SAEDIAS

Sep 24: Pullback Update

2009-09-24T23:18:00.000-07:00

As expected, the 1075 level held for the time being and we're now seeing the minor pullback that I talked about in the last post. Currently the breadth is showing that the move down is not as strong as that of the last three major down moves (i.e. positive divergences) so I am expecting the 1037 level to hold (however the larger support is at 1015). The ratios that I have on the chart below have all moved ahead of price (as have the internals), but interestingly the longer term indicator is showing a rather notable negative divergence - which could be giving a clue as to more downside ahead. But for that to happen we'll need to see stronger conviction from the sellers - the relatively high volume of the last two days doesn't count as it was brought forth by the blow-off top triggered by the FOMC meeting and today by the weak housing sales data. Also the USD will have to close and confirm above the channel that it has been trading in since the March equity lows (which it's very close to doing, but until that happens I will not be convinced that the 5th wave down is complete). On a side-note, the driving force of the rally of the last three weeks has been value stocks (and small caps) and that's what has come down most in the last two days.

Bond update:

In the previous post I mentioned a strategy to confirm potential signals - here's the improved version (currently issuing a buy signal):

Sep 17: A Potential Minor Pullback Prior to 1120

2009-09-17T16:55:00.000-07:00

Strong internals with a lack of any kind of serious negative divergence have kept me from taking on any short positions until today. The market reached the 1075 level that I've talked about since last month, and though it isn't a previous resistance, it is a major fib prior to the 1120 level (which is the 50% retrace of the entire bear market). However, if we do get the anticipated pullback, it will be rather shallow and from there reaching the 1120 will be almost a certainty (there is no previous resistance above for the S&P and the DOW while the S&P has broken through the ascending resistance of the broadening top).

I've covered most calls today and gotten in on QQQQ Nov puts (and if the action is convincing may look to play the Sep 42 put tomorrow) but will cover pretty fast if the downward action isn't convincing.

I've been developing a few automated strategies, one of which uses non-price related indicators such as breadth, volatility premium, option data, etc. and it is currently rather bullish - which supports the idea that the pullback may be rather short-lived:

Sep 12: Weekend Update

2009-09-12T10:43:00.000-07:00

Updated futures premium chart:

Sep 10: Yesterday's Call a Few Days Too Early

2009-09-10T12:48:00.000-07:00

I jumped the gun on the consolidation (as did a lot of specialists, with the NYSE specialist shorts reaching multi-month highs yesterday), got stopped out on the speculative puts early on and added some November A calls (+15%). Some things that fueled the rally (after a mild decline) were: fresh 52-week lows on the USD, better than expected initial claims, strong 30-year bond auction, TXN and PG earnings outlooks etc. but it was also justified from a technical standpoint:

(Here's the longer-term outlook)

Sep 9: Consolidation Mode

2009-09-09T17:17:00.000-07:00

Got another reflation rally today with the bleeding continuing for the dollar. Selling pressure, however, is beginning to build up. Today's action was important in reversing the intermediate term indicators to positive - so a rather mild correction is expected before the indices move higher (1075 still looks strong on the fibs). The equal-weighted to S&P cash index ratio has moved to a new record high (with technology, retailers, and $RAG also making new highs before others), suggesting that the small caps are still fueling the move up (with growth stocks playing a particularly important role in the last two weeks).

Here's one indication of just how overbought we are on the Q's:

A broader breadth indicator using NYSE data:

There are also neg. divergences for volume on SPY and QQQQ with down volume building up. I've hedged my calls from last week and am net short with OSK and QCOM puts (and though I'm not a fan of ever shorting APPL, today was a high-volume confirmation to yesterday's unusually good setup).

Sep 8: Potential Reversal Down Tomorrow

2009-09-08T21:38:00.000-07:00

The dollar held the key channel resistance and very possibly started its 5th leg down (talked about in previous posts). Despite this strong move there wasn't a much of a reflation rally in equities today, which along with several negative divergences in breadth, implied volatility, etc. could suggest a possible reversal down day tomorrow (the longer term indicators are also still signaling that we are in somewhat of a downtrend) - that's the way I played it today.

Here's the dollar update:

Sep 3: Switching Horses to Play a Potential Up Move

2009-09-04T01:09:00.000-07:00

Though we may see a bit of a reversal tomorrow, the longer-term signals still suggest that we'll be in somewhat of a downtrend for some time. That being said I think today was a decent day for some profit-taking on the short side as bull potential has been building, but I will only continue to play the up move if we start out on a strong note tomorrow.

Though the recent rally in gold has been much anticipated by many (which I've played with GOLD and AUY calls), here's one reason why it's not smooth sailing from here on out:

Update of the USD chart from the previous post:

Sep 1: USD Breaking Out of Multi-Month Channel

2009-09-01T21:48:00.001-07:00

Aug 31: A Few Longer-Term Indicators

2009-08-31T20:16:00.000-07:00

McClellan Summation Index for volume:

Copper-to-Gold ratio and Shanghai:

Weekend Update: Aug 30

2009-08-30T15:46:00.001-07:00

Domination by small caps:

Breadth update:

Volatility premium:

Corporate and treasury bonds:

Aug 24 PM: On QQQQ Calls and More

2009-08-23T22:40:00.000-07:00

Though we may pullback a bit Monday to Tuesday to get rid of some of the overbought conditions, as I mentioned in the previous post we should be headed for the 1050 to 1075 range on the S&P.
It's obviously not what some of the 60min internals previously showed, but notice how much larger the positive divergence on on-balance volume was prior to the negative one at the top of the channel (it should also be noted that 60min internals are less reliable than on the daily interval and were only used because there were no signals on the daily). So somewhat poor judgment on my part. However, the 4-day up move did go against the daily negative divergences outlined in the Aug 17 post, which I believe suggests that the top is within reach as exuberance is starting to kick in (the ISE equity call/put is flirting with the low 200's). The same thing apparently happened in the 1938 rally, the analogous top of which is also fast approaching:

The approximate 1075 S&P target looks good on the fibs, while 1050 is the 50% retrace off the 2008 top and 1044 is the Oct 14 high. Friday's move looks quite strong with on balance volume making new highs on both 60min and daily intervals (SPY), parabolic SAR issuing a buy signal etc. However, besides the mentioned negative divergences we are also very close to the ascending resistance of the broadening formation/rising wedge while the weekly MACD histogram is beginning to diverge with price and the VIX is about to make a bullish cross on the weekly.

Over the weekend I took a closer look at QQQQ calls as one of the widely-used tools to capture the current momentum (charts below). On Friday there was a great 600+% play on the August 40 call, which was obviously rather speculative, but a gap fill on the Q's at the open and strong volume confirmation of a reversal on the 1min (on news of Bernanke's speech) were all good indications that the call had a high probability of finishing in the money:

In general, though volume was well within the current price of 40.19, the calls that gained the most were about 10% out of the money.

The following graph shows the risk that's associated with buying the farther out of the money options.

So even though the current discount (i.e. theoretical to bid value) is highest for Sep 45 and Oct 47 calls, they are too susceptible to time decay to be appealing. However, there are a few very attractive (undervalued and yet almost immune to theta) calls at somewhat lower strikes/farther out, and should likely gain faster than the following graph suggests, provided that the market heads higher:

Aug 19: Backtesting Rising Neckline/Descending Channel Top

2009-08-19T16:48:00.000-07:00

Negative divergences on 60min internals suggest that we'll be lower tomorrow and making our way to the 97.0 level in the next two days:

Yesterday we tested the horizontal neckline of the double top and today the rising neckline of the slanting H&S (which I thought was somewhat less probable coming into today). If we do happen to break through this level then we'll go to 1050 on the S&P, but as of right now it is more likely that we'll drop to ~97 and then make a push up.

Aug 18 Intraday: Backtesting Db Top Support

2009-08-18T12:41:00.000-07:00

Getting a 50% retrace of yesterday's move and backtesting the support of the double top (after-hours included, or H&S on normal chart), with the dollar consolidating its two day up move at key resistance. Everything is playing out exactly as mentioned in the previous post so far.

Aug 17: One Foot into the Pullback

2009-08-17T21:59:00.000-07:00

The sell signal given last Thurs. was once again confirmed today by a substantial move lower (and confirmed the bear momentum going forward). At the open my gap-down strategy was triggered once again and suggested a high probability of a weak close - which we got. The next key support to watch on SPY is 97.0, which is the projection off the double top. Tomorrow, however, will likely be a bit of consolidation with the first half of the session in positive territory - beside short-term oversold internals, the dollar is also up against some resistance.

OEX/equity put-to-call:

Aug 15: Weekend Update

2009-08-15T00:29:00.000-07:00

Breadth update:

[more to come]

Intraday Aug 14

2009-08-14T09:58:00.000-07:00

Today we're getting the expected bounce from the USD ($DXY) - in part technical and in part due to the lower than expected UMich. sentiment number - which is helping the major sell-off in oil and equities

Aug 14: Index and Dollar Update

2009-08-13T15:43:00.000-07:00

We're still retesting the previous support of the ascending channel, while internals and technicals are diverging further. We got the exact kind of consolidation that was expected in yesterday's post and now have a hanging-man candle on each of the three indices. The positive close on strong volume, though, will likely carry over some positive momentum into tomorrow, but I expect a close in the red.

As for the dollar, it is interesting to note that today we closed at exactly the level that was mentioned yesterday as a key pivot reversal, so I still hold by my statement that we may see a bit of consolidation which will hinder the bulls from breaking key resistances directly above.

Aug 13: Premarket Update

2009-08-13T00:32:00.000-07:00

Today we retested the inner channel with more strength than anticipated yesterday (however it should have been expected from the low OEX P/C ratio and low specialist short sales) and though the move failed to confirm on the 60min, we have a good chance of seeing more upside tomorrow (at least in the first half of the session). The plans of the bulls may be somewhat stunted, however, by the USD ($DXY) holding support at around 78.42 (i.e. 50% retracement of the recent upswing).

For a move to 1050 on the S&P, however, internals will need to have a reversal in the current trend ($TICK chart below):

On balance volume is rather bullish in the long-term, though somewhat pressured in the IT:

Intraday: Setting up for 98.67

2009-08-11T12:38:00.000-07:00

To be hit tomorrow on the 5th wave, from which we could get a relatively strong bounce...

I started accumulating puts on Thur/Fri. of last week in part due to negative divergences on internals:

Weekend Update: On Volatility and More

2009-08-08T12:54:00.000-07:00

This week the transportation average ($TRAN) confirmed the higher highs on the Industrials, affirming (according to Dow Theory) that the market still has more upside to come. Since December 2008 I've been playing this market with the premise that the 2009 lows would be hit in late February to early March, and I believe the $TRAN is now a final confirmation of this - however, the same does not hold for 2010. That being said, I do still think that a pullback to at least the 950 level on the SP500 is in the cards for us (and possibly much lower).

Particularly, I'd like to focus on volatility:

Though the ratio of implied to realized volatility is not far from historical lows, the current downward movement is more negative than positive for the short-term outlook.

Why implied volatility may already be too low, despite not bottoming:

Also, the $VXN has made a third straight higher low on the weekly for the first time since the October highs - which may presage a major outbreak.

However, in the coming days, implied volatility may still need to come down to one standard deviation below the mean to trigger any kind of meaningful bear signal (unless it acted ahead of price):

EPCR 10MA is also close to a potentially strong bear signal:

The ratio of OEX to equity put/calls looks even more dangerous for the bulls (suggesting that smart money is seriously hedging):

(from Cobra)

The next two charts from SentimenTrader confirm:

Negative divergences on breadth (advances, McClellan Oscillator, %above 10thru50MA, etc.)

Value is leading this last move up but still playing catch-up:

Intraday: Topping at 38.2%

2009-08-07T10:56:00.000-07:00

Intraday Aug 6

2009-08-06T10:43:00.000-07:00

The market is dropping purely on the strength of the dollar - $DXY is backtesting its previous major support at ~78.3 (while the longer-term USD trend is still down). Hence, oil/energy is leading the pack down, while $Comp is leading the indices - as was expected as it has been topping out relative to the other indices for days now. However, for the shorts to sustain this momentum they will need to close sub 990 on the S&P and 9175 on the Dow; the trend is clearly bearish already for the Nasdaq.

(Taken from Cobra)

Intraday Aug 5

2009-08-05T08:33:00.000-07:00

Correction: The top level reached today was the November 2008 top. The 38.2% retracement off the 2007 top is at 101.87 for SPY and 1016.0 for the S&P (based on closes), so we may be due for another push up after retesting the bottom level of the rising channel (blue).

Intraday Aug 3: Taking Upper Path

2009-08-03T08:28:00.000-07:00

As a reaction to the anticipated start of the 5th wave down on the USD, the SPY took the top path which I had from Jul 30:

Updated USD chart (note that the move down may not be as large as I have it):

Here is a chart showing the low levels of supply and demand (volume) and the potential breakout on supply on the 60min:

And a longer-term one showing resistance at the daily 300MA, PPO, MACD, and levels of new NYSE highs:

(both charts are from Frontline)

Sat Aug 1 Weekend Update

2009-07-31T23:36:00.000-07:00

So far we've been moving according to the paths I outlined in the Jul 30 intraday post and have managed to escape a major downfall - so if we're able to make a reversal at the 98 level on Mon, that may be a potential entry point for longs.

Here is the updated SPY chart:

Cyclicals, unlike technology, do not appear to be topping just yet:

We are very close to a break-out from the volatility channels. The action of $COMP/$VXN this week may give a pretty strong signal to either side (for the intermediate term):

I mentioned the overbought nature of the $VIX and $VXV relationship last time - here is a longer term chart to give a sense of the current levels; though it has already issued a sell signal, there is nothing preventing us from going to the overbought levels again:

The implied volatility of oil ($OVX) appears to have more inclination of reversing than the other volatilities:

(The four above charts are from Calex)

Small caps are extended relative to large caps at the current triple top for the ratio:

(from Contrahour)

The candle action on the indices is bearish into Monday, with the Thurs. shooting star on the $COMP being confirmed and dojis on both S&P and Dow.

However, the real X-factor this week will be the USD. We are still very much in the 5th wave of the bear move from the March top and are very close to breaking down hard from the current minor support (chart from a previous post). Open interest is still very low for the dollar index and large traders are still staying away (who have been better timers than commercials):

(the bottom oscillator is open interest)

Pre July 31: Bear Potential Increasing

2009-07-31T01:21:00.000-07:00

Though we may very well see the kind of push higher outlined in the last post, the importance of today's action shouldn't be overlooked as its implications may result in a pretty strong sell-off as soon as tomorrow (Jul 31).

1. Specialist shorts and odd lot volume reached an over-a-month peak, as did the specialist to non-specialist ratio:

2. OEX put/call ratio over equity P/C has once again hit critical highs, suggesting that the retail crowd is becoming complacent while the specialists have been loading up on puts (graph taken from Cobra):

While P/C on the Q's is ticking up higher:

3. There are negative divergences on volume and breadth, as well as bullish percent indices (BPI's). (graph taken from Contrahour)

4. S&P has hit the precise top of the broadening formation and $COMP has formed a shooting star (as did stocks like AAPL, V, XRX, and COF), which many times has served as a key pivot point; the QQQQ/SPY ratio is also topping with a negative divergence relative to the Q's.

Chart also from Cobra.

5. $VXN is close to breaking out of a 10-day channel while the $VIX/$VXV ratio is still near the May 2008 lows, suggesting a much too exuberant outlook on one month volatility.

6. AAII and Rydex bullish levels also speak of the current euphoria of retail investors (charts from SentimenTrader)

One should also note that the rally, despite major strides, is still not confirmed by the Dow Theory, with $INDU lagging $TRAN substantially (not too relevant to tomorrow's action).

Jul 30 Intraday

2009-07-30T08:31:00.000-07:00

Outlook for Jul 30...

2009-07-29T14:26:00.001-07:00

Retail buy trades, algorithm program volume, and odd lots today at the highest level in Jul. - all suggestive of exuberance and low volume being manipulated by computer program trades. But even more important, the cumulative tick 20ma and 5ma reached previous highs, which were the peaks for the last 12 months. This suggests that almost everyone now is buying at ask prices, which is obviously unsustainable (even in the next couple days).

Long-term USD:

Outlook for Jul 29: RS on 60min

2009-07-28T13:33:00.000-07:00

Today the dollar strengthened into the open and resisted the market being pushed higher - the AUD/USD breakout from the bull flag a few hours before the open turned out to be a fakeout. We retested 97.35 on SPY on 60min, as I suggested yesterday and went back up toward the descending resistance of the symmetrical triangle (see graph). From what it appears, we may be in a possible formation of a right shoulder and a retest of the rally high of 98.64 (hit in pre-market of 7/27). Usually the market likes to retest any key levels that are hit in after-hours - hence I would not rule this scenario out before the market starts to pull back. Though we are at key resistance and a 50% Fib off the 2008 summer highs, the 38% Fib of the whole bear market (9400 on the Dow and 1008 on S&P) is still enticingly close for the bulls. But it's also a dangerous level for the bears, for if we hit that, the gates will be open for the push to ~1200 and 11,000. That's partly to what I would attribute the current tug of war.

Setup for Jul 28: Another Reflation Rally?

2009-07-27T23:33:00.001-07:00

SPY is topping on lowest volume since Dec 26, 2008 and is hitting against the upper band of the rising channel in the graph from last post. Judging by the current AUDUSD breakout from a bull flag, there is still a chance that the 5th wave talked about yesterday will try to complete, overcoming the upper resistance for at least some time - and possibly attempt to approach the key 38% retracement of the entire bear market (9400 on the Dow, 1008 on S&P)...Or it could be done on a retest.

Particularly notable today is the options data, with the equity put/call at the lowest level (.54) since April 13, the day after which the market dropped 1.7%. However, statistically there is no evidence (since 2003) that the current levels provide a higher probability of a down day - surprisingly so. The OEX put/call 5-day moving average is also at a multi-month high, suggesting that smart money is getting well prepared for a down move. Hence, it is surprising to me that the combination of these two levels does not provide any kind of statistical short bias for tomorrow - perhaps a slightly more neutral bias if anything. How's that for an oxymoron. But what is evident is that there is a bearish bias for the coming few days.

I've been taking a closer look at broadening patterns, such as the one we currently have on the daily. Here's a 2006 article that puts the pattern in a broad historical context of failed tops, however, one should remember that, in general, the chance of being resolved to the downside is negligibly better than to the upside (50.3 vs. 49.6 - according to Bulkowski).

If a reflation rally is averted, key levels on SPY are 97.35 and 96.75. The bigger levels to watch on the Dow are: 8900, 8700, and 8600. 8900 is the 23% Fib of the move up and key level since 2002, 8700 is the 38% Fib of the move up as well as the neckline of the inverse H&S on the daily and 8600 will be key for the bulls to hold as it is the 50% Fib and the halfway point of the broadening pattern, which at times acts as a pivot reversal for the throwback.

Jul 25: Weekend Update

2009-07-25T12:05:00.001-07:00

We are currently in the fifth wave of the rising wedge (graph below), which suggests that we may see a break through the upper band of the rising channel before getting at least a 38-50% retracement (in the coming days) of the recent upswing. (Note that in after-hours SPY went up .3% and closed at 98.40).

Specialists have been buying more shorts as of Thurs.:

This week we need to confirm the bullish breakthrough of the inverse head and shoulders pattern on the daily by holding the 8700 level on the Dow (which is the 38% Fib of the run-up from 8100). If we hold then I would look to 9500 (see 1938 comparison); otherwise, we have a bull fakeout on our hands and the previous H&S levels come back into play. Note, the failure rates of H&S patterns on the S&P are only 18% (Kirkpatrick, 2007) and tend to play out given the first chance, even if the integrity of the structure has been compromised.

Two historical comparisons as a rough guidance:

Though we've rallied more than 11% in two weeks, the volume still has not indicated that this is anything more than a short-covering rally - however, down volume has for the first time given us an erroneous sell signal (as far back as I can remember), which may be hinting at a tectonic shift happening within the market. By the same token, the implication of an inverse H&S (that the Dow will go to 11k, and S&P to 1200) is somewhat dubious considering the current valuation of the market:

P/E
1. Standard and Poors a. 134 as of June 30 b. operating P/E 16.8 for '09 and 12.6 for '10 (as of Jul 21), which means that for net earnings it is closer to 20 for '09 and 15 for '10
c. Wilshire 5000 current estimate is at 18.4
d. the most positive are my own summations of Thompson bottom-up estimates (for S&P 500) of 15.5 in '09 and 12.8 in '10

P/B and Tobin's Q
1. Wilshire 5000 at 1.71, while my own bottom-up estimate for S&P is 2.02
2. Tobin's Q is at .79 (using Jun11 Q1 Fed numbers)
All these things suggest that we are still about two times above the 1982 bottom levels (as well as the three other 'great' bottoms).

Considering a rising cost of capital from here on out, once interest rates start rising, adding another 20% to the figures above (if the inverse H&S completes) will overinflate the market. But by historical trends, this is something that may very well happen by the end of 2009/early 2010 - which will also in effect mean another slump for the market until 2013.

Setup Jul 21: Options Data Suggest We Fall

2009-07-21T00:03:00.000-07:00

Today we saw the reflation rally that I mentioned before the open yesterday, with the indices compensating the lower dollar and with almost no strength of their own. They moved against both the VIX and the treasury bonds (TLT) (i.e. all were up), with the S&P and DJI coming up to some critical resistances (which if broken at the end of the week will suggest a character reversal in the market - see chart). As we are already balancing in a semi-neutral state after the massive rise of the previous week, with numerous bearish divergences, a correction is imminent. And today's option data (if it is not a glitch carrying over from expiration) suggests that we may fall by a couple of percentage points (graphs below).

However, for the bears to regain control we'll need to see a close below 910 (gap support) on SP500 in the next 3-4 days. That will be almost impossible to do if the AUD/USD chart from the last post does not stabilize/move back to its bear channel (or if the USD index does not hold off the initiated 5th wave down) - so it is important to watch not only for this movement but also for any kind of decoupling that may occur between the indices and the USD. Tomorrow will also be looking at AAPL, XLF, MS to see if they can extend today's weakness (though AAPL did show some strength in after-hours)...Futures are flat, dollar still testing lows.

Outlook for Mon Jul 20: Potential Reflation Rally

2009-07-20T02:12:00.000-07:00

Though futures are tame and we are due for a pullback from a very overbought condition, the action of the AUD/USD and the USD index is leading me to believe that we may be in for a potential reflation rally to start off this week (Bloomberg has an article on it as well).

We'll have to see what changes at the open, but may need to wait for Bernanke's comments on his 'exit strategy' plans first...

Hedge Funds as Market Timers

2009-07-18T00:40:00.000-07:00

As it's the weekend I wanted to shift focus from daily market action to something else that I am currently reading about: the general outperformance of market-timing hedge funds. Broadly speaking, market-timing is my own main strategy of choice, hence the interest...

Some weeks ago I calculated the distribution of daily market returns for the last 6 months, the year before that, and since 1928 (see charts below - as the one for the year before last and historic are very similar, I include only the most recent and the historic).

As you can see, the distribution over the last half year has been unusually wide (fat tails with low kurtosis or 'peakedness') by historic standards. The only way that one could have fully utilized this feature of the market to his or her advantage (instead of getting completely whipsawed) was to gauge sentiment and implement market-timing strategies. That may seem rather peculiar to the fundamentalists out there, but as pertaining to the use of fundamental analysis, I'd like to say that, though I am a firm believer in using it to capture long-term performance (1+ years), it can be utterly useless in the short-term. For instance, in the most recent rally if you picked the 50 worst companies (from a fundamental standpoint) you would have outperformed the 50 best companies. It's funny how that works, but it is a fact - which I have found not only from my own research but from that of other experts as well.

Anyway, to substantiate my argument (not only through outerperformance of the market 3 to 1 YTD, but theoretically as well) I'd like to note a few key conclusions made by the paper below:
1. Market-timing strategies outperform analogous buy-and-hold strategies (p12)
2. The alphas for all factor models are positive and statistically significant at the 1% level (Table 3)
3. The timing coefficient is greater in bear markets than bull markets (Table 11), hence market-timing funds should be outperforming most other strategies in the current environment: "It appears that the funds provide investors with protection in bear and volatile markets. This payoff feature potentially mitigates losses in undesirable market states, and thus is valuable for risk-averse investors." (p12)
4. Onshore and smaller hedge funds appear to be able to market-time better than others: "This is perhaps because market timing requires a fund to move in and out of the market frequently and small funds are more nimble in performing timing strategies" (p23)
5. "The evidence of timing ability with the market timing hedge funds appears much stronger than the previously documented for mutual funds." (p24)

SSRN-id676110

Waiting for the Bull Victory Dance

2009-07-16T14:56:00.001-07:00

Options expiration week giving us some crazy volatility (indices up 6+% in 4 days), which may keep us in the festive end zone territory till Monday. If we do manage to hang on to the gains tomorrow, Monday's movement will be particularly indicative of how deep the pullback will be. Some basic warning signs:

1. Down volume 5&20 MA's at the second lowest level since the first days of Jan (right before the market tanked)
2. Second hammer on VIX in two days after retesting major falling wedge on the daily around the 25 mark.
3. Negative divergences with breadth, financials, RSI, MACD, etc. (10 and 60min) Daily MACD finally beginning to align with bearish weekly.
4. Close above the 2/20 Bollinger Band, which never leads to anything more than a consolidation.
5. In real terms RS is notably below the LS and H (so up move predominantly on the deterioration of the dollar).

Also, despite the big upswing, we have yet to deviate from the H&S pattern of '02-03. There is a second possible target around 9000, but it is less probable. The graph also shows similar trends in volume, suggestive of the fact that this is nothing other than a shorts-covering rally:

Down volume:

Exaggerated Second Right Shoulder or to New Highs?

2009-07-15T12:16:00.000-07:00

Major short squeeze today on relatively low volume (catalyzed by GS and INTC earnings)...We've seen this kind of pattern before (H&S with a bear fakeout at the neckline and then an overshoot of the right shoulder on a short-squeeze): one example, 2002-2003 topping pattern, and another smaller one at the end of 2007. The current overbought condition will likely resolve to the downside in the next 1-2 days and possibly retest the RS highs before falling hard. The VIX closed higher today and made a nice hammer at the 25 level (diverging with the market), while the 92.40 gap on the SPY has been filled, giving a potential all-clear signal to the bears. Best to tread carefully with stops, but that's the general idea until we're proven otherwise.

Also, if the AUD/USD stays on course, the market will have no choice but to go down (in real terms it is still making lower highs):

A couple trades put on today: XLF and MS August puts

One Possible Scenario

2009-07-14T16:20:00.001-07:00

Today was the first time we moved against the historic probabilities (since I started talking about them), which of course, will happen from time to time - but in reality the market didn't really go anywhere, it just formed a doji-like candle on the daily. The Dow bounced around the whole day at the 50% fib retrace from the Jul 1 top, on low volume. We did get some interesting action in after-hours with SPY reaching 91.70 (in reaction to INTC beating first call estimates by 125%) and bumping against some major resistance. See the graph below for one possible scenario in the coming weeks. Though it is possible that we will see a gap-fill of the Jul 1 92.40 level, I really don't see it happening without a day or two of the kind of consolidation that we saw today. The VIX closed at a new and fourth consecutive low (25.02), making a complete back-test of the end-of-June lows - which increases the chances of a down day, but will have the exact figures later...

Jun 14 Setup: Prob of Lower Close 75%

2009-07-13T23:15:00.000-07:00

The action today was slightly more bullish than expected - despite negative early futures the Dow opened higher and back-tested 8130, instead of the anticipated 8100, but everything else worked out just as predicted in the last two posts. We are still carrying over some positive momentum into tomorrow, which will likely mean a bounce for the Dow to the 8380 level (also the 38% fib retrace of the move off the June top). The possibility that we'll hit the critical 911-914 resistance on the S&P (also the top of second left shoulder and 50% retrace from top) is less likely, but it does exist. I surmise that the up movement will be on the rebound of the USO (and tech), as many indicators suggest - and we should again see the daily switching off of the financial and energy sectors to lead the indices higher.

However, due to the fact that we're really overbought on the daily interval, a lower close is anticipated. So the rally (i.e. short squeeze) should stall for at least one day in the form of a 4th Elliott wave, and then we'll see if we're setting up for a strong shoot lower, or if we move up to make the second right shoulder of the H&S pattern on the daily (as well as the 5th and final wave of this move up).

The 75% probability of tomorrow's lower close was found by simply combining the overbought tick and down volume levels to see how many profitable trades were made in the past by shorting on a day like tomorrow (see trade summary). One other thing to consider is that the VIX today fell unusually low with respect to longer-term gauges of volatility (which may also be indicative of a move lower tomorrow).

VIX chart found on Cobra's blog:

Though the banking index ($BIX and $BKX) is possibly breaking out of a long-term descending wedge, it looks like the bias is negative for tomorrow:

Jul 13 Setup: Possible Bounce off of 8100

2009-07-13T01:47:00.000-07:00

The market has moved according to its historic probabilities (outlined in the previous posts) in the three days since I began to post them. The AUD/USD and equities relationship panned out exactly the way I mentioned in this graph (the crossrate broke through the fibonacci retracement levels, but failed to make new lows, and the Dow retested its lows at 8100). Though the probabilities are less clear as to whether we will finish up or down tomorrow - here are a few things to consider:

1. The short-term charts in the previous post suggest that we are still substantially oversold.
2. Financials (XLF) and energy (XLE) i.e. the leading sectors - and particularly transports (IYT) - have held up better than the rest of the market in that last two days; and the Dow has begun forming a pretty solid base at 8100.
3. The VIX and the market have moved down together, which, at current rates of change suggests that there is a 57% chance that we'll finish in the green tomorrow.
4. The USO has technically completed it's double top pattern (supported by the indecisive candles last two days), and may take a few-day breather before resuming its down trend.
5. The current pattern on the 60min MA's of the NYSE advance-decline % has resolved to the upside at least two of the last times.
6. Bullish divergences on the 60min stochasitics and RSI (but rather neutral on the MACD's and 10min RSI's)

Hence, one scenario that may play out is that we retest 8100 at the open, and head higher in the next 1-2 days before resuming our descent lower. However, if we hit new lows on the futures and the AUD/USD, all long bets are off and should probably be covered at the open.

Wknd Update: Going into Expiration Week

2009-07-11T02:59:00.000-07:00

Getting a bit of a positive momentum swing into early next week - will outline the scenario for Monday in the next two days. A few charts from SentimenTrader do a decent job of giving both a short and longer term perspective:

Seven days was all she wrote...

Jul 10 Setup: Prob of Down Move Up to 100%

2009-07-09T22:25:00.000-07:00

The market may very well move in either direction tomorrow, but judging from a study of price movement, the last 6 times we had the same kind of price action that we have had in the last 3 days (i.e. a big drop followed by consecutive dojis with higher highs and lows, etc.), the market moved lower the next day by an average of 1% (see the trade summary below) - the chance of that happening randomly is less than 2%, but who knows what tomorrow will bring.

Though we have been moving according to the bull-favoring probabilities that I have outlined in the last two days, today's market gain was purely the reaction to the lower dollar. I have been watching the AUD/USD chart (below) pretty closely to gauge the subsequent moves of the market, and so far it is showing inclination to move lower (if it reverses into the open, the markets and oil will rise). Though the USO showed a potential reversal doji today, it too will fall again if the dollar remains on course. There is an inverse H&S forming on the longer time frames on the three indices (and a possible smaller H&S within that pattern), so those will need to be watched closely.

Jul 9 Setup: Probability of Up Day 60-80%

2009-07-08T18:13:00.000-07:00

Today the market acted according to the probabilities I mentioned in the last post. The Dow closed in the green as it was supposed to, forming a doji-like candle that has formed in similar conditions (you can see some of the others in the graph of the last post). As the probabilities favored a higher close and quite possibly another up day, I looked at today's bottoming process as a good opportunity to pick up a few longs. Remember I was neutral coming into today (left just one short position open) because I thought the shorts had limited downside but didn't want to step in front of a halting train. So today's push lower played right into the hands of the bulls, who were able close their shorts and go long with more conviction. Counting the market's moves in 5-wave structures helped to determine the ~8100 bottom on the Dow and ~870 low on S&P, however, I was almost stopped out on the retest, which moved lower on the 1-min but held on the 10min interval. Here are some probabilities going into tomorrow:

1. When the VIX forms a shooting star after a consecutive move up, the probability of an up move the next day is 80% (chart below)
2. When the USO declines >15% in 6 days, as it has currently, the chance of an up day is 64%. I assume that if oil rebounds so will the market.
3. When the up/total volume ratio 5 day moving average was less than 31%, the likelihood is 66%.
4. Current CBOE equity P/C ratio pattern suggestive of a 62% prob.
5. The 75% chance I talked about for today's move remains pretty much the same for tomorrow when the holding period of the long position is changed from 1 to 2 days (however drops off substantially for three days).

Also,
1. Indices breaking out of a multi-day descending wedge
2. Bullish divergences on RSI on 10 and 60min
3. Dow MACD bottoming at previous low and about to bull cross (with bull divergence on histogram)
4. Alcoa kicked off earnings season with -.26 vs expected -.39 and is up 4% in after-hours (ascending triangle forming on all index futures).

Hence, I'm slightly bullish currently with two long positions (picked up at the 8100 level) I'm playing with calls, but if we break lower I'll get stopped out and go back to the drawing board. Looking for at least a retest of the 89 level on SPY, which is the 23% fib level of the move from the June top, and if we pierce higher, the next minor levels will be around 89.70 and 90.40 - and we'll only close the current open gap on 92.40.

Congestion on the Way Down

2009-07-07T23:23:00.000-07:00

As forecast in the last post, the S&P reached the 880 level in the first half of this week, with the Dow breaking the horizontal neckline of the H&S pattern and the 23% fib retracement of the entire bear market, moving down to test October and December 2008 lows (while the S&P broke its ascending neckline, only testing the Jan and Feb highs). The Nasdaq-to-S&P ratio appears to have finally topped, with the tech-heavy index moving strongly off a double top. Though we are very close to levels where panic selling will catch fire (and push indices into territory with few resistances), we are currently testing some major levels off of which we should get a bounce in the next day or two. Historically speaking, if we consider NYSE advances, declines, up volume, down volume, tick, and CBOE equity put-to-call ratio (each by itself), the probability of an up day tomorrow is ~60%. However, if we combine tick and down volume characteristics, we get a 75% chance of an up day for the Dow (see chart below for details).

Also, if we combine up and down vol with equity P/C conditions we get three similar historical instances, in all of which the market was higher the next day. Just something to consider. I've exited my shorts at today's close to stay neutral going into tomorrow and to look for another entry point.

On a sidenote, some longer-term perspective from SentimenTrader:

Jul 2: Fall Into the Gap-Downs

2009-07-02T14:56:00.000-07:00

The market has been nearly ticking off with the precision of a clock. The head and shoulders pattern on the daily, which it seems nearly everyone has been expecting has all but completed itself. The overbought conditions on cum. tick, breadth, volume, etc, and the negative divergences on MACD and RSI have materialized in what was a very big down day (considering the light volume conditions and the positive bias going into a holiday weekend). I expect this momentum to carry over to the early part of next week, during which we'll finally test the crucial level of 880 on the S&P - however, for a short-term technical prognosis I will probably be looking more at the Dow, as it has been giving clearer signals.

Below is a chart and strategy summary of a gap-down strategy I use, which has been rather accurate (+90%). Though it considers shorting and covering 100 shares of SPY, I actually do the trading with puts of SPY, TNA, etc., which brought in gains well over 50% in each of the two sessions. If you had decided to take the overnight risk, and got in a day earlier (on the case of a bear flag, a topping shoulder, negative divergences, etc.), your profits were over 100%. In that case the signal can be used as confirmation/foreshadowing of the further move down.

Below is an update of the down volume chart, which is similar to tick and advance-decline% charts in its suggestion of a strong carry-over of bearish momentum into next week.

For Jun 30: Rising Wedge Contradicted by ADP

2009-06-29T14:02:00.000-07:00

Dow is currently within 60 points of forming the top of right shoulder; while the neckline of the S&P isn't as well-defined as that of the Dow, it is within 5 points of the top of the left shoulder - and the Nasdaq is well within reach of forming a double top. It's interesting to note that today we again saw TLT up with the market and IYT not confirming the up move (IYT/SPY ratio has been decreasing since May - suggesting that transports not supporting the rest of the market). USO is trading at the top of its rising channel, while the VIX RSI is historically low; the VIX itself closed below the 2,20 lower Bollinger Band for the third straight day, which has not a occurred a single time in the last year!

Though volume is particularly low, that is to be expected with the shortened holiday week. However, considering the following chart it is still giving rather bearish signals:

Weekly and monthly bearish outlook hasn't changed either:

Jun 25: Longs Jumping in the Last Wagon

2009-06-25T12:50:00.000-07:00

Low down volume over the last two days left the back door open for the bulls to rush in, in a last minute attempt to stay in the major upward channel. Homebuilders ($HBM) and retailers ($RLX and XRT) led with 4% gains (on LEN news, BBBY earnings, and TWB and DBRN merger news), while the usual leaders, financials, energy, and tech lagged. The move allowed the USO to backtest a major resistance, VIX to retest its major support, and cumulative tick to reach overbought levels on the daily. Ball is in bear court - but if they're unable to show strength early in the day then we'll be looking for the right shoulder formation on the Dow, which will be a good opportunity to pick up some shorts.

Though I was rather bearish a few hours before the open today, here is the warning signal that made me reconsider (time Central Standard):

And below are the other charts:

Jun 25 Setup

2009-06-25T01:43:00.000-07:00

Going against futures. Very little up potential on overextended breadth.

Jun 24 Setup

2009-06-23T23:19:00.000-07:00

Tracking Lower: Jun 23

2009-06-22T22:35:00.000-07:00

Today we saw the big down move, which was substantiated before the open in the following note, and which other analysts were rightfully calling on StockTock. I mention it because of some of the amazing short set-ups it allowed for. As for the general set-up tomorrow, here is a graph that may give some guidance:

Chart Update: Like Looking Down a Ski Slope

2009-06-17T21:39:00.000-07:00

To those who don't find skiing enjoyable in June, perhaps a water slide will do...
(The rest of the chart updates can be found here)

Mentioned in the chart above:

A further look at down volume:

That first bump was a cinch:

And an update of the forest (instead of the trees):

Resolution to a Tight Trading Range

2009-06-16T00:40:00.000-07:00

A key debate in the last two weeks has been whether we'd see the market make a final push to the 966-980 level or whether the bulls would run out of steam at 950. Market internals have been increasingly divergent with price, suggesting that the bulls may not have enough firepower for yet another move, however, the anemic volume has made the market increasingly more susceptible to manipulation/propping-up by the big financial firms at the end of the day-sessions.

Considering that we are currently hovering at an important level (multi-year resistance), I wanted to find out just how susceptible the market is to a move above this key level. Though strong resistances are almost always broken with great confidence, just in case, one should also keep in mind a possible scenario of a building up of positive potential, as witnessed by the formation of the ascending triangle in last two weeks on the daily chart. Today, however, after days of extremely low volatility and volume, it finally broke to the downside. So what are the odds now of the bulls once again regaining control? To put the current pattern in a historical context, I ran a little study, the conclusions of which are summarized by the two charts below:

Outlook: Week of Jun 8

2009-06-06T21:14:00.000-07:00

The Friday job numbers suggested that the bottom in the labor market has been reached (graph below with the full article here). Though it's not totally evident that we can trust these numbers, for now we'll accept them at face value.

Naturally this caused a major rally in the dollar, with UUP breaking a key intermediate resistance level (see below). The reason this is important is that the dollar has been pushing an overbought market to even more extended levels.

However, what most people don't realize is that the higher highs that we've been seeing in June are merely an illusion created by the falling USD. In real terms, the market actually put in a top on May 8 (below), as I was initially forecasting.

In an attempt clarify some of the mixed signals the market is currently giving us, I've made the following breakdown of the things that may influence the market on Monday (Jun 8) and in the coming weeks:

Bearish Case
1. Deterioration in volume - up decreasing, down increasing; momentum down for next few days with 5MA just crossing 20MA (and is even more bearish for cumulative tick and breadth)

2. MACD and RSI bearish divergence on hourly and daily intervals.

3. S&P and DJI have not been able to close above their multi-year resistances, which also served as the triple top level in the 2002 bear market.

4. AUD/USD had two large red candles this week, which last time happened at the February market top from which both the AUD/USD and the market descended to the March lows.

5. COT open interest and commercial trader interest are picking up for the USD, while small speculators at a long-term low (a combination of factors which in the past signaled a bottom for the dollar). Also, UUP is moving on up volume that we haven't seen since early January.

Also note the current ultra-low mutual fund asset levels bullish on the USD (contrarian indicator) - found here:

6. Financials have been unable to match their May 7 and May 8 tops (currently ready to make a big move from their month-long symmetrical triangle).

7. Nasdaq showing a semi-hanging man and Dow a doji, signaling indecision and a possible reversal.

8. Longer-term signals show that we are in fact topping:

Bullish case
1. All indices have managed to close above their 200SMA, and on Friday bulls managed to get a gain on the Dow while the USD was up big.
2. Oil bounced back well on solid volume, and would have been very positive if it weren't for the USD.

3. Though the S&P and DJI haven't closed above their multi-year resistances, the 2002 peak at this level for S&P was 967 and 9067 for DJI - implying potential upside of 2.9% and 3.6% from current levels (assuming a flat dollar), and possibly more.
4. Though TLT has stabilized at the 90 level, potentially signaling some upside for long-term treasury prices, and hence lower equity prices, IEF (7-10yr Treasury prices) has been selling-off on high volume, suggesting low demand for treasuries, which may very well have the implication of imminent inflation.

So, bottom line, bearish case currently substantially outweighing in the intermediate term and also has an edge in the short-term, but in order for a true reversal to occur a significant trigger will be needed. That's why on Stocktock.com I recently mentioned that we may see the bulls move the market to 966-980 on the S&P to squeeze the last of the shorts, which would act as a blowoff-top momentum kind of swing. However, provided that the local bottom is in for the USD, we would need to see some major exuberance on the side of the bulls to see that kind of move.

Indicators: Update

2009-06-03T22:44:00.000-07:00

Some posts back I mentioned a few indicators that consider futures premiums. In updating the VXX/VXI indicator (which looks at how expensive next month implied volatility is to current month IV) I realized that the values needed to be adjusted for the April expiration. Once this is done, the indicator looks noticeably better. Currently it is showing a somewhat bearish signal for the market (i.e. that current month volatility is getting expensive relative to that of the next month), and though the VIX is currently in a bearish divergence itself, the signal is nowhere as clear as that of the ratio. Also notice that the previous signals given by the VIX (i.e. similar double bottoms) resulted in the market going higher, whereas VIX/VXX has been more accurate on each occasions - comparison below.

Also here is the update for the S&P futures premium. Though it's not giving us a definitive signal, it is showing us a slight negative divergence with the market for what it's worth.

Two other noteworthy bearish divergences are in BPI(S&P, Technology, Consumer Discretionary, Financials , Materials) and the % stocks above their 50MA (NYSE, Nasdaq, SP500).

And here is another (taken from xTrends), which suggests that leading sectors are no longer leading the market higher:

Another possible clue to an imminent top may be that the ISEE Call/Put ratio recently topped at 237 on May 29 (a level not seen since Dec 31 2007):

Technicals: Crossroad Crosses

2009-06-02T18:10:00.000-07:00

Below is the comparison of our current cycle with that of last year.

The market's currently approaching some multi-year resistances on all three indices, starting all the way back from 1999 (seen as the red line in the charts below). Coupled with the 200SMA which is still a barrier for the Dow and S&P, that makes for some pretty heavy resistance. So the next two days will be key to see if we can break it with force or breakdown lower. You can find some of the other updated charts here

For the Fundamentalist in You

2009-06-02T12:52:00.000-07:00

Now that the market has significantly come off its lows some of you are probably wondering which stocks are outperforming the rest of the market and which are 1. still potent on the upside or 2. ready for a nice pullback. Hence, I created an Excel spreadsheet with ~50 top movers mixed in with some of the stocks that I track and ranked them according to a number of fundamental parameters. To do this I wrote a little macro to give weights to each parameter and to color the cells (dark blue=best, dark red= worst, white=neutral) for more convenient viewing, and then sorted by the top ranked - actually, though, you can sort by any parameter that you choose. I picked a host of parameters that I think are most useful in the current environment (i.e. gearing, liquidity, etc.) but there is enough data for you to create your own ratios. Though the best ranked companies are generally better fundamentally than those ranked last, I have not optimized the ranking in any way nor have I double-checked the calculations - so do take with a grain of salt.

Alright, here is the link to the file, enjoy and let me know if you have any questions!

Coppock Curve Has Hit a Nerve...

2009-06-01T20:47:00.000-07:00

One of the first stories I opened up today on Bloomberg read, "U.S. stocks are worth buying for the first time in six years, according to an indicator that has signaled bull markets all but once since World War II." Seems to be on everyone's mind: there's a pretty good article on it here, confirming the bullish views, and one contrary view here. I decided to calculate it myself and see if it, indeed, has the predictive power that many say it does. Below is the graph using Robert Shiller's historic S&P 500 values (inflation adjusted).

As you can see from the graph, if we assume that we are already up 30+% from the current lows, the indicator does a pretty poor job (50/50) of telling us whether we should be bearish or bullish in the coming months (and even worse if we consider the two premature failures of 1931). I suppose that one reason for this is that the indicator only takes price into account (as opposed to volume, breadth, tick, etc.), and though it appears to be of little value to most traders on a daily and weekly time intervals, I think it does a decent job of placing the current low within the historical context on a relative basis.

Turning the Volume Up

2009-06-01T17:47:00.000-07:00

The sort of volume that we saw in today's reflationary rally was hardly reassuring that we'll be able to see the 38% retracement level (from the Oct 2007 highs) any time soon. The breakdown is below with the rest of the charts updated here; as you can see the down volume's moving averages give us a pretty good sense of when the market will be tender enough for a true grill-down. Soon I'll post a few charts that show what volume looks like in true new bull markets.

Also, today we saw GS and other financials rise on weak volume and then two hours before the close selling off on heavy volume, adding to their general absence from the topping process.

Finally, below is the Nasdaq chart, showing a pretty high probability (89%) of a 2-3 day consolidation after the kind of move we saw today.

Blowoff Top?

2009-05-31T11:53:00.000-07:00

The buying that we saw the last hour of Friday is the same kind of end-of-the-month price action that we saw at the end of November 2002, after which the market opened slightly higher on December 1 and headed lower.

Friday computer-generated buying programs failed to stimulate internals. The below graph can be found here.

Below are some of my own graphs, which can be found here.

On Timidity and Consumer Confidence

2009-05-26T22:59:00.000-07:00

Since that last update the market has been treading water. Some key events that are bringing us closer to the move downward are:

1. Financials ($BIX,$BKX) have checked out of the topping process since May 8.
2. The market is getting squeezed between the 20EMA and 200MA (and the major trendline resistance below the 200MA - seen better on weekly graph), while testing the upward trend from below by forming lower highs.
3. We saw a double top formation with a shooting star on large volume as well as the first close below the 20EMA on Friday 22nd.
4. The VIX has finally shot out of it's multi-month descending wedge, forming a slight negative divergence with the market.
5. The USD (UPP) and long-term treasury prices (TLT) have hit (and started to bounce off) their major support levels.
6. Bears have stepped in with big volume last week at the end of day sessions and we have seen institutions beginning to sell-off at a faster pace (graph below from StockTiming.com).
7. All the key medium-term indicators mentioned previously are still at heavily overbought conditions.

Today, however, the bears got caught with their hand in the honey jar - dare I say without any shorts on. The market took off the minute the consumer confidence numbers came out, but what is interesting is that there was barely any reason for this: the cumulative index rose (55 from 41 in April) predominantly due to the expectations index, which rose 42% in connection with the market rally; the present situation index only rose by 13% and was pretty much in line with estimates - certainly not enough to muscle the market the way it did. As the up volume was still missing, we can conclude that what we saw today was a nice short squeeze.

As you can see from the chart above, expectations start oscillating much in advance of the meaningful troughs.

Prevailing Optimism/Risk

2009-05-21T16:08:00.000-07:00

It's interesting to note that despite the deterioration in the recent market rally, we are still seeing a high level of optimism/risk-appetite (and hence a negative divergence) in some key indicators. The futures premium historically is a decent contrarian indicator (i.e. when futures relative to current index levels are high, the market tends to head south), and it is especially potent when used along with the volume put/call ratio - for instance Ned Davis Research has shown that when both futures and CBOE P/C are at 'pessimistic' levels the market gains 38%, and when optimistic it loses 12% (Technical Analysis by Kirkpatrick). Well, P/C today finally came off it's lows around .5-.6 while the S&P futures premium still remains at its peak; that's somewhat peculiar considering that the premium moved way ahead of the market bottom in March, but is in line with NDR findings.

The second indicator that implies a divergence in sentiment/information is the US - Australian Dollar cross ratio, which has had a particularly good correlation to the market in the last year (.93). I find the current downward move in the market especially strong as it occurred against a falling dollar, but going against this highly seemingly-dependent relationship may suggest that FX traders know something that equities traders don't...(perhaps stimulated by concerns of a possible US credit rating downgrade). The dollar's strengthening against the Yen in the last few weeks has confirmed this tendency of traders going after riskier currencies (if based on interest rates - JPY .10, USD .25 - one assumes the USD is riskier than the JPY) - article on this here, though take with grain of salt.

However, the most likely explanation is that the USD/AUD is VIX-like, exhibiting the most optimism/risk-taking at the top of the market and vice-versa, with possible slight divergences at market extremes. And for now I would read both indicators as bearish divergences (i.e. erring on the side of exuberance), though USD/AUD does give something to think about.

Below I plotted the VIX futures premium to see how people's expectations of volatility in the next month (VXX) altered with those for the current month (VIX). Though both have been steadily declining, as the rally progressed expectations of more volatility in the future have also steadily increased - however, the ratio topped with the dollar at the end of April and has since stabilized, suggesting complacency with the general decrease in both values...

Here are some of today's graphs from SentimenTrader.com that show that it may be wiser to err on the side of caution rather than complacency/exuberance.

One basic indicator that I haven't mentioned yet that I think is particularly good at detecting tops is the % above 50-day moving average, and particularly good when used with something like the put/call ratio. The current daily peak %above 50MA of 94% is the highest since 2003 (see below)- as you can see it's already come down to the 81% level.

Also, in a previous post I mentioned the Bullish% Index (BPI), which shows the % of stocks indicating current point-and-figure chart buy signals. For the NYSE we're at the most optimistic level since July '07 (when the market turned lower). There is a good post on the Nasdaq BPI here. And below is the chart:

The following graph shows the benefit of using %above 50MA together with P/C (can be found here). Considering the simplicity of this indicator it's a bit surprising how accurate it is.

Technicals: Blooms into Blossoms

2009-05-16T19:19:00.000-07:00

On May 5th I mentioned a few indicators that showed the market getting overextended. It topped on May 8th, and due to it's current highly trending nature one could have easily called it without the use of any more indicators. In the chart below you can see that the market has been trending in a well-defined channel on both the up and down swings, with the lower and upper limits serving as support and resistance. At the top the market tested the secondary level three times (slanted blue line) but failed to test the upper resistance and broke out of the channel the next day (a clear confirmation signal).

Since then the market has formed a new channel, which has been helpful in timing the May 13 upswing and May 15 deterioration. So the new question becomes: how extensive is this pullback going to be? The next two graphs may give us a clue. In the first, you can see that the current 8600 top for the DJI is quite important for two reasons: 1. it's a Fibonacci level made from the strong 11800 level 2. it's a third linear point in a multi-year progression (top slanted blue line). From this we can surmise that the next level will be the 24% Fibonacci mark, which would finalize the formation of the reverse head and shoulders bottom talked about here and at iVolatility.com. Or some support may be found at the extension of the middle blue line.

Currently the market is somewhat oversold in the very short-term, however, in the intermediate-term it is still substantially overbought. In fact Cumulative Tick and ADP 20-day moving averages are just coming off their highs, suggesting a very risky period to be long equities. If you look at put/call ratios for 3x short ETF's such as TZA (small-caps) and FAZ (financials), you will see that they are extremely low (as opposed to SPY) - see below.

The next chart (borrowed from DecisionPoint.com), shows the components of the McClellan Summation Index (which I think is of value on its own). All three oscillators show that in the intermediate term the S&P is historically overbought.

The next chart (from the Ord Oracle) does a pretty good job of bringing several key ideas together.

Here's what the McClellan SI looks like currently:

IMF Stability Report

2009-05-14T18:47:00.000-07:00

The IMF came out with its semi-annual Stability Report recently in which it increased its previous estimate of writedowns on US-originated assets by $500bil to $2.7tril in 2009. The total amount from 2008 to 2014 reaches close to $4tril (see below), of which roughly two-thirds will be incurred by banks.

In the last post I mentioned the default rates on speculative-grade bonds rising to 14% in '09, possibly why the CDS rates on the insurance sector have shot up so much recently.

The report also shows a notable worsening in systemic asset classes.

Loan charge-offs are projected to peak after 2010 slightly below the Depression levels of 5%.

As for emerging economies, the report forecasts annual cross-border portfolio outflows of around 1% of EM GDP over the next few years. Also, given the run-up in emerging market corporate external debt in recent years and a slowdown in financing, refi needs faced by EM economies are projected to rise by $100bil in 2009 to $1.6tril. The graph below shows Emerging Europe in the tightest position with current refi needs at ~20% of their GDP.

Foreclosures: Control Alt-A, Delete.

2009-05-13T16:34:00.000-07:00

Looking at trends in refinancing my be helpful in gauging the strength of the coming wave of new mortgage defaults and how it may impact equity prices.

The graph below shows a rather positive relationship between equities and Mortgage Bankers Association's index of total mortgage applications and refinancings (weekly). That's pretty natural if one considers that stocks over the long term move together with bonds and opposite of interest rates (i.e. most of the mortgage apps. and refi's occur when interest rates are lowest). But interestingly the relationship looks more potent than the one between TLT (20-year Treasury ETF) and equities.

The current decreasing amount of refi's could suggest a build-up of pressure in the coming wave of foreclosures. By the same token, higher Treasury yields may imply that investors are becoming less risk-averse - however, the dangers of the former element will play a greater role in the coming months. Here's why:

And a somewhat newer graph (found here):

Despite being in the cradle between first and second waves of mortgage defaults, filings for foreclosures are hitting a record for the second straight month (aided by unemployment and the still record-falling home prices - 14% YoY in Q109).

Below is a chart of the Alt-A delinquencies:

Moody's junk bond default rate at 9%, and forecast to go to 15% in 2009, will only aggravate the situation, as will Fannie and Freddie if they keep borrowing at the current rate ($25bil just in the last week) - really making Government Motors look like a little auto parts shop.

The current newsflow makes the coming wave of foreclosures more imminent and less predictable, even if it is a few months away - what tops it off is that the market is moving further way from low interest rates (and hence high refi rates). The direct implication of this is that Option-ARM borrowers will face resets sooner than the expected 5-year mark; and according to Barclays Capital there are plenty of such borrowers who have yet to default - 37%, 63%, and 82% of '05,'06, and '07 originated loans, respectively, are still outstanding.

MM Good Assets. Not Enough?

2009-05-11T22:49:00.000-07:00

There's been a lot of talk regarding money-market cash sitting on the sidelines as a potential force that could move equities higher. According to this data MM assets topped a few days after the March equity lows and have since come down by ~$120bil, while the S&P market cap has increased by ~1.8tril since this time. That means that so far roughly 7% of the rally can be attributed to the flow out of MM funds into equities.

From the graph it appears that the rate of flow of funds into equities is about twice as fast as that out of MM funds, which could either mean that the rally is not getting a vote of confidence from MM's or that they are a bit lagging/waiting for a lower entrance point - I would guess it's a little of both. But in either case we see that the total MM funds accumulated since the panic began in September are only able to push S&P by ~5% on their own - perhaps we need to look elsewhere for other major forces.

However, if we consider the broader trend in MM funds since the beginning of 2007, we see that the potential of these assets is substantially greater - but could one really count on it until SP500 reaches 1300? Probably not.

OI Wide Shut

2009-05-07T21:20:00.000-07:00

Extending the theme of red shoots, COT open interest looks to be at a very low level for the S&P - commercial and larger trader long positions are coming down as % of open interest (.75) while total shorts/OI has stabilized at peak level (.9). In the chart one can see the index hovering above the upper limits of the Bollinger Bands for only the second time this year.

COMEX Gold OI has also been stabilizing since the middle of April and increasing ever so slightly, while for oil we continue to see a negative divergence in OI and price (inventories are also at a 19-year high) - possibly suggesting a near ceiling for price. The plateau in OI for copper has mirrored the double-peak of price and the leveling off of US inventories (most of the move up has been fueled by dissolving London and Shanghai inventory).

Technicals: Red shoots. For now.

2009-05-05T23:39:00.000-07:00

The beauty about predicting market reversals (more so at the top than the bottom) is that it's akin to a finely orchestrated diminuendo...Or to stepping in front of a train that's coming to a screeching halt - whichever you choose. The indicators I'm following suggest that we're due for the actual reversal as early as tomorrow, May 6. Some things I don't like with the rally going forward are:

1. The diminishing volume,
2. Cum. Tick 20MA forming a pronounced downtrend from 12m high - waiting for ADP to confirm.
3. Insiders selling - Vickers and InsiderScore.com sell/buy ratios highest since mid 2007.
4. Lowest smart money confidence since May 08, when indices peaked. Difference between 'dumb' and 'smart' money also at a two-year peak (see below).
5. Various other negative divergences (UpVolume/TotalVol, Equity Put/Call Ratio, iTraxx Sub Financials, Citigroup Economic Surprise Index, Bullish % Index etc.)
6. VIX futures at premium to current level (article), suggesting higher volatility in the near term.
7. SPY put/call ratio at 1.6 is now at the level at which S&P previously peaked (below). China's FXI P/C is topping at 1.1 and Brazil's EWZ is hovering at 1.6 (though having come down some since 4/20); in the last 12 months FXI has had the best predictive power.
8. About 3-4% of the last 10% of the rally can be attributed to the weakening of the dollar, which has now reached a fairly strong support level, while COT long positions of open interest are still rather high.

I'm still debating as to how extensive the pullback will be, but irrespective of that, a few possible considerations might be: puts (or June straddles) on the most overvalued retailers, up ~70% on average since the March lows, and calls or strangles on 3x inverse market ETF's. I would wait, however, before jumping in with both feet for indicators like McClellan and its summation index (below) to top - though do keep in mind that the current trend of 38 days above 0 is historically indicative of a higher market in the months ahead...

To help with resistances and supports I made a simple histogram of # of times each level was hit since November 08 for the Dow and SP500 (see below).

Also I found interesting the discussion of a daily market strength indicator here and decided to create my own variation (below), which basically quantifies each daily candlestick (i.e. the closer the close to the high the better, the bigger the candle body the better, etc.). The 20MA shows broader cycles of market strength and tends to precede an actual peak or trough (e.g. in the last 2 weeks it has diminished).

Who says you can't time a bottom?

2009-05-05T19:45:00.000-07:00

In January 09 I wrote a document in which I compared the S&P to CPI trends, now versus the 1930's (see graph below) to give a guidance of when the market should bottom - it's natural that risk taking doesn't come back to the market until people are sure that both inflation and deflation are under control. Interestingly, it turned out that both the current S&P movement and CPI movement almost precisely duplicated that of the late 1930's - the graph below is the current updated version. It looks like the fears of overshooting on the upside or not having the so call called right exit strategy have so far been allayed.

If this relationship served as a guidance for the recent bottom, then the cumulative tick and ADP trends I talked about in the first post actually helped to predict the market bottom to the day. Here is a graph I sent to a hfund manager on March 9; as you may see the 5MA relative to the 20MA shows that the bear rally has fully exhausted itself...Is it always this simple? Probably not.

History: Rhyme and Reason

2008-12-24T00:13:00.000-08:00

History does not repeat, it rhymes, supposed Twain. So what shall one make of the articles floating around on the net likening the current financial crisis to the Great Depression and Japan's 'Lost Decade'? What intrigues initially is that, plotting the three respective periods (mid 1994-present, 1924-1948, 1984-present) produces remarkably similar graphs, despite the great variance in monetary policy responses - not to mention the broad cultural and political ideology disparity between each epoch.

Surely the effects of heavy-handed quantitative easing by Mr. Greenspan early this century could not have gone unnoticed, and seem to appear in the graph as an invisible crutch holding up the market after the tech-bubble burst. In fact, the soft landing (unlike the more severe crashes endured by the 1929 S&P and the 1929 Nikkei) and smooth transition into the housing and commodity bubbles could be considered a success, if it weren't all financed by foreign debt, which in turn allowed for household consumption to outpace disposable income and for the savings rate to hit levels not seen since the Depression. I think that even this could have had a lot fewer short-term repercussions if it weren't for the over-leveraging in the CDO/CDS market, which, as far as I can tell resulted from major loopholes in the regulating mechanism...but I'll leave that for another time.

Another interesting graph is the price/book ratio of the S&P 500 lagging the P/B of the Tokyo Stock Exchange (TSE) by 10.5 years (the same lag that is used in the previous graph). Considering the various accounting differences that exist between US and Japan, on top of general discrepancies, it's stunning that the peaks of the ratio are anywhere close to each other - but they are actually .1 within one another. If history is an indicator then we have quite a ways to fall from our current P/B of 1.7 and a Tobin's Q of .7 During all four of the great bottoms in equity, price-to-book was below one and Tobin's Q ~.3 (see Russell Napier's Anatomy of the Bear for more guidelines).

From the two graphs then it is likely that we are due for a 1-2 year bear rally and then into an even more prolonged bear market (btw, that's what star analyst Napier himself predicts). How prolonged and extreme each of these periods is, depends very much on our current life support: the government. The only way it appears that we can escape a 20 year bear market is through major government-facilitated spending - isn't that what helped us get into this mess in the first place? - and finding a middle ground between Japanese policies and those of the 30's. Nobel Laureate Paul Krugman recently wrote on Washingtonpost.com: "There's nothing magic about spending on tanks and bombs rather than roads and bridges. The reason World War II worked more effectively than the WPA was that it was bigger: the caution that had limited previous stimulus efforts went away in the face of total war." So far we haven't been as hesitant as the Japanese in responding to the crisis - that's good. But as we get out of this emergency, credit-crunch, proverbial 'heart-attack' state - to use Lawrence Summers' analogy - we will face two great dangers ahead: thinking we are out of the woods before we are (i.e. raising interest rates too soon, as inflational pressures mount) and keeping non-competitive financial firms on life support at the expense of the rest of the economy. The first mistake was made by both FDR in 1937 - when reserve requirements increased and the money stock dropped - which resulted in a deep recession, and by Japan from 1996-1998 when they not only raised interest rates but also increased taxes and curtailed public investment. This was aided by a weak yen and a sagging market, both of which resulted in banks having trouble meeting the 8% capital ratio mandate, but PM Hashimoto's tightening monetary policy is regarded as the final straw that sent the Japanese market tumbling and helping fuel the 1998 Asian Crisis. The second thing that we cannot allow ourselves is to support the firms that helped us get into this debacle at the expense of competitive firms. For Japan the pendulum swung the other way from the Great Depression, and instead of letting the banks fail they let most of them vegetate by letting them accept more and more non-performing loans (NPL's) from so called 'zombie' firms that were incapable of ever paying their debt. Our banks are currently accumulating such NPL's at an accelerating pace, but how far we get in depends on how much of the cancer we cut out from the financial sector.

Going into a little bit more detail: This graph actually doesn't look too bad because the series has quite a substantial lag and the previous peak of 4% is dwarfed by the double digit peak-NPL of other countries that have gone through serious financial crises. The peak of the early 90's can be attributed to the Savings and Loan (S&L) crisis that was ongoing from 1986-89, and though it was much smaller than what we are going through today (I'd say at least by a factor of 5), the consequences were quite severe. An IMF paper has the gross fiscal cost at $180billion or 3.7% of GDP with more than 1,400 savings and loan institutions and 1,300 banks failed, while employment in New England decreased by 10%. The lag for peak-NPL is about 4 years, with Japan reaching its peak of 35% in 2002. It's not evident that we are going to see a similar level because for one the Japanese count their NPL's 60 days past due, while in the US it's 90 days. I haven't seen a figure for NPL as percent of GDP in the US, but in Japan it was 10% in 1995 and 18% in 1998. I wouldn't be surprised to see something similar here because all the 'toxic assets' that we have on our hands are essentially repackaged NPL's as CDO's. That's exactly what was going on in Japan around 1995 until the whole thing popped - they were bundling and repackaging bad loans as CDO's and relying heavily on derivatives and other financial instruments (as noted by the CRS report for Congress).

A Boston Fed paper looks back and points to some other broad similarities: In the decade before the first bubble, economic performance and monetary policy were very similar:

"In terms of economic performance, there are, again, similarities between U.S. experience in the 1990s and Japan’s experience in the 1980s. In both cases, growth was stronger in the second half of the decade. Real GDP in Japan grew 5 percent per year from 1985 to 1990 compared to 3 percent in the first half of the decade. Real GDP in the United States grew 4 percent per year in the second half of the 1990s, compared to 2 percent in the first. In both cases, business investment was a key driver, accounting for an increasing share of economic activity. And in both cases, productivity growth strengthened over the course of the decade, helping to hold down inflation, even as unemployment rates declined.

Inflation rates in both countries were also shaped in similar fashion by fluctuations in oil prices. Sharply declining oil prices contributed to the very low rates of inflation in Japan in 1986 and 1987 and in the United States in 1998. Rising exchange rates may have damped inflationary pressures as well. By the end of each decade, however, oil prices were rising rapidly and boosting inflation rates...

Monetary policy also exhibited some similarities. In both countries, concerns over sluggish growth at mid decade led policymakers to cut interest rates. Later, as growth picked up, policymakers expressed some anxiety about the implications of rapidly rising asset prices; but these concerns were allayed by low rates of inflation and strong productivity growth. When sentiment to tighten did develop, international considerations intervened. And in both countries, when interest rates were increased at the end of the decade, the stock market declined."

Cumulative capital gains also match:

"OSS (2000) present estimates that the cumulative capital gains on stocks in Japan amounted to about 150 percent of GDP over the four years 1986 through 1989...In the United States, the increase in the market value of equities, including mutual fund shares, from the end of 1995 to the peak in the first quarter of 2000 amounted to 165 percent of GDP (excluding mutual fund shares, 130 percent)."

The paper, however, sees two key difference between Japan and US: "According to Wood (1992), bank loans amounted to 90% GDP in Japan in 1991 compared to less than 40 percent in the United States." I think it's actually closer to 55% nowadays, but it is apparently true that banks play a bigger role for Japan. And the second difference is that "The increase in the value of real estate[in the US], including structures, between 1995 and 2000 was less than 100 percent of GDP and was simply not the factor in the United States that it was in Japan," where capital gains on land were 300%. As this paper was written in 2001 (when the US house price index was still 35% below its peak) I don't think a full perspective on the issue could have been gained at the time.

It is true that the Japanese housing prices have moved more quickly and occurred earlier in the cycle, partly due to tighter monetary policies of Japan (see above) and I think partly due to the inelastic nature of the Japanese housing market, which inherently has less inertia than the one in US. It should be pointed out that the monetary policy earlier this decade was not only loose with respect to Japan, but with respect to our own history, and one that strongly deviated from the Taylor rule (see below); as Stanford professor John Taylor himself writes, "There was no greater or more persistent deviation of actual Fed policy since the turbulent days of the 1970's". As for the housing bubble, it should be mentioned that our bubble started a bit later than in Japan, and didn't really take off until the Clinton administration eliminated capital-gains taxes on houses in 1997, as is confirmed by the housing price graph. So in essence, these factors have helped extend our day of reckoning.

Here's one Japanese economist's view:

"What we are seeing now is the second stage of the bubble. Alan Greenspan (former chairman of the Federal Reserve) had a plan to help the economy out of the IT bubble, namely to stimulate a housing bubble through low interest rates, during which time companies would fix their balance sheet, and eventually resume borrowing, allowing rates to increase and the housing bubble to gradually shrink. But what happened in the US was that companies did NOT borrow money even after their balance sheets were repaired. Managers were too traumatized. On Wall Street, there was consternation. The cost of funding was going up, 'normal' people had bought their houses and companies were not looking for financing. So Wall Street found a new market, the subprime market, $1 trillion went into the subprime market in two years, because the borrowers were willing to pay high interest rates on their homes."

If Japan spread its economic woes throughout the 1990's, with the market crash in '90, then a housing bust from '92 to '96 and the financial meltdown in '98, we will have the last two of these neatly coinciding. Accordingly, the stock market will likely react with new lows in the coming years (though naturally one should expect it to rebound ahead of the economy and company earnings).

The Fed paper also mentions something interesting in a footnote. I mentioned the price-to-book ratio instead of the price-to-earnings earlier because I think it's more reliable at comparing two contrasting markets, and in the long run that's true. But what about the peak-P/E - how does it match up?

"French and Poterba (1991) point out that Japanese price-earnings ratios tend to be higher than price-earnings ratios in the United States because of extensive cross-holdings by corporations of one another’s shares and, to a lesser degree, because of certain accounting differences. According to their estimates, a price-earnings ratio of 60 in Japan in the late 1980s was equivalent to a ratio of between 35 and 40 in the United States. The starting dates of 1981 and 1991 also tend to present the United States in a more favorable light relative to Japan. In both cases, price-earnings ratios were already relatively high by historic standards, but more so in the case of the United States."

Another source confirms the ratio levels, once the adjusted for cross-holdings (btw, here you'll find an explanation of why Japanese earnings estimates are more accurate than ours) - see table below. The 1989 P/E value of 33.7 in the table coincides with the low 30's S&P levels in late 1999. Monthly P/E for the S&P reached a double peak in June and December of 1999: the ratio including negative earnings rose slightly above 35, the one including only positive earnings rose a tad over 30.

Call the Put, What Makes the Market Tick

2008-12-13T10:59:00.000-08:00

Here are a couple of things that may help if you still happen to be in the market and would like to put the volatility that's out there to work for you. Picking entrance and exit points is akin to sitting across from someone and trying to define their mental state by looking at the curvature of their lips. What are the internals, what is on the mind - here's a peek:

Note: Try to use the cumulative tick and advance/decline charts together to confirm a signal and try to stay away from broad down-trends (red lines) in either. Usually a pretty strong signal is given at the end of such down moves. As you may have noted, the advance/decline chart resembles the McClellan Oscillator, which I think is also quite good. Try to use the equity put to call ratio (http://cboe.com/data/PutCallRatio.aspx) along with volume (enter on high, exit on low), and use the 20d-100d MA as confirmation. I believe some traders use that as a signal in and of itself, but the 10d-50d is a bit more sensitive and has worked a little better for me.