted a sharp increase in inflation expectations, which may continue to drag down stock prices:
Expectations for annual consumer-price gains have jumped by 43 percent to 2.10 percentage points since the central bank began its second round of asset purchases in November, as measured by the breakeven rate for five-year Treasury Inflation Protected Securities. The measure is close to levels before the recession — when the central bank’s benchmark interest rate was 5.25 percent, compared with about zero today.
The weekly chart of the S&P 500 below aligns well with possible concerns about the Fed and inflation. A potentially bearish reading on a weekly chart should be taken more seriously than one found on a daily chart. During a healthy advance, indicators, such as RSI, tend to make higher highs when the market makes a higher high. That is not what we have on the chart below, which means we should continue to be open to raising more cash this week. Materials (XLB) and foreign stocks (EFA) would be the first place for us to look relative to possible sales.
The daily chart of the S&P 500 below also points to a market that may be looking over its shoulder for the Fed. The blue arrows show a series of lower highs. The red arrows highlight lower lows. Put the blue and green arrows together and you have the makings of a bearish short-term trend in stocks.
With the QE2 June termination date right around the corner, the S&P 500 closed last week below 1,336, a level that has been important to traders since early April. The longer we stay below 1,336, the more we will err on the side of playing defense.
We mentioned on May 13 that defensive stops were needed in a fragile environment. We currently have a substantial cash position, as many of our lines in the sand have been crossed. If weakness continues, which seems to be the current bias, we are willing raise more cash.