Reasserting the uptrend

Posted on March 27, 2011 by robertpal

The S&P500 gained 2.7% last week as the index rose through two key moving average indicators, albeit on weak volume. Although this unconvincing bounce helped to sustain the uptrend from August, we would rather see a close above 1330 (16 points away from Friday’s close) to safely call this a short-lived correction in a sustained uptrend.

The Nasdaq saw a stronger recovery vs. the S&P500  last week, rising over 3.7%, but had suffered a higher loss during the early March weakness.  This index continues to sport obvious underperformance vs. the S&P500:

VIX saw a significant decline last week. As noted in the chart below, VIX fell from over 29 and closed just below 18 and below its 50-day moving average near 20. The index at 29 represented a huge gap from its 50-day moving average of 19 (such large gaps tend to mark turning points in equities), which coincided with the correction’s bottom during the week of March 14 (foreshadowing the bounce last week). VIX is now at a neutral reading (neither bullish nor bearish), and the Put/Call ratio at .84 is likewise neutral.  See the VIX chart below:

Our “NYMO” indicator, the McClellan Oscillator advance/decline measure of the New York Stock Exchange, flashed a positive sign last week.  The indicator closed above its 13 and 34-day moving averages, and importantly, its cumulative summation index returned to bull market territory (closing over the 400 level):

As for other indicators, most saw improvement on the week. Our corporate debt/medium-term Treasury ratio turned around to positive territory last week, tipping the scales in favor of equities. Small Cap stocks continue to beat large caps, and growth continues to shine vs. value.  Discretionary stocks performed better than Staples on the week, another positive.

What had originally looked like an oversold bounce is getting closer to transforming itself into a resumption of the strong uptrend and another possible bout with the recent highs. Volume however has been weak, and quality stocks are not showing the eager bullishness that one would expect in this uptrend. The uptrend is tiring, and positive seasonal conditions may be giving it enough juice to continue higher in a rather haphazard way.

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Market Tour Update

Posted on March 21, 2011 by robertpal

Although the bounce from the lows that were touched earlier in the week were impressive (the S&P500 fought back a 4% loss to a 1.9% loss by week’s end), volume was light on the bounce, and Friday’s action, as the major indices whittled away at their early morning gains as the close drew near, was less than impressive for the Bulls.

Both the S&P500 and Nasdaq stocks trading above their 50-day moving average fell to the lows last seen in August, then bounced as the week ended.  VIX and the Put/Call ratio remain elevated but settled back from extremes reached earlier in the week (VIX hit its highest level since early August). The “Fear” readings in these two indicators suggest more jittery market behavior is likely.

Probably the most disturbing technical indicator that soured last week was the NYSE Summation Index which, for the first time since November, fell below the Bullish zone market by the 400 level (the index closed at 387 on Friday). This level has been useful in identifying bullish and bearish zones in equities. Last year, it remained convincingly below 400 from the “flash crash” into August.  A bearish cross of NYSI vs. its 20-day moving average also occurred two weeks ago.  See the chart below:

On the bright side, financial stocks outperformed for the second week in a row. The return of dividends and potential stock buybacks for the group, deferred since the 2008 crash, caused the relative strength index of XLF (Financials ETF) to push above the 50 line this week.  See below:

Our Corporate Bond Medium-term Treasury Bond ratio bounced last week but remains in favor of bonds, a trend change noted in last week’s Market Tour update:

As for our other indicators, Discretionary stocks took a hit in relative strength vs. Staples (a negative for equities), but small caps and growth continue to follow their relative strength uptrend vs. large caps and value, respectively, two additional signs of a bullish trend.

Although its weekly trends remain up, the Nasdaq appears to be experiencing more technical damage than the S&P500, as it maintains its relative underperformance.

So, we have a mix of positive and negative indicators, with the NYSE Summation Index flashing the most disturbing signs. A “watch and see” attitude may be most prudent at this juncture. We see next level support on the S&P500 at 1260, with major support near 1230 (below which a clear downtrend would be at hand). A move above 1300 (Friday’s close was 1279) would positively reinforce the continuation of the uptrend and cause us to sift for bullish opportunities.

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Warning Signs

Posted on March 14, 2011 by robertpal

Several of our proprietary trend-following indicators flashed warning signs last week, but significant damage to the uptrend in equities was avoided. Our S&P500 trend-following indicator closed the week on a positive note (after generating a sell signal following Thursday’s close). Volume on declining days, however, has been noticeably stronger than volume on up-days, suggesting institutional distribution.

More disturbing is the gap down seen last week on the Nasdaq. In addition to the selloff on higher volume, the Nasdaq continues its clear downtrend in underperformance vs. the S&P500. Stocks trading above their 50-day moving average fell below the trough formed during the November setback, suggesting perhaps a further correction toward the August lows. See below:

We found similar underperformance in small caps versus large caps, suggesting asset shifts toward more defensive positions. Interestingly, financials caught a bid last week compared to the broader S&P500. There has also been clear movement into more defensive positions in healthcare and staples.

Our relative performance of copper (our proxy for the industrial economy) versus US Treasuries reversed gains from the prior week that took the ratio above resistance market by three highs achieved since 2006. Strength in this indicator has reliably identified bull markets in equities. See the chart below:

Similarly, our corporate bond/treasury bond ratio flashed a clear warning sign last week. Historically, when LQD (investment grade corporate bond index) leads IEF (7-year T-Bond), equities are favored. This uptrend (which has persisted since the November setback in equities) was broken last week, flashing a warning sign to equity bulls. See the chart below:

Equities are facing their biggest challenge to the uptrend since the August and November corrections. As price is the ultimate judge of the market’s health, we will look for any break in the price uptrend as a signal to shift to the short side.  This week, we lightened up on longs, established some partial shorts as hedges, awaiting either a clear signal to more aggressively join the downside trade, or to “buy on the dip” should price action suggest a basing pattern and establish new support.

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A More Selective Uptrend

Posted on March 6, 2011 by robertpal

Despite a rise in volatility, with daily gains and losses of 150 points or more on the Dow becoming more commonplace, the uptrend in equities remains intact. One particular change that appears is growing divergence across international markets and sectors (i.e. the underperformance in emerging markets and more pronounced weakness in Financial stocks), which suggests that should the uptrend continue, a more selective stance may be warranted.

The S&P500 and the Nasdaq both found support at the “50″ line of their respective relative strength indicators; in an uptrend, support is typically found in the 40-50 range (with highs over 80). See the chart of S&P500 below, where the blue vertical line denotes the spilt between a bearish trend with RSI lows below 40 (to the left) and a bullish trend.

We have been carefully eyeing the Nasdaq relative to its 2007 peak. That peak, at 2861, represents resistance to the uptrend. Based on our proprietary fractal models, we could exceed the previous high on the Nasdaq but remain susceptible to a 10%+ correction or a long-term top.  Read more on our Market Forecast Blog. See the weekly chart of Nasdaq below: 

Interestingly, the Nasdaq has been underperforming the S&P500 since mid-January. Looking back 20 years, we find the Nasdaq outperforming the S&P500 at market bottoms (it surged decisively following the 2002 bottom for 15 months, and did the same at the March 2009 bottom). In both cases, its relative underperformance was not an omen for a general market decline, but simply a favored rotation to other sectors and asset classes. All the more reason to be more selective should this uptrend in equities remain intact.  See the weekly Nasdaq/S&P500 chart below:

 

Money continues to be flowing toward commodity-driven indices and sectors. Canada (ETF symbol EWC) and Russia (ETC symbol RSX) are two such markets that sport a wealth of natural resources (and are increasingly driven by demand growth from China).  On the flip side, emerging markets feeling the inflationary pinch from rising raw materials prices are underperforming. See below:

 

 

Silver, gold and oil ETF’s maintain their lead with silver (the “poor man’s gold”) outperforming its yellow cousin. At some point, these asset classes get crowded by traders and investors, only to relinquish their gains to other interesting plays.

Relative strength continues to be shown by semiconductors, as SMH has outperformed the broader Nasdaq.  See below the chart of SMH relative to the Nasdaq. It is noteworthy that the semiconductor space has underperformed the Nasdaq since late 2003 and has only broken out in relative performance since Q4 2010.

 

Other sectors and asset classes displaying bouts of relative strength include the following (in no particular order of significance):

  1. Inflation-protected bonds
  2. Oil, Gold, Silver, most agricultural commodities
  3. Resource-rich economies (Canada, Russia)
  4. Healthcare and Utilities (potential risk-averse plays)?
  5. Currencies such as the Canadian and Australian dollar (their natural resource-driven economies playing a role in their strength).

As the rally in equities matures, it behooves the trader and investor to identify those asset classes and sectors exhibiting relative strength and to allocate funds to those areas.

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Disclosure: The Absolute Return currently holds positions in Gold, Silver, Oil, and Canada ETF’s.

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Putting the “sell-off” in perspective

Posted on February 28, 2011 by robertpal

Viewed from the perspective of the 26% gain in the S&P500 since September, last week’s 1.7% decline in the S&P500 did very little to dent the uptrend. Volume on the decline was modest and compared similarly to the volume on a short bout of selling in late January.  The worst of the decline also compares to the decline experienced in November. So as declines go, the current Mideast tumult was no different than the two prior declines.  See the chart below:

One indicator we watch is S&P500 stocks trading over their 50-day moving average. As expected, this indicator dropped but found support at levels of the November setback, indicating no major damage at this time.

Dow Theory is a bit precarious as the Transports took a larger hit than Industrials last week as the price of oil surged. The index settled at support near 5,000 at its late January lows. A close below support would constitute an intermediate-term downtrend and a red flag.  See the chart below:

Last week’s selling in equities attracted a bid to Treasuries, as the 30-year Treasury Bond price bounced over 2% on the week. Other than this unsurprising reaction to the decline in equities, all other indicators remained positive for equities despite modest pullbacks as their main trends remained unchanged.

Some of our trailing stop hedges on the uptrend were executed last week.  While we continue to maintain stops on our long positions, we added some new longs as the market sold off, anticipating a potential “buy on the dip” as buying pressure nonetheless remains intact (we saw a nice bounce on Friday).  With a weakening dollar and outperformance of small caps, we find the large cap universe increasingly interesting.  Also interesting is emerging market equities, having sold off over the last several months.

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Joining the Crowd

Posted on February 21, 2011 by robertpal

As more bullish equity enthusiasts join the uptrend, equities are increasingly vulnerable to a shock that, by all indicators, will be addressed with “buying on the dip.”  The buying pressure in equities continues to track with the persistent growth in bullishness among investment advisors. Our trend-following indicators flash green throughout. Some noteworthy trends:

Small caps and growth continue to outpace large caps and value. After hitting trendline support in early January, the ratio of small vs. large cap continues to shine, following a steady uptrend since the bottom in March 2009. We are watchful for a peak in this outperformance leading any peak in the S&P500. The small cap/large cap ratio last peaked about 18 months before the peak in SPX:

US equities maintain their relative strength lead vs. emerging markets, a lead which formed in November 2010.  Bubble talk of China real estate, geopolitical risk and rising inflation and monetary tightening in emerging markets have encouraged outflows into developed market equities.  This might present an opportunity for selective investment in certain emerging markets vs. others. Technically, Malaysia (ETF symbol EWM),  Indonesia (ETF symbol IDX) and South Africa (ETF symbol EZA) have seen some impressive bounces. This contrasts with MES (The Gulf States ETF) as one can expect has lagged emerging markets due to continued political unrest:

As for other positive signs for equities, Dow Theory remains consistently bullish as the Transports reached a new recovery high, following the lead of the Dow Industrials.  Strong relative strength growth in Corporate Bonds vs. Treasuries, a measure of risk appetite and preference for stocks, also continues. We added a relative strength ratio of LQD (the iShares iBoxx Investment Grade Corporate bond ETF) vs. S&P500 at the bottom of the chart (below). Note the price crossing its 34-day moving average indicating turns in preference of equities vs. bonds. This signal has been on an intermediate-term  ”buy” on equities since September:

We continue to see lagging performance in the Nasdaq vs. the S&P500. This likely represents concentration in money flows into a broader mix of sectors (industrials, materials, financials) versus the tech-heavy index. We are a bit cautious toward putting too much credence in this relationship, however, as QQQQ, which is the ETF that holds the Nasdaq 100 stocks, is weighted 19.74% in Apple Computer and is therefore heavily influenced by this particular stock.  APPL has been lagging the SPX since mid-October 2010.

Our trend-following strategy keeps us positive on equities. We are very comforatble with partial hedges on these longs, however, with index puts on SPX and trailing stops to protect profits.

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More positive indicators support the uptrend; time to be cautious?

Posted on February 14, 2011 by robertpal

Equities appears to be running on all cylinders, as most indicators remain positively bullish.

Our Dow Theory indicator has turned more positive as Transports surged last week and remain 4% off their 2008 high. We like to see the Dow Industrials and Transports move consistently to lend support to the uptrend. See the chart below:

VIX remains low at 15.7, matching the lows reached in late 2007 through May 2008 (and, more recently, April 2010). Low volatility has introduced bargain prices on options; those seeking protection can purchase cheap puts, while those joining the bullish camp can find inexpensive calls (many in-the-money calls sell for barely any premium over intrinsic value). The gap in VIX price vs. its moving average, once again, is wide enough to suggest that a bit of caution is warranted for equity bulls. See below:

Our NYSE McClellan Oscillator closed positive on all counts last week, underscoring strength in advances vs. declines and the broad participation of most equities in this uptrend. See the chart below:

At this stage of the rally, one would expect laggards to start catching a bid. One such laggard has been the Staples sector, and there is no sign of catch-up from this group. Staples have been lagging Discretionaries, and this relationship was pronounced last week as the latter sector surged above its 16-day moving average and handily beat the sluggish Staples sector (food commodity inflation may be taking some toll on the group):

Underscoring the strength in the “risk-on” trade is the performance of our US Treasury/Copper Futures ratio,  This ratio broke out to a new high (breaking resistance hit in 2006, 2007 and 2008). The COPPER/USB ratio underscores inflationary pressures. A rising Copper (or CRB) denotes inflation, while declining bonds (and corresponding higher interest rates) also support inflationary tendencies.  The COPPER/USB ratio does a fine job confirming the trend in the equity markets (see the chart below with SPX plotted at the bottom):

Asian equities continue to take the heat and lag US equities. Tightening monetary policy through rising interest rates in many Asian countries is inducing fund outflows which are finding their way back into the US. Our EPP/SPX ratio (the iShares MSCI Pacific ex-Japan index vs. the S&P500) broke trendline support this week (as the dollar strengthened too), underscoring a shift in sentiment toward the US. See the chart below:

Prices of 30-year US Treasuries rose slightly on the week but continue to linger near a support shelf near 115. Testing support will be key and we will watch this behavior for signs of a reversal (and potential coincident decline in equities). At these levels, some allocation back into bonds may be a prudent move:


Other indicators remain positive. Our Corporate Bond/US Treasury ratio continues to support the uptrend in equities. Small Caps outperformed Large Caps, and Growth outperformed Value. Signs of these relationships changing will indicate an improvement in lagging sectors and will underscore an aging uptrend in equities.

Even in the historically weak month of February, dips appears to be bought as buying pressure remains. It is under these conditions that a surprise selloff triggered often by some unsuspecting event catches us off-guard.  With options prices remaining inexpensive, it may be wise to protect one’s equity portfolio with an index-based put (i.e. one-month SPY puts) as insurance.

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Market Tour Update

Posted on February 7, 2011 by robertpal

Equities push toward recovery highs, yet subtle signs of an aging bull continue to fester in our market indicators.  

On the positive side, one indicator we watch is the relationship between copper prices and the 30-year Treasury price. This serves as an indicator of economic growth expectations. As the price of copper (a proxy for industrial metals and hence economic growth) rises, and the price of treasuries falls (rates rise), bullish expectations toward economic expansion prevails. This ratio (Copper Vs. $USB) broke through resistance this week as marked by peaks seen in 2006, 2007 and 2008, and is a solid reinforcement of the uptrend in equities.  See the chart below:

The CRB likewise has seen strength in industrial metals and agriculture (manifested in global price increases for food), despite the weakness in Gold prices as the “risk-on” trade (favoring equities) has re-emerged.

We also saw a surge in our LQD (corporate bond price) Vs. IEF (intermediate-term Treasury bond price) ratio. Historically, a flat to rising trend in this ratio has been positive for stocks.  See the chart below:

Pacific markets have outperformed US equities since April 2010, but have given up that performance since Q4 2010. Although money has been flowing out of emerging markets (and bond funds) and into US equities, we believe this outflow has been overdone; our ratio of EPP (MSCI Pacific ex-Japan ETF) vs. the S&P 500 has found support off a rising trendline formed since early 2009.   See the chart below:

On the downside, once again VIX has turned complacent, falling from its spike to 20 back down to below 16. For the Bulls out there, this would suggest cheap call options to participate in the rally. Another negative is the continuation of Dow theory divergence, as the Dow Jones Industrial Average closes in toward its recover high while the Dow Jones Transports lag (and fall). Airlines have been particularly weak, as rising oil prices may be taking its toll on the index. See the chart below:

Asset allocations out of bonds (and emerging markets) into US equities have helped to extend the current rally.  February tends to be a weak month for equities, however, so we will position our expectations on the cautious side to protect our equity gains.

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Overdue correction needs time to resolve

Posted on February 1, 2011 by robertpal
A relatively sharp decline in global indices (the much-needed respite we have spoken about in this blog, triggered by events in the Middle East) needs some time to find its footing before our trend-following strategies are re-engaged to follow the uptrend.

Nasdaq took the brunt of the selling this week; this was clearly seen in the percentage of stock remaining over their 50-day moving average, which sharply dropped below their low seen during the correction in November.  In addition, Nasdaq relative strength, which has been weakening, saw a sharp drop on Friday. See the charts below:

VIX surged above its 50-day moving average.  A large gap in VIX below its 50-day moving average warned of a possible reversal (which transpired this week). Now, VIX rests well above its 50-day moving average; we will be watching this gauge as a possible clue to resumption of the uptrend:

A sharp decline in the LQD/IEF ratio, our spread of corporate bond prices vs. intermediate-term Treasuries, is a concern worth noting. A flat or uptrending slope in this ratio has been favorable to equities. Although the trend remains up, this indicator warrants watching for a potential trend change.  See the chart below:

 

Although the uptrend in equities remains intact, we will be watching our indicators for stronger signs of a change in trend. Holding off on adding large long positions (partial entries may be warranted) and maintaining our stops.

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Nasdaq leads the decline; Dow Theory divergence and small cap weakness bear watching

Posted on January 24, 2011 by robertpal

As equities take their first noticeable breather since mid-November, it is noteworthy to observe the relative weakness in the Nasdaq compared with the S&P500. The Nasdaq’s swift correction in relative strength (the composite fell 2.39% on the week vs. .76% for SPX) is its most extreme since equities rallied off their September lows.  Some frothiness in technology and a few bad apples in the earnings mix proved enough to shake the bulls from their perch in this sector of the markets.  See the chart below:

Nasdaq breadth indicators swiftly fell to levels achieved at the lows in November. Stocks trading over their 50-day moving average fell over 10% to 70%, nearly matching the level seen at the bottom of the pullback in November’s 5% rout.  Although this respite in bullish frothiness was needed, it was met with light volume, a positive reinforcement of the bullish uptrend and perhaps enough to entice some nibblers to buy.  See the chart below:

In fact, we focus on the Nasdaq and its relationship to its former high at 2,859 achieved on Halloween 2007. A decisive break of this high (another 6% to go) will reinforce the bullish trend and coerce other equity indices to follow along.

Moving on to other sectors and styles, we have found some curious changes that bear watching.

The Dow Jones Transportation Index took a hit this week, printing a divergence from the Down Jones Industrials. This is the first significant divergence in Dow Theory seen since the September bottom and bodes watching. There was no single culprit in the transportation index decline, spread across airlines, ground and maritime shipping.

As for style, this week we saw a noteworthy correction in the relative strength of small caps vs. large caps, a larger hit that the one we saw in November. This could be normal profit-taking in the frothier side of the market in favor of more conservative equities. Although the uptrend in small caps vs. large caps remains intact, watch for style rotation as the significant market gains from the March 2009 bottom begin to wear. Small cap outperformance peaked about 18 months before the S&P500 peaked in October 2007. This could suggest the need for large caps to “catch-up” to the performance of small caps before this Bull run is over. See the chart below:

Reviewing our sentiment readings, our Put/Call alert flashed last week came to fruition as the low seen had in the past preceded market declines.  See out chart below (from last week’s blog):


Today, this indicator reads neutral-slightly bearish at .79.  VIX similarly printed an extreme reading last week and preceded the pullback as noted in this blog. Today, VIX crossed above its 50-day moving average, eliminating the “risk gap” we have noted before. Based on past market behavior, VIX could see some more upside (and equities some downside) before a modest “November-like” correction is over.

As the uptrend remains intact, we suggest holding off with new buys until some basing is seen. In the November correction, prices took a hit quickly then stabilized; in November, our indicators resolved themselves to the bullish camp rather quickly after the first few days of declining prices. Watching price and our indicators this week will play an important role in assessing the health of the Bull run.

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