As of 4:40 p.m. EDT: Today’s session had broad participation from relatively attractive sectors and better interest in QE2 winners. The standouts in terms of volume vs. average volume were energy (IEZ, OIH, XES, XOP, XLE) and agriculture (RJA, DBA). Even in the context of a new bear market, we could see a sharp rally based on either (a) the Fed, or (b) better than expected economic news. The CCM End of a Correction Model finished the session at 44%. One day means little, but today showed noticeable improvement over recent up days.
As of 12:35 p.m. EDT, the CCM End of Correction Model sits at 33%, meaning 33% of the things we would expect to see at the beginning of a new rally have taken place; 67% have not occurred.
We can expect more volatility (up and down) over the next ten days or so. The Federal Reserve has their annual Jackson Hole conference this week. Ben Bernanke is due to deliver public remarks on Friday. In 2010, the Fed used Jackson Hole as a forum to signal a second round of money printing was on the way (known as QE2). Relative to what we may get on Friday, we tend to agree with the comments below from an August 23 Forbes article:
Carlos Sanchez, associate director of research with CPM Group, noted that the Fed’s decision Aug. 9 to put a timestamp on how long they will hold rates at near-zero was a change from previous comments. “That in itself was a very strong signal. I don’t know if the Fed will be so quick to act with another policy tool to help stimulate economic activity – it takes time to trickle through the larger economy,” he said.
The market believes QE3 is not in the short-term cards or
The market believes another round of quantitative easing (QE) will not be effective, longer-term, in boosting asset prices.
Monday’s session also featured unimpressive moves by QE2 winners. We will continue to monitor QE-friendly assets this week. While we believe the odds have shifted over to the bear’s camp, strong countertrend rallies often occur in the context of a bear market.
The video below expands on the topics in the August 22 article Dip Buyers Beware: Odds Favor Lower Lows in Stocks. Numerous long-term bearish signals recently appeared on weekly and monthly charts. Since monthly signals are more important if they are still present at the end of the month, the video focuses on weekly charts. From a fundamental perspective, weakness, as shown in the video, in transportation stocks (IYT), basic materials (XLB), and small-caps (IWM) hints at weaker than expected economic growth in the coming quarters. The fact that emerging markets (EEM), Canada (EWC), and Sweden (EWD) are also flashing red flags speaks to the increasing odds that a global bear market has kicked-off, rather than weakness being isolated to a particular sector or region of the globe.
We will continue to hold gold (GLD), silver (SLV), and a small allocation to bonds (TLT) until conditions improve. The Fed has bailed out the markets in the past – we will see what they have in store for us on Friday.
Whether you rely on fundamentals, technicals, or a combination of both, investment analysis centers around looking at probabilistic future outcomes based on historic outcomes that occurred under similar circumstances. Given the weight of the fundamental and technical evidence we have in hand and in the context of history, the odds have shifted from favoring higher highs in stocks and risk assets to favoring lower lows. Until conditions improve, we will continue to err on the side of caution and treat the current market climate as unfavorable for intermediate to longer-term investing. We have minimal exposure to global stocks. We have positions in gold (GLD), silver (SLV), bonds (TLT), and cash.
Investors can expect debt problems in Europe to remain for some time. According to the New York Times:
Chancellor Angela Merkel of Germany on Sunday re-emphasized her opposition to issuing bonds backed by all the euro zone countries, a position that will be greeted enthusiastically by many of her fellow citizens but could unsettle investors at the beginning of what could be another difficult week in global financial markets.
From a fundamental perspective, economically sensitive areas of the market are weak. Materials stocks look vulnerable to more downside, which does not bode well for future economic activity. Commodity producing countries, such as Brazil, led the markets higher off the March 2009 lows. Brazilian stocks (EWZ) now look weak relative to the S&P 500 (SPY), which means they are laggards, not leaders (see below).
The strong interest in bonds (TLT) and the across-the-board weakness in global stocks are bringing into question Wall Street’s canned responses of ‘buy on dips’, ‘this is an excellent buying opportunity’, ‘valuations look attractive’, and ‘you have to buy when there is blood in the streets’. On August 19, bond king Bill Gross told Reuters recent action in Treasuries should not be ignored:
“They certainly reflect, in terms of their yields, not only a potential for a recession but the almost high probability of recession and the result of lowering of inflation — that is key.”
We agree the expressions above, related to dip-buying, will apply to this market at some point in the future, but the weight of the evidence screams loud and clear, “you better pay attention and you better have specific risk management plans in place”. The video below covers some actions you can take right now in terms of planning; actions that apply to do-it-yourselfers and investors working with an advisor. This is not the time to stick your investment head in the sand. Worst-case, you put together bear market contingency plans and throw them in the trash if conditions improve. The charts below look bearish longer-term; if they improve, we are happy to change our investment stance. Flexibility is always important. If you believe it is too late to sell, the video below is worth a look.
Even if the bearish odds correctly forecast investment outcomes over the coming months, sharp countertrend rallies, which can last several weeks or several months, are to be expected. Bull markets do not go straight up and bear markets do not go straight down. Notice during every bear market rally below, the slope of the S&P 500’s 200-day moving average was negative and price remained below the 200-day, which is what a bear market looks like. Today, price is below the S&P 500’s 200-day moving average and the slope is in the process of rolling over in a bearish fashion saying “be careful”.
Volatility makes staying invested difficult in bull markets and remaining cautious difficult in bear markets. The chart below is a monthly chart of the S&P 500 Index going back to 1984. We have removed the month-to-month price swings and kept only the forty-six month exponential moving average (EMA). If you look at the chart below, it seems like it would have been relatively easy to remain invested from 1984 to 2000 since prices kept going up. In the year 2000, the odds shifted as the moving average turned down generating a “be careful” signal. Another “be careful” signal was generated in 2008 when the blue line again turned down. Looks easy – right?
The chart below is the same chart as the one above, except the month-to-month price swings have been added back. It doesn’t look so easy anymore. The basic ideas shown in the chart below apply to all the remaining charts:
When price is above a moving average (blue line below), it is bullish.
When price is below a moving average, it is bearish.
When the slope of a moving average is positive, it is bullish.
When the slope of a moving average is negative, it is bearish.
Notice in the chart above, price remained above the blue moving average from 1984 to 2000, which was bullish. Price broke below the moving average in 2000, 2008, and 2010, giving a “be careful” signal. More importantly when using the moving average above, notice the slope of the moving average remained positive from 1994 to 2000. The blue line gave a “be careful” signal in 2000 when it rolled over. It gave another bearish signal in 2008.
The slope of the monthly moving average on the chart of economically–sensitive and commodity-dependent Brazilian stocks (EWZ) recently rolled over in a bearish manner (see red arrow below right). The orange arrow demonstrates that stocks can recover after a change in the moving average’s slope, highlighting the need to always keep an open mind and remain willing to adjust in a bullish manner if conditions improve.
Rather than facing budget problems common to the United States and Europe, many emerging market countries are fighting a battle with inflation. Rising inflation can erode profit margins and put a crimp on consumer spending. The long-term fundamentals are better in emerging markets (EEM) relative to more developed nations, but their stock markets share troubling signs with the U.S. and Europe. When the monthly moving average shown in blue below rolled over in 2008, prices headed much lower. A similar bearish signal recently occurred in the Emerging Markets Index (red arrow on right).
Transportation stocks are used in Dow Theory, based on their direct link to current and future economic activity. Another axiom for managing risk is when shorter-term moving averages are above longer-term moving averages, it is a good sign. When shorter-term moving averages cross over and below longer-term moving averages, it is a sign of weakness. In the 2003-2008 bull market in transportation stocks, the seventeen-week exponential moving average (blue line below) stayed above the thirty-week moving average (red line). “Be careful” signals were given in 2007 and 2008 (red arrow). Last week a new “be careful” signal was given. Notice how transportation stocks performed (very poorly) after the bearish signals (red arrows).
Economically-sensitive stocks of companies in the basic materials sector have tended to perform well when the blue moving average below has a positive slope (see green arrows). During bull markets, price held near the blue moving average line (orange arrows). The last two times the blue moving average line rolled over, price fell in a painful manner (red arrows). On the far right side of the chart, the blue moving average line just rolled over in a bearish manner, which adds to the bearish weight of evidence for the intermediate-to-longer-term outlook.
The same concepts outlined here can be applied to individual stocks. Johnson Controls (JCI) has a wide variety of business lines, including car batteries and HVAC systems. Like most companies, the demand for their products and services is higher when the economy is growing and unemployment is low. When the blue moving average shown below rolled over in 2008, it was a red flag for the economy and markets. In the first half of 2009, the moving average turned up signaling better economic times ahead (see green arrow). Notice how the price of Johnson Controls’ stock behaved after the moving average turned. Unfortunately, the moving average shown below for JCI recently turned negative (see red arrow on right below).
Dividend stocks have been popular investments based on the thinking the income will offset the risks in a bear market. When the moving average below turned negative in 2007, dividend stocks were hammered just like everything else. The dividend stock exchange-traded fund (DVY) performed much better after the slope of the moving average turned back up in 2009 (green arrow). The right side of the chart aligns with other bearish signals.
Another commodity-rich nation, Canada, is flashing a “be careful” signal. Compare the look of the blue line below the two red arrows. Notice how poorly Canadian stocks performed after the negative turn in the blue moving average in 2008.
Last week, Sweden’s financial regulator said banks are unprepared for a freeze in money markets. Sweden’s stock market also has a bearish look to it.
With higher growth rates, small-cap stocks are popular during periods of prosperity. Small-caps also carry higher risks than their blue-chip brethren, and thus tend to be avoided during recessions and bear markets. A bearish moving average crossover took place last week in the Russell 2000 (small-cap) Index adding another building block to the bearish case.
The economy and markets above could improve, but until we see evidence of a turn, we will err on the side of being conservative. If you review the charts and markets above while asking yourself, “Does this chart currently look like a bull market or the early stages of a bear market?”, it is difficult to draw bullish conclusions for stocks and the economy. The Fed’s Jackson Hole remarks could alter the market’s risk-reward profile, but as we noted last week QE2 winners are not forecasting a QE3 miracle.
Even with today’s bounce in stocks, the CCM End of Correction Model sits at 11%, meaning only 11% of the things we would expect to see at the end of a correction are in place now. 89% of the things we would like to see to feel better about a rally in stoks are not in place. The odds favor more downside over the coming weeks.
Inexperienced investors in the commodity markets should keep in mind that while gold and silver look good now, silver dropped 59% in the last bear market and gold fell 32%. Both silver and gold held up better than stocks (and the dollar) early in the last bear market (as they are now), but eventually deflationary fears caught up with precious metals. Risk management is required for all positions, even “safe” positions like gold and silver. We own both gold and silver, but it is important that we understand the downside potential of any asset.
The chart below shows the performance of the U.S. Dollar Index relative to gold (2008-2009). Notice between points A and B, the dollar began to form a base relative to gold, which was a warning to watch gold holdings more closely. Gold peaked on March 17, 2008, just as the dollar/gold ratio was forming a base.
The chart below shows the U.S. Dollar Index in 2008. The Ultimate Oscillator, near point A, perked up as the dollar began to strengthen in a more meaningful manner. Near point B, the 200-day moving average began to flatten out, indicating a weakening downtrend. Near point C, the slope of the 50-day moving average turned up, which was another feather in the dollar bulls’ cap.
The chart below shows the dollar in 2011. In terms of similarities to the chart above, it is a mixed bag. Near point A the Ultimate Oscillator has shown some strength similar to 2008. However, the slope of the 200-day (point B) is still pointing down and not close to flattening out. The slope of the 50-day, near point C, does indicate a market that is trying to form a base. ADX, near point D, indicates a somewhat trendless or sleepy dollar. Sleepy markets often make a sharp move higher or lower when they wake up.
If the chart of the dollar/gold ratio begins to look more like the second chart presented above, in terms of forming a base, we would become a little more cautious on our gold holdings. The dollar switched places with gold in 2008 in terms of taking the “safe haven” lead. We may not see that switch take place in the near future with the budget and entitlement mess in the United States, but we must keep on eye on the dollar to properly manage our gold and silver.
We remain concerned about the possible domino effect on the economy with the first domino being government debt. The technical deterioration and fundamental problems outlined in our August 14 video also need to be monitored very closely.
We head into today’s trading session with a significant cash position, gold, silver, and bonds. We still have a limited exposure to stocks. This morning’s weak futures and more talk of banking problems in Europe will most likely have us reduce our stock exposure even further today. We may do some selling within the first hour of trading depending on market internals. We may take a larger step away from risk as the big picture is becoming very concerning again.
If today’s losses come on weak volume and/or better than expected market breadth, we may adjust our plans for the day, but we believe today’s activity will warrant additional defensive moves. Please see this post for our bearish QE2-winners analysis.
In 2009 and 2010, the Federal Reserve was able to reverse sharp declines in asset prices by pumping large amounts of printed money into the global financial system via quantitative easing. With the Fed’s 2011 Jackson Hole speech set to take place on August 26, we recently reviewed the ETF winners from QE2 looking to see if the market is anticipating the launch of QE3. Like the bearish similarities to 2008, our findings below are not encouraging for the stock market bulls. A recent review of QE2 winners indicates one of two things:
The market does not believe the Fed will announce QE3 in the coming weeks or
The market believes the deflationary forces in the economy are so great that QE3 would have little impact on asset prices.
The Fed clearly telegraphed their intention to implement QE2 during Ben Bernanke’s remarks at Jackson Hole on August 27, 2010. Our March 2011 analysis of QE2 winners showed that silver (SLV) prices responded by gaining almost 90% from August 2010 to March 2011. The table below was originally presented in March 2011.
The 2011 Jackson Hole remarks from the Fed are scheduled for August 26; last year they were given on August 27. This year the financial markets peaked in early May; last year markets were also topping out in May, which means we have similar conditions coming into this year’s Jackson Hole remarks as we did in 2010.
The chart below shows silver (SLV) nine calendar days before the Fed’s 2010 Jackson Hole remarks. Notice how the markets were anticipating market-friendly news, indicated by silver’s higher low made prior to Jackson Hole 2010.
The chart below shows silver ten calendar days before Jackson Hole 2011. The chart of silver looks better today than it did last year. You might be tempted to say the markets are front-running the Fed anticipating another Jackson Hole miracle for asset prices. Unfortunately for the bulls and the global economy, the rest of the QE2 investment winners do not support another QE miracle save from the Fed.
The price of oil is obviously economically sensitive. In a world where central banks have their printing presses working overtime churning out paper currencies, oil also serves as a de facto currency (similar to gold). Last year, nine calendar days before Jackson Hole, with the financial markets teetering on a fine bull/bear line, oil equipment & services stocks (below) were showing some signs of life, which indicated hope for better economic outcomes and an anticipation of QE2.
In 2011, ten calendar days before Jackson Hole, oil equipment and services stocks look significantly weaker sending concerning signals about the economy and the possible effectiveness of any further quantitative easing (QE3).
The entire energy sector (XLE) had clearly made a higher low and higher high prior to Jackson Hole 2010, which aligned with a more optimistic outlook for asset prices and the economy.
Heading into Jackson Hole 2011, energy stocks seem to be favoring weak economic outcomes, which is another reason to have cash, precious metals (GLD), and bonds (TLT) on hand.
Coal stocks (KOL) were firming up in 2010 as the Fed put its finishing touches on their planned Jackson Hole remarks.
At a similar point in 2011, coal stocks, a big QE2 winner, look decidedly weak.
Traders, anticipating the possible impact of QE2, piled into metals and mining stocks (XME) nine days before Jackson Hole 2010.
In 2011, traders seem to be avoiding metals and mining stocks, suggesting they do not anticipate a lasting impact from any Jackson Hole remarks.
Natural gas stocks (FCG) gained almost 50% after Jackson Hole 2010. Nine days before the 2010 conference, signs of a new uptrend were appearing in the sector.
Today, a firm downtrend remains in place in natural gas-related stocks, which seems to question favorable economic forecasts.
Some Fed front running in natural resource stocks (IGE) appeared to take place in August of 2010.
Few signs of front running appear on the current chart of natural resource stocks.
Agricultural commodities (RJA) were anticipating future inflation in 2010, which indicates traders had faith the Fed’s printing press could reverse deflationary trends.
The prices for agricultural commodities look very deflationary today; they show little faith in the Fed’s ability to re-inflate in the second half of 2011.
The Russell 2000 Growth Shares ETF (IWO) gained over 40% after Chairman Ben Bernanke’s 2010 Jackson Hole speech. Traders began building positions ten days prior to Ben’s remarks.
Whatever the Russell 2000 is currently anticipating, it does not appear to be bullish or asset-price friendly.
The ever-volatile semiconductor sector (SMH) also painted a picture of some hope heading into Jackson Hole 2010.
Ten days before Jackson Hole 2010, semiconductor stocks seemed concerned about consumers opening their wallets in the coming months.
Like the vast majority of QE2 beneficiaries, the private equity ETF (PSP) was firming up nicely in the summer of 2010.
Today, private equity’s chart has that decidedly waterfall-like look of so many charts.
In the summer of 2010, global financial markets were sitting on a fine bull/bear demarcation line as we outlined in this August 15 video. The Fed’s August 2010 Jackson Hole speech telegraphed the central bank’s intention of launching QE2. The impact on asset prices was dramatic in 2010. Even if QE3 is announced, the impact may be much more muted in 2011. Our 2011 Jackson Hole strategy is to review the Fed’s remarks with an open mind. We will also review the market’s response with an open mind, but as of this writing, our bias heading into the Fed’s annual summer conference will remain defensive and bearish.
Today’s early read is a positive. The market did not get any new or firm news out of Europe yesterday, and yet, we are rallying today. When the market reacts better than expected to negative news, you need to pay attention. With the Fed’s Jackson Whole speech coming on August 26, we are working on a QE3 asset analysis; the results will be posted in the next 24 hours. Right now, we want to focus on the markets since they are showing some signs of life, which is good news.
As we noted on August 12, a rally back to 1,260 would be reasonable based on the big picture. Wednesday’s early action means little if it cannot (a) hold into the close, (b) produce some decent volume (interest from buyers), and (c) see improvement in market breadth. We have to start somewhere, so we are keeping an open mind.
The “Death Cross” Is Not So Deadly: The “death cross” formation historically has resulted in a 0.4% drop in the S&P the month after, but the market traditionally gains nearly 5% in the ensuing six months, according to a Wall Street Journal report Thursday. A 5% gain in six months is hardly “deadly”. We agree a “death cross” is not a good thing, and it does indicate a weakening market. However, all technical systems need to be viewed in the light of how the market performed after a signal occurred. A “death cross” is concerning and should be respected, but it does not mean the end of civilization as we know it.
The S&P 500 gained 34% after our July 2010 comments above, so the death cross under those circumstanced did indeed prove not to be deadly. Unfortunately, the odds of the recent death cross being deadly for stock is greater now than it was last summer.
We studied market history going back to 1930 looking for death crosses that occurred under these basic conditions (similar to what we have today):
When the 50-day crossed the 200-day, the 200-day was flat or nearly flat.
The death cross occurred after a substantial and prolonged rise in stock prices.
Prior to the death cross, the slope of the 200-day moving average, for the most part, had been positive looking back several months to more than a year.
Our study looked at the Dow Jones Industrial Average from 1930 to 1956. From 1957 to 2011, we studied the S&P 500 Index. We found sixteen death crosses between 1930 and 2011 that met the basic criteria above (see table below).
We calculated the risk-reward ratios for stocks following the death crosses above. The table below shows what we should care about: (a) percent of time stocks gained, (b) percent of time stocks lost money, (c) the average gain, (d) the average loss, (e) the risk-adjusted gain, (f) the risk-adjusted loss, and (g) the risk-reward ratio for being invested following similar death crosses in the past.
The term risk-reward implies that even in these historical cases, there were instances where stocks made money after the death cross, but the odds of success are lower than the odds of failure. Our analysis from July 13, Gold and Silver Picking Up Steam Relative to Stocks, aligns well with the recent death cross and less than favorable odds for stocks. Since July 13, stocks have significantly underperformed gold (see SPY relative to GLD below).
In recent weeks, we have been selling stocks (SPY, IYT) and adding to our precious metals positions. Given the recent breakdowns in stocks, we like gold (GLD) better than silver (SLV). We still like silver, but we will be watching it more closely than gold. We will err on the side of holding our gold.
For those who may have missed it, we are again presenting the video below, which covers:
The current technical backdrop in the context of bull and bear markets.
CCM Market Models: How they have helped us in the past and what are they telling us now?
Possible strategies based on bullish or bearish outcomes.
Fundamentally, why did the markets sell off so rapidly?
Limited options for government further stimulus
Waning confidence in central bankers
The video above covers the type of information we might discuss over the phone or in a meeting with a client. It is presented here for informational purposes only and does not represent investment advice.
3:15 p.m. EDT: The CCM End of a Correction Model sits at 44%, meaning 44% of the things we would expect to see at a lasting turning point have occurred; 56% have not occurred yet. Today’s rally is decent looking with the exception of low volume. The S&P 500 ETF (SPY) traded 662M shares during one of the big sell-off days last week - Friday’s SPY volume was 313M shares. Today, only 175M shares have exchanged hands, well below the three-month average of 242M.
11:08 a.m. EDT: Today’s gains are coming on very low volume, which means institutions and hedge funds are waiting to see what happens at Tuesday’s meeting in Europe. NYSE volume is tracking 32% lower vs. the same time on Friday.
CCM Clients: Today’s Short Takes, in video format, covers:
The current technical backdrop in the context of bull and bear markets.
CCM Market Models: How they have helped us in the past and what are they telling us now?
Possible strategies based on bullish or bearish outcomes.
Fundamentally, why did the markets sell off so rapidly?
The video covers the type of information we might discuss over the phone or in a meeting. In addition to the video, we are happy to answer any other questions that you may have.
As stated in the video, it is still important that we keep an open mind about (a) better than expected outcomes, and (b) worse than expected outcomes. Better than expected outcomes could be set in motion by the Federal Reserve, which meets in Jackson Hole, Wyoming on August 26. Worse than expected outcomes could be set in motion by a number of events related to the economy, debt, currencies, and/or stock market.
As we mentioned last week, even if a new bear market has already started, the S&P 500 could rally back near 1,260.
Short Takes is a stock market blog updated regularly by Ciovacco Capital Management, LLC. This financial blog covers investing topics, such as economic cycles, stocks, commodities, currencies, and technical analysis.