Archive for August, 2011

Resistance Levels Cluster Between 1,220 and 1,260 for S&P 500

Wednesday, August 31st, 2011

As we have mentioned in the past, big countertrend rallies are common in bear markets. The rallies below are from the last bear market (2008).

Overhead Resistance For Stock Market - Ciovacco Capital - Short Takes

Our comments from noon today are supported by the charts below:

As of Noon EDT: After reviewing the big picture, we are inclined to be patient and not chase the market from these levels. We will post some charts and additional comments later today. Odds are very high we will choose the “do nothing” alternative. We want to see how this market handles the next form of bad news. If anything, between current levels and 1,260 , we can envision traders beginning to sell. Keep in mind, we stated on August 12 that a rally back toward 1,260 was well within historical norms.

Overhead Resistance For Stock Market - Ciovacco Capital - Short Takes

Overhead Resistance For Stock Market - Ciovacco Capital - Short Takes

Overhead Resistance For Stock Market - Ciovacco Capital - Short Takes

Overhead Resistance For Stock Market - Ciovacco Capital - Short Takes

Overhead Resistance For Stock Market - Ciovacco Capital - Short Takes

Overhead Resistance For Stock Market - Ciovacco Capital - Short Takes

Hedging Strategies May Now Come Into Play

Wednesday, August 31st, 2011

As of Noon EDT: After reviewing the big picture, we are inclined to be patient and not chase the market from these levels. We will post some charts and additional comments later today. Odds are very high we will choose the “do nothing” alternative. We want to see how this market handles the next form of bad news. If anything, between current levels and 1,260, we can envision traders beginning to sell. Keep in mind, we stated on August 12 that a rally back toward 1,260 was well within historical norms.

This morning’s ADP Employment Report showed 91,000 new jobs created in August, which is good relative to the market’s extremely low expectations. The majority of markets closed above their 20-day moving averages yesterday, which is the first sign the short-term risk-reward outlook is improving. Another positive development, especially if it can hold, is a handful of markets, including the S&P 500 Index, have 200-day moving averages that are either flat or turning up again. If you look at the math on calculating the 200-day for the S&P 500 Index, you see that as long as the S&P 500 can stay near or above 1,200, the 200-day would remain flat or turn up a little over the next few weeks.

If the S&P 500 can hold above 1,200, we are open to adding some risk back into our portfolios. If the markets were to become weak again, we would most likely offset the risk-oriented positions by hedging with an inverse position – which is a form of fence-sitting in the short-run. If the market moves higher in a convincing manner, you remove your hedges and consider adding more risk. If the market drops rapidly again, you remove your risk-based/long positions and keep your hedges, which can make money as markets fall. The “do nothing” alternative is also an option.

We have seen enough to at least consider implementing a long followed by a short/inverse (if necessary) strategy. Step one would be to add some risk. Step two is to decide if you want or need to hedge that risk in the coming days and weeks. Step three (if applicable) would be to decide to keep the bullish positions or the keep the bearish positions. This basic strategy is discussed in the video we posted on August 29. Please see these comments from last night for more information. It should be noted that any long/short strategy should be considered only by very experienced market participants.

These ETFs have 200-day moving averages that have ticked back up:

DBA, RJA, PGX, TIP, XOP, IYR, XLB, IBB, XLE, FCG, MDY

These ETFs have 200-day moving averages that have flattened out:

DVY, EWC, VNQ, IEZ, EWA, OIH, SPY, VTI, RSP, IWD

Tepid Interest in QE2 Winners Raises Questions About QE3

Tuesday, August 30th, 2011

The Federal Reserve printed money in 2009 and bailed out the stock market. The Federal Reserve printed money in 2010 and bailed out the stock market. As the financial markets anticipate the next Fed statement due to be released on September 21, the markets are again teetering on the edge of a deflationary abyss.

On August 30, the Fed released the minutes from their last policy meeting. Before we take a look at the buying interest in top-performing QE2 ETFs, let’s review the key portions of the Fed minutes:

Committee’s forward guidance regarding the federal funds rate, by being more explicit about the period over which the Committee expected the federal funds rate to remain exceptionally low, would be a measured response to the deterioration in the outlook over the intermeeting period. A few members felt that recent economic developments justified a more substantial move at this meeting, but they were willing to accept the stronger forward guidance as a step in the direction of additional accommodation. Three members dissented because they preferred to retain the forward guidance language employed in the June statement.

The Committee noted that it had discussed the range of policy tools that were available to promote a stronger economic recovery in a context of price stability, and to indicate that those tools, including adjustments to the Committee’s securities holdings, would be employed as appropriate.

The most important phrases appear to be “were willing to accept the stronger forward guidance as a step in the direction of additional accommodation” and “to indicate that those tools, including adjustments to the Committee’s securities holdings, would be employed as appropriate”. The “step in the direction of additional accommodation” implies that there will be another step, which supports the stance that more quantitative easing (QE) may be on the way.

On August 18 we examined the winners from QE2 to assess the market’s stance on the probability of a third round of quantitative easing (QE3). The statements from the Fed minutes above were new information for traders as of 2 p.m. on August 30. If traders and institutional investors believed QE3 was due to be announced after the September 21 Fed meeting, common sense tells us the trading volume for the winners from QE2 should be above average. The table below shows just the opposite – trading volume for the QE2 winners was unimpressive on the day the Fed minutes were released.

QE2 Winners ETFs - Ciovacco Capital - Short Takes

You can make the argument that volume in general has been light due to August vacations. We do not buy that argument. When profits and manager performance are on the line, vacations do not get in the way of what is perceived to be an opportunity to front run the Fed. You can read the lack of interest in QE2 winners in one of two ways:

  1. The market does not believe QE3 is imminent.
  2. The market questions if QE3 will be effective in boosting asset prices in a sustained manner.

We believe the odds of QE3 being announced at the September meeting are higher than what is baked into the market’s cake. We will continue to monitor the QE2 winners for clues to assist us in making the best decisions possible. It is possible volume and interest in QE2 winners will pick up in the coming days, but until it does, we will continue to hold cash and a small allocation to bonds (TLT). If you missed the August 30 video below, it describes possible strategies based on how the present day market behaves relative to similar markets from 1987, 1990, 1998, 2000, and 2007.

Video: 2011 Correction or Bear Market?

Video: 2011 Correction or Bear Market?

Strategies For The Current Rally In Stocks

Tuesday, August 30th, 2011

Assuming the intermediate-term bearish outlook does not change, we will be looking to use the recent rally as a possible opportunity to consider adding to our bear market assets (bonds, cash-alternatives, inverse ETFs, etc.). Some fixed-income instruments that did well in the entire 2007-2009 bear market and also did well in Phase II of the bear market (they did well in both periods) include BND, IEF, TLT, SHY, AGG, MBB, TIP, and BSV. The inverse ETFs fitting that profile were PSQ, RWM, and SH. The video below compares the present day stock market to 1987, 1990, 1998, 2000, and 2007.

Video: 2011 Correction or Bear Market?

Video: 2011 Correction or Bear Market?

Short List of Buy Candidates Not Very Attractive

Monday, August 29th, 2011

As of 2:45 p.m. EDT, volume on the NYSE was 31% lower than the same time on Friday. Institutions are taking a more cautious approach than individuals today:

From a short-term perspective, there is no question the market has shown some real signs of improvement, meaning the current rally could continue for a time. However, as we review the most attractive investment opportunities, based on head-to-head rankings, the intermediate-term outlook remains unfavorable. We are having difficulty finding risk-based investments with reasonable risk-reward entry points. As we mentioned last week, we like agriculture (DBA). We would like to take a stake in DBA based on strong fundamentals (see article) and relatively attractive technicals. Volume in DBA was unimpressive on Thursday and Friday of last week. Today, as of 11 a.m., DBA has given back most of its gain for the session. We will continue to look for reasonable buy candidates, but we have no interest in entering a market that remains questionable from a longer-term perspective. The current rally still looks vulnerable to selling in the days ahead.

Many markets look better in the short-term, but longer-term many hurdles remain making buys at current levels questionable from a risk-reward perspective.

Dividend ETF DVY Technical Analysis - Ciovacco Capital - Short Takes

Europe, Bearish Technicals Drag Down Longer-Term Outlook for Stocks

Sunday, August 28th, 2011

With Ben Bernanke’s Jackson Hole speech in the rear-view mirror, the markets will most likely turn their attention back toward Europe. In the short-run, it is doubtful market-calming news will emerge concerning debt and slowing growth in Europe. Add in a bear-market-like technical back drop (see video below) and we have a recipe for continued stress-inducing volatility in the stock, bond, commodity, and currency markets.

While a strong countertrend rally in risk assets could easily emerge following the recent waterfall declines, comments from policymakers will remind seasoned traders sharp rallies are often retraced in relatively short order when conditions are this unsettled. Christine Lagarde, the new managing director of the International Monetary Fund, said in her prepared remarks over the weekend in Jackson Hole:

  • European banks should be required to raise more capital to prevent further contagion of the debt crisis.
  • The United States needs to address the slide in housing prices.
  • Short-term stimulus is needed in both the U.S. and Europe.

Lagarde said the global economy has entered a “dangerous new phase” in which “we risk seeing the fragile recovery derailed.” In the United States, many questioned the need for Bank of America to raise additional capital, and yet the mortgage-saddled bank gladly took in new funds from Mr. Buffet. In Europe, talk centered around the shorts and traders targeting banks without merit, and yet the director of the IMF sees reasons to be concerned. The problems in Europe are far from over.

In the September 5 issue, Fortune reported on the growing concerns about the mountains of debt in the euro economy:

Even if Europe’s banks don’t face a liquidity crunch, a drop in the value of sovereign bonds would severely deplete their capital, forcing them to halt new lending. The credit crunch would probably throw Europe into a severe recession. That in turn could kill the U.S. recovery, since the European Union accounts for 21% of U.S. exports. Even a truly apocalyptic outcome — where one or more weak nations abandon the euro, causing gigantic defaults and a Europe-wide banking crash — can no longer be dismissed.

Without question, the markets face serious fundamental hurdles. As we outline in the video below, the current technical backdrop for stocks compares favorably enough with the dot-com and mortgage/housing bull market peaks to keep an open mind about lower lows in the months ahead. Even if we have entered a new bear market, countertrend rallies are to be expected. The video covers some bull/bear clues to watch for in the coming weeks.

Video: 2011 Correction or Bear Market?

Video: 2011 Correction or Bear Market?

This week brings some important economic reports which have the potential to move the markets. The best hope for bullish outcomes is better than expected economic progress since many believe countries can grow their way out of this mess. Thursday’s ISM manufacturing report is forecast to come in at 48.5, indicating a contraction in manufacturing activity. On Friday morning, the monthly labor report is due to be released. The early Bloomberg consensus calls for a meager 67,000 jobs; the low end of the forecast range calls for a loss of 5,000 and the high end points to 150,000 new jobs having been created.

Our approach in the short-term is to respect the bearish tone while keeping an open mind about better than expected outcomes. At some point, a sharp and somewhat promising rally will materialize. As the rally begins to take shape, we will review the relative merits of the long (SPY) and short (SH) sides of the market. If a stock rally looks unconvincing, we will also consider adding to our positions in fixed income instruments, such as TLT and BND, under more favorable risk-reward conditions. We will continue to watch the list of top-ranked ETFs for both bullish and bearish indications. Should stocks rally, we will be looking for signs of shorts entering the market between 1,180 and 1,230 (see chart below).

ETF Rankings Technical Analysis - Ciovacco Capital - Short Takes

Today’s Rally: Good, Not Great

Friday, August 26th, 2011

From CNBC:

A plunge in recent economic data puts the probability of a double-dip recession above 80 percent, according to modeling by Bank of America Merrill Lynch released Wednesday, reflecting the toll the U.S. debt downgrade, Europe’s woes and stock market volatility has taken on economic activity.

Wild intraday swings in prices are common in bear markets. Sharp countertrend rallies are also common within the context of a downtrend. Volume on the NYSE is running lower than yesterday’s levels, which shows a lack of conviction to buy. Market breadth is excellent and may indicate this rally has further to run. We have stated for some time that a countertrend rally all the way back to 1,260 would be well within the bounds of a bear market rally. We are happy to reenter this market if we see what we what to see. We need to be concerned where the market will be in three months, not three days or three weeks.

Notice in the chart below: (a) the slope of the 200-day is negative (thin blue line), (b) the 50-day (thin red line) is below the 200-day, (c) price is below the 50-day, and (d) price is below the 200-day. These are common to bear markets, not bull markets. The current rally, given what we know today, looks like a typical bear market rally. Please revisit the video in this post for more on (a) through (d) above.

ETF Rankings Technical Analysis - Ciovacco Capital - Short Takes

The top buy candidate we have right now is DBA, the agriculture ETF. While there are many good signs on a daily chart, DBA is approaching an overhead resistance level where it has reversed in the past. DBA normally trades 2,000,000 shares per day. As of 2:10 pm. EDT, DBA has tallied only 912,000 shares. We would like to see DBA break above resistance on a day where at least 2,500,00 shares change hands. DBA may break to the upside and we may buy it, but some patience is in order. The debt problems in the United States and Europe will be with us when we open for business next week. We will make decisions based on evidence rather than emotions. The evidence may surface next week, but it is not here yet.

ETF Rankings: Significant Downside Still Possible In Stocks

Friday, August 26th, 2011

On August 3, we commented that recent breakdowns called for a defensive bias. Unfortunately, our concern about the market’s intermediate-term outlook has become more acute in recent weeks as we noted on August 22. The research presented below highlights the significant downside risks that remain in the financial markets. Until conditions improve, we will maintain a very defensive/high cash posture.

Prior to Ben Bernanke’s Jackson Hole remarks, we reviewed all 223 of the most liquid ETFs that we follow using the CCM Asset Allocation Model. The results of the screening and ranking process are not encouraging. Prior to the Jackson Hole speech, risk markets look absolutely terrible. The list below, with the exception of gold (GLD), points to deflationary outcomes. Fear of deflation could eventually induce more selling in gold and silver.

Notice the bearish tone of the top-rated positions in the table below – the VIX, shorts, bonds, and gold. Unless the tone of the market and the tape improve dramatically, all the evidence we have in hand before the open on August 26 points to significant downside risk in global equities. Note the positions listed below will be the exact wrong place to be in the event of a rally in risk assets, which is why we prefer to remain patient looking for better entry points and/or a read on the market’s reaction to Jackson Hole.

ETF Rankings Technical Analysis - Ciovacco Capital - Short Takes

Even in the top-rated ETFs above, we see little in terms of attractive risk-reward entry points. We like the short side of the market, but we would prefer to find a better entry point. Gold still looks good, but the recent volatility has a toppy characteristic to it. We will revisit the top fifty or so ETFs in our recent ranking post- Jackson Hole. We are open to better than expected outcomes, but there is very little evidence, if any, to support the bullish case. The tape needs to improve. The ETFs above could be very volatile – inexperienced investors and traders should be very careful.

Action in Gold and Silver May Be Bearish For Stocks (Updated)

Wednesday, August 24th, 2011

Updated as of 8:00 a.m. Thursday

After Wednesday’s close, the Chicago Mercantile Exchange announced that they were raising the margin requirement for gold by 27%. This means the collateral they need to hold from traders buying on margin (borrowed money) jumped by 27% in a day. This is basically an attempt to break the back of gold. Central bankers do not like to see gold rising in a rapid fashion since it draws attention to their inflation-inducing and currency-debasing printing presses. Is it just a coincidence that the margin requirement was raised two days before Chairman Bernanke’s Jackson Hole remarks? It’s difficult to say “commodity prices have come down” when the chart of gold is rising in a vertical manner.

Since significant gains can evaporate quickly in markets heavily dependent on printed money, we booked our profits in gold (GLD) on Wednesday. We also sold our remaining stake in silver (SLV). While it may not feel that way given the last two days, gold is still up significantly off the summer 2010 lows.

Gold Silver Ratio Technical Analysis - Ciovacco Capital - Short Takes

Gold and silver may both go on to make new highs, but their current risk-reward profile is much less attractive following gold’s recent vertical ascent. We are very open to re-entering gold when a more attractive risk-reward profile is in place. While it has also been hit hard in the last two trading days, silver was still a better place to be than stocks over the last three weeks.

Gold Silver Ratio Technical Analysis - Ciovacco Capital - Short Takes

Given the Fed wants to avoid deflation, especially in the form of falling asset prices, the two-day sell-off in gold and silver does not give a lot of confidence in the market’s expectation for inflationary/bullish outcomes following the Fed’s Jackson Hole speech this Friday. Silver was the biggest winner after last year’s inflation-inducing QE2 remarks from Jackson Hole. As noted on August 18, traders do not seem to be expecting a repeat performance of the 2010 post-Jackson Hole market.

The chart below shows the current gold/silver ratio (GLD/SLV). Silver tends to outperform gold during economic expansions and periods of positive inflation. Gold tends to outperform silver when fears of economic weakness and/or deflation move to the forefront. Notice the gold/silver ratio moved back above its 200-day moving average on Wednesday - the ratio is also close to a bullish crossover, as the 50-day approaches the 200-day (see chart below). These are deflationary, and possibly bearish, developments for asset prices. Given the change in margin requirements for gold, we do not want to read too much into any short-term analysis in the precious metals market, but the balance between downside risk and upside potential remains a little uncomfortable.

Gold Silver Ratio Technical Analysis - Ciovacco Capital - Short Takes

In the context of the last bear market, the move above the 200-day moving average that is shown above may not be a good sign for stocks, gold, or silver over the next few months (see next four charts).

Gold Silver Ratio Technical Analysis - Ciovacco Capital - Short Takes

Gold Silver Ratio Technical Analysis - Ciovacco Capital - Short Takes

Gold Silver Ratio Technical Analysis - Ciovacco Capital - Short Takes

In 2008, gold did recover and make a higher high, which is obviously possible in the coming weeks.

Gold Silver Ratio Technical Analysis - Ciovacco Capital - Short Takes

Gold Silver Ratio Technical Analysis - Ciovacco Capital - Short Takes

We are open to revisiting stocks if, and only if, we see something more than a snap-back rally. Our August 25 post identified another in a long series of concerning bearish developments for stocks. Volume on both the NYSE and NASDAQ was lower on Wednesday vs. Tuesday, indicating the big players were not participating as enthusiastically as individuals. Stock market breadth was positive, but far from great (not really aligned with the gains on Wednesday). It would not be surprising to see hedge funds short this rally in the coming days, especially if the S&P 500 gets back to the 1,200 to 1,260 range, which would not be out of character for a countertrend rally in a bear market.

Given what we know today, the current rally in stocks may be nothing more than a standard bear market bounce. If the Fed disappoints on Friday and stocks can hold their own, it may mean the economy is in better shape than what the markets have priced in (a bullish sign). Regardless of what is said at Jackson Hole, the market’s reaction will help us. The bias remains to the downside, but the bulls have made some short-term progress in the form of stabilization. We need more information before deciding if we like the long or short side of these markets. We have a neutral stance with cash and a relatively small allocation to bonds (TLT).

Bulls Need to Recapture 1,200 on S&P 500 Before Month’s End

Wednesday, August 24th, 2011

This morning’s much better than expected durable goods report for July has bullish and bearish implications:

  • Bullish – economy is better than expected.
  • Bearish – Less likely the Fed will deliver a market-friendly speech at Jackson Hole on Friday.

It should be noted the durable goods number this morning was for July - before the stock market dropped. Consumer and business confidence had not been hit hard yet by falling asset prices.

The fact that the pre-open stock futures remain in the red after a good durable goods report is a little concerning. When markets can shrug off bad news, it is a good sign. When markets do not respond to good news, it is a bad sign. Futures did improve after the durable goods report, but not as much as you would expect.

As we outlined on August 23, numerous long-term bearish signals are present on weekly charts. Similar bearish signals can be found on monthly charts, but these signals become much more meaningful if they carry into the end of the month. We can add the monthly Bollinger Bands for the S&P 500 Index to the growing list of concerning signals (see chart below). We got some good economic news today and the Fed is on tap for Friday. If the S&P 500 can close above 1,200 on Wednesday, August 31, it will negate the bearish signal on the chart below.

Bear Market Odds Favor Lower Lows Technical Analysis - Ciovacco Capital - Short Takes

If the bears can maintain control of the markets, we would consider adding to our fixed income holdings if a good entry point appears. We also have an interest in agricultural commodities, which trade as ETFs under the symbols DBA and RJA.

Our strategy will come into better focus over the next week. As of this writing, there is little in the way of encouraging news, both fundamentally and technically, for the bulls. However, as we have mentioned on several occasions, markets rebounded in 1994, 1998, 2004, and 2010 after similar dire circumstances. We will remain cautious until we see some evidence supporting a sustainable turn in asset prices. In addition to agriculture (RJA), our watch list for bullish outcomes includes, Australia (EWA), energy (XES), and real estate (IYR). If bearish conditions hold, our short list includes Treasuries (TLT), gold (GLD), diversified bonds (AGG), TIPS (TIP), silver (SLV), gold stocks (GDX), the Yen (FXY), and Australian dollar (FXA).