Stock Chartist

Reversion to the Mean Still On Track

2009-12-03T07:49:00.011-05:00

This morning's Labor Report was a shocker but I'm not convinced that "pleasant surprise" expectation hadn't already been baked into the market. Hasn't everyone been talking, month-after-month, about labor market improvements in terms of continually smaller increases in the unemployment rate? So, if the numbers remain unrevised, then the risk has flipped from upside on pleasant surprises to now finally risk of downside move from unpleasant surprises.

I'm going to stick with the report I had drafted before the announcement because I believe it's still relevant.

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We've arrived here at the Southern Command Post on the West Coast of Florida, I've set up the wi-fi network, installed a new wide-screen second monitor to my system and am ready to go.

I had a lot of time over the past several days while driving to ponder where this market may be headed and my thoughts often drifted back to where we have come from. During the depths of the Crash from October to April we continually looked for precedents to divine what the future. We looked to the 1929-32 Great Depression Market Crash and the 2000-03 Tech Bubble Crash. We also dissected the 12-year secular bear market of the 1970's looking for similarities between that era's oil shortages, politics, currency situation and stock market and the present situation.

Along with the Coppock Curve, a very long-term indicator that gave me some confidence in March that we had reach the bottom was something I labeled "Reversion to the Mean". The Indicator statistically determines through regression analysis of the S&P 500 Index since 1939, the market's growth and the upper and lower boundary (at two standard deviations) of its volatility around the mean. In a May 1 piece entitled "Measuring Market's Health: Moving Averages, Coppock Curve, Mean Reversion" I wrote:

"....while we're holding our breath that all these signals ultimately follow through with a promise similar to past experience, it could also mean that we're not going to see the all time highs of 1500+ for some time. If the market follows the track of the 1974-75 Bear Market, the highest we might see the market by Year-End 2009 is 1050-1075 and 1250-1275 by Year-End 2010. While that's a respectable 20+% gain for next year, it's not the sort of volatility we've grown accustomed to over past several months. But then again, who needs that level of volatility."

Flash forward seven months and we see that the market has actually followed fairly closely the trajectory of the 1974-75 Bear Market.

The high so far this year was today's intra-day high of 1119.13, marginally higher than the 1075 forecast on May 1 when the Index as 877.52. If the market continues on the 1974-76 track then we should look forward to a minor correction back to around 1000 followed by another upleg carrying the Index above 1225 by next year-end:

The projection is calculated simply by applying the ratio of the 1974-76 index to the extrapolated lower boundary of the long-term regression line so the Index's future path is a copy of the path it traced in the prior period:

Last May, I thought there was a slim chance that the two recoveries could follow nearly identical paths. It will be amazing to see whether the correction on in the forecast actdually materializes.

2009 Rewind: Part 4

2009-12-02T09:02:00.002-05:00

As you read this, my wife, our dog, and I are cruising down I-95. In the meanwhile, I thought you’d be interested in highlights of just a few of the 157 posting so far this year (there were 259 postings covering the difficult 2008 crash). This is the last part of this 4 part series.

August 7, 2009: Difference Between Correction/Consolidation and Reversal

The 9-month long, inverted head-and-shoulders (Nov, 2008-July, 2009) was a classic, clear-cut, near perfect example of a bottom reversal pattern that you can't find many clearer than. Once having been completed, the odds of it now failing were slim to none. By early August, the market had was flirting with 1000 on the S&P 500 Index, a level that happened to be the bottom end of the nearly year-long, consolidation in 2004 in the Tech Bubble recovery bull market. Some were beginning to look for the consolidation in the current recovery (and are still continuing to search as the Index is another 10% higher and bumping against 1100. At the time I wrote:

“I've mentioned here before the rule-of-thumb for measuring targets out of head-and-shoulder patterns: at a minimum, the neckline represents the approximate mid-point of the total move. If the distance from tip of the inverted head to the neckline represented a 43% move (952 neckline/666 tip), then the minimum target could be around 1350-1375. It won't be a straight line since there will probably be major, lengthy consolidations along the way…. The recovery from the Tech Bubble Crash saw a major correction that lasted most of 2004 between 1050-1150; my interim target for the first one (after this traders' remorse correction) is the 1150-1200 area.”

That’s almost where we find ourselves today, level I believe is a likely and excellent place for a consolidation.

November 9, 2009: One View of Market's Future

Almost a month ago, when the Index was at almost the same level as Friday’s close, I began putting a plan into place for what I see as a short but rather steep correction in Q1, 2010. It was before the Dubai mini-crises, the Greece mini-crises and what be the beginning of a temporary end to the erosion of the $US. The only thing that seems to be working right now is gold, silver, GOOG, AMZN, PCLN and NFLX. Even other large cap tech stocks like INTC, CSCO, MSFT are having difficulty marching ahead. The market has gotten very narrow.

“As the market approaches the target (1125-1150), it's time to start speculating about what might come after. To repeat, this is mere speculation and guesswork as no one can predict the future but we have to some view so as to develop an action plan….

The correction or consolidation could be short lived as the true top of this bull market could be nearer 1350. With the neckline at 950 being half-way between the bottom at 660 and the top, on a percentage basis, a potential 17% correction demands an action plan. “

There’s a saying that’s especially true in stock charting: “If you don’t know where you came from, you won’t know where you’re going.” (o.k., I confess, I made it up.) This short recap of the highlights of this ride to 1100 tells us from where we’ve come. Only the stock market, over the next couple of months, will reveal whether we actually could tell today to where we were going.

2009 Rewind: Part 3

2009-12-01T09:02:00.003-05:00

June 30, 2009: Half-Full or Half-Empty Views: A Head and Shoulder Market Top?

One of the most popular and referenced (linked) articles was what, back then, was a bold call contradicting the prevailing belief that the market had formed a head-and-shoulder top and would soon break through the neckline. Finally, the long-awaited correction would arrive giving everyone who missed getting in since March another opportunity to then jump in the bull market (that never quite came, by the way). My view, granted from a longer-term perspective, was that a more correct interpretation of market sentiment was that an inverted head-and-shoulder would lead to a break out and an unabated continuation of the March bull market. As I wrote then:

“I'm a longer-term trend trader. Rather than seeing something negative in the above chart, I see something quite the opposite. If it comes about, I see the move down as the right shoulder of another head-and-shoulder pattern, one that's inverse (upside down)….. Of course, I'm partial to my interpretation because I have more opportunities to be correct. There's no clear-cut requirement for a right shoulder. The preference, of course, is to have it match in time and scale the left shoulder. But (and this is what it now looks to me like) it can turn out to be shorter and shallower due to the strength of the market driven by the sidelines money waiting to be invested.”

As it turns out, I was correct and, as we are all know, the market broke above the neckline at 950 and proceeded to roll ahead to 1113, a level that it’s hit 6 out of the last 9 trading days but so far has been unable to forge above.

July 20, 2009:The Campaign for Your Economic Mind

Throughout the summer, from June to mid-July, the contest between bulls and bears continued. The bears thought economic woes were far from over and whatever relief seen in the market up to that point was only a temporary reprieve before another round of declines of Crash proportions. The bulls, on the other hand, saw the economy improving (at least, it wasn’t still getting worse), the market had hit bottom in March and was anticipating an economic recovery.

I wasn’t going to attempt to predict the economy’s future but, what I did see was that the market was riding replicating a round-trip that was similar to the Tech Bubble Crash of 2000-03.

“The floors we stopped then could, in all likelihood, also be stops we make on the much slower ride back up this time….In 2003, the market had a "traders' remorse" pullback to test the support of the double-bottom neckline at 1010; there could be a similar test after crossing above the neckline of the inverted head+shoulders bottom this fall/winter or early next year…..the beginning of that pullback lines up nicely with the upcoming effort to cross above the 300-day moving average…..After having successfully tested the current neckline and breaking above the 300-day moving average, whenever that happens (probably in 2010), there should be a clear run to the 1060-1160 range for a consolidation, the stops made on the way down in 2001-02 and the way up in 2004. We were on an express elevator as the Lehman and other financial calamities caused the market to skip the stop on the way down last year. There will be a consolidation pause, whenever it comes, and there's a good chance it will be at around that level.”

2009 Rewind: Part 2

2009-11-30T09:02:00.003-05:00

March 19, 2009: The Debate is Settled: The Market Has Hit Bottom

"The raging debate is whether the market has hit bottom. My unconditional answer is 'yes'....I'm not clairvoyant but the market is. Market prices have taken all these risks into consideration today or, more correctly, the millions of investors, large and small, have factored these and many more issues I haven't even thought of into consideration and determined that stock prices will more likely move up than down in the near term. When prices move up too much, investors will stop buying and some might even start selling thereby ending the advance."

My conviction that the market had reached a bottom was based less on a top-down than on a bottom-up approach. Since the previous November’s “Lehman” low, I started scanning individual charts to see whether some had halted their declineswere gaining support due to their low prices and . Many successfully resisted the market’s second decline in March and failed to make new lows. It appeared that some stocks were attempting to form reversal chart patterns.

I posted a spreadsheet in this post of 60 stocks I felt had formed and were breaking out of basing chart patterns (the list was expanded to over 200 in subsequently posts). Most did follow through with their break out and proceeded to lead the recovery bull market move. Some didn't, however, later retreating back to the March 19 levels.

April 17, 2009: The Next Industrial Revolution

"We often use metaphors when describing challenging situations, so what we're facing as the world economy resumes its forward momentum might be considered a "World-wide Industrial Revolution". The first was in Great Britain as factory production began displacing independent trades people. The second was in the US and Europe when technological and economic progress gained momentum with the development of steam-powered ships, railways, and later in the 19th century with the internal combustion engine and electrical power generation. The Internet Age might be considered a sort of Industrial Revolution. The next could be the industrialization and "consumerization" of the rest of the world."

Since the article, the S&P 500 Index has increased 28.10%, a respectable Bull Market but our standards. But the U.S. market continued to lag the rest of the world, except for Japan (10.76%):

I concluded the article by writing “This coming Industrial Revolution will be about the rest of the world gaining closing the gap….We're going to hear a lot more again about resource shortages, escalating commodity prices and booming international stock markets. If you don't feel comfortable buying foreign ADR's, you can participate through the foreign market ETFs.”

I followed this up with several more articles about foreign markets, including one entitled “U.S. Stocks: The World's Laggards” in which I wrote “In the meanwhile, while your waiting for the US market to signal a green light, take advantage of the new, wonderful tools created by those mad financial inventors. Put some money into foreign ETFs (also look at foreign currency ETFs -FXA, FXF, FXC, FXB and UDN - they've formed reversal patterns too as the $US has started to decline in value against other currencies.)”.

Even though I believe foreign markets, especially the emerging markets of Asia will outperform the US and that is some place I want to have a chunk of my portfolio in, I also believe these markets have run up too far, too fast they may be in the throes of a brief correction.

Rewind to Some 2009 Highlights

2009-11-29T09:02:00.005-05:00

As you read this, my wife, our dog, and I are cruising down I-95 so I won't be spending much time following the market. However, I will be switching back and forth between Bloomberg and CNBC on our Sirius radio connection. In the meanwhile, I thought you'd be interested in highlights of just a few of the 157 posting so far this year (there were 259 postings covering the difficult 2008 crash).

And what a year it's been. Many of the articles were informative, some prescient and some, regrettably, disappointingly off the mark. But if you've been a regular reader here since the beginning of the year, I can say with some pride, generally you've been guided along a cautious and, basically, profitable path.

Over the next several days, as I’m trying to avoid the troopers’ radar traps, I'll highlight and comment about some of the more memorable posts. I expect to return to full operation by Thursday so, in the meanwhile, come back daily and reminisce with me and learn from the events of the past year.

January 29, 2009: "Cramer's Take on Gold and Gold Producers"

Because of the current obsession with gold, it might be interesting place to start this journey at one of the five articles in January I couldn’t help but make defending technical analysis from Cramer's derision. In this piece, Cramer compared an analysis of AEM (Agnico-Eagle) from one of the technical analysts from theStreet.com) with his own fundamental analysis. As reported in the MadMoney transcript, he said:

The stock [AEM] held firm after hitting its 200-day moving average. Then last week, AEM broke out of its trading range on a high-volume rally, which was further confirmation for technicians. Chartists like AEM all the way down to $44. [I], on the other hand, need more than Agnico-Eagle's sudden popularity to recommend the company. Favorite stock in the sector or not, and AEM is his top pick, there's no fundamental reason for hiding in gold, a traditional hedge against market chaos and inflation. If anything, it's deflation that's the problem, with virtually every other asset losing value. And while you could definitely call this market chaotic, investors who buy now will be doing so at too high a price. Think about it: AEM is trading at 80 times earnings.
If you own Agnico-Eagle, cash out. If you missed the trade, don't bother trying to catch up. Just wait for a pullback – down to under $44, actually….The technicians' sell price is [my] recommended entry point. Only then does AEM make sense as a defensive play against market volatility.”

My view was "the miners have performed similar to the rest of the market but have a long way to go to maintain relative parity with the price of gold.....The fundamental issue is whether the factors driving the price of gold are different that those driving stocks? If yes, will there be a reversion to some parity and, if so, will gold price drop or stock prices rise? If not, will gold producers continue to outperform other stocks to be more in line with the price of gold?

As it turns out, of all the gold miners, AEM was 41 out of 48, seventh from the worst performer. While GDX, the gold miners ETF has increased 48% since the end of January and the typical gold mining stock has appreciated 100% over the period, AEM has increased only 11%. It merely underscores that pouring over financial statements, listening to conference calls, looking at analysts ratings and reading their reports rarely lead to the best performing stocks and definitely have nothing to do with decisions about the timing of a purchase.

Positioning for Year-End and Speculating with EDZ

2009-11-24T06:29:00.006-05:00

"An Emperor who cares for nothing but his wardrobe hires two weavers who promise him the finest suit of clothes from a fabric invisible to anyone who is unfit for his position or "just hopelessly stupid". The Emperor cannot see the cloth himself, but pretends that he can for fear of appearing unfit for his position or stupid; his ministers do the same. When the swindlers report that the suit is finished, they dress him in mime and the Emperor then marches in procession before his subjects. A child in the crowd calls out 'The Emperor is wearing nothing at all' and then the cry is taken up by others. The Emperor cringes, suspecting the assertion is true, but holds himself up proudly and continues the procession." (The Emperor's New Clothes by Hans Christian Andersen in 1837 from a collection of Spanish stories of 1330 as summarized in Wikipedia)

Somewhat like that little boy, I feel like crying out "Cash on the sidelines lost their opportunity to buy into the market this year; there won't be a year-end rally!" We, the market's towns people have been hearing stories about institutional money on the sidelines waiting to be put to work before the end of the year. There was going to be a blow-out top as money plows into the market because institutions "can't go into year-end with so much money not invested" and will "chase performance" by bidding up leading stocks.

I'm sorry - this royal idea wears no clothes. If they needed or wanted to put all that cash to work in stocks then institutions had many months already to do so. Furthermore, the market's stellar performance over the past 9 months is an invalid reason for institutions to start putting their cash hordes to work today. Everyone knows you buy stocks today based on expected future performance and not because prices have risen 65% over the past nine months.

With only 23 trading days left in 2009, there just isn't sufficient time left for sidelines money to be employed to generate any meaningful returns. Individual investors are going to be disappointed if they look to have bad investments salvaged by this sidelines money or hoping to piggyback on a year-end surge driven by the sidelines cash finally being put to work. Their emphasis should start shifting to become positioned for a clean start on the next year.

On this score, I was intrigued by a recap on the CNBC site last week of recent on-air interviews entitled "Everyone's Talking About a Year-End Rally". Recommendations these "experts" had for you, the individual investor, included:

Robert Howe, CEO of Geomatrix: the November-to-January period are the strongest months for investors.
Michael Hasenstab, co-director and portfolio manager at Franklin Templeton Fixed Income Group: Investors must diversify and invest globally to benefit from from higher interest rates.
Graham Secker, European equity strategist at Morgan Stanley: Expect a 10%-15% upside in European stocks in the next quarter
Rahul Chadha, head of India equities at Mirae Asset Global Investments: Long-term investors who missed the emerging markets rally should increase their exposure; Indian markets remain fairly valued even as they trade at the high end of the historical range.
David Bassanese, founder of PennyWise Investments: is overweight on Australia.
Alex Wong, director of Asset Management at Ample Capital: sentiment remains positive for the Hong Kong market.
Sandeep Malhotra, head of global investment strategies at Clariden Leu: the dollar will continue to erode; the growth story is in emerging markets.
Mat Kaleel, chief investment officer at H3 Global Advisors: expects a correction in both oil and gold.
Robert Howe, CEO of Geomatrix: Buy banks but be wary of property stocks as it is a volatile sector,
Ed Ponsi, president of FXEducation.com: The dollar could see some short-term strength.
Adrian Foster, Asia Pacific head of financial markets research at Rabobank: the dollar is range-bound for the next few weeks to come.
Ray Attrill, global head of research at Forecast Australia: Expect lows for the dollar by mid-year and new highs for Aussie in the early part of 2010
Mitul Kotecha, head of global FX strategy at Calyon Hong Kong: China will likely allow the yuan to appreciate by 5%-6% in 2010

Phew! Confusing to say the least. Besides that, I wind up on the other side of most of their trades. For example, in anticipation of what I see as strengthening in the Dollar into next year (see "One Reason the US Dollar Index Might Increase"), I liquidated most of my foreign currency and markets ETF positions, even the BRIC ones; I even added some EDZ, 3x Emerging Markets Bear ETF.

This last one is a pure spec bet that everything must, at some put, in a correction. EDZ first started trading at the end of 2008, hit a high of 95.74 on March 2, and is now around 5.50. A 38% retracement is around 30 and 50% around 40 so there's plenty of upside potential if foreign market's top out and this extremely volatile ETF finds some firm ground. I'd be extremely happy if the ETF reached the lower resistance trendlines. I'm playing this but don't recommend it for any but those who have willing to take the risk and lose.

Protect Yourself Against An Imminent Market Correction

2009-11-22T08:11:00.004-05:00

Winning in this game we love means your portfolio out performs a benchmark index because if all you do is match the market, you might as well put your money in an index fund or market index ETF and not even go through the motions of playing. However, if you do play then beating the market when it trends up is tough and demands near perfect stock selection (pick stocks with positive relative market performance and cut losses from mistakes early). But beating the market when it trends down is easy .... if you successfully manage or avoid the downturns.

The important questions isn't if it’s true to the Lunar cycle theory or not (last week, the market has sold off 1.6% since the New Moon and there are still seven more trading days until Full Moon on Wednesday, December 2) but where the market will be in 3-6 months and how best (i.e., with the least risk) might we prepare our portfolios to make the best advantage of whatever move occurs.

Optimistically, momentum indicators have finally confirmed that a bull market is intact since the 200-dma just recently crossed above the 300-dma. This long-awaited cross puts all the moving averages in perfect alignment, fastest on top to slowest, with the Index above them all, an arrangement I’ve dubbed a "bullish cross". In March 2008, the mirror image of this alignment (slowest on top to fastest with the Index beneath all) confirmed the onset of a bear market of major proportions, the Financial Crises Crash. A final step to nailing down the bull market will be when the 300-dma finally turns up for the first time since January 8, 2008. Mathematical extrapolations (see my post "Mark These Dates") say the turn should occur around December 3 (just in time, coincidentally, with the new lunar phase).

Many traders and investors believe this bull market has unstoppable momentum and has now finally gained a permanence, overwhelmed the bears and will continue for the foreseeable future. But others who look at fundamental economic and financial indicators like P/E ratios or Fibonacci guidelines (50% retracement of bear market decline) argue the market is due for a correction.

I'm in the latter camp, albeit having arrived early (see “Begin Pruning, Trimming and Weeding Your Portfolio” of October 16, “Ascending Everest: the Mid-Station Rest Camp” of October 18, “More Evidence We're Approaching a Top” of October 23 and “One View of Market's Future” of November 9). I prefer both the simplest of momentum indicators (moving averages) and the simplest of trend analysis (resistance and support trendlines). They've suggested to me from the outset of this bull move in March that the 1125-1150 area could be significant because it is an area of past congestion and an area where equilibriums between buyers and sellers have ended in reversals (in other words, an area of many pivot points). There’s a strong likelihood, therefore, that the area can again produce a pivot point (why? because of market psychology and behavioral finance).

“If so, what’s our strategy”, you must be asking? How can we create some protection with minimal risk while at the same time leave room for upside opportunity in the event that our calculations are wrong? We know that the long-term momentum indicators point to further upside gains; it’s the 10-15% market correction we want to protect against. It’s at this point that the bald former football player on Fast Money shouts, “I hedge my bets through options!” Of course, he’s “selling his book”, as they say on The Street. However, this time he may just be right. What options do we have?

"Buy and hold": only protects against opportunity losses in the event we're wrong and the market continues going up; but it provides no protection against real losses if the market goes down instead.
Diversification: only a partial successes – if you select correct places to diversify into and if all asset classes don't move in tandem as they did last year.
Sell positions and move into cash: outstanding strategy in confirmed bear markets but a less than optimal defense in corrections because it protects against losses but creates opportunity losses if our timing is off either in getting out or in coming back in.
Hedge positions: Bingo! Involves limited risk yet offers upside potential

Assume that you have a $100,000 portfolio whose performance moves precisely in tandem with the S&P 500 Index. A simple and direct option hedging strategy is available: buy SPY puts. For about 9.5-10.00% of the value of the portfolio, or approximately $10,000, you could buy ten on-the-money puts with March expiration that would insulate a $100,000 portfolio through increased option value (beyond the cost of the premium). If you were wrong and the market moved up, at expiration you would retain the increase in portfolio value offset by the premium paid for the options.

But the “insurance” premium of the options and exposure to risk can now be reduced without giving up any upside potential because of the introduction of Ultra (2X) and UltraPro (3X) SPY longs and shorts. These ETFs also have call and put options available; because these ETFs themselves are leverage, ProShares now provides the means for a more efficienct leveraged investment “insurance”. This ability of buying options on double and triple ETFs appearsto be an inequality in the market that doesn’t appear to me to have yet been arbitraged away. Rather than costing 9.5-10.0% through options on the underlying security, and equal portfolio value can be “insured” with fewer on the money calls or puts on SPY UltraShort (SDS) or UltraLong (SSO) ETF’s, respectively, for about 4.5%, half the cost. [Because they are only less than 6 months old, I have excluded the UltraPro etf’s from consideration.]

Click here to download a spreadsheet summary of this SDS calls hedge strategy (with comparison to SPY puts), plus this graph:

Note that the spreadsheet is an example using data as last week when I purchased these options. Before you pursue the strategy, you should do your own analysis and evaluation for correctness and appropriateness for your own situation. I welcome comments and suggestions on why my analysis might be faulty or how it might be improved.

One Reason the US Dollar Index Might Increase

2009-11-20T19:17:00.009-05:00

Have you heard the story about the man who bought a U.S. Treasury Bill for $1000 knowing before hand that he'd only get back $995 at the Bill's maturity. "What kind of idiot would do something like that?", you ask. It's irrational, it doesn't make sense. Give someone $1000 knowing you're going to get back - not more money in the form of interest but less money. You're paying someone to take your money. Again, it makes no sense.

I pondered how and under what circumstances something like this might make sense and then - I figured it out. No one living in the US would do something so irrational. But there are some who would. People who live in, do business in and aren't dependent on the $US might do it. If I lived in the U.K., for example, I might convert my Pounds into $US in order to buy some Treasury Bills if I thought, or knew, that when I converted those Bills back into British Pounds they converted back into more Pounds than I original paid. As a matter of fact, if I lived almost any place in the world other than the U.S. (or China, for that matter) I could see making a profit by parking my money in $US's if I had a fair degree of certainty that $US's become more valuable to me in my currency down the road. What I gave up in interest (or paid in "negative interest") I might recoup in exchange conversions.

That's what I'm guessing might be happening. Foreign investors or sovereignties are looking at the distinct likelihood that the $US will soon increase in value, more than the increases over the past 4 days (the DXY, US Dollar Index, is up to 75.61 from 74.88, or 1%, since November 16).

Does this signal the end of the Dollar's decline? Has a deal been made to prop up the $US. Does this have anything to do with negotiations to have the Chinese allowing the Yuan to edge up in value also?

One can speculate about all sorts of conspiracy theories that are way beyond our understanding or comprehension. What we do know and fear, however, that a rise in the $US, a rise in the US Dollar Index, will probably be detrimental to US stocks. Perhaps that's what has lead to the market's recent weakness.

Something like this was last suspected about a year ago (November, 2008) when the rise in the Dollar's value of came to a surprising, abrupt and screeching halt. Perhaps its mirror image has begun to be re-enacted today. And what better time to pull something like this off than Thanksgiving week, a time when many have already begun taking time off for an early Holiday break.

By the way, while you're contemplating, look at the tops that have been made in the graphs of most of your foreign exchange and foreign market ETFs. Conspiracy theories are so much fun .... unless you're counting on a continued fall in the $US.

Lunar Phases and the Stock Market

2009-11-16T11:51:00.005-05:00

Let me start out by admitting my reluctance in submitting what you're about to read because those naysayers, those doubters, those who consider "technical analysis" to be almost on a par with tarot cards and astrology, they all will use this piece as further evidence or proof for their disparagement. They will use what follows to undermine whatever credibility and currency I may have gained through 400+ postings in this blog over the past 4 years.

For the rest of you, however, those of you who are willing to expand your mind and are a bit more open-minded about looking for a wider than typical range of indicators and statistics to guide your investment decisions I offer the following interesting curiosity (click on image to enlarge):

Early Christmas greetings, you ask? No, actually this is a chart of the S&P 500 Index since May 28 to current. More importantly, it is the S&P 500 Index through the past 6 full lunar cycles. Each read bar represents the trading days during which the moon was waxing (growing from new to full) and the green bars cover the trading days during which the moon was waning (shrinking from full to a mere sliver).

Hold on, don't hit the "close window" icon just yet; let me explain. On inspection you'll see that there's been an interesting correlation over the period. The market finished higher than where it started in 5 of 6 green periods and finished lower than where it began in 4 out of 6 red periods. Assuming that waxing periods (growing to full) are coincidental with market declines while waning periods (shrinking to new) are coincide with market increases, then market has been in sync with the lunar cycle 75% (9 out of 12) of the time for the past 6 months. I'll take those odds any day, that's enough for me.

I didn't discover or invent this relationship but it is something that I've been thinking about and research for over three years, ever since a NYTimes article by Mark Hulbert entitled "Fly Me to the Moon, and Let Me Profit on My Stocks" in which he quoted the findings of a number of academic papers. O.K., I was skeptical myself so rather than accept others' conclusions at face value I replicated the studies and found that that intervals between new and full moon were more reliable than the interval of "7 days before and after a new moon" that the academicians used to "predict" these market ripples.

At this point, skeptics usually interject that going backwards proves nothing since almost anyone can support almost any hypothesis if they structure their data correctly. So I started tracking my model through each succeeding moon cycle. Honestly, sometimes it worked better than other times. But even through the last market Crash, I still mental noted that the moon cycle coincided with the market's swings more often than not.

The market has risen around 25% since June so the lunar cycle clearly don't pinpoint major market turns. What they might do, though, is show you what you might want to expect over the very near term.

Where are we now? Tonight will be a new moon and, according to the Lunar Cycle advocates (as represented the chart above), we're embarking on a cautionary 15 days. We're having a very good day today (market is at 1111, up 1.67% as I write this) and the market is approaching the 1125 target of my "road map". What will the coincidence of this road map destination and the Lunar Cycle new moon bring? Can't wait to find out.

One View of Market's Future

2009-11-09T20:54:00.012-05:00

I first started writing about the critical area between 1150-1200 on August 7 (wow, doesn't seem like 3 months ago), the day the Index broke through 1000 for the first time since the March 9 bottom and closed at 1010.48, or 7.6% below today's close. In "Difference Between Correction/Consolidation and Reversal" I wrote,

"The recovery from the Tech Bubble Crash saw a major correction that lasted most of 2004 between 1050-1150; my interim target for the first one ...... is the 1150-1200 area. What will this correction look like? It could be a wedge, a pennant, a channel or merely a return to a trendline or moving average ... but it won't be a head-and-shoulders."

Many readers then were skeptical and wondered whether the market would be able to cross above the 300-DMA or to stay above 1000. But the market labored ahead and three successive surges (the current surge since November 1 will the fourth) each ended at successive new highs.

A couple of days ago, I outlined a "game plan" which appears so far to be working and close to hitting the goal of 1125 (I beg some lea way to extend the target range to 1150). As the market approaches the target, it's time to start speculating about what might come after. To repeat, this is mere speculation and guesswork as no one can predict the future but we have to some view so as to develop an action plan. If the view turns out to be wrong (and we'll know when that is), we modify the action plan:

The market begins to stall out in December as:

the door for the sidelines-money slams shut for the year
tax selling begins to capture losses and record gains in anticipation of possible higher 2010 tax income rates

The 1150-1200 is a critical area for past pivot points where the market turned in 1998, 2001, 2002, 2004, 2005, 2006 and 2008. These pivots occurred both when the market was trending up and down.
The turn is usually caused by an economic catalyst and one that could fit the bill perfectly would be:

The $US Dollar firming and possibly reversing its descent.
The "Soft Dollar Trade" (buying foreign currencies, gold and commodities), considered by many as "over-crowded", begins to unwind and the market begins to decline.

A logical target for the bottom of this correction is the neckline of the market's inverted head-and-shoulders bottom, or approximately 950 in the S&P 500, a 17% decline from the high.

The decline fall within the definition of a correction falling short of the 20% required to considered a "Bear Market".
The Index will find support on the 200-DMA, the crossing of which is a key indicator identifying Bull and Bear Markets
The 200-DMA will have crossed the 300-DMA by then
The 300-DMA will have turned up, the final hurdle before the book on the Crash can be finally closed.

For those who are habitual chartists and think in terms of graphs rather than words, here's a depiction of what the above scenario might ultimately look like (click on image to enlarge):Many out there will scoff and say this is pure fiction, nothing more than reading a Ouija board. But is it any more fictional than some of the stories that are spun by the "talking heads". They represent prestigious firms with large research departments but I write this blog. We'll follow the future unfolding and learn who's projection, given when, winds up being closer in the end.

The corrrection or consolidation could be short lived as the true top of this bull market could be nearer 1350 with the neckline at 950 being half-way between the bottom at 660 and the top on a percentage basis but a potential 17% correction demands an action plan. Help us all out. What will the market correction look like and what actions will you be taking when the arrives?

Note: I refer the scoffers out there who brush off this exercise you to "Fairy Tale with a Happy Ending", something I wrote on November 6, 2008. I inserted a chart in that article similar to the one above. That chart turned out to be uncannily similar to the market's actual ultimate course with the major difference being that it took longer to get here than I had projected. So be careful in rejecting this exercise too quickly.

More Stocks on the Move

2009-11-07T09:53:00.003-05:00

I did a little market researching this weekend and visited two, outstanding but dramatically different retailers: Whole Foods and Ikea. And even though they cater to two different clientele, I found one thing they had in common: both were filled with shopping families lugging their kids and totting bags full of stuff. It sure didn't look like these stores were suffering much from the 10.2% (or close to 17% as some say when you add in those who stopped looking) unemployment.

At the end of October, I inserted some chart projections and outlined the following game plan:

"If the market successfully bounces around 1018, there's a possibility it could then lunge ahead .... for a final gasping 10.5% gain to 1125..... The 1125-1150 range of significant for several reasons: 1) it's been mentioned by many analysts as the high for the year and 2) it's on the extension of top boundary of that channel....Violating the 50- (and 200-) day moving average wasn't calamitous in July (the market then proceeded to surge ahead by over 25%). Another big, though not as extreme, move may follow this violation. Simultaneously, the 200- may cross the 300-dma and the 300-could turn up paving the way more gains later."

The market did touch an intra-day low of 1029.38 (pretty close to 1018, wouldn't you say) a couple of days later and has since jumped to 1069.30. Even with a consolidation or correction anticipated just over the horizon (I can't tell just yet how severe or deep it will be), it's might also be prudent to replace some of the stocks that you're pruning some of the losers out of your portfolio with better performers just in case the bull market surprises us all and continues moving higher and longer than expected. If there's another 6-7% left before a correction begins (or, if I'm wrong and the market continues heading even higher) then what sorts of stocks might lead in addition to the precious metals, energy and other groups or stocks mentioned here previously.

Last July, I outlined a screen called "Stocks on the Move" and presented a spreadsheet of 135 stocks meeting the following criteria:

Price per share > $15
Price percentage change today > 0.5%
Relative Strength Indicator today > top 50%
MoneyStream Surge for past week > top 50% (proprietary to Telechart grew out of joint venture with a large regional brokerage firm to develop a price/volume indicator. The result is an indicator with much the same objectives as OBV and is interpreted in the same way you would interpret OBV. Generally, you look for divergences.)
EPS percentage change from 4 qtrs back > top 50%
Volume surge over past 5 days > top 50%

Since then, those stocks have appreciated, on average, the marginally more than the S&P 500 Index (12.9 vs. 12.0%). However, relative to the high price during the period (July 22-Nov 6) the group's performance, on average, more than doubled that of the Index (25.0%). If STEC, DRIV and ICON had been excluded from the original group, the groups average performance had been appreciably better than the index (for an updated spreadsheet of these 135 stocks, click here).

A new "Stocks on the Move" screen now produces a list of 107 stocks, of which only 7 stocks were on the previous list (the list is on the second tab of the spreadsheet). Of the total, only 39 stocks are trending such that the moving averages are aligned in a Bull Cross (P>50DMA>100DMA>200DMA>300DMA) and the 300DMA has turned and is now rising. Based on these technical indicators, these 39 might have the best chance of smallest impact of any market correction. A short list of these stocks might include:

AMZN
ATHN
BIDU
DGIT
GG
IAG
LL
MELI
SYKE
TEVA

Another Basket of Speculative Low-Priced Stocks

2009-11-04T23:15:00.007-05:00

I don't know how many of you were readers back in the depths of November 2008 and February 2009 but I floated the idea of assembling a basket of low-priced stocks, something I called "Perpetual Call Options". Well, it seems that there's a lot of truth in the saying "timing is everything" (or "don't fight the tape" or any others of the many sayings around Wall Street).

Back then my thought was that there were just too many stocks that had been beaten down by the extreme general pessimism everywhere in the air and that while one or two of those companies might fail (ala Lehman, GM or CIT), they wouldn't all disapper; some would eventual recovery and their prices would rise sufficiently to offset the ones with losses. Here is a recap of the results of both lists (click on image to enlarge):

The market is up 19.8% since February 9, the day I wrote about both the second (coincidentally, the market was at approximately the same on both dates). Over the same period, both of the lists have appreciated over 60%. As expected, three of the stocks in the November lists declined since November but the gains on the others more than offset those losses. Likewise, three of the stocks in the February list underperformed the market but, here too, several others did significantly better that the market.

Others gave a pejorative label to the strategy, they dubbed it the "dash for trash" - the strategy of buying low priced, high volatility stocks, with barely any regard for the fundamentals in the hope that market momentum will cause them to appreciate. Well, guess what, if my sample of two is any example, it worked.

But I'm not like another blogger elsewhere who continually writes "I bought them (yesterday, last week, or whatever) and just sold 'em (yesterday before the close) and pocketed a huge profit" (sound familiar TK?). Unfortunately, I was too conservative myself and only bought and still have a couple of them. I wish I could say my picks were based on skill but it really wasn't. The selection was made when the market was a very depressed and-remember-stock selection was like shooting fish in a barrel.

As the market moves into a new phase, will the "perpetual call" or "dash for trash" strategy still pay off? Are there any stocks left that are suitable for another highly speculative basket? Interestingly, there are still over 1400 stocks (about 30% of the total) under $5 and around 2400 (almost 50%) under $10. So why do we always chase after the likes of JPM, PG, AMGN, AAPL or AMZN.

With the economic productivity numbers coming in today better than anyone expected, some are now talking about a real burst in profits as volume begins to build faster than people costs across the economy. It's the sort of environment where the stocks of survivor companies, those have been left behind for dead, can start shining again because they're starting from a low profit base, low valuation and low stock price. The upside potential is great and the downside ... well, they're not far from zero now.

If you put an equal small dollar amount ($1000 for 625 shares of stock selling at 1.60, for example) in each of about 10 highly speculative stocks together a small basket you might wind up in 6-9 months with the basket having grown in size, much more than had you put that same money into SPY. You probably will get some duds or failures but you'll also have one or two stars.

I trolled the charts of stocks under $2, stocks that look they're making an effort to start heading up. I came up with a typical list of random stocks:

Stop! Before you go out and buy these stocks, memorize these caveats:

The stocks were selected randomly and not based on any fundamental analysis (or rigorous technical analysis either).
Success on the prior lists above are no guarantee that any other list of "perpetual call options" or "dash for trash" will produce equal results or positive results at all.
This discussion is more about a tactic rather than about specific stocks. There is a large universe of stocks to pick from and you should make your own selection.
You know your own tolerance for risk so, if you do something like this, you have to decide on how large the basket could be and how many stocks in that basket to spread the risk.
Many low-priced stocks are thinly traded so you should set the price you're willing to pay and use limit orders.

Most importantly, the two "baskets" I described above were started at the beginning of one of the best bull market recoveries in stock market history (over 60% in 7 months). Basket 1 above actually took a large loss between November to February and only started appreciating as the market recovered. There's no need to hurry and put something into place because the best time to launch a strategy like this is at the beginning of a bull market trend. It's perhaps best to stick this in the back of your mind and pull it out after the consolidation.

US Dollar Index (DXY), Gold (GLD) and the S&P 500 (SPX)

2009-11-02T20:05:00.008-05:00

Several days ago, in "Managing Portfolios Today With Three Indicators", the first indicator in the list of three indicators impacting today's market listed was $US. You've heard the talking heads say this and you read other blogsters write about this but have you seen the relationship presented graphically. I haven't so I thought I'd research it and bring the results to you.

The charts below are the value of the S&P 500 Index (.SPX) and the price of the gold etf (GLD) in both cases compared against the US Dollar Index (.DCX) which measures the performance of the Dollar against a basket of currencies: EUR (Euro), JPY (Yen), GBP (Pound), CAD (Canadian), CHF (Swiss)and SEK (Swedish).

Each panel contains trading over the past three trading sessions for the S&P; you should note that currencies trade 24-hours/day so you'll see gaps between the Dollar Index on one day and it's value at the opening of the US market's the next day. The Dollar Index is the blue line; the S&P Index and GLD are the multi-collar (or tan) lines.

S&P Index vs. US Dollar (click on chart to enlarge): Sure enough, there is a pretty distinct inverse correlation these between the value of the dollar and the US market (most clearly seen in last Thursday trading). Today, the market had a terrific first hour and a half of trading as the Dollar Index was declining. But at around noon, the Dollar Index starting rising and the market starting falling. It continued until 2:10 when both reversed direction. Is the tail (dollar) wagging the dog (market) or the other way around?
I'm sure the reasons are complex and convoluted but there's no mistaking the fact that as the dollar's value drops, US stocks become more valuable because of the large percentage of profits made overseas, because its less expensive for foreigners to buy stock in US companies .... all the above reasons and more.
Gold vs. US Dollar Index (click on chart to enlarge): Underlying worldwide supply/demand factors (industry and jewelry usage, sovereign demand) impact the price of gold and gold is also traded around the clock so the relationship between Gold and the US Dollar Index, although inversely correlated, is less direct.
Each time the US Dollar index increased, the price of GLD (in $US) went down and vice versa.

Granted, three days offer only a peak and more data over longer periods are needed for sound economic or academic conclusions. But when I looked at the same data others have been looking at, I clearly see the relationships.

Editorial Comment: I feel somewhat unpatriotic but, for the sake of exports, our stock market seeing higher earnings, improved ability to pay our debts to foreign holders (in cheaper dollars), and improved export opportunities I'm rooting for a weaker $US.

The biggest risk will be in the importation of inflation through higher worldwide commodity prices (expressed in the lower valued $US Dollars) and higher cost of all the cheap goods we've come to expect flooding our retail stores. It may be a simplistic, short-term perspective but a weaker Dollar may actually help rejuvenate our industrial sector by reducing our reliance on imports.

What do you think?

Stock Market Road Map

2009-10-31T17:10:00.010-04:00

Has a consolidation correction actually already begun and we just don't realize it?

We've been in an uptrend frame-of-mind for so long, that it's sometimes difficult to fathom that something might have changed or that the current market just isn't what we've grown pleasantly accustomed to over the past seven months. But my sense over the past several weeks is that something has changed. Besides the nearly 3% drubbing the market took on Friday and the whipsawing swings of sentiment on Wednesday and Thursday, are being broken and there's increased risk of moving averages being crossed.

So let's zero in more closely than usual, step by step, on the market's recent action to see if we can distill out clues to whether the market is possibly in the early phases of an emerging chart pattern or whether the uptrend is still intact so we don't feel like we're wondering aimlessly:

End of Month Patterns: This is probably the first time you will have heard this but the Sept-Oct had a distinctive bend to them this year. Instead of following historical precedent as the "worst months of the year", September and October (and to a lesser degree August) had awful end-of-month cycles. The last 7 trading days of September plus October 1 and the last 9 trading days of October turned in 3.9% and 5.62% declines; the final 3 days of August plus September 1 likewise saw a 3.2% decline. The first portion of both months showed respectable gains. If November follows suit, Monday won't be good but the remainder of the month to around Thanksgiving could deliver a sizable gain.
Trendlines: I've inserted an upward sloping channel by connecting the pivot points (points where balance of power flipped between buyers and sellers) at the beginnings and ends of those end-of-month declines discussed above. Since Friday's close violated the bottom support trendline, the obvious question is where will be the next low. My guess is that Monday, November 2, could see an intraday low at a key level, 1018, another 1.7% decline, since that was the intraday low on October 1 and a level the market gaped through in August. It seems to be an important play area for the market. [Coincidentally, my Elliottician friends are quick to point out, 1014.8 is a 38.2% Fibinacci retracement level between the 1098.74 close and the 879.13. A bounce at this level with conviction will support a continuation of the trend.]
If the market successfully bounces around 1018, there's a possibility it could then lunge ahead following the September-October routine for a final gasping 10.5% gain to 1125, with the sidelined cash finally being put to work before year-end. The 1125-1150 range of significant for several reasons: 1) it's been mentioned by many analysts as the high for the year and 2) it's on the extension of top boundary of that channel.
Moving Averages: Although the 50-DMA was violated last week, the 100-DMA is still intact and will probably remain so in the near term.
Violating the 50- (and 200-) day moving average wasn't calamitous in July (the market then proceeded to surge ahead by over 25%). Another big, though not as extreme, move may follow this violation. Simultaneously, the 200- may cross the 300-dma and the 300-could turn up (as described in "Mark These Dates .....") paving the way more gains later.
A Reversal Formation: If the market does bounce around 1018 either Monday or Tuesday, then the level becomes an important element, along with the October and November peaks in defining a pattern that could dictate the course of the market during the first half of 2010. Will these precursors become the early phase of a reversal or merely the beginning of a consolidation pattern. We'll leave predictions like that for economists (and stock analysts focusing on fundamentals); for chartists, all we can do is anticipate and be prepared to react when it happens.

Some inquisitive readers may question "What happens if you're wrong? How will you know if you're wrong?" Agreed, this is pure speculation but it's a plan, a map, and we use maps to help us know where we are and find our way to where we want to go. If the map indicates a turn but the road goes straight or if it indicates straight but the road has a bend then .... we know we're in the wrong place and we have to change our course.

That's the same with this fictional market road map for the next couple of months. Rather than a prediction, it's a plan of action for managing risk and measuring expectations. As of Wednesday next week, we'll know whether the risks are higher and plans and actions have to change or, if we're lucky, we'll see higher prices by Thanksgiving.

Managing Portfolios Today With Three Indicators

2009-10-28T21:34:00.012-04:00

I don't know how many of you are full-time traders, how many self-manage your portfolios on a part-time basis or how many visit here only periodically to get a different take on the market, something that you can take back to your financial advisers just to let them know you're looking over their shoulder.

But I spend most of my day with my Fidelity trading platform (Active Trader) running on one screen and my charts or whatever else I might be working on, reading or playing (I'm a mediocre chess player) on another screen. Furthermore, as the day progresses, I have either Bloomberg or CNBC running muted over my desk so I can see how the market is doing and watch for any major news headlines. Periodically during the day, I calculate how closely my portfolio tracks, percentage wise, the S&P in the hope that it does better than the benchmark index (either gaining a greater percentage or losing less of a percentage).

The reason I tell you this is that I find that my portfolio rarely ever moving opposite the benchmark. They usually move in tandem, it's only a matter of degree. So managing my portfolio is rather simple. It's essentially a cash, or risk, management decision: how much do I want to have at risk given what I see happening in the market and only secondly in what types of assets it should be invested. In short, the portfolio management decision is essentially a market timing decision. I spend most of the time trying to figure out whether the direction of the market's trend has changed (the answer I share with you).

As an aside, I went to an MTA (Market Technicians Assoc.) meeting last night and heard an excellent presentation by Frank Teixeira, of Wellington Funds and the manager of John Hancock's new Technical Opportunities Fund that I'd like to share with you. One of his points that obviously resonated with me, is that more and more institutional investors are disappointed with Index funds or the notion that "there's always a bull market somewhere" and it's only a matter of finding it. They're disappointed in "buy-and-hold" since the strategy since 1999, a long ten years, has led to returns only marginally above break even. Given the two market crashes since 2000, the objective now is managing risk and the tactic is to consider cash a safe default investment.

He also said that the world of investment alternatives has greatly expanded with the introduction of all sorts of etf's and adr's. There's no way one person can become familiar with all industries, all commodities, all interest rate trends, all currencies around the world. But the worldwide search for investments can be narrowed by using technical analysis (studying trends) and looking at charts. Human behavior, as represented in price trends (charts), is the same around the world for all assets.

Having said that, the key to where the market will be next March can be found, I believe, in essentially three areas: 1) the foreign exchange value of the $US, 2) monetary policy as reflected in interest rates and 3) the US economy as reflected in the S&P 500 index. [The only thing that has a significant impact on our portfolios but we have no way of predicting or monitoring is what Congress does with income taxes.] Here are the relevant charts:

$US: If this were a stock chart you wouldn't consider anything in the price action to indicate that a bottom has been reached and that a reversal pattern is being formed. If this were a stock, the only safe assumption would be that, at best, the downward trend remains in tact and, at worst, it will remain at current levels for a while (a couple of months) before turning back above 78.
20+ Year Long-term Treasury Rates: When interest rates increase, bond prices fall and vice versa. If this were the a stock's chart, I would sell or short it. Moving averages indicate that longer-term trends have turned down (how could they not have from the historically low current rates) and there's higher interest rate (lower bond prices) since the chart depicts a possible head and shoulder pattern. [A caveat is warranted here. Treasury Bond ETFs are relatively new so there's no history of how the ETF will perform over a wider range of interest rates.]
S&P 500: This is what we're all interested in. If the neckline of the inverted head-and-shoulder that everyone now believes was the bottom is the mid-point of the move from bottom to top (a standard technical charting conventional rule), then the full extent of the bull market run could be to 1328. But the full move can be divided into two, separated by a period of consolidation. We could no be seeing the beginnings of that consolidation (given that volume supporting further upside is waning as indicated by OBV diverging from price).

Bottom line? We are in or very near a consolidation. It's best to reduce exposure to risk by increasing cash relative to investments (I'm currently at 10% and plan to increase to 25% at the next opportunity). Looking at the above exchange and interest rate trends, I will look for investments that take advantage of those trends. But until the market indicates otherwise, the correction should be short with another leg up possible sometime in 2010. As Teixeira said, this first phase of the recovery has seen "a rising tide lifting all boats"; the next phase will see much more divergence among stocks, between the leaders, the average and the laggards.

Each Zig or Zag Is Not A Direction Change

2009-10-26T19:03:00.007-04:00

If you listen to the "talking heads", everything sounds like a turning point, a change of direction, a crises, a screaming news story "Extra". But every zig or zag does not make for a change of direction in the market's momentum.

Remember how you got swept away like many of the rest of us with euphoria last Monday, October 19, as the market crossed the same level going up as it did a year ago when it cratered along with Lehman, it actually nudged across 1100 intra-day but closed at 1086.48. And now, 5 days later, CNBC stirs the pot by bringing out Doug Cass to announce, again, that he's shorting. [Interesting, though, Cass has been shorting since August as this SeekingAlpha article of August 30, some 7.5% lower than last Monday's high, entitled "Doug Kass Goes All In Short".] A zig last week and a zag today. Even though I've been saying the market's close to a top and today wasn't pretty if you're in the market like I am, I don't believe the momentum trend has yet changed and I don't believe last Monday will be the high-level market for this rally.

On the Friday before that high, October 17, I wrote "Begin Pruning, Trimming and Weeding Your Portfolio". I followed that up with two more articles last week about the market sending signals that it's tired and wants to take a rest. I listen to the market but I don't believe it says that you have to dump everything overboard just yet.

I'm still hoping the market will shrug off the psychological barrier represented by round numbers like Dow 10000 or S&P 1100 (the Lehman level a year ago) and make a final push through November to the mid- to upper-1100's. As I've described before (see "Ascending Everest: the Mid-Station Rest Camp", that's were the real resistance is. In the same way that we didn't jump all in until the market hurdled some key benchmarks on its way up, there are a number of hurdles that it has to trip over on its way down before we call it quits. On the other hand, we were going to buy after a correction that never came last summer, so we must also be on guard against waiting for a blow-off top that may never come to sell into.

Last week in "More Evidence We're Approaching a Top", I pointed to the rolling 12-month returns as an obstacle to moving much higher. Here's some more evidence that upward momentum is beginning to wane.

If you think back to April and May, we were looking to volume in the form of OBV (On-Balance Volume) as evidence that the bottom had been reached. That indicator is now pointing to a divergence. For the first time since the rally began in March, OBV failed to make a new high as the index inself was making a new high (click on image to enlarge):

It's not time to jump yet but it is another signal that momentum might be changing direction and that a correction might be coming soon.

More Evidence We're Approaching a Top

2009-10-23T11:43:00.006-04:00

I bet you think the above graph is my EKG as I look at the market's gyrations. It's actually an oscillator, a momentum indicator that measures the market's gyrations, on a rolling basis, in terms of each month's prior twelve-month return. The chart above covers the past 81 years from January, 1929 to January, 2010 (click on image for larger and sharper view). Prior to 1939, the data is the DJ-30; data after September, 2009 are based on my assumptions (to see the spreadsheet with data, click here).

You often hear or read about Fibonacci lines, arcs or fans that many say tell you that a move in the market or stock is over-extended because it has reached a critical benchmark like a 50% retracement. But there are few measurements that are linked to a time dimension, like 12-month returns; the above chart does.

I think it's an amazing picture. What I find most amazing is its regularity. Usually, after the market has several back-to-back exceptional 12-month runs (where returns over the previous 12-month exceed 25%) it is followed by several back-to-back months of negative 20% return.

Conversely, when the market has a sharp sell-off, or negative back-to-back 12-month returns of over 30% (see 1932, 1937, 1974, 2002, 2008), there follows a bounce back of 25-30% returns. It's fairly regular and predictable.

What does this mean for us today? I appended a couple of hypothetical scenaria through June, 2010 to see what the graph would look like (the red lines at the right). Case 1 assumes the Index will remain flat (in practice fluctuate in a narrow range around...) yesterday's close of 1057; Case 2 assumes the Index will continue to move ahead and peak at 1125 in February and retreat moderately back to 1075 by June, 2010. The result is a spike equaling 1983's spike out of that recession and the 1997 bounce.

In any event, nothing continues growing forever. Moves much beyond the extent of repair that's already been achieved is inconsistent with market history going back to the Depression. That's not to say there will be a significant decline sometime in the near future. The other possibility is that the annual changes moving forward will decline to the point that somewhere in 2010, the market will be no higher and, yes, possibly lower than 1080 (I spelled out two possible forms the correction might take in "Two Market Consolidation Models: 2004 and 1933-35"). But I feel technical evidence is showing that we're quickly approaching the top of these climb.

Fuel for the Cold Winter Months

2009-10-21T09:54:00.010-04:00

I've written here recently about the oil & gas complex as possibly the last group to breakout of long-term reversal patterns (see "Mysterious Happenings in the Oil Patch"). Cousins of the group that might be particularly interesting since we're approaching the winter heating months are the fuels used to heat our homes and workplaces: UNG (Natural Gas ETF) and UHN (Heating Oil ETF). What do these charts look like; I'm including OIL (Oil ETF) for comparison purposes (click on charts to enlarge):

UNG: Due to what many say is over-production and the unavailability of storage capacity for the excess, natural gas prices have tumbled. But the price of UNG has fallen even more than the underlying commodity due to short sellers. Prices have begun to firm (note the small cup-and-handle formation that began in August) and there's a possibility of a short squeeze as sellers start to cover which could drive the price back up to the first resistance trendline at 18.
UHN: If you live anywhere other than the sunbelt and use heating oil and haven't locked in your rate for the winter, then you might want to consider buying a winter's worth of this ligthly traded ETF (so if you do trade it, use only limit orders). It's hard finding a more perfectly formed ascending triangle reversal pattern. The characteristic of this pattern is that it very clearly depicts how buyers come in to the stock and overwhelm the sellers at higher and higher levels. They run out of steam at the resistance level but, the theory is, at some point in the near future as the bottom trend line continues to approach that resistance, a breakthrough will occur.
OIL: Not surprisingly, OIL has a pattern similar to UHN. If one breaks out, the likelihood is that the other will too. The interesting thing about OIL is that many drillers, service, refiners and marketing firms have clearly formed reversal head-and-shoulders, double-bottom and, yes, ascending triangle, patterns and are ready to breakout when the big money is ready to come in from the sidelines.

So whichever of the Oil & Gas participants interests you the most (yes, don't forget the large integrated international firms like COP, XOM and CVX) putting some money to work in this sector is prudent.

Mark These Dates .....

2009-10-19T21:02:00.005-04:00

Mark these dates on your calendar: November 17 and December 3. What's happening? These dates could mark when the market clearly steps out of a "bottom recovery" and, after what I hope will be only a brief consolidation, into unqualified bull mode.

On what do I base this? On the fact that the last of the slower moving averages, the 200-day MA, will cross above the slowest moving average, the 300-day MA on November 17. At that moment, each of four moving averages will be perfectly aligned from slowest (at the bottom) to the fastest (at the top) with the Index above them all - a perfect bullish alignment.

And what happens on December 3? That's when the 300-day MA could begin trending up for the first time since January 3, 2008, nearly two years ago. If it does, the last obstacle to declaring the recovery's end will have been cleared.

The above assumes that the market continues growing at about the same rate as it has since Labor Day, or approximately 6% per month, or 0.3% per day. If that happens, the S&P 500 will hit 1198 the Monday after Thanksgiving and the 300-day moving average will hit a low point a few days later, turning up from that point forward.

Why is the 300-day moving average's turning up so important? Moving averages are momentum indicators and incorporate the market's action over the preceding 300 days. It takes a lot of effort to overcome the impact of over a year's worth of lower closes and, once having achieved it, significant effort (a huge move down) would be required to reverse the momentum's direction. As a matter of fact, since 1963 (the extent of my database), a turn in the 300-day moving average has usually been followed by an extended move (either in time, percentage or both) in the direction of the turn.

I consider the direction of the 300-day moving average to be a confirmation of another momentum indicator we heard much about this past June and July: the Index crossing above of its 200-day moving average. Granted, the Index has risen sharply since then (about 27%) but the move has consistently been susceptible to being called a Bear Trap rally. Once the moving averages are aligned and all have turned up, there can be little question that a Bull Market is in progress.

Some will claim that I flip-flop and inconsistent. How can I one week say that I'm pruning, trimming and expecting a correction within days and weeks of say that the market is likely growing into a bull market. I don't feel being inconsistent at all. Consolidations happen all the time in bull markets and there's no better place to have one than the market transitions from one stage to another.

As a confirmation of the market's continued internal strength, here's an update of the indicators you've seen here before (click on table to enlarge):

The number of new highs continues to increase (1-year highs now at 510, or 10% of all stocks) and the number of stocks with Bull Crosses (the alignment described above that the Index could achieve on November 17) has grown to 1002 or nearly 20%. Meanwhile, the number of rollovers (that's stocks making new lows) is still less than 20 and stocks with Bear Crosses (the inverse of Bull Crosses) is 199, a mere 3.9%, and many are local and small regional banks.

The alignment of moving averages evidences that the correction could come soon (December to early 2010) and when a correction does arrive it might not be long nor deep. Again, no one can predict the future but, at least, that's what our operating assumption will be until the market tells us otherwise. "Sell in May and go away" and the "September-October worst month" scares were hollow. Hopefully this perverse market doesn't surprise us again by turning traditionally strong months into weak ones. We'll just have to stay alert and nimble, reacting quickly to any surprises it may throw our way.

Ascending Everest: the Mid-Station Rest Camp

2009-10-18T21:26:00.006-04:00

The market ride since March sometimes feels like a trek out of a valley in the Himalayas. Nearby peaks are clearly visible but we're already starting to feel winded and slightly dizzy from the lower oxygen at these higher elevations.

So far, the climb has been exhilarating but nothing like the climb to the top. [Please, don't get literal on me and ask what happens after you reach the top. I'm only using a metaphor and will need to come up with something else, for example "flying like an eagle", after reaching the top.].

In any mountain climb, it's necessary and appropriate to rest and regain strength at a mid-station in preparation for the final assault on the peak. Let's look at where we've come from and get a fix on exactly where we are in order to gauge where we might be headed (click on image to enlarge):

Some technicians visualize sloping trendlines but I focus on the horizontal elevations marking support and resistance levels. These lines are conceptual rather than real or concrete; they indicate where a struggle between bulls and bears, buyers and sellers, demand and supply has taken place in the past and may, in all likelihood, be repeated in the future. It's where the equilibrium of a struggle has been broken with one force taking over control from the other and reversing the previous trend of momentum.

Because that struggle takes time and extends over a range of prices, it's more appropriate to consider "zones" rather then points. In the above chart, the peaks in 2000 and 2007 are represented by the blue dotted line where bears were victorious over bulls and began the downward momentum of the Tech Bubble and Financial Crises Crashes. The lower solid red trendline marks the bottoms where bulls were victorious, successfully turning momentum around leading to subsequent bull market moves.

Between those two are other areas, marked by circles, where equilibrium was broken and momentum reversed leading to consolidations, recoveries or corrections. These zones, marked by dotted red lines are at approximately 950, 1080 and 1150. What makes these levels important is that the reversals (support or resistance) recurred several times over the past ten years.

What makes me feel uneasy is that by entering the zone between 1080 and 1150, the market is closing in on the same mid-station as that of 2004 in the ascent from the Tech Bubble Crash. The 1150 elevation zone has seen a reversal five times since 1998 so there's a good probability that we'll see a reversal somewhere around that zone again sometime between now and early 2010 (for a further description of what that consolidation might look like, see "Two Market Consolidation Models: 2004 and 1933-35" and "Comparing Labor Days in 2003 and 2009").

That rest camp is a mere 5-7% away. Could the market zoom right past that level and head to the next congestion at 1260-1270? It could but the odds are against it.

Begin Pruning, Trimming and Weeding Your Portfolio

2009-10-16T13:31:00.006-04:00

Readers here know that I've long thought that the market was going to run into resistance, start to consolidate this long bull market somewhere around 1100-1150. For example, in the discussion section of my Facebook page, I wrote on August 5, "I see a run up from current levels starting around Labor Day that will carry Index to a 2009 high of 1150, or up 15% from current levels." On that day, the index closed at 1002.72; Wednesday's close was 1096.56.

We're only 5.5-6.0% away from that mark, only a couple of good trading days as sidelines money makes a mad dash in the form of a blowoff top, a "steep and rapid increase in price followed by a steep and rapid drop in price", according to Investopedia. If it happens, there will be even more confusion and mixed signals than Cramer's double message (sell if you have profits; buy if you still have funds on the sidelines).

You'll hear talking heads start declaring the market might even climb all the way back up to 1350-1400. There will be talk of corporate spending on the increase, employment starting to rebound, the second wave of defaults (option ARM mortgages) not being as bad as first feared, the commercial real estate crises begin averted and a growing concensus that a weak dollar actually reducing the market's P/E by the higher foreign profits it produces.

But rather than being too doctrinaire, I'm beginning to think that now might actually be a good time to start "pruning" your portfolio. Begin trimming stocks you added during the run up since March-April that haven't performed that well; if they have grown less than the market has while you've owned it, they probably won't do better than the market in the future. Rebalance the portfolio by reducing the exposure in stocks that have significantly out performed the market and now represent too large a percentage of the portfolio.

Rather than thinking of these moves as "selling" the market, clearly a defensive move, view it as an offensive strategy, beginning to prepare for next leg. Funds generated through this "housecleaning" can either be held as cash or you can add to those remaining positions that are still working nicely and have room to grow (i.e., not bouncing up against resistance in the form of trendlines or moving averages).

Now is the time to start the process. If you wait until the market actually starts topping off you'll be confused, befuddled, fearful of missing some of the action, leaving money on the table. In the same way that we cautiously took incremental steps rather than jumping all the way at the beginning as confirming signs presented themselves, we have to begin taking incremental steps as we approach the top.

Rather than picking low hanging fruit, we're trimming the bush and prunning the tree of dead branches. Now is the time to start cleaning up to prepare for the next season.

REITs and Energy: New Darlings

2009-10-11T20:16:00.004-04:00

I have to travel again this week so my posts might be sparse. In the meanwhile, though, I recommend you take a look at a group that appears to be in the last stages of completing very distinct bottom reversal patterns: REITs.

Remember the "perpetual in-the-money call option" strategy of last November and February? It might be appropriate for resurrecting it and applying it to REITs. For example, here are some low-priced, high-volatility REITs; construct for yourself a basket (to spread the risk, a small, equal amount invested in each of 4 or 5) and there's a good chance you might make a nice return even if one or two go further down in price:

These currently all sell for less than $10 and many still pay nice dividends.

As money on the sidelines continues to try find stocks that haven't already been propelled to what many consider unsustainable prices, they may also begin pushing up the oil and gas, solar and various alternative energy stocks like coal and uranium. Here, too, clear bottom reversals have been formed and stocks are about to break, or have broken, out (see "Mysterious Happenings in the Oil Patch" and "SOLR: A Winner When Clean and Alternative Energy Heats Up"). Whether its part of the weak-dollar trade along with precious metals, energy stocks of all sorts (including the oil service stocks) are starting to heat up again.

Even as the market edges closer to a consolidation, a much needed midstream pause, there are still stocks that could have room to grow.

Five Stocks Making All-time New Highs

2009-10-07T19:05:00.009-04:00

Life used to be so simple 9 months ago. All stocks were on sale for rock bottom prices and hundreds, if not thousands, were in the starting gates waiting for the starting gun (if you remember the analogy. All we had to do was find stocks that had formed clear reversal patterns, pick the ones with the highest volatility and buy a bask full of them and we would make a huge profit with little risk.

But finding stocks with momentum or a potential for momentum is harder now. Few stocks are still forming reversal patterns and the risk is that they breakout just as the broader market or, more correctly, the stocks that have been driving the market up to now, start running out of steam. [See yesterday's report on media stocks.]

Alternatively, we could hitch a ride on the stocks that have had huge runs over the past four or five months and hope they aren't the ones who'll run out of steam first. Remember, for example, Diedrich Coffee, Vanda Pharmaceuticals or Dendreon?

As a true chartist, I much prefer looking among stocks making new highs and the more significant the new high the better (for example, all-time new high is better than 2-year which is better than 1-year new high). Here are several that meet the criteria:

CERN
NPK
PETS
CHKP
MNRO

But I give you these with a word of caution. Keep your thumb on the market's pulse and make your own assessment as to its health and strength. Any guesses in which life cycle stage the market is in now?

I think the market is transitioning from the accumulation to the mark-up stage. That transition will be completed and the exciting mark-up stage will be launched after the consolidation correction we will have to contend with, probably most of next year (see "Two Market Consolidation Models: 2004 and 1933-35"). Or in which emotional stage it's in?

I feel we've just experienced a huge relief rally, are waiting for a test to see whether "it's for real" and then the market will move into the "optimism" state.

Since the easy pickings are over, the easy money has been made, market timing is again going to be important. If you buy stocks today, even if they're breaking out to all-time new highs, don't get wedded to them. The market has to mature and it's about to experience some turmoil as it evolves into the next stage.

Another Laggard Industry Group Coming to Life: Media

2009-10-06T21:10:00.009-04:00

"Dash for the Trash", that's what CNBC called the market run-up this past summer. If you recall, I called it "shooting fish in a barrel". Besides stocks in the huge Oil & Gas complex, another Industry Group that seems to have lagged behind this past summer and seems to be now trying to catch up are stocks in the Media-Periodicals and Broadcasting Groups.

We all know the story of why traditional print and broadcast media is "dead" and some have wished them their R.I.P. Fundamental Analysts list such handicaps as 1) lower subscription revenue due to competition from online entertainment, 2) high costs, like paper, 3) low ad rates due to slow economy and decline in subscribers, 4) consumer preference for to entertainment on demand and choice.

But some of the stocks in these two groups seem to be stirring. They appear to have formed reversal base patterns (true, they weren't very far away from $0.00) and, because there aren't very many stocks left that haven't had huge percentage gains from the depths, these may come back to life.

Here are a few with interesting charts (click on symbol for chart):

MNI (McClatchy)
LEE (Lee)
AHC (A.H. Belo)
NYT (NY Times)
BCI (Gannett)
TVL (Lin TV)
SBGI (Sinclair)
CETV (Central European)
CBS
TV (Grupo)

As you know, I think we're getting close, both in time and level, to an interim market consolidation so might be a little late to make major commitments to this group. But because they're mostly high volatility and many have low prices there might be a little juice left to squeeze out of them.

The list is assembled strictly based on a review of the charts; no researched was performed on their financial health. If you're interested, perhaps you should assemble your own "etf", or pool, of a number of the stocks to reduce the risk of any one of them failing while you own them.

Market Extremes Turn Coppock Curve Unreliable

2009-10-05T20:34:00.005-04:00

It's been a while since we touched base with Mr. Coppock and his Curve. If you remember, it was one of the indicators that signaled that the market was turning over in November, 2007 and one of the indicators that gave me confidence that we had hit bottom in April (along with the "Reversion to the Mean" indicator in both cases).

So if it was so accurate in calling the top and and the bottom, I was wondering how the indicator would perform if the market did take a tumble in the near future. Actually, the correct question to be answered is "what sort of a drop would it take for the Coppock Curve to again signal a market top?"

To find out, I projected forward from the September close (the Curve is based on monthly data only; see "The Coppock Curve, Another Constructive Indicator") and came up with some disturbing results. They were disturbing but not in the way you might expect. What I discovered was that the extent and rapidity of the market's recovery (50% in six months), either: 1) precluded any risk of a significant market top in the foreseeable future, or 2) the Coppock Curve is an inconsistent indicator and it's being "on the money" concerning both ends of this past crash was merely a coincidence.

Here's what the data reveal (click on image to enlarge):

A relatively flat market projected through June, according to the Curve, increases the chances a decline in the second half of 2010:
A decline to the March-April lows projected to occur by year-end followed by a modest recovery would not cause the Curve to turn down:

We could hypothesize hundreds of other future paths for the market. The bottom line purely from a technical perspective is, however, that last year's decline and this year's recovery have been so dramatic and extreme that a momentum indicator like the Coppock Curve appears to be less reliable for indicating significant changes in the long-term trend. Complacency due to the Curves current unward trend is, therefore, dangerous and to be avoided; other long-term trends should be considered.

I'm not an expert in the Coppock Curve and welcome alternative interpretations from others.