Monday, October 25, 2010

Hammering toward the April highs

The age of the uptrend continues to assert itself as equities close well off their highs on Monday, October 25th. Breadth and sentiment indicators continue to point to a decline in momentum while the equity indices struggle to meet their April highs.

The dollar fights to print a bottoming formation (see the bullish reversal hammers that have formed on 10/25 and during the prior week). The consensus accepts the likely outcome of a dollar bounce/rally being accompanied by a decline in equities. Treasuries appear to have settled into a consolidating frame of mind rather than a correction, while corporate bonds have recently caught a bid, both favorable indicators for equities.

On 10/25, the Nasdaq, S&P500 and the Dow all printed inverted hammers (nearly shooting stars), as rallies early-on faded throughout the day. Such days will be necessary to tame the bullishness and relieve the markets of their euphoria a bit prior to making further advances. It is not clear, however, that a correction looms in the near-term, while the trend and our indicators, although overbought, continue to support a bullish stance. This is not the time to enter new long positions, but a time to revisit stops, take selective profits, perhaps sell some calls, and look to the markets for further direction.

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Sunday, October 17, 2010

Using trend-following technical analysis techniques, one would continue to desire to follow the trend, trade "what you see" as opposed to trade "what you believe."  However, the "believe" is the challenging word, as we are inclined to believe that the age of this rally in equities is in its final days.

There are more signs of tiredness in this uptrend. We watch the percentage of stocks trading above their 50-day moving averages; both of these indicators for the S&P500 and the Nasdaq have been in the 85-95 range since early October, a range that in the past has preceeded market declines. See the Nasdaq Bullish Percentage chart below. Note that whenever the red Bullish Percentage line is in the 85-90 area, the green equity index line ultimately turns down.

















In previous blogs we have noted that VIX has fallen to levels that are risky for equity longs. Once again, VIX has gapped well-below its 50-day moving average, a sign of caution for bulls.  See the blue rectangle in the lower right portion of the chart below:



















The Put/Call ratio has also closed at a relatively low .71 (a contrary bearish sign), and Advance/Decline stats have started to weaken (the Nasdaq A/D fell while prices rose on Friday, a negative divergence).

A negative cross of the NYSE McClellan Oscillator, below its 20-day exponential moving average, is further cause for concern. To rub more salt in the wound, Financials took a significant hit versus the S&P500 over the last two trading days. Although we have seen a solid uplift with technology stock outperformance (thanks mostly to Google), we would prefer to see relative strength in Financials also (we had seen a few such signs during the previous week).

So, what we "see" in the markets is a potential trend-change, which may simply be a correction or even a consolidation of recent gains. We plan to tighten stops, take select profits, and hedge with partial short positions just in case the trend change signals prove true.

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Sunday, October 10, 2010

Markets continue their ascent with few signals of a potential trend change and an earnest intent to reach for the highs attained in late April.

As for sentiment readings, bullishness continues to sit at heightened extremes (and lows in the case of the US Dollar). VIX has started showing signs of increased complacency, as the gap between price and its 50-day exponential moving average grows larger. This is a cautionary signal and underscores the extended nature of the equity markets.  See chart below:




As for sectors, financials struggle with the broader market, as technology firms and discretionaries lead. Strength in bonds as rates continue to shave basis points appears to be providing support to equities and pressure on the dollar.

As for style, small caps bullishly continue to lead large caps, and growth leads value. Our nightly test of the small to mid-cap stock universe (about 3,000 equities) continues to reveal breakouts and interesting long opportunities, another sign of internal market strength.

The US Dollar appears to have hit a point where Elliott Wave theoreticians are clamoring for a potential trend change. Dollar Bulls rank in the single digit percentages. With the inverse relationship we have seen in the dollar vs. equities, a reversal in the dollar's fortunes could spell trouble for equities. We continue to remain on watch for a trend reversal in equities; it is sure to come and will likely catch us off-guard. Any correction or consolidation we feel would be a buying opportunity assuming our trend forecasting indicators agree.

With US Elections coming up, as well as a G20 meeting in November (which will raise currency debates to a heightened level), we may see current events influence this market more so than economic statistics (a disappointing employment report on 10/8 did nothing to squelch the uptrend in equities). Earnings also loom as reports start trickling in this week (following an upbeat report by Alcoa). The next few weeks can be very interesting!

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Sunday, October 3, 2010

Weighing the reward/risk of being long

Most indices continue to look healthy and a recent Dow Theory confirmation (both DOW and Transports reaching new intermediate-term trend highs) add to the positive tone.

However, we are noticing some obvious divergences on the Nasdaq. Upside momentum is slowing considerably as seen by a waning RSI (which crossed below its 14-day exponential moving average).  At the same time, the percentage of Nasdaq stocks trading above their 50-day moving average is close to falling below its 10-day exponential moving average, another indicator we watch to assess price momentum.  See the chart below:


























Nasdaq relative strength vs. SPX appears to be correcting from overbought:

















We like to see technology lead the markets (we also like to see Financials lead but that has certainly been a struggle).  The loss of Nasdaq momentum could simply be a sign that the index got ahead of itself, and money is gravitating to areas where relative strength has lagged (notice below how energy has picked up this week:

















So, the uptrend continues (yes overbought and ripe for a pullback) as money begins to shift into other sectors that have lagged (even Financials saw a modest relative strength pop this week).  Rather than establishing long positions in the major indices, one is cautioned to take a more selective approach and favor those sectors that have lagged the general market and to tighten stops on those sectors that have gotten ahead of themselves.

We would view a correction in the indices (preferrably around 10%) as a buying opportunity, should our trend-forecasting indicator support that view.

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