Archive for September, 2011

Bearish Signals Carry Into Month End

Friday, September 30th, 2011

Video: Downside Potential In Stocks and The Euro

Video: Downside Potential In Stocks and The Euro

ECRI Says Recession Unavoidable

Friday, September 30th, 2011

From the Economic Cycle Research Institute’s (ECRI) website:

Early last week, ECRI notified clients that the U.S. economy is indeed tipping into a new recession. And there’s nothing that policy makers can do to head it off.

ECRI’s recession call isn’t based on just one or two leading indexes, but on dozens of specialized leading indexes, including the U.S. Long Leading Index, which was the first to turn down – before the Arab Spring and Japanese earthquake – to be followed by downturns in the Weekly Leading Index and other shorter-leading indexes. In fact, the most reliable forward-looking indicators are now collectively behaving as they did on the cusp of full-blown recessions, not “soft landings.”

Some comments from the Daily Ticker:

Weakness in leading economic indicators has become so pervasive the Economic Cycle Research Institute (ECRI) now predicts a new recession is unavoidable.

“The vicious cycle is starting where lower sales, lower production, lower employment and lower income [leads] back to lower sales,” co-founder Lakshman Achuthan declares in the accompanying video.

Whereas Achuthan said the jury is still out in late August, the weakness in leading economic indicators — and ECRI uses a dozen for the U.S. alone, he notes — has become a “contagion” that is spreading like “wildfire.”

Short-Term Conviction Faltering For Bulls (Updated)

Thursday, September 29th, 2011

The expression “we are stuck in a trading range” can lull investors into a state of short-term complacency, especially when the market has exceeded expectations since the early August low. While there were many important market moving events over the past seven weeks, the bulls tended to look forward to the Fed’s September 21 statement and Germany’s approval of the July 21 changes to the European Financial Stability Facility (EFSF). The Fed meeting disappointed and stocks reacted in a negative manner. It may be too early to grade the reaction to Thursday’s EFSF vote in Germany, but as we postulated on Wednesday, it appears as if the bullish gains following the vote may be short-lived.

A CNN article summarizes some of the concerns related to the latest version of the European bailout fund:

But there is now widespread agreement among economists and investors that the €440 billion fund is not big enough to be effective if some of the larger euro area economies fail. Some economists have estimated that the fund would need up to €2 trillion to bail out Spain or Italy. Both nations are struggling with unsustainable levels of debt and dim economic prospects.

“Even an enhanced EFSF will have barely €100 billion to throw at the bond market…minus, of course, any new commitments made to Greece” said Carl Weinberg, chief economist at High Frequency Economics, in a note to clients.

More recently, European officials have been discussing ways to increase the fund’s ability to absorb bad sovereign debt by leveraging its assets in some way. However, experts say the fund is unlikely to see an increase in the amount of money it is able to deploy.

It may take the Europeans several weeks or months to negotiate and ratify the next “solution” for the debt-ridden economies in the block. The Fed has signaled it will take action, but only if the data supports an imminent threat of deflation, which is not currently the case. It may be the bulls have little to hang their short-term hats on now.

The markets have known for weeks that the problems in Europe will be with us for some time, which seems to be reflected in the S&P 500’s short-term trends. The S&P 500 has traded between 1,101 and 1,231 for seven weeks. As described and shown in the charts below, the bulls controlled the trading range from August 9 until the high was made on August 31. Since the S&P 500 hit 1,231 on August 31, we have gone four weeks without making a new high, which signals the bears have regained the upper hand within the trading range. The shifting trends below tell us the odds of a bearish break from the trading range have increased in recent weeks.

The bulls can regain some momentum by having the S&P 500 close over (a) 1,180, and (b) 1,220, but presently the bears are making a stealth move to recapture the short and intermediate-term trends. In the daily chart of the S&P 500 below:

  • The green trendlines are formed by the first set of higher highs off the August lows (peak 1 and 2). The green trend is clearly bullish with a positive slope.
  • The orange trendlines are based on a lower high made using peak 2 and 3. Notice the slope of the trend shifted from up to down.
  • The red trendlines are based on the lower low that was made at point B relative to point A. The lower low at point B is one of the steps required in a trend change from up to down.

Trend Change - Ciovacco Capital - Short Takes

Investors should be careful about bullish predictions based on oversold readings from one technical indicator. As shown in the table below, the CCM Bull Market Sustainability Index (BMSI) uses a wide variety of ways to determine the probabilistic outlook for the stock market.

Bull Market Sustainability Index - Ciovacco Capital

What does the Bull Market Sustainability Index tell us now about the longer-term outlook for stocks? It is bearish. In fact, the historical risk-reward profile is one of the worst looking out three months.

Bull Market Sustainability Index BMSI - Ciovacco Capital

As we outlined on September 22, we still believe the odds strongly favor a bearish break of the current trading range and a move below 1,050 on the S&P 500. Consequently, we may add to our deflation-friendly bonds (TLT) and our stake in the U.S. dollar (UUP). We may also add shorts (SH) back into the mix very soon.

Gains After German Vote Wiped Out

Thursday, September 29th, 2011

Yesterday, we stated concerning this morning’s German vote:

If we get a move higher in stocks after the German vote, it may prove to be relatively short-lived.

As of 3:00 p.m., the S&P 500 is 30 points below today’s high of 1,175. If these trends hold into the close, the short-term bearish case will have picked up steam again. What matters is how we finish the day, not what we see at 3:00 p.m.

Bear Market Rallies Can Be Deceiving

Thursday, September 29th, 2011

As we head into trading today, keep in mind the S&P 500 lost 24 points yesterday.

The weekly chart of the S&P 500 has an indicator, known as the MACD Histogram, below price. A good rule of thumb, especially from a short-to-intermediate term perspective, is to trade or invest in the direction of the histogram. When the blue bars are rising it is bullish. Conversely, when they are falling it tends to be bearish. Notice last week (red arrow bottom right), the histogram ticked down which seemed to signal the next leg of the bear market was about to kick off. This week it has ticked back up giving the bulls the upper hand again.

Inverse ETFs - Ciovacco Capital - Short Takes

As we mentioned in yesterday’s post and video, bear market rallies can be strong allowing more money to come off the sidelines. A simple support and resistance analysis, coupled with weekly moving averages, tells us a rally back to the 1,230 – 1,280 range on the S&P 500 cannot be ruled out. The most logical area for a potential resumption of the longer-term bearish trend comes in between 1,200 and 1,260. Our weekly high was 1,196.

Markets are cruel. Bear markets can be very cruel. The weekly chart of the S&P 500 Index shows a significant rally from the March 2008 lows to the May 2008 highs. Notice the MACD Histogram was improving during that period (as it is now). Many talking heads made the call that “we hit bottom”, partly due to improving weekly indicators. We have heard similar bullish calls in recent weeks.

Weekly Chart - Ciovacco Capital - Short Takes

What happened after the “bottom had been made”? The S&P 500’s impressive rally was retraced and then some. Stocks dropped 53% after the longer-term bearish trends took over again.

Weekly Chart - Ciovacco Capital - Short Takes

The example above shows the problem of using any technical indicator in isolation. As shown in the table below, the CCM Bull Market Sustainability Index (BMSI) uses a wide variety of ways to determine the probabilistic outlook for the stock market.

BMSI - Ciovacco Capital - Short Takes

What does the Bull Market Sustainability Index tell us now about the longer-term outlook for stocks? It is bearish. In fact, the historical risk-reward profile is one of the worst looking out three months.

BMSI - Ciovacco Capital - Short Takes

Early Read on German Vote is Bearish

Wednesday, September 28th, 2011

It is difficult to predict how the market will react to what is expected to be a favorable German vote Thursday approving the July 21 changes to the European bailout plan. However the early read as of 12:50 p.m. on Wednesday leans bearish. If we get a move higher in stocks after the German vote, it may prove to be relatively short-lived.

The objectives in Europe are similar to the Fed’s objectives in the United States in terms of trying to hold off deflationary forces, which make debts more burdensome. The Fed and European leaders are trying to create positive inflation and spark some type of economic recovery. Just as we looked at inflation-friendly assets to forecast a probable disappointment to the Fed’s Operation Twist announcement, the performance of inflation-protection assets on Wednesday is leaning decidedly toward deflationary and weak economic outcomes (see table below).

Would silver (SLV) be down 5.0% if market participants thought the Fed and Europeans could inflate away their debt? Would metals and mining stocks (XME) be down 3.70% if the vote in Germany was expected to clear a path for favorable economic outcomes? Obviously, the important thing is to see how the positions close on Wednesday (figures below are intraday). With high volatility, they could easily finish the day well into green territory.

German Vote Disappointment? - Ciovacco Capital - Short Takes

Let’s look at the other end of the spectrum – a favorable reaction to Thursday’s vote in Germany. The video below explores how high the S&P 500 could reasonably tread before running into possible areas of resistance. While we do not believe it is a highly probable outcome, our reasonable bear market upside target of 1,260, published on August 12, is still valid.

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: Update - Bearish Case For Stocks

Video: Update - Bearish Case For Stocks

The current trading range in stocks has been frustrating for bulls and bears alike, especially if you consider yourself to be an investor, rather than a trader. We still believe the ETF table (below) and analysis we posted on September 11 provide a roadmap and way to monitor the battle between inflationary forces and deflationary forces. We also believe the odds heavily favor deflationary outcomes in the coming months, meaning assets such as bonds (TLT), shorts (SH), and the U.S. dollar (UPP) will remain on our watch lists and most likely in our portfolios.

Investment Strategy - Dollar Rally - Deflation - Bear Market

Since we originally posted the table above, the silver ETF (SLV) dropped from 40.52 to a low of 27.41, which is a loss of 32%. A decline of that magnitude in silver does not bode well for future economic outcomes or stocks.

Bearish Case Remains Intact

Tuesday, September 27th, 2011

The video below examines the upside potential of a countertrend rally in the S&P 500. The S&P 500 peaked on Tuesday at 1,196. Logical areas for a reversal fall between 1,196 and 1,260. Should the short-term uptrend be broken, it still remains reasonable for the S&P 500 to head toward 1,018 (at some point in the coming weeks).

Trading Range Stock Market - Short Takes Ciovacco

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: Update - Bearish Case For Stocks

Video: Update - Bearish Case For Stocks

Most Likely A Prudent Time To Cover S&P 500 Shorts

Tuesday, September 27th, 2011

There is a sound axiom in the markets – “When the market does not do what you expect it to do, it is time to pay attention.” In terms of timing an entry point, our rationale for adding to our S&P 500 short positions (SH, RYURX) was based primarily on last Thursday’s breakout from a bullish flag pattern (see below). Yesterday’s sharp rally from 2:00 p.m. to 4:00 p.m. after the CNBC announcement pushed SH back into the flag below, meaning the breakout was in jeopardy of failing. This morning’s futures indicate we will get confirmation of the failed breakout at the open. Consequently, we will most likely exit our SH position within the first hour of trading today.

Bears Gain Momentum - Short Takes Ciovacco

As of yesterday’s close our loss on SH was only 1.25%. The high-end of our allocations to SH represents 37% of an account/household. This means the loss on SH, relative to an account’s balance is only 0.46%. The short-term risk-reward of SH has deteriorated in the last two trading sessions. The reason we added to our positions last week (breakout above) is no longer in place.

Do we believe stocks have put in the final low? No. However, it is not uncommon for a bear market rally to revisit the 50-day, 100-day, or 200-day moving average. A move back to the 200-day on the S&P 500 would represent a gain of 10.15% relative to Monday’s close. We are not willing to let a loss run on the short side of the market. We would much rather be wrong based on our current loss of 1.25% on SH than a loss of 11.4% (1.25% + 10.15%) if the S&P 500 rallies back to its 200-day moving average. One thing we learned in the last bear market - If your short position is not profitable, cut the losses very quickly since bear markets can rally in a strong and rapid manner.

We are happy to consider SH again if a more attractive risk-reward entry point surfaces in the coming days and weeks. Part of managing risk properly is being able to admit when the odds have shifted against your position. This morning we asked ourselves these questions:

  1. Would I buy SH today based on the current short-term outlook? “No”
  2. Has the risk-reward profile of SH changed since last Thursday? “Yes”

Comments in this morning’s Wall Street Journal (WSJ) highlight the concerns that remain longer-term relative to the European bailouts.

There are still plenty of headwinds that could trip up markets, said Kathleen Brooks of Forex.com. “A €2 trillion to €3 trillion plan to stem the sovereign-debt crisis and save the euro zone is fantastic in theory, but in reality it might never see the light of day,” she said. “The markets have ignored comments from Finland that it would not support any extension to the EFSF—this is significant since it is one of only six euro-zone members with a triple-A credit rating.”

Also, Spanish Finance Minister Elena Salgado said a plan to expand the EFSF to as much as €2 trillion isn’t on the table, while Slovak parliamentary speaker Richard Sulik said Greece should be refused further aid. The remarks showed a deal on expanding the bailout facility is far from certain.

Meanwhile, the Spanish Treasury sold €3.23 billion of three- and six-month treasury bills at auction Tuesday, getting away roughly the amount of paper it was aiming to but at an average yield of 1.692%, more than the 1.357% yield seen at the last auction.

This article contains the current opinions of the author. The opinions are subject to change without notice. This article is distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. The charts and comments are not recommendations to buy or sell any security. Market sectors and related ETFs are selected based on his opinion as to their importance in providing the viewer a comprehensive summary of market conditions for the featured period. Chart annotations are not predictive of any future market action rather they only demonstrate the opinion of the author as to a range of possibilities going forward.

Stocks Rally On CNBC Report

Monday, September 26th, 2011

At 1:40 p.m. today, the S&P 500 was up 3 points. The CNBC report below ignited a strong rally into the close. Institutions and hedge funds did not seem to be all that impressed - volume on the NYSE fell 26% today. Here is the text taken from the CNBC website:

CNBC HAS LEARNED FROM A TOP EUROPEAN FINANCIAL OFFICIAL ABOUT A DETAILED PLAN THAT IS CURRENTLY IN THE WORKS ON LEVERING THE MONEY FROM THE EUROPEAN FINANCIAL STABILITY FACILITY. THE PLAN WOULD USE AS WE UNDERSTAND IT SOME OF THE EFS MONEY TO SHORE UP BANK CAPITAL VERY SIMILAR TO A TARP. NOW THE VERY NEW PART THAT WE ARE HEARING IS THAT THE PLAN WOULD ALSO USE SOME OF THIS MONEY AS SEED MONEY FOR A EUROPEAN INVESTMENT BANK THE EIB IS A BANK THAT IS OWNED BY THE MEMBER EUROPEAN GOVERNMENTS THAT DOES RECONSTRUCTION PROJECTS. NOW UNDER THE PLAN THE EIB WOULD FORM A SPECIAL PURPOSE VEHICLE AN SPV THIS WOULD ISSUE BONDS AND PURCHASE SOVEREIGN DEBT WITH THE BONDS IT USED SO IT WOULD TAKE THE CAPITAL FROM THE EFSF LEVER IT UP THESE BONDS COULD ALSO BE USED AS COLATERAL AT THE ECB. OUR UNDERSTANDING IS THE PLANS FOR LEVERING THE EFSF ALREADY WELL ADVANCED.

After a market-moving announcement like this one, it is a good idea to look at the fundamentals and technicals and ask, “If I did not know about this announcement, would I buy into this market?” We will take a look at the state of affairs tonight and tomorrow morning. Our bias is to not overreact to a report like this, but we want to review things with an open mind.

The Wall Street Journal noted the following potential drawbacks with the European plan outlined on CNBC today:

First, the scheme relies on the private sector to lend to the EFSF in times of trouble. But that’s precisely when the private sector is least likely to be lending. And, to be honest, European banks aren’t exactly super-healthy right now.

Second, it won’t come as cheap as ECB financing, or as cheap as the EFSF’s own triple-A bond market funding. That means higher funding costs for the leveraged EFSF, which it would likely have to pass on to the rescued countries.

Third, banks would be wary about large commitments to a leveraged EFSF. The EFSF is an off-balance-sheet vehicle. Its creditors have no recourse beyond the guarantees that the euro-zone countries pledge to it. When the size of the EFSF’s bond and loan portfolios exceeds those guarantees, the creditors have to start wondering who will repay if things go terribly wrong. (The ECB would have this problem, too, if it financed a leveraged EFSF. But losses on the ECB’s own balance sheet are ultimately the responsibility of the euro-zone nations. Thus the euro-zone nations might be more likely to stick a private EFSF creditor with a loss.)

Fourth, the amount of leveraging is dependent on banks’ willingness to provide financing, the collateral “haircuts” that might be demanded, the price the banks would charge for acting as intermediaries, etc. Whatever the volume of a privately leveraged EFSF is, it’s surely smaller than an ECB-leveraged EFSF.

European Central Bank Expected To Make Moves

Monday, September 26th, 2011

If you are wondering why stock futures reversed so quickly morning, as European stocks were falling again after their open, this was leaked to the media (from Bloomberg):

European Central Bank policy makers are likely to next week debate restarting their covered-bond purchases along with further measures to ease monetary conditions, a euro-region central bank official said. The reintroduction of 12-month loans to banks will also be discussed at the ECB’s Oct. 6 policy meeting, said the person, who spoke on condition of anonymity because the information is confidential. Interest-rate cuts are likely to be discussed, though they are not on the current agenda, the official said.

These moves are unlikely to change market dynamics longer-term. However, they could have an impact over the coming days and weeks. Central bank and government intervention is to be expected. If you recall, stocks reacted positively in the short-run to several government announcements during the last bear market. However, the bounces were often short lived.

As mentioned in last night’s post, the S&P 500 faces a cluster of resistance between 1,149 and 1,180. A break above 1,180, would bring 1,193 into play. If you see the S&P 500 go up by roughly 10 to 15 points this morning, keep in mind last week’s drop was 106 points from top to bottom. Markets do not go straight up in a bull market, nor do they go straight down in a bear market.