Archive for May, 2012

Bailout Talk Sparks Rally Off Lows

Thursday, May 31st, 2012

Markets love bailouts, but the story behind today’s story paints a concerning picture. From the Wall Street Journal:

The European department of the International Monetary Fund has started discussing contingency plans for a rescue loan to Spain in the event that the country fails to find the funds needed to bail out its third-largest bank by assets, Bankia SA, people involved in the handling of the Spanish crisis said Thursday.

A major issue in any bailout of Spain, which could end up being bigger than those already agreed for Greece, Ireland and Portugal, would be the size of the contributions made by the IMF and the EU and where those funds would come from.

“A bailout loan could stretch the resources of both the IMF and the euro zone to breaking point and raise serious questions about the purpose of the euro,” another of the people said.

“Neither the IMF, nor the euro zone, can shoulder this bill with three other euro-zone bailouts in progress. The money is simply not there,” a second person said.

The full WSJ story is here.

German Index Can Assist U.S. Investors

Thursday, May 31st, 2012

200-Day MAs Should Provide Good Feedback:

You do not have to be an investing expert to know events in Europe are dictating the day-to-day movements in all global asset markets. Germany is a leader in Europe because, relative to the rest of the European Union, they have their financial house in order. The trend has been for the stronger nations, such as Germany, Finland, and the Netherlands, to take on more burdens from their over-extended neighbors. As a result, any future bailout activity will impact the finances of the stronger nations. The basic concepts are captured in the following excerpts from Bloomberg:

Proposals for more liberal use of European bailout money are likely to face resistance in creditor countries such as Germany, Finland and the Netherlands, the scenes of growing taxpayer opposition to more aid.

“It’s hard enough to bail out local banks let alone non-domestic banks,” said Harvinder Sian, a London-based fixed-income strategist at Royal Bank of Scotland Group Plc. “A crisis lesson so far is that big ideas coming from Brussels [EU Commission] or the guys taking the money are noise up until the point that the Germans get on the same page.”

Fundamentally, if the German economy and stock market can withstand the next moves in the seemingly never-ending cycle of European bailouts and rescues, the U.S. economy and stock market will most likely show some improvement.

From a technical perspective, the German stock market is a few steps ahead of the S&P 500. The 200-day moving averages for the S&P 500 and German DAX are shown in pink below. The DAX’s performance near the 200-day may provide an early read on where the S&P 500 may be heading.

The video below describes the charts above in more detail, keying on possible scenarios and the impact on your investments. DeMark support and exhaustion counts are also reviewed on daily, weekly, and monthly charts. The video identifies key levels to monitor in the coming days and weeks, providing valuable input for future buy, sell, and hold decisions depending on how things play out in Germany.

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: Germany Can Assist With Risk Mgmt

Video: Germany Can Assist With Risk Mgmt

The table below shows possible areas of support for the German ETF (EWG) based on DeMark indicators, which are proprietary tools from Market Studies, LLC.

Clear and sustained violations of the levels above by EWG would increase the chances of additional pain for global investors. Conversely, if EWG holds above these levels, the probability of a rally in risk assets improves.

European Financials Near 2011 Low

Wednesday, May 30th, 2012

Banks in Europe are on the ropes, which is often when policymakers make some type of “market calming” or market manipulating announcement.

We need to be ready to shift gears quickly - Press conference risk is currently high. For now, the bears remain in control.

Europe: Policy Options Remain Limited

Wednesday, May 30th, 2012

Before the markets opened on May 30, a Dow Jones article captured the serious nature of the escalating crisis in Spain:

European stocks fell Wednesday as the euro sank to its lowest level since July 2010 and Spanish bond yields soared, with concerns over Spain mounting. “Investors are heading for the exits once again as fears for a Spanish economic collapse heads closer to becoming a reality,” said Mike McCudden, head of derivatives at Interactive Investor. “It appears to be only a matter of time before it’s not just the banks that need bailing out, but the country itself,” he added.

“The ECB’s rejection of the Spanish government’s plan to recapitalize Bankia…puts Spain on the steps of the region’s fiscally based liquidity hospital, the European Financial Stability Facility/European Stability Mechanism. It looks increasingly likely that it will be knocking on the door soon asking to be admitted,” said JPMorgan. “Spain looks to have gotten to the point where it cannot bear the burden alone. The Spanish government recognizes the need for burden-sharing, but it does not want the kind of burden-sharing that was made available to Greece, Ireland and Portugal,” it added.

The markets in the U.S have been relatively calm having avoided new lows for six trading sessions. U.S. investors expect the European Central Bank (ECB) to bail out the markets once again. As we outlined in detail on May 26, the market may be underestimating the problems associated with the narrowing list of possible policy responses in Europe.

As shown in the chart below, on Wednesday morning the yield on a ten-year Spanish bond hit 6.70% for the first time since November 2011. If the ECB had a “solution” with little in the way of negative consequences, it is logical to assume they would have acted already. The ECB will take action at some point, but the low-hanging fruit is no longer on the policy-response tree.

At 7:00 a.m. EDT Wednesday, Bloomberg reported on a possible policy response in Europe:

The European Commission called for direct euro-area aid for troubled banks and touted common bond issuance as an antidote to the debt crisis now threatening to overwhelm Spain. The commission, the European Union’s central regulator, sided with Spain in proposing that the euro’s permanent bailout fund inject cash to banks instead of channeling the money via national governments… Proposals for more liberal use of European bailout money are likely to face resistance in creditor countries such as Germany, Finland and the Netherlands, the scenes of growing taxpayer opposition to more aid.

Since they are all flawed in some way or involve having Peter bail out Paul, the expression “likely to face resistance” has been common in recent media reporting. When push comes to shove, Europe will do something. The question is how low do the markets have to go to qualify as a shove.

The tables below, originally shown on May 26, have been updated as of the May 29 close. Even while the S&P 500 tacked on 14 points, Treasury bonds (TLT) and the U.S. Dollar (UUP) had very modest declines showing risk-averse investors were not impressed with the “good” news from Greece and the Wall Street rumor of a giant stimulus package coming from China. The tame reaction from TLT and UUP was one of the reasons we did not buy into Tuesday’s rally.

While the S&P 500 and EWG recaptured two of the support levels in the table below on Tuesday, it appears as if those levels will be surrendered early in Wednesday’s session.

Market Models Show Improvement

Tuesday, May 29th, 2012

Nothing dramatic occurred on Tuesday in terms of changes to our market models. The Bull Market Sustainability Index (BMSI) did pop back into the low end of “healthy” territory, which makes us more open to redeploying cash. The other models (MRM, 80-20) remain in neutral territory. The classifications are updated automatically each day based on the current readings relative to historical readings.

Our current allocation remains in line with the recommended allocation, but that may not be the case if we get some bullish follow-through this week. Even if we rally, based on what we know today, the door remains open to lower lows sometime in the next few weeks. We may be in a bottoming process, which implies it could take some time.

As a point of reference, we have not yet seen a bullish MACD cross on the daily or weekly chart of the S&P 500. If we are to see a sustained rally both would have to see “black over red” on MACD.

Volume Offsets Positive Price Action

Tuesday, May 29th, 2012

Today’s move in the markets was positive. However, the conviction behind the gains was not all that impressive. As of 4:00 p.m., the handful of ETFs below traded roughly 68% of their average daily volume (way below a typical day). The light ETF volume points to tepid interest from institutions and hedge funds.

Last June, a low volume rally did carry stocks higher, but it was fully retraced later in the summer. We are open to adding to our holdings, but we would like to see a little more conviction from buyers. It appears as if stocks could move higher; the question is how sustainable will the move be?

Conservative assets, such as TLT and UUP, hardly experienced a mad dash toward the exits. TLT lost 0.31% today and UUP dropped only 0.04%. Both remain above the support levels shown below.

Treasuries Set Up For Possible Reversal

Monday, May 28th, 2012

There are three reasons to be open to a possible reversal in Treasuries:

  1. Valuations / near-record low yields
  2. Slowing momentum
  3. Better than expected outcomes in Europe

The fundamental problems in Europe are serious and the options for policymakers are limited. Therefore, it is understandable investors have flocked to U.S. Treasuries and German bunds. However, when there is a possibility of yields slipping into negative territory, you have to ask yourself how long current trends can continue without at least some corrective activity. From the Wall Street Journal:

For the first time, the two-year German bond yield may dip below zero, a rare occurrence in the global fixed-income universe and one that flags growing fears over the future of the euro zone. …Bunds and U.S. Treasury bonds have been the primary safe harbor, and the strong demand has sent yields, which move inversely to their prices, to record or near-record lows. The most striking manifestation of that this week is the two-year German bond’s yield, which Wednesday touched a record low of 0.02%. At the same time, Germany sold a same-maturity bond with a zero coupon, basically allowing the nation to fund itself with almost free cash.

After rising for seven straight weeks, long-term Treasuries (TLT) dropped 0.64% last week. Similarly, the seven-to-ten-year Treasury ETF (IEF) recorded its first weekly decline in ten weeks. The markets appear to be trying to back off the “run for the risk exits” stance. From Bloomberg:

“Yields will stay low, but the Treasury rally is losing momentum,” said Hideo Shimomura, who helps oversee the equivalent of $75.3 billion in Tokyo as chief fund investor at Mitsubishi UFJ Asset Management Co., a unit of Japan’s biggest publicly traded bank. “European governments are defending the euro. That’s the priority. The fear of the destruction of the euro will fade.”

The slowing momentum in TLT is evident when examining the weekly chart. Since a picture is worth a thousand words, the May 18 video below compares the current charts of TLT and the euro (FXE) to the S&P 500’s prior to the March 2009 bear market low.

Video: Bullish Divergences For Stocks

Video: Ciovacco Capital MRM

While the situation in Europe can take numerous paths after the June 17 elections in Greece, recent history points toward policymakers and the European Central Bank (ECB) taking action should Spanish and Italian yields continue to rise. After the close on Friday, Spain announced a $24 billion bailout for Bankia SA, effectively nationalizing the country’s third largest bank. Spain’s action fits the pattern of using public funds to keep the system propped up. The odds are better than average if things do not go well in Greece or Spain, the ECB will act as the lender or buyer of last resort, which could prompt selling in U.S. Treasuries.

From a tactical perspective, the table below can be used to monitor the health of the current rally in conservative assets. As long as TLT and the U.S. dollar ETF (UDN) hold above the support levels in the table below, the bulls will still have the upper hand. If these levels give way, it will add to our short-term concerns about Treasuries.

If you own TLT or IEF, another relatively easy way to monitor the health of the current rally is to keep an eye on the daily MACD. A bearish cross occurs when the black line drops below the red line. The negative slope of the black MACD line below (see red arrow in chart below) is indicative of slowing enthusiasm from Treasury investors.

As you can see, MACD has experienced a bearish cross on the daily chart of IEF below.

Preparing For Market Reaction To Greece

Saturday, May 26th, 2012

If you believe policymakers will once again bail out the markets, it is important to understand the limitations associated with each possible policy response. Writing for the Wall Street Journal’s Brussels Beat, Stephen Fidler touches on the problems associated with the narrowing list of options for European leaders. The drawback with euro bonds is one of timing:

The deliberations at Wednesday night’s European Union summit suggest most options to increase government burden-sharing are a long way from fruition. That includes the proposal that has received the most attention: euro bonds… Even if Germany, Finland and Austria dropped their objections today—a development of which there was little sign on Wednesday night—constitutional changes and other interim steps would mean the first euro bond couldn’t be issued for years. Some analysts say a more explicit signal that the euro zone is heading toward euro bonds, and a road map laying out how, might help bolster confidence, but even most proponents don’t see them as a crisis-fighting tool.

Markets are not interested in “solutions” that will take years to implement. History tells us a debt crisis is nearing some form of conclusion when depositors begin to flee from troubled banks. One possible response to slow the flow of funds is to insure deposits. Fidler highlights a fair question:

How effective would euro-zone bank guarantees be for countries at risk of leaving the currency bloc?

Euro bonds are a long way off at best. EU bank guarantees mean little if your bank is no longer located in an EU country. That leaves the first family of all moral hazard, central banks, to do the heavy lifting. If the first two rounds of unlimited three-year loans (LTRO) “fixed” the problems in Europe, you would not be reading this article. Fidler reminds us another round of LTRO has a questionable cost/benefit ratio and a significant stumbling block:

The ECB’s main policy “bazookas” have flaws that may undermine their ability to settle the crisis. It could further flood three-year money into banks, through an extension of its Long-Term Refinancing Operations. But while most analysts consider the fund injections in December and February as essential to resolving a crisis of confidence in banks, the benefit to the bond markets of beleaguered governments such as Spain and Italy was short-lived. There is another obstacle to expanding this program…. To get loans from the central bank, banks need to pledge assets as guarantees. And their pool of eligible assets has shrunk significantly.

The gravity of the debt crisis in Europe is captured in the last sentence above. Banks are running out of collateral.

Another major problem that we pointed out in October 2010 is when banks use LTRO funds to buy questionable government bonds; it makes the financial sector even less attractive to investors and a normally-functioning capital market. The purpose of bailouts and central bank assistance is to take a step back toward, not away from, normally functioning markets - LTRO has failed miserably on that front.

When the ECB decided not to take part in the Greek bond haircuts (they were paid in full), it reduced the effectiveness of the the central bank’s intervention into the bond markets. If the ECB steps in and buys large quantities of Italian bonds in an attempt to lower yields, it pushes other investors further back in the future haircut line. If the ECB will not take part in future writedowns, then the other bondholders must take bigger haircuts. Fidler sums up the problem:

If the ECB steps in to buy significant quantities of these bonds in an effort to calm markets, officials and analysts say private investors may well pull out. The reason: They fear subordination in the event of a restructuring.

The subordination work-around being talked about is for the European Stability Mechanism (ESM) to become a bank and lever-up using printed/borrowed money from the ECB. The ESM could take a place in the haircut lines with other investors, removing the subordination concerns. Fidler points out some obstacles here as well:

This approach would entail the ostensibly forbidden central-bank finance of governments and raise questions of moral hazard, potentially discouraging beneficiary governments from pushing ahead with economic overhauls.

Money printing and moral hazard; two terms that have unfortunately been used extensively in recent years. How long can central banks print money before inflation begins to accelerate in a 1970s-like manner? As evidenced in the slowing downside momentum in inflation-protection assets, such as silver and gold, the markets appear to be signaling an increasing concern about the future value of paper currencies. Markets are also thinking about the next round of inevitable market intervention from policymakers and central banks. Beginning at the 7:00 minute mark of the May 25 video below, we highlight numerous “bullish divergences” on weekly and daily charts, including charts of silver (SLV), a basket of commodities (RJI), agriculture (RJA), natural gas stocks (FCG), German stocks (EWG), Spanish stocks (EWP), gold (GLD), Italian stocks (EWI), small caps (IWN), regional banks (KRE), coal stocks (KOL), and telecom stocks (IYZ). The divergences tell us to be open to a bottoming process for risk assets, possibly unfolding over the next three weeks. Later in this article, we outline ways to monitor if the assets listed above are likely to respond favorably to the technical set-ups shown in the video. Historical examples of similar technical set-ups are provided below the video player, helping you answer the question - “How can these divergences possibly help me in the coming weeks?”

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: Bullish Divergences For Stocks

Video: Ciovacco Capital MRM

The charts that follow were originally presented on May 25. The chart below shows a weekly bullish divergence between price and a technical indicator, MACD Histogram, that foreshadowed the March 2009 low in the S&P 500. A bullish divergence occurs when price makes a lower low and the indicator makes a higher low.

The next chart shows evidence of slowing bearish momentum in the euro in the first quarter of 2009. The chart below turned out to be very useful to investors in stocks, bonds, commodities, and precious metals.

The current chart of the euro, shown below, may also turn out to be very useful over the coming months. The euro has been in a significant downtrend for the last thirteen months. The recent lower low in price has not yet been confirmed by MACD Histogram.

There are times when the best game plan for your next move in the markets is to take a wait-and-see stance. The outcome of the June 17 election in Greece is uncertain at best. The people of Greece may elect pro-bailout/austerity leaders, which would most likely be the most market-friendly solution. The decision tree for investors becomes much more uncertain and complex should Greek voters take a “throw the bums out” stance. If traditional parties in Greece fail to regain control, it could get ugly for global investors. To complicate matters, the markets do not know what the policy response will be after the Greek electorate has spoken.

In an environment where the unknowns are too long to list, we can use the markets to help us align with the proper investment path. The table below shows possible areas of resistance for a handful of key markets. If the market can begin to march above resistance, we will become more open to redeploying cash into risk-on and inflation-protection assets, including those listed previously in this article. The markets below, on average, would have to move 2.49% higher to clear overhead resistance.

Greece Elections Investing

We would also become more confident about a bullish market reversal if defensive assets, such as the U.S. dollar and Treasuries, begin to break down. If TLT and UDN clearly violate the levels shown below in a bearish manner, it will increase the odds for a pop in stocks, commodities, and precious metals.

Video: Ciovacco Capital MRM

Since deflationary forces are being driven by fears of more writedowns and possible unrest in Europe, we can monitor key support levels to assist us in making additional incremental reductions to the risk side of our portfolio. The table below is based on possible areas of support identified using DeMark Indicators, from Market Studies, LLC. The “Above” columns show the market’s current position relative to support “Level One” and “Level Two”.

support table Ciovacco Capital

How can we use the table above to monitor downside risk? The line in purple shows areas of support are roughly 2.72% below where the markets closed on May 25. The second layer of support is roughly 5.34% below the May 25 closing prices. If the majority of markets move below the values in the Level One column, we will be more apt to take another incremental step away from risk (raise more cash). Another incremental step may be taken based on the Level Two column.

The current trends in commodities and precious metals support the bearish and deflationary case for stocks. Central bankers are trying to create positive inflation, including asset price inflation. If commodities continue to decline, it reduces the probability of the bulls regaining control of the markets. If the levels in the table below are violated, the case for deflationary outcomes will improve.

support table Ciovacco Capital

Thinking in extremes is a good way to test your market preparedness. If you can answer the questions below without hesitating, you most likely have a good handle on the current environment:

  1. How would I manage my assets, including cash, if the S&P 500 moved from current levels to over 1450?
  2. How would I manage risk if the S&P 500 moved from current levels to 850?

The incremental approach discussed above, is one way to manage risk in an uncertain world.

Trend Channels In Play

Friday, May 25th, 2012

The chart below is as of 2:00 p.m. EDT Friday. The 1280 price level was derived using a point-and-figure chart for the S&P 100 Index.

Weekly Divergences Should Be Respected

Friday, May 25th, 2012

It is important to set the stage for what the content here represents and what it does not represent. The fundamental content relates to the possible issuance of euro bonds; an idea that may never move past the conceptual stage if Germany has its way. The technical content below refers to “set-ups”, not buy signals or sell signals.

The bears remain in control of the markets as of the close on May 24. This article outlines numerous technical set-ups that tell us to be open to a rally in stocks, commodities, and the euro. We should also be open to declines in U.S. Treasuries and the U.S. dollar. Even if the set-ups shown here prove to be useful in forecasting a rally in risk assets, the bears could still maintain control for one to three weeks.

While it has probably not been well-received in Germany, Italian Prime Minister Mario Monti said he believes a euro bond/debt sharing agreement can be formed to extinguish the debt fires in Europe. From Bloomberg:

“Europe can have euro bonds soon,” Monti said in an interview on Italian television station La7 yesterday. Germany has an interest in ensuring no country leaves the euro, while Greece will probably remain in the currency region even as “anything can happen”. Monti continued, “A united Europe is in Germany’s interest. We’ll have euro bonds if the euro area, and therefore Germany, will want them.”

The comments from Monti may be more of a bargaining tactic than a portrayal of what took place during this week’s meeting of euro leaders. From Bloomberg:

Monti’s account of the meeting contrasted with that of Luxembourg Prime Minister Jean-Claude Juncker, who told reporters in Brussels that joint debt sales “didn’t find much support,” particularly in the German-speaking area, while the French-speaking area was more enthusiastic. Back in Berlin 15 hours later, Merkel’s coalition and the opposition Social Democrats and Greens agreed that euro bonds “are not up for discussion,” Volker Kauder, the floor leader of Merkel’s Christian Democratic Union, told reporters. At the same time, the two sides will “exchange studies” on the redemption fund before next month’s meeting.

The video below, created on May 24, covers numerous technical set-ups that align with the possibility of breaking the log-jam in Europe. The chart below shows a weekly bullish divergence between price and a technical indicator, MACD Histogram, that foreshadowed the March 2009 low in the S&P 500. A bullish divergence occurs when price makes a lower low and the indicator makes a higher low. The video in this article describes the chart below in more detail.

The next chart shows evidence of slowing bearish momentum in the euro in the first quarter of 2009. The chart below turned out to be very useful to investors in stocks, bonds, commodities, and precious metals.

The current chart of the euro, shown below, may also turn out to be very useful over the coming months. The euro has been in a significant downtrend for the last thirteen months. The recent lower low in price has not yet been confirmed by MACD Histogram.

The video below covers potentially bullish set-ups in the euro, Swiss franc (FXF), a basket of commodities (DJP), agriculture (RJA), natural gas stocks (FCG), German stocks (EWG), Spanish stocks (EWP), silver (SLV), gold (GLD), Italian stocks (EWI), small caps (IWN), regional banks (KRE), coal stocks (KOL), and telecom stocks (IYZ). Potentially bearish set-ups are shown in U.S. Treasuries (TLT) and the dollar (UUP).

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: Bullish Divergences For Stocks

Video: Ciovacco Capital MRM

If you are bearish or short, the video above does have something for you. At the 02:18 mark, a head-and-shoulders set-up is shown on the EAFE Index (EFA). If the head-and-shoulders set-up wins out over the bullish divergences, a 27% drop in EFA moves into the realm of reason. A recent head-and-shoulders set-up, originally shown on May 13, did help forecast the recent drop in the S&P 500.

The bears still have an ally in Spain. On Friday morning, Bloomberg reported:

Spain’s government is analyzing “with all caution” requests from regional governments to help them regain access to capital markets, Deputy Prime Minister Soraya Saenz de Santamaria said. “These are complex mechanisms, which have to analyzed with all the difficulties and complexities,” she told reporters today after a cabinet meeting.

The term “set-up” respects that more needs to take place to move to a “buy signal”. Elections are less than a month away in Greece, which leaves large quantities of uncertainty on the table. Germans have little-to-no interest in sharing liabilities with their European brothers and sisters. Technically, the bulls have made only modest progress since May 18. However, the possibility of debt-sharing or some form of compromise in Europe coupled with the numerous bullish set-ups necessitates an open mind relative to better than expected outcomes over the coming weeks and months. As we have covered in the past, an acceleration of the bearish trends, similar to June 2008, is also a plausible scenario. Our plan is to monitor developments and adjust accordingly.