Short Takes

Video covers possible areas of overhead resistance for stocks, as well as updates to long-term bearish signals in global stocks and commodities. The primary trend remains down - countertrend rallies are to be expected. During Friday’s gains volume on the NYSE fell 31%. The video is best viewed in full-screen mode. After you click on play, use the button in the lower-right corner of the video player to switch to full-screen mode.

Global leaders continue to make statements, vows, and promises, but they have done next to nothing in terms of concrete actions. According to Bloomberg:

Policy makers are “committed to a strong and coordinated international response to address the renewed challenges facing the global economy,” G-20 finance ministers and central bank governors said in a statement late yesterday in Washington. Many urged Europe to implement a July promise to expand the powers of a rescue fund, Japanese Finance Minister Jun Azumi said.

Silver futures are down over 8% this morning - gold is down less, at less than 2%. This is a deflationary and ominous sign for stocks. As we mentioned on September 11, the gold:silver ratio has moved in a similar manner to what transpired in August 2008. After the gold:silver signal in 2008, all asset prices, including precious metals, performed poorly relative to shorting the market.

For those who believe everything will be fine once the next bundle of cash is shipped to Greece, Bloomberg highlights the short-term nature of the next “fix”:

Even if Greece receives its next aid payment, due next month, default beckons in December when 5.23 billion euros of bonds mature, said Harvinder Sian, senior interest rate strategist at Royal Bank of Scotland Group Plc.

On September 22, we listed twenty-two reasons why the S&P 500 may be headed below 1,050. While the headline was interesting, we are not big fans of price targets. We prefer to use technical analysis as a way to monitor the markets, rather than forecast. However, it can be helpful to know where markets may find support from potential buyers. Areas of support may offer an opportunity to “cover” a short position or reduce exposure to defensive assets. The video below explores downside potential in the stock market and euro.

We sold our relatively small position in gold mining stocks (GDX) yesterday. We added to our deflation-friendly S&P 500 short (SH) and our stake in the U.S. dollar (UUP). We made no changes to our Treasury position (TLT). We do not plan to hold any of these positions for the long-term. SH was up 3.14% on Thursday - UUP was up 1.04% and TLT was up 3.76%.

Long-term downtrends and bear markets do not mean stocks go down every day - countertrend rallies will occur and they can be sharp.

Money can be made in this market – this bear market most likely has a long way to go. The first priority is to protect your current assets. You still have time to take defensive action.

Easy steps to get help fast:

1. Call us or email us (see link at bottom).
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3. We can schedule a time to talk via phone about your situation and concerns.
4. You can fax, mail, or email your current statements to us. We can begin developing a stop-loss plan which balances the desire to capture the next countertrend rally with the need to limit downside risks. We will build an Excel file with prudent levels to watch.
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There are numerous fundamental and technical reasons supporting a move below 1,050 on the S&P 500:

1. The market is fixated on the approval of the next bailout for Greece. There is little evidence supporting an “all clear” signal in the markets if the next pile of money is delivered to Greece. As signaled by the bond market, Greece is most likely headed for default.
2. It may only be a matter of time before the bond market turns its full attention toward Italy. The expression, “Italy is too big to fail, but too big to bail”, says it all.
3. Politicians in the United States are more interested in getting re-elected and catering to their core base than solving problems, which is an ongoing and sad commentary on the lack of leadership in this country.
4. Before the dot-com bust, investors thought stocks were invincible, which was somewhat rational since the S&P 500 went on a credit-fueled bull run from 1982 to 2000. The NASDAQ, a recent market “leader”, remains 50% below the March 2000 peak of 5,048. Needless to say, as we enter the third bear market in the last eleven years, investors no longer think “stocks always go up”. Consequently, they will be much less willing to listen to the self-serving Wall Street creed of “you have to think long-term”. A mass exodus from stocks could make 2008 look like a correction.
5. Before the mother of all credit bubbles burst in 2008, investors believed “housing prices can never go down.” After watching their home equity evaporate before their eyes, homeowners around the globe fully understand that asset prices, all asset prices, fall after a credit bubble bursts.
6. Until very recently, investors thought the Fed was omnipotent. Yesterday’s reaction to ‘Operation Twist’ clearly demonstrates the investing public understands fiddling with the money supply and shifting a bond portfolio on the deck of the economic Titanic has significant limitations and unintended consequences. On September 9, we noted the market’s collective yawn to the Wall Street Journal headline, “Fed Prepares to Act.” This was a clear signal the markets were not excited about ‘Operation Twist’.
7. Government bailouts and large-scale stimulus spending are a thing of the past. The Fed and deficit spending prevented the last bear market from doing what it wanted to, which was purge all the bad debt and businesses from the system. We cannot hope for a repeat Fed/deficit-spending performance, meaning this bear market could be worse. The S&P 500 could drop well below 1,050 before this bear has run its course.
8. The official shift from an inflationary bias to a deflationary bias occurred on September 9. Our recent analysis supports a deflationary shift has taken place, meaning the bias for all asset prices is now to the downside. In this stage of the bear market, investment options may be limited to shorting (SH), conservative bonds (TLT), and the dollar (UUP). We own all three. The table below shows asset class performance during a similar period in the last bear market.



9. Widely watched retracement levels and long-term trendlines point to possible buying support coming in between 1,018 and 1,044 on the S&P 500 – if we get down that far and bounce, it may offer a good time to consider covering short positions and cutting back on defensive assets.
10. Emerging markets have lead markets higher countless times in the last decade or so, including off the 1998, 2009, and 2010 lows. As we highlighted on September 12, emerging markets have been laggards for some time now, which was a big red flag heading into Wednesday’s Fed announcement.
11. The technical deterioration in the European indexes points to a crisis that is just getting started, not one that is nearing completion. The mountains of debt and flawed structure of the euro also support that theory.
12. The S&P 500 needs to catch up with Europe in terms of declines. As noted on September 13, U.S. stocks recently reached the top of a trend channel that preceded big declines in 2008 and 2010.
13. Short position data recently indicated significant downward pressure could still be exerted on stock prices. We are not the only ones that have seen the items listed on this page.
14. Stocks dropped over 50% after the technology bubble burst. Stocks dropped over 50% after the housing bubble burst. A logical case can be made that stocks will also drop over 50% in the wake of the bursting of the “Fed bubble”.
15. The lack of interest in QE2 winning assets, something we have noted numerous times since August 31, was another deflationary red flag heading into Wednesday’s Fed meeting. Our analysis the day before the Fed announcement also supported a bearish reaction to shifting the Fed’s balance sheet. We were short stocks (SH) and long the dollar (UUP) heading into the 2:15 announcement, a stance that had me questioning our sanity around 2:00 p.m.
16. On August 26, our ETF and asset class rankings pointed to more downside in stocks. When the top-ranked ETFs include the VIX (VXX), a short (SH), and bonds (BND), it means something is wrong with the long side of the market.
17. Even recent action in gold and silver is leaning toward deflationary or bearish outcomes. The gold:silver ratio remains above its 200-day and the 50-day is above the 200-day. These are deflationary shifts since silver is the more economically sensitive precious metal.
18. The parallels to 2000 and 2008 that we presented on August 12 are still in place and they remain concerning. Long-term sell signals are easy to find on weekly and monthly charts.
19. The domino effect of crippling levels of debt will eventually impact corporate earnings (see video in post). There are very few, if any, safe haven stocks in a bear market.
20. A clear topping process has unfolded, along with a now almost-officially-failed rally attempt. The chart below was originally presented on August 3; the version below has been updated.



21. The slope of the S&P 500’s 200-day moving average is rolling over in a bearish manner. The 50-day moving average is below the 200-day, which is known as a death cross. As our research indicted on August 17, the current death cross, occurring last in an economic cycle, may be more deadly than most.



22. The CCM Bull Market Sustainability Index (BMSI) officially moved into bear market territory on September 6. On September 22 it dropped all the way down to -601, which clearly aligns with poor risk-reward markets in the past (see table below). A risk-reward ratio below 1.00 is unfavorable and tells us the odds favor lower lows in stocks and risk assets in general.

We will maintain a bearish bias until fundamental (mainly Europe) and technical conditions improve. If the S&P 500 (SPY) breaks below last Monday’s low of 1,136, we would consider adding to our deflationary/bearish stance, which includes bonds (TLT), the dollar (UUP), and a short (SH). Since gold, silver, and gold mining stocks may get caught in the deflationary downdraft for a time (see “If The Dollar Continues To Rally” table above), we may sell our GDX relatively soon.

As shown in the chart below, the Dow was having a rough day on August 9 as it waited for the Fed’s statement to be released. After digesting the pledge to keep interest rates low “at least through mid-2013”, stocks spent the rest of the day rallying.

Since top performing ETFs that experience gains on above average volume can turn out to be attractive investments during the subsequent rally, we screened ETFs after the close on August 9 looking for:

1. The day’s top performers in terms of percentage gain.
2. ETFs that trade at least 500,000 shares per day.
3. ETFs that had daily volume on August 9 above their 3-month average volume (conviction).

The screen above helps us keep track of where institutions, pension funds, hedge funds, etc. are seeing potential for gains. You would think that if the market was anticipating a similar bullish reaction to this Wednesday’s Fed announcement, the top ETFs from August 9 would have (a) made money on Tuesday (9/20), and (b) seen a lot of buying interest as measured by trading volume. There were fifty-three ETFs that met the criteria above after the close on August 9. On Tuesday of this week, only 25% of the fifty-three ETFs made money, posting an average gain of 0.49%. The lack of interest in Fed-friendly assets was highlighted by the 75% of the fifty-three ETFs that lost ground on Tuesday, posting an average loss of 0.79% (see table below).

Using the figures above, a back of the envelope “Fed Risk-Reward Announcement Forecast” yields a weak ratio of 0.20. A ratio of 1.00 would “forecast” 50-50 odds of a favorable reaction to the Fed. Tuesday’s ETF activity leans toward a disappointing reaction to Wednesday’s Fed announcement. Obviously, the most important thing to watch is price and volume action (conviction of buyers) from 2:15 to 4:00 p.m. on Wednesday. However, given the Fed has telegraphed its menu of possible policy options, the market does not seem to be anticipating a strong rally to follow the Fed announcement; if it did, it stands to reason the buying interest in Fed-friendly ETFs would have been more convincing on Tuesday.

Is the market anticipating a somewhat surprising announcement of QE3? Based on the performance of QE2-winning ETFs on Tuesday, the answer appears to be a definitive “no”. We have been tracking QE2 winners for a few weeks looking for signs of life. More details on recent performance of QE2 ETFs can be found here.

Concerns we have mentioned in recent weeks, including tepid interest in Emerging Markets and Greece / weak technicals, also align well with the possibility of a disappointing reaction to the Fed’s statement. Another scenario calls for a sharp rally to roughly 1,260 on the S&P 500, followed by a sharp reversal. The bullish scenario where debt problems in Europe are resolved and stocks sprint higher into year-end remains a possibility, but not a highly probable outcome. Our large cash position allows for a flexible stance heading into the Fed meeting. If the S&P 500 (SPY) breaks below last Monday’s low of 1,136, we would consider adding to our deflationary/bearish stance, which includes bonds (TLT), the dollar (UUP), gold mining stocks (GDX), and a short (SH).

It would not be surprising to see the stock market spike higher in the next few days and then reverse course in a rather abrupt fashion (we may have seen it late today). The video below analyzes the current market from the perspective of a short or inverse position. An inverse or short position increases in value when stocks go down. Bullish and bearish signs to look for in the coming days are outlined in the context of the 2000-2002 bear market. We also compare the present day S&P 500 to 1998 and 2010. After clicking play, use the button on the bottom right corner of the video player to view in full screen mode.

More information: This video contains an update to the bearish case for stocks (as of Sunday). The advance-decline stats for the markets have weakened in the last two sessions.

CCM Clients: We are putting together a video which covers our strategy and thought process on how to manage our short positions (SH, RYURX). The video will be completed sometime today. We have a very specific game plan in place should the markets continue to climb higher. The weight of the evidence still points to bearish outcomes in the weeks ahead (lower lows in stocks), but we must be prepared for bullish outcomes as well. Having plans in place reduces the odds of making decisions based on fear, rather than based on reason and facts.

Financial markets tend to get fixated on a small number of issues, which often leads to questionable decision making for investors. It is important to look at a scenario where the second Greek bailout package is approved. The immediate question for the markets would become, “Now what?” The odds are fairly low approval of the second bailout will stabilize the bond, currency, and stock markets for an extended period of time. The excerpts below shed light on this concept:

The Economist – September 17:

The latest, inadequate plan for a second Greek bail-out, agreed at a summit in July, should be thrown away and rewritten.

National Public Radio (NPR) - September 12:

Juergen Michels, chief eurozone economist at Citigroup, says the size of the European rescue fund will very likely have to be increased. He says talk of eurozone defaults in the next year or so is simply realistic. “We’ll probably also have to see defaults,” Michels says. “Greece, at the end of the day, is likely to have one, and it’s also likely to happen for Portugal and Ireland.”

Wall Street Journal (WSJ) – September 19:

But even if Greece gets its money in October, it may only postpone the reckoning: Its budget deficit this year is likely to be 10% compared with a target of 7.5%, says Citigroup. And Athens has barely started on a promised privatization program. The market is convinced the Troika—the name given the team of officials from the International Monetary Fund, European Central Bank and European Commission—will ultimately have to admit that Greece won’t meet its targets. That would pave the way for a default and coercive, rather than voluntary, debt restructuring.

We will maintain a bearish bias until fundamental (mainly Europe) and technical conditions improve. If the S&P 500 breaks below last Monday’s low of 1,136, we would consider adding to our deflationary/bearish stance, which includes bonds (TLT), the dollar (UUP), gold mining stocks (GDX), and a short (SH). As covered in the video below, stock market technicals were raising some yellow flags as of the September 16 close, even before the near waste of time weekend meetings in Europe.

When Bloomberg noted investors have pulled more money from U.S. equity funds since the end of April than in the five months after the collapse of Lehman Brothers, it reinforced our “run for the exits” concerns from September 1:

We believe the psyche of investors is on the verge of reaching a tipping point, which could cause a very rapid decline in asset prices. It is next to impossible to know if and when they will reach for the sell button in unison, but the risk for such an event is elevated and must be considered in all portfolio management decisions. Stocks dropped 34% in twelve trading sessions in 1987. High volatility occurred before that drop, indicating an increased willingness to run for the exits. If you have not noticed, the markets have been volatile recently. An “Oh, my God” type event is difficult to predict, but the conditions are in place to make for an interesting next few months.

Regardless of what happens in Europe, stocks are not the place to be if a recession is around the corner. The odds of a recession are increasing. A bearish economic outlook is supported in Friday’s Wall Street Journal:

“It feels like a recessionary environment. What they call it later on I can’t tell you,” says Bart van Ark, chief economist of the Conference Board, who put the odds of recession at 45%. Since 1988, every time the Conference Board’s estimate of the probability of recession topped 40%, a downturn followed shortly thereafter.

We remain skeptical of the current advance in stocks, primarily due to the weak participation and conviction behind moves in economically sensitive sectors, such as energy and commodity-related stocks. The current advance looks narrow (again) with the S&P 500 Index and NASDAQ QQQ’s being used as the main exposure vehicles. The sectors, asset classes, and portions of the globe that lead the markets higher off the November 2008/March 2009 lows are not providing a lot of confidence the current advance is sustainable. China and emerging markets, shown below, were leaders off the 2008/2009 lows. Following the bottom in 1998, emerging markets also led the way to higher highs. Emerging markets and China continue to lag the S&P 500, which is not what we want to see.

The bulls still have a good grasp on the short-term trend. It was only five days ago the market was on the edge of taking out important levels on the downside. Sharp moves like what we have seen since the intraday reversal on Monday are typical in bear markets. It remains well within bear market reason for the S&P 500 to revisit the 1,260 level, as we mentioned on August 10.

How the market behaves between 1,230 and 1,260 will go a long way in helping sort out the debate between the bulls and the bears. If the S&P 500 barrels through these levels in impressive fashion, it would obviously be a win for the bulls. The most likely outcome for the S&P 500 is a reversal between current levels and roughly 1,260. If a reversal does occur, the manner in which the market comes down will be very important. If we see a pullback on weaker volume and see bullish divergences appear on charts (especially weekly charts), then it may represent a good entry point for bullish positions. If the reversal is swift, backed by volume, and negative market breadth, then the bearish case will remain firmly intact. The important thing is to keep an open mind and make decisions based on facts rather than fear of missing something. Our current high position in cash allows us to adapt if conditions improve.

We still have all of the following to contend with:

1. The problems in Europe are very serious and have not been addressed in a meaningful way. This week’s developments are more in a series of “kick the can”/short-term Band-Aids. Very little has been done to address concerns about Italy – a much, much bigger problem, in terms of size, than Greece.
2. The debt debate in the United States will come back into the news cycle soon.
3. The U.S. economy is stalling and the economic numbers have not shown signs of improving. The four-week moving average of jobless claims is above 400K and rising (not a good sign).
4. U.S. stocks market performance relative to Germany remains near the top of a trend channel that has preceded stock market weakness in the past (more detail).
5. Estimates for corporate profits may need to come down significantly in the next few months. Profits were still in decent shape in the fall of 2007 and spring of 2000. Financial markets tend to lead earnings and the economy.
6. Monthly charts of European stocks have long-term sell signals in place similar to those in late 2007/early 2008
7. Rather than helping stimulate growth, China is trying to tame inflation via tighter monetary conditions. China was a leader off the November 2008 lows in stocks – today it is a laggard.
8. Global stimulus spending helped fuel economic activity around the globe since 2009 – there will be no repeat performance. The United States will be cutting spending, not increasing it. Europeans are cutting back as well.
9. Housing prices in the U.S. could fall another 10-25%, according to Robert Shiller, the economist who co-founded the S&P/Case-Shiller index of U.S. home prices.
10. Investors have lost faith in global policymakers.
11. More importantly, investors have lost faith in the Fed’s ability to ride to the rescue. If they launch another round of money printing (QE3), it will have a much more muted impact on asset prices; it may even have a negative impact using the “are things this bad?” rationale. ‘Operation Twist’ is probably coming our way next week; it will not add new money to the financial system, which is significantly different than QE.