Short Takes

Video Covers Bullish & Bearish Scenarios

The bulls remain in control of the stock market, but numerous yellow flags can be identified using technical analysis. In this week’s chart-packed video:

(a) European financials at the 1:40 mark, (b) Treasury yields 2:32, (c) internet stocks FDN 4:32, (d) home builders ITB 5:40, (e) credit spreads 6:46, (f) food & beverage PBJ 8:48, (g) high beta vs. low beta 9:45, (h) low volatility vs. S&P 500 10:55, (i) % stocks greater than 50-day 11:52, (j) trend change in bonds AGG 14:40, (k) U.S. dollar UUP 15:30, (l) financials XLF 16:19, (m) financials vs. utilities XLF vs. XLU 17:28, (n) consumer staples XLP 18:17, (o) utilities vs. S&P 500 19:08, (p) healthcare XLV 19:44, (q) risk-on vs. risk-off XLY vs. XLP 19:56, (r) oil & gas XOP 20:55, (s) stock vs. bonds SPY vs. IEF 21:46, and (t) S&P 500 vs. VIX Fear Index 27:51.

As markets begin to advance in a near-vertical manner, it becomes more and more difficult to manage risk. Charts that “go straight up” can also “come straight down”.

The bulls are still in control, but when they finally lose control, gains in this type of environment can evaporate quickly.

Stocks may well advance further, but if they do without taking a breather, the risks of a sharp and rapid “give back” will only increase next week. Another reason for booking gains this week was that our holdings (IWM, IYT, MDY, etc.) tended to be in the higher beta category (more volatile). If we are to have exposure in this environment, we would prefer to do via lower beta options (SPLV is one of many examples).

Most Recent Comments & Charts Via Twitter: You can access them here (@CiovaccoCapital). You do not need to know anything about Twitter to view our comments or use the links to view charts.

This week’s video will most likely be ready for consumption Sunday before noon. It will include 60-minute, daily, and weekly DeMark analysis for the S&P 500 Index, as well as traditional charts. We will post the video here and via a link on Twitter (@CiovaccoCapital).

We took some profits in technology stocks today by reducing our stake in QQQ. The short-term risk-reward profile for the markets is cloudy. We prefer to lock in some gains when QQQ is up (we sold when it was in the black) rather than during a pullback/mini-panic.

After the Sunday talk shows, the bias concerning the fiscal cliff may be negative early next week. Locking in some gains is never a bad idea in range-bound markets. The S&P 500 has gone nowhere since the end of Q1 2012.

More charts and comments via Twitter (@CiovaccoCapital) – you do not need to know anything about Twitter to view our commentary.

We removed all our hedges today, selling VXX and PSQ at 10:00 AM EDT (before VXX really tanked) and the remaining hedges at the close. The market’s dynamic may shift back to risk-off after Friday morning’s employment number, but the odds favor at least a few more days of upside in stocks. Many of our long positions did well today: XME up 3.8%, FXI up 2.6%, PIN up 2.2%, EPI up 1.9%, XLB up 2.0%, IYT up 1.52%, AAXJ up 1.81%. The S&P 500 gained 1.0%.

One of the reasons for removing our downside protection was based on the risk-off vs. risk-on chart below. It shows the ratio of bonds (IEF) to stocks (S&P 500). When the ratio is moving higher, risk-off is in favor. The last two times the downward-sloping blue trendline turned back the ratio (see R1 and R2) gains in the S&P 500 followed (see points A and B).

Nothing says the pattern above has to hold into Friday, but our primary reason for hedging our portfolios was to protect against a steep drop which could have followed a break of 1,400. With the S&P 500 closing at 1,427 today, support appears to have held, at least for now. What happens near R3 remains important. If a weak employment report causes the ratio to break out to the upside, it would be a big win for stock market bears. As of Thursday’s close, the stock bulls regained the upper hand. We will enter Friday’s session with an open mind and maximum flexibility.

We continue to monitor things closely for our clients. Thus, Short Takes posts may be limited. You can get a feel for what we see via this link to the @CiovaccoCapital Twitter feed. You do not need to know anything about Twitter or be a Twitter user to read our comments.

Fortunate To Book European Profits Last Week

We felt the risk-reward ratio in Europe had reached an unfavorable level late last week (9/20/12). We took some significant profits off the table on Thursday, September 20. The vertical charts caught up with Europe this week; FEZ was down 5.08% in the last five sessions, EWP was down 6.80%, and EWI dropped 5.65%. It was nice to have them off the books and the profits tucked away in cash this week.

We entered this week with a significant cash position from our profit taking over the past few weeks. From a risk-reward perspective, we like emerging markets relative to the U.S. and Europe. Thus, we did some buying in that region of the globe this week.

Good News…Bad News

The good news this week was risk-on vs. risk-off charts held at logical and important levels, similar to the S&P 500 chart below. The bad news is the short-term strength has been in risk-off (bonds, shorts, currencies, etc.). The charts will give us the info we need one way or another (bullish or bearish). Trendlines are underrated; on September 26 we hypothesized the market was ready to bounce near support. You can see the original version of the chart below here; support has held thus far.

The S&P 500 was up 13.83 points on Thursday, which means Friday’s session “gave back” less than half of the gain. The NYSE Composite finished the week with support in close proximity (see below).

While there is no question risk markets are fragile, it was good to see bonds remain tame Friday; TLT was up a meager 0.06% and IEF was flat. The S&P 500 also closed near support this week as shown below.

Still Booking Gains Until Signs of Life Reemerge

On Friday, we continued to incrementally take profits in the SCHF/EFA positions we established over the summer. If support in the charts shown fails to hold, booking more profits Friday (9/28/12) allowed us to reduce risk a little until the current battle between risk-on and risk-off becomes clearer. Even if support holds, we believe there are better risk-reward opportunities relative to EFA/SCHF. Small caps have four trendlines below price that may act as support (see below).

Markets are either going to hold the support levels shown in this post or another leg down is on the way. There is no need to guess. We just need to pay attention and manage risk accordingly. Any continuation of the corrective process would have us consider some intermediate-term defensive positions, such as bonds or currencies. If the markets continue to fall, the manner in which they come down matters (divergences? strong volume? breadth? etc.).

The chart below (via link) could improve before the end of the week, but as it sits now, it is concerning for risk: CLICK HERE for CHART.

While markets may make another push higher, we decided to book some profits in silver (SLV), copper (JJC), Italy (EWI), Spain (EWP), and the Euro STOXX 50 (FEZ). The short-term risk-reward in many markets is either unfavorable or hard to define. Should markets push higher in a convincing manner, we are happy to redeploy some cash. For now, we are comfortable having less exposure to risk. If markets push higher in an unconvincing manner, we will consider further risk reduction. Maximum flexibility remains part of the plan.