A Few ETF/ETN Picks – One Year Later

July 28, 2009

Here is an update on our ETF/ETN picks that are one year old today.

Not your normal 12 months by any stretch.

Staying disciplined and taking what the market gives leaves us well ahead of the market in even the worst of times.

ETF/ETN picks after 1 year

ETF/ETN picks after 1 year


Breakout or Fakeout?

June 16, 2009

The S&P 500 celebrated its great technical accomplishment highlighted in our last note by doing exactly nothing. Maintaining a tight 32 point range from top to bottom, the S&P 500 netted just over 3 points from our previous note to the closing price last Friday, June 12. This week has changed the tune, giving up more than 34 points in just two days. Surrendering initial support in the 925-930 area designated by the May highs, the SPX is once again bearing down on the 200 day moving average, this time from above.  Additional support of the 50 day moving average is also moving into the area, just 15.5 points below the 200 day as of today, and rising.  The lows from May, which are also the highs from April and February, mark another major support level in the 875-880 range.

spx06.16.09 intraday

Both the MACD and the daily 13/34 exponential moving average indicator have signaled a negative divergence by not confirming the new highs in the price of the average.  With the January highs holding as resistance, the head and shoulders bottom we discussed in Still overbought, but over first resistance also is still in play.  As we noted, “…finishing the inverse head and shoulders bottom should happen somewhere around the end of June time wise to produce a symmetrical pattern. At this point, it looks like the January highs need to hold as resistance to keep the inverse head and shoulders pattern in play. This is also the approximate level of the 200 day moving average currently and the 200 day stopped the SPX multiple times from 2001-2002, plus twice early in 2003. The first test early in 2003 led to the formation of the right shoulder in the bottoming pattern and the second test required a test of the 50 day moving average as support before breaking out and leaving the 200 day well behind.”  With the 50 and 200 day moving averages relatively close together this time, plus the support of the recent lows/previous highs around 875-880, this market has plenty of candidates for a right shoulder not far from current prices.  A convincing move back below 875 would signal a deeper correction with targets as low as 741 still completely valid.

spx06.16.09

Which brings us to the market leading NASDAQ Composite.  Since our last note highlighting the breakout by the COMP, a brief rally has fizzled out with the last two trading days completely erasing the gains and setting up a quick test of the breakout point as support.  The rally stopped short of filling the gap opened on the way down in early October 2008, but did manage to bring the 50 and 200 day moving averages into a bullish golden cross.  Plenty of support exists for this market, but it doesn’t come into play until 60-120 points below the breakout point at 1785 if the breakout fails to hold.  Targets as low as 1500 do not invalidate the uptrend if the SPX makes a run toward the 2002 lows or even 741.  The MACD is also showing a negative divergence here by not confirming the new high in price and the ROC shows a failure to build momentum on the breakout.

comp06.16.09

We are again returning to our short positions, including SH, after precautionary stop outs proved unnecessary and untimely.  Our position in SH specifically was re-entered exactly at the stop out price (see Security Growth for details).


The S&P 500 closes above the 200 day moving average

June 1, 2009

The NASDAQ leads the market higher; leaves the 200 day behind

The S&P 500 accomplished something today, trading above the 200 day simple moving average for the first time in over a year. It was last call in May of 2008 at the 200 day for the SPX before dropping over 50% to the lows of this past March (the SPX hasn’t actually closed above this trend line since late 2007). Today also marks a new high for 2009, some 42% above those March lows in less than three months! Year-to-date the SPX has gained just over 4%.

SPX for 6/1/09

The NASDAQ is the real star leading the markets higher and breaking free from the recent consolidation range. The NASDAQ is also some 8% above its 200 day simple moving average and almost 10% above the early January highs. Sitting on a year-to-date gain of 16% and almost 45% above the March lows, large cap techs are showing investors’ renewed interest in risk.

COMP for 6/1/09

At this point, we are exiting the position in SH with a small loss on this renewed strength (see Security Growth for details).


Still overbought, but over first resistance also

May 5, 2009

Another update finds the market shaking off initial profit taking to challenge the highs for the year. Monday’s big push finally left the late January, early February highs behind for the S&P 500 (SPX) after about two weeks of backing and filling to make room for the exit of early profit takers. Volume for this stage of the rally has not been impressive, declining since the large profit taking day in the third week of April. What is impressive, is new buyers have stepped up to continue to push prices higher. Fear of “missing the bottom” is setting in and chasing the rally at this point remains dangerous.

spx050509

The NASDAQ has been leading the charge, already surpassing the highs for the year to challenge the early November 2008 highs and the 200 day simple moving average. Up more than 39% in less than two months is a remarkable move and building on that through the seasonally weak summer session is going to be difficult. Up days are beating down days by more than 2 to 1 since the bottom, but the pace of gains is decelerating. Volume has remained relatively solid and this change in market leadership posture is notable. Investors have clearly decided to favor more aggressive stocks in this recovery, with the small and mid caps also showing relative strength.

comp050509

It’s time to break out a chart we were saving for later, as the comparison may be valid already. This is a chart of the bottom formed in the SPX during 2002-2003, after the tech bust. While the bottom itself formed an inverse head and shoulders pattern (which we expect this time also), the recovery from the right shoulder is what really interests us here. Since the drop was not as violent and much more time was worked off with the head and shoulders bottom, the moving averages were not as far above the low prices and were overtaken sooner as a result. But look at the trend that steadily moved up from March to June, before flattening out for the summer, then racing higher again into 2004. It was less than a 30% gain for the first leg up in 2003 from the March low; it’s already 36% for the SPX from the bottom in March this year. While the low was much lower this time, the highs and resistance levels from both years are almost identical. In 2003, the SPX overtook the early January highs around 930 in early May. After a quick, steep drop below 920 to test the breakout, it was off to the races for another straight month, rising over 10% before the June highs. Then it was one test of the inverse head and shoulders neckline in early August at 960 before moving over 1150 by early 2004. This year, the early January highs are in the area of 944 and the SPX is again challenging them in early May. A breakout here followed by a retest of the 920 level could again produce a similar result. The only problem is finishing the inverse head and shoulders bottom, which should happen somewhere around the end of June time wise to produce a symmetrical pattern. At this point, it looks like the January highs need to hold as resistance to keep the inverse head and shoulders pattern in play. This is also the approximate level of the 200 day moving average currently and the 200 day stopped the SPX multiple times from 2001-2002, plus twice early in 2003. The first test early in 2003 led to the formation of the right shoulder in the bottoming pattern and the second test required a test of the 50 day moving average as support before breaking out and leaving the 200 day well behind. Either of those would be a welcomed event for this market to burn off some overbought conditions and excess euphoria. With the VIX at the lowest levels in seven months, purchasing some protection via puts is probably a good idea. We continue to hold and look to add to our position in the ProShares Short S&P 500 ETF (SH) which is about 5% under water now from our first entry. Select longs continue to beat the market averages by a wide margin.

spx20022003bottom


Overbought and moving into resistance

April 14, 2009

An update on the SPX chart today to show the market finding resistance near previous highs. We are adding a new indicator to the top of the chart, the MACD. The negative divergence in the MACD histogram reinforces the strength of this resistance as the market advance begins to stall. Finally, we have a short term reversal pattern showing in the candlesticks as an Evening Doji Star has formed over the last 3 trading days. Taken together, it looks as if profit taking may have already started.

spx041409

The NASDAQ chart shows similar resistance being met at the Jan highs with negative divergences in the MACD histogram and the Rate of Change indicator which is approaching the zero line.  Both of these confirm the loss of momentum as the market approaches resistance.

comp041409

Exactly the opposite looks to be developing in the ProShares Short S&P 500 Fund ETF (SH) as positive divergences are present with the price firming near support.  Hedging long exposure here and/or taking profits looks like a good idea.  It’s still a bear market rally at this point.

sh041409


Some positive developments

April 2, 2009

We have a lot to show, so we’ll keep each one short and sweet.

First, an update on the SPX battle with the 50 day. The bear trap looks to be pretty solid with assistance from the Feds. How much backing and filling needs done is still up for debate. We have added a new indicator to the bottom of the chart this time, the daily 13/34 exponential moving average indicator. We have it set on a favorite parameter of John Murphy at Stockcharts.com that we have referenced previously in Is it really 2001 again? Look for further reference in the charts below.  This indicator on the daily chart is more of a leading indicator (subject to some whipsaw) and becomes more valuable when combined with the medium and long period charts.  The daily indicator has turned positive (above zero) and has held positive ground for the first time since early in the year.  This is the most positive showing for this indicator since April/May of 2008.

spxtesting800040209

Here is a weekly shot of the same indicator.  Even with this indicator still deeply in negative territory (below zero) a clear positive trend change is visible.  This is confirmed by the SPX moving above the 13 week exponential moving average, which drags the indicator higher.  These are also the first positive developments in this indicator since April/May of 2008.

spxweekly040209

Finally we have the monthly chart featuring the indicators referenced previously (MACD, RSI, ROC) plus an overlay of the 20 month Bollinger Bands set to two standard deviations.  This shows all of these indicators to have been severely stretched, yet showing signs of recovery.  The MACD histogram is now climbing for two months in a row and the RSI is closing in on 30, which marks the top of oversold territory.  The ROC has at least ceased its vertical drop and the Bollinger Bands are finally well below the current price as opposed to being violently penetrated to the downside.  This at least shows stabilization, with potential being revealed by the shorter periods.

spxmonthly040209


The bears aren’t dead and buried yet

March 30, 2009

The SPX only stayed above the 50 day simple moving average this time for 5 days.  At the turn of the year, it at least managed 7.  The 2002 lows are crucial support to test the will of new buyers.  If they fail to hold, the 741 level will serve as the canary to warn of a possible complete retest of the March lows.

So far, we have only another headfake to the upside created by jawboning from the Feds.  We still believe this is part of a bottoming process, but we need more honest buying (not short covering) to confirm the lows are already in.

spxtesting800033009


The Feds use a backhoe for a gravedigger

March 25, 2009

“It’s déjà vu all over again.”
– Yogi Berra

In mid-December, after the Fed lowered rates to 0 to .25%, we noted:

Aggressive action by the Federal Reserve today pushed most markets above their respective simple 50 day moving averages for the first time since September.  We have highlighted the 50 day as resistance level number one in prior notes and have shown it to be critical resistance along with the 200 day and 80 week.  This is a primary step to recovery and opens the door to a potential challenge of the 200 day near the beginning of 2009.

That rally was short lived, eventually failing after a more sustained move above the 50 day near the beginning of the year.  What is interesting is that we may be seeing a similar sequence of events again.

After a brief dip below the 2002 lows, the SPX has rallied back significantly on the back of announcements from the Treasury and Federal Reserve.  The combination of these announcements (along with better economic reports) has again pushed most major market averages over their simple 50 day moving averages.  Unfortunately, volume has not expanded with this push, even though volume levels are higher than earlier in the year.

The market managed about 7 days above the 50 day in early January.  So far, we have 3 days on this trip.  To avoid a repeat of action earlier in the year, it is critical that the SPX remain above the 50 day and the 2002 lows.  The Feds can do all of the grandstanding and wagon circling they want, but the market will not be forced higher.  We need to see organic buying build on this foundation for the bears to truly remain buried below the 2002 lows.  Ideally, a high volume rally will spring from support at the 50 day to challenge the Feb highs in the area of 875.  If this occurs, the 50 day and 800 will serve as very solid support going forward as we move toward the Jan highs around 940.

If the market again fails after a quick Fed induced burst over the 50 day, we look at 741 as the first support level below the 2002 lows.  A significant break at 741 would argue for at least a retest of the lows at 667.  With other indicators showing improvement, including some leaders exhibiting notable relative strength, it is our assumption at this point that the lows at 667 will not be broken.

spxtesting800032509


How many bears could a bear trap bury, if a bear trap began to bury bears?

March 18, 2009

A shovel is not enough longs, we may have hit rock.  The question is, did we hit rock bottom?

The 50 day moving average is in play once again.  Can we remove this huge stone in time for Easter?  The resurrection of the market depends on it.

spxtesting800031809


Phases of fear and elation in the VIX

March 18, 2009

Here we show a nice relationship between the VIX and the SPX.  While this is a commonly referenced pairing, many still challenge the value of using the VIX as a market indicator.  There are numerous ways too use the VIX and almost everyone has their own tweaks.  This chart shows a very clear inverse relationship with several distinct “phases” discernible in the value of the VIX.  These “phases” correlate well with the action in the SPX.  We have labled these phases “euphoria”, “fear” and “panic”.  We also included the 400 day moving average (equivalent to the 80 week) which we discussed previously in The Significance of the 400 day (80 week) moving average.  This bull/bear market reference point matches up very well with the action in the VIX, as the VIX moves into the “fear phase” just as the 400 day is coming under assault, before eventually breaking.  A final test of the 400 day from below, which we highlighted in late April 2008, was accompanied by one last dip into the “euphoria” zone for the VIX.  That was the “last chance” to get out before the drop gathered steam as the SPX then dropped over 50% in less than 12 months.

We added the notes on Bear Stearns and Citigroup for a consensus of the “expert” opinion at the time.

vixspx031809


Most Profitable Mutual Funds Ever

February 20, 2009

Friday February 20, 10:55 am ET
By Max Rottersman

HANOVER, NH (ETFguide.com) – The highest mutual fund advisory fee, of all time, was collected from the Fidelity Magellan Fund (FMAGX).  In 2001 it took in $792 million.  Magellan has earned the top three, all-time records, grossing $1.8 billion between 2000 and 2002.  Much of that is profit, from future retirees who don’t read their statements.   Most can’t believe such large sums go directly into one manager’s pocket.   After all, if they did, wouldn’t we read about it in the press?  No.  Mutual fund companies provide a steady stream of advertising dollars.  It isn’t a conspiracy.  It’s natural self-interest for all involved, from The New York Times to the Wall Street Journal.

Ironically, American mutual fund regulation is the finest in the world.  I’m not joking.  There’s no secret to the numbers I’m pointing out.  They’re sent to every shareholder once a year.   Sadly, few journalist read fund financial statements either.  And any Fidelity shareholder who doesn’t like the fees is free to leave.

Mutual funds are corporations run on the behalf of their shareholders, represented by a board of trustees.  It’s a legal structure that makes for some confusing language; for example, fund fees are often called expenses (which legally they are), rather than fees (which functionally, you pay).  For example, Fidelity never charges you, the shareholder, directly. Rather, the fund trust pays a fee, from the fund’s assets, to various Fidelity companies (which are separate from the fund corporation) for various services.  Your board of trustees enters into contracts, on the shareholder’s behalf, with the advisor (like Fidelity) and other service providers.  Ironically, mutual funds were born during a ‘socialistic’ time in American history.   Again, I kid you not.  Should shareholders revolt, trustees can easily fire the portfolio management companies which serve the funds.   Interestingly, that has seldom happened.

If you have any question about the profitability of the fund business, consider this.  Last year, these five funds alone earned over $2 billion in advisory fees. Fidelity Contrafund: $522 Million (FCNTX), PIMCO Total Return Fund: $506 Million (PTTAX), Growth Fund Of America: $450 Million (AGTHX), Europacific Growth Fund: $439 Million (AEPGX), Fidelity Diversified International Fund: $374 Million (FDIVX). Again, believe it or not, these are the fees the manager charges for a few people to pick stocks for the fund.  The operational costs are separate.

Flying under the radar, because they don’t offer shares directly to the public, the CREF Stock Account Fund paid $586 million in advisory and administrative fees, the largest amount of any fund in my database.  TIAA-CREF says it’s ‘at cost’.  We have to assume it’s true, that the teachers did their own homework and thought for themselves.

Every shareholder should understand that all mutual funds have two basic costs.  The first is the cost to manage the portfolio; that is, buy and sell stocks and bonds.  A single person with a brokerage account can do this.   In mutual funds, the fee for this ‘portfolio management’ work is called the advisory fee.  The second basic cost is operational.  This work is often done by hundreds of people: administrators, call center workers, accountants, IT professionals, custodians, printers and lawyers.  The operational work is what shareholders ‘see and touch’ when they deal with their mutual fund.  Shareholders seldom, if ever, have any contact with the portfolio manager (advisor).

In 2001 Fidelity charged shareholders $162 million for operational costs (on top of the $792 million).  Fidelity probably makes some money on these costs too, since Fidelity subsidiaries handle shareholder servicing, administration and other ‘touch’ services.  Yet most people don’t believe me when I say most of the advisory fee is profit.  They just can’t believe it’s legal for Fidelity to collect $792 million for a few people picking stocks (which they pay a handsome salary in the millions, but it’s a fraction of what they charge). Here’s a list of 58 Fund Managers Who Took in Over $100 Million in Advisory Fees Last Year.

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For a nasty looking market, try UGL why?

February 9, 2009

What shines more than gold in a paper currency print-off?

How about double gold?

A new ETF from Proshares is designed to return twice (200%) the daily performance, before fees and expenses, of gold bullion as measured by the U.S. Dollar fixing price for delivery in London. This ETF is structured as a partnership and it uses a combination of forward and futures contracts.

It just started trading in early December and has already moved from 23 to 33 for a more than 43% gain.

ugl020909

Also available in silver sporting almost a double.

agq020909


The Kondratieff Cycle

February 2, 2009

kondratieff-cycle

Graphic compliments of The Long Wave Analyst.

Professor Nickolai Kondratieff (pronounced “Kon-DRA-tee-eff”)

Shortly after the Russian Revolution of 1917, he helped develop the first Soviet Five-Year Plan, for which he analyzed factors that would stimulate Soviet economic growth.  In 1926, Kondratieff published his findings in a report entitled, “Long Waves in Economic Life”.  Based upon Kondratieff’s conclusions, his report was viewed as a criticism of Joseph Stalin’s stated intentions for the total collectivization of agriculture.  Soon after, he was dismissed from his post as director of the Institute for the Study of Business Activity in 1928.  He was arrested in 1930 and sentenced to the Russian Gulag (prison); his sentence was reviewed in 1938, and he received the death penalty, which it is speculated was carried out that same year.  Kondratieff’s major premise was that capitalist economies displayed long wave cycles of boom and bust ranging between 40-60 years in duration.  Kondratieff’s study covered the period 1789 to 1926 and was centered on prices and interest rates.

Kondratiev waves — also called Supercycles, surges, long waves or K-waves — are described as regular, sinusoidal cycles in the modern (capitalist) world economy.  Averaging fifty and ranging from approximately forty to sixty years in length, the cycles consist of alternating periods between high sectoral growth and periods of slower growth.  The Kondratieff wave cycle goes through four distinct phases of beneficial inflation (spring), stagflation (summer), beneficial deflation (autumn), and deflation (winter).

The phases of Kondratieff’s waves also carry with them social shifts and changes in the public mood.  The first stage of expansion and growth, the “Spring” stage, encompasses a social shift in which the wealth, accumulation, and innovation that are present in this first period of the cycle create upheavals and displacements in society.  The economic changes result in redefining work and the role of participants in society.  In the next phase, the “Summer” stagflation, there is a mood of affluence from the previous growth stage that changes the attitude towards work in society, creating inefficiencies.  After this stage comes the season of deflationary growth, or the plateau period. The popular mood changes during this period as well.  It shifts toward stability, normalcy, and isolationism after the policies and economics during unpopular excesses of war.  Finally, the “Winter” stage, that of severe depression, includes the integration of previous social shifts and changes into the social fabric of society, supported by the shifts in innovation and technology.


Stocks: A Range-Bound Recovery in 2009

December 24, 2008

S&P’s chief investment strategist says a bear-market bottom may already be in place—and tells why 2009 could be a better year for stocks

By Sam Stovall From Standard & Poor’s Equity Research Investing
Excerpted from a report published by Standard & Poor’s Equity Research Services on Dec. 22

Investors will remember 2008 as a year of change. Not just change in the White House, but also the pocket change that they used to call their portfolios.

Let’s face it. This bear market started as the perfect storm of popping bubbles—commodities, emerging markets, hedge funds, and real estate. From Oct. 9, 2007 through Nov. 20, 2008, the S&P 500 (SPX) declined 52%, making it the third-worst bear market since the 1929-32 crash. One of the more amazing characteristics of this decline was its speed. The average “mega-meltdown,” or bear market decline of more than 40%, traditionally took 21 months to play out. This one took 13 months.

Not surprisingly, all 10 sectors within the “500” fell, from a 22% slump for Consumer Staples to a 74% thrashing for the Financials. Finally, 125 of the 128 subindustries in the S&P 500 declined.

Factors Backing a Bottom

Where do we go from here? Probably not lower, in our opinion. A few months ago, I wrote that 700 on the “500” might be a worst-case scenario for a decline, citing the trendline drawn off of the 1932 low, the average bear-market retracement of prior bull market advances, and the applying of a bear market P/E ratio on a conservative “top-down” EPS estimate. We got close to that level, as the S&P 500 closed at 752 on Nov. 20. Since then, it rose 21%—technically signaling the start of a new bull market. So I say why quibble? What’s 50 points among friends? Besides, we believe there are several reasons that a bear-market bottom may already be in place.

Read the rest of this entry »


Markets move above the 50 day moving averages

December 16, 2008

Aggressive action by the Federal Reserve today pushed most markets above their respective simple 50 day moving averages for the first time since September.  We have highlighted the 50 day as resistance level number one in prior notes and have shown it to be critical resistance along with the 200 day and 80 week.  This is a primary step to recovery and opens the door to a potential challenge of the 200 day near the beginning of 2009.

A rally to the 200 day would be quite significant as the recent violent plunge has opened up a large gap over the 50 day.  A similar test of the 200 day as resistance came in early 2002, though the gap was not as dramatic, because the market did not fall to such lows as quickly as this year.

See the charts for the major averages below, with the 50 day moving average in blue and the 200 day in red:

djia121608

spx121608

comp121608

nya121608


Worse than the tech bust by any measure

November 20, 2008

The 2002 lows are under assault and this drop so far makes that one look like child’s play. All long term indicators are more negative now than at any point in the 2000-2002 bear.

spx112008


Major Stock Index Averages Test the Lows Again

November 13, 2008

So far the trading range is still holding up.  Quite a sharp bounce from these levels once again.

djia111308

The S&P 500 actually broke the lows today before rocketing back.

spx111308


Once, Twice, Three Times a Bottom…

October 30, 2008

Time for another chapter in the saga of capital destruction we call the stock market.

Just in time for the negative GDP number everyone has been waiting for, the market is finding a bottom.  It may not be the ultimate bear market bottom, but it’s probably the bottom for 2008.  As we noted in We’re sure scared now…bringing it all together, “Historically, a retest of the lows develops within a few months to verify the strength of the bottom.  Hitting the exact lows again is not a necessity, but a second significant down move usually at least comes close.  This offers a great time to pick up relative strength leaders as they separate from the pack.”

We have seen not only one, but two tests of the lows since that writing, in the broad market indices.  Neither one of those tests completely reached the initial low, but both were violent and low enough to be considered valid.  The updated chart of the Dow Jones Industrial Average shows pullbacks of 1,500 and 1,100 points respectively, with both lows about 300 points above the initial low of October 10.

What has developed now is a trading range.  Not exactly bullish, but much better than the ski slope drop of the last few months, October in particular.  Seasonality is also about to turn positive as the November through April time period is historically the best six months of the year for the markets.  November itself is one of the best single months to be invested.

So how do we decide what to do?

There are several options here really.  Trading range strategies are particularly profitable in times of high volatility.  Selling premium and initiating spreads are some preferred options trading strategies for this kind of market environment.  For long term investors, picking up relative strength leaders near the lows is a great strategy.  Many stocks have been unfairly punished and are now wildly undervalued.  For indexers or 401k investors that have protected their assets with bond funds and stable value funds and cash, start moving it back in on these bad days as long as the lows hold.  For aggressive traders, we know there are some serious mean reversion trades already started.

What we must all keep in mind is that we do not know if the lows will hold or not.  As long as they do, buy them but don’t commit all of your capital at once.  Take little bites and dollar cost average into positions, especially if you are not trading.  There are many great opportunities here, but there will be many in the future also.  Don’t let yourself get stopped or margined out (heaven forbid) when you should be buying more.  The amount of forced liquidation by hedge funds is not something that is knowable by anyone.  It is creating great prices, but it could carry much further if the selling continues to feed upon itself.  If the trading range is broken to the upside we would become more bullish and would start to look at the 50 day, 200 day and 80 week moving averages as resistance.  Another bullish clue we are looking for is for volatility to drop, specifically the $VIX needs to drop under the 20 day moving average which has provided support since the breakout in early September.


A short history of modern finance

October 16, 2008

Link by link
Oct 16th 2008
From The Economist print edition

The crash has been blamed on cheap money, Asian savings and greedy bankers. For many people, deregulation is the prime suspect.

THE autumn of 2008 marks the end of an era. After a generation of standing ever further back from the business of finance, governments have been forced to step in to rescue banking systems and the markets. In America, the bulwark of free enterprise, and in Britain, the pioneer of privatisation, financial firms have had to accept rescue and part-ownership by the state. As well as partial nationalisation, the price will doubtless be stricter regulation of the financial industry. To invert Karl Marx, investment bankers may have nothing to gain but their chains.

The idea that the markets have ever been completely unregulated is a myth: just ask any firm that has to deal with the Securities and Exchange Commission (SEC) in America or its British equivalent, the Financial Services Authority (FSA). And cheap money and Asian savings also played a starring role in the credit boom. But the intellectual tide of the past 30 years has unquestionably been in favour of the primacy of markets and against regulation. Why was that so?

Each step on the long deregulatory road seemed wise at the time and was usually the answer to some flaw in the system. The Anglo-Saxon economies may have led the way but continental Europe and Japan eventually followed (after a lot of grumbling) in their path.

It all began with floating currencies. In 1971 Richard Nixon sought to solve the mounting crisis of a large trade deficit and a costly war in Vietnam by suspending the dollar’s convertibility into gold. In effect, that put an end to the Bretton Woods system of fixed exchange rates which had been created at the end of the second world war. Under Bretton Woods, capital could not flow freely from one country to another because of exchange controls. As one example, Britons heading abroad on their annual holidays in the late 1960s could take just £50 (then $120) with them. Investing abroad was expensive, so pension funds kept their money at home.

Once currencies could float, the world changed. Companies with costs in one currency and revenues in another needed to hedge exchange-rate risk. In 1972 a former lawyer named Leo Melamed was clever enough to see a business in this and launched currency futures on the Chicago Mercantile Exchange. Futures in commodities had existed for more than a century, enabling farmers to insure themselves against lower crop prices. But Mr Melamed saw that financial futures would one day be far larger than the commodities market. Today’s complex derivatives are direct descendants of those early currency trades.

Read the rest of this entry »


We’re sure scared now…bringing it all together

October 14, 2008

A historic level of fear, even panic, has developed as forced liquidation is removing some players from the market completely. Another difficult lesson in leverage and risk management for some really bright folks. Brings to mind one of my favorite quotes, compliments of John Maynard Keynes, “The market can stay irrational longer than you can stay solvent”.

Irrational may be a mild description for what we’re seeing in the markets currently.  After a 1,000 point range on Friday from top to bottom, the Dow Jones Industrial Average added almost another 1,000 points Monday.  Clearly the selling was overdone on the downside and the market was drastically oversold after a 3,000 point decline from top to bottom in the previous eight trading sessions.  Thankfully, those nasty shorts decided to take some profits and get the rebound started Friday morning.

We wouldn’t consider this the all clear signal however.  Historically, a retest of the lows develops within a few months to verify the strength of the bottom.  Hitting the exact lows again is not a necessity, but a second significant down move usually at least comes close.  This offers a great time to pick up relative strength leaders as they separate from the pack.

The correlation noted in Here we are again? 2001 vs. 2008, Is it really 2001 again? and Back to the future again and it’s not pretty has finally culminated in the fear based washout we have been looking for.  Admittedly, it was at much lower levels than we expected, but the timing was almost perfect.  The rebound in 2001 started on the morning of Friday, September 21 at 944.75 on the Standard & Poor’s 500 (SPX).  The rally continued on Monday and Tuesday of the next week, covering a respectable 75.54 points or 8% from the lows.  Another 20 points were added by the close of the week after a brief rest on Wednesday and Thursday. By the end of the following week, another 30 points had been added (for a total of 126.63 points or 13.4%, from the lows).  Two weeks later, the net gain was flat after a brief run over 1,107.  Sideways trading then developed until a clear break over 1,100 in the first week of November.  Around Thanksgiving, the new high of 1,163 had brought the market back from the lows by over 23%.  The rest of the year saw a peak gain of only 10 more points in the first week of December.  A final 3.5 points was all that was left for the first week of the new year, as an intermediate top at 1,176.97 was found.  That top was tested again in late March of 2002, after a 100 point (8.7%) drop into late February.  That was all she wrote for that bounce however, as the SPX found new lows at 768 in October, finally the low for the entire bear market.  Patient buyers were rewarded as the final retest of the lows completed a massive head and shoulders bottom in March of 2003 at 789.

In 2008, the rebound started on the morning of Friday, October 10 at 839.80 on the SPX, almost three weeks behind schedule.  So far, the monster rally of Monday, October 13 has added 167.13 points or 19.9% from the lows.  A morning look at the futures market suggests another 20 or so points may be in the works for Tuesday.  In just three trading days, this bounce has covered almost the entire distance of the rebound in 2001-02, on a percentage basis.  The preceding decline was also much more violent as the SPX dropped from 1,300 to the lows at 839.80 (35.4%) in just six weeks.  In 2001, the fall drop was 28.2% over 16 weeks.

What Does it All Mean

If history holds, only a small portion of this bounce is behind us and there will be plenty of opportunities to get in at decent prices.  The first leg of this rally is past, but the second leg could be just as profitable.  At the very least, consolidation will develop following these monster gains.  This will give nimble traders the ability to buy the dips.  Long term investors are almost guaranteed to get another chance at prices near the lows in the coming months.  The key is to watch overhead resistance, and there is a ton of it.  Fibonacci retracements, moving averages and previous lows all will take their bite from the rally.  Don’t forget The Significance of the 400 day (80 week) moving average indicates we are still in a bear market.  No other long term indicators have given buy signals either.

One more market comparison to consider is the crash of 1987 which found its low on Tuesday, October 20.  This price action may actually be more appropriate considering the violence of the decline.  This October “crash” market dropped 35.9% in 8 weeks, bounced 19.8% in two days, then dropped back to within a few percentage points of the low in early December.  The market then totally recovered within two years.


Back to the future again and it’s not pretty

September 10, 2008

This post is the latest in a series covering the correlation of S&P 500 price movement during the bear markets of 2001 and 2008.  Previously, Is it really 2001 again? highlighted a number of similarities for both indicators and chart patterns in addition to the timing and relative resistance levels observed by both markets.  This expanded on the first entry Here we are again? 2001 vs. 2008 which started the discussion by showing the two markets spending a similar amount of time above the 1400 level, meeting resistance at a similar level in the area of 1560, forming a similar double top including a final fall retest followed by an extreme decline and culminating in a spring washout setting up an early summer bounce.

The correlation remained tight as both markets failed their early summer bounce by late May in the area of the 200 day moving average and the 50% retracement level of the fall to spring decline.  The correlation weakened over the summer as the current market started a much more drastic decline from the May top than occurred in 2001.  This time the spring lows were broken by July instead of waiting for September as in 2001.  A solid bounce from the July lows this year brought the S&P 500 back to just above the March lows where resistance was encountered around the 50 day moving average in the month of August.  Suddenly the correlation has returned as the market failed in August of 2001 at the 50 day moving average also.  As the calender turned to September in 2001, volume picked up as the market went into free fall.  Of course the 9/11 attacks affected the market as the month progressed and forever after.

But this year, the month of September has not started off any better despite the Feds attempt to stop the bleeding in the credit markets by taking control of mortgage giants Fannie Mae (FNM) and Freddie Mac (FRE).  High volume distribution has been the theme with the exception of some serious short covering following the announcement this past weekend (and late Friday for those in the loop).  The bad news for the Feds and everyone else is, even as impressive as the short covering rally was Friday/Monday, it still never reclaimed the 50 day moving average nor the March lows.  If the July lows at 1200 don’t hold here, a repeat of 2001 may yet be in the cards.  The S&P 500 didn’t bottom until dropping under 950 in 2001 and the final bottom in 2002 saw intraday trading under 775.  We’re not ready to say it will get that bad this time, but taking out the July lows would suggest scary days ahead.

For those brave longs an entry at the July lows around 1200 is a good place to start.  Lows for the year are regularly made in September/October.


Leaders starting to crack

September 5, 2008

Large technology stocks in the QQQQ (PowerShares NASDAQ 100 Index ETF) had an awful day on the largest volume since bottoming in mid July.  All of the short term indicators are on sell signals and the relative strength against the S&P 500 is in danger of turning down.  If support at the July lows fails, a move back to the March lows is almost guaranteed and there is a significant chance they will not hold either.  These stocks are already oversold so a bounce from support is possible, but the heavy selling we have seen since returning from the holiday does not bode well for the worst month of the year.  Losing support from the leading sectors of tech and small caps would suggest the bear market has more room to go on the downside.  The NYSE Composite Index (NYA) found new lows today and is the first major index to do so.  The action in the techs and small caps will go a long way in deciding if the other major averages are to follow the lead of the NYA.

The small caps as represented by the IWM (iShares Russell 2000 Index Fund ETF) are holding up a little better.  This is more than likely a result of the strong dollar, but we have to consider this a small positive for the moment.  After failing at the June highs in early August, IWM pulled back and tested first support in the 71-72 area.  After a second attempt to rally fell short on low volume, we have returned to the 71-72 level again.  Volume has been lower in distribution than that of the rally off of the July lows, and both the 50 and 200 day moving averages have provided support so far.  Relative strength against the S&P 500 has also been maintained unlike the big techs above.  The negative divergence signaled by the MACD histogram in our last note did in fact foreshadow weakness at the old highs and this indicator has yet to change.  In addition, the MACD itself has followed the histogram by producing a sell signal of its own.

These ETFs must strengthen soon to keep their leadership status intact.  Without their help and guidance, the market as a whole could be in for another bloody September/October.


Not a positive look here

August 18, 2008

Financial and Consumer Discretionary sectors lead the way lower.

XLF (Financial Select Sector SPDR ETF) looks to be rolling over. Multiple indicators confirm the XLF is running out of steam (MACD, RSI, Relative Strength, ADX).

Our entry into the SKF (UltraShort Financials ProShares) looks poised to deliver great returns going into the fall.


Small cap leaders overbought

August 18, 2008

The IWM (iShares Russell 2000 Index Fund ETF) is showing signs of being overbought as it challenges the June highs.  This level is significant long term support/resistance as shown here.  A negative divergence has developed in the MACD histogram as the MACD itself is approaching levels that have marked previous tops.

A pause in the rally here is likely.  We are looking at downside support in the area of 68-72.  Maintaining the trend in relative strength is crucial to any further rallies.

We are also rapidly approaching the September – October washout period that has historically provided excellent entry opportunities.  Small caps maintaining relative strength and holding support throughout this typically volatile period would be a major positive for the market as a whole.


The smaller they are, the faster they rise

August 12, 2008

Great action in the Russell 2000 Small Cap Index. Leading the market higher and looking to challenge the June highs.

Here is a chart of IWM (The iShares Russell 2000 Index Fund ETF). Notice the building bullish volume and increasing relative strength on the breakout.

This, plus strength in technology, is very encouraging for US stocks.


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