Sunday, August 28, 2011

Clean up time

Hi there, and welcome back to CRI's S&P 500 blog.

Amid all of the 'end-of-the-world' talk out there the broader stock market (as measured by the S&P 500 stock index) has worked its way back to the 50% rule and begun to consolidate in a very orderly (if not swift) fashion. Currently, the market is doing nothing more than cleaning up the excess's of the past year's bull run. We have made a very natural 50% correction of that move and shall now need some time to confirm that this is indeed nothing more than a healthy correction within a massive bull market.

As has been previously stated, this correction comes on the heels of US federal political instability rather than poor economic fundamentals. As a result, one is left with the feeling that if only Washington could just get it's act together the market would stabilize and resume its previously well established up-trend. Make no mistake, the 135 area (on SPY in this case) shall now act as considerable resistance to the upside but given that the two primary drivers for stock valuations (earnings and the yield curve) continue to be supportive, a resumption of that uptrend would seem likely upon a resolution. The big 'if' now is indeed Washington (or more succinctly - US Federal political leadership) and given the current extreme polarization of the US Congress (and now the US Fed's insistence that any solution must be fiscal in nature and not monetary) that much needed leadership is in serious question.

So lets review how our two primary market participants ought to be positioned.

Investors: As has been the case now for several weeks, cash is king! Investors were given a very clear 'exit' signal when our time tested trending indicator (that being the relationship between the weekly 13 EMA and the 30 SMA) crossed bearishly 5 weeks ago. That exit should have come on a break of key support in and around the 125.70 level (or about 6% higher than where we are currently). Until the moving average relationship turns back up, investors are well advised to sit on the sidelines and watch the fireworks. Ironically enough, this camp is cheering for further price deterioration which would make their exit look all the more significant.

Traders: This camp was well advised to begin shorting the market in earnest through the final week of July and again when the important 125.70 level was breached. Those that were fortunate enough to get short should have been more than happy to take profits on those short positions as we approached our well established downside target zone (119.15 - 111). The fact that the market has basically oscillated around the 50% level (for the past four weeks) suggests that the market is trying to relieve the oversold condition that developed on the initial downward move. The recent consolidation in price has both relieved that short term oversold condition and may be laying the ground work for the next leg lower. Should the 110.27 level be taken out, one would have no choice but to look for another move lower equal to or greater than the previous. This bear flag formation would imply a price target of 96.65 [(134.82-110.27)-121.20]. Conversely, should the 121.20 level be taken out, one ought to look for a counter-trend rally that would imply an initial price objective of 122.935 [50% retracement; (135.6+110.27)/2]. Should that breakout occur, one could also argue that the 13 EMA shall act as resistance and it ought to be in and around that level as well.

So in summary then, the market needs political leadership in order to continue the expansion that was established last fall. The US Federal reserve has stated that it will be very reluctant to initiate a QE3 program and that in its opinion, fiscal stimulus is what is needed. Couple this with extreme political polarization in Washington and there appears to be no quick resolution on the horizon. All of this suggests that the market will have to take some more time to clean up this mess and that if one were to suggest a general direction for price in the coming weeks/months, that direction continues to suggest down rather than up.

That's all for this week,
Brian Beamish FCSI
The Canadian Rational Investor
the_rational_investor@yahoo.com
the-rational-investor.com

Saturday, August 13, 2011

A violent conclusion to a well telegraphed event

Hi there, and welcome back to CRI's S&P 500 blog.


The past two weeks have virtually wiped out an entire years worth of growth in the market and have underscored the significance of adding a little timing to anyone's portfolio. 

From the violent break seen just weeks ago prices have fallen more than 14% and as of yet haven't shown clear signs of a bottom. Yes downside targets have been hit (and even exceeded at times) but to get back to a more 'normal' market we may have to see some violent tugging and pulling over the coming weeks/months. Make no mistake - the bull run (that was initiated with QE2 and the re-alignment in the US Congress) just 10 months ago is over and some tough slogging will have to lay ahead.  It is unfortunate if you are just reading this blog for the first time because you will fail to fully grasp how entirely predictable this correction has been.

So what happened?
To answer this one need only look at the charts above. First is our regular weekly chart of SPY (S&P 500 depository receipts) and then below that is a daily look at SPY. First off, our time tested trending indicator (that being the relationship between the Weekly 13 EMA and the 30 SMA) and our 'investor-signal' turned negative two weeks ago. Our collective 'stops' (that being the point that if breached would represent our time to get out) were just under recent lows (support) at 125.70. We here at the SPY blog made it very clear that cash was king and all those that did get out - congrats! 

Market Participant Position Review
 
Investors: Those out there who consider themselves investors in stocks and not market timers are sitting in cash. How long is anyone's guess, but until our 'Investor-buy' signal comes back - cash is king. Yes our downside targets have been hit, but that by no means we are in a bull market.

Traders: Traders were well advised to short the market when it broke back below the 13 EMA (at or near 130.68) just three weeks ago. Those that were able to short on the break (if you don't like to short stocks then consider buying Put options) are well advised to take some profits. Readers were made well aware of our target zone (119.15 to 111.15) which has now been hit and if its one thing you shouldn't be in this kind of market is greedy. Take it - you won - be happy!

So where do we go now?
That is a very good question, and a reason why I have included the daily chart in this week's blog post. Based on the daily chart, we entered and extremely oversold condition just a few days ago. Traders would have seen the fact that the market was getting 'washed-out' - and figuring the risks were relatively low. They gained further support on the news that European countries would be outlawing the shorting of bank stocks for the next two weeks. With the short sale ban, those wanting to short will have no choice but to sit on the sidelines. Those willing to step into the breach have been rewarded for their courage as the SPY itself has rallied some 7% off the bottom. This vacuum has and will pressure stocks higher as late summer trading volumes are very thin and anyone who did want to sell (positions that they already owned) has already done so. The rally may be short lived as we head into the Labour Day weekend. The week following the holiday is when many professional traders come back to work and will be more than happy to sell into any strength. Additionally, the short sale ban will have expired and those wishing to short European bank shares will be given the green light to do so once again. 

Summary: In this very oversold market, expect there to be a slightly bullish bias to trade but once the 'no-shorting' ban expires (in about 2 weeks) and the Labour Day weekend holiday is behind us - there is no telling were they will take this market - Cash is King!

That's all for this week,
Brian Beamish FCSI
The Canadian Rational Investor
the_rational_investor@yahoo.com
the-rational-investor.com

Thursday, August 4, 2011

All good things must come to an end

Hi there, and welcome back to CRI's S&P 500 blog.


As the title of this week's blog entry outlines, the bull run that began last fall has run its' course. Our time tested trend indicator (and our 'investor buy/sell' signal) has turned negative with this weeks collapse in equity prices. Furthermore, those investors that bought on the last bullish cross-over (at or near 110.95) should have exited that position when the market moved through the most recent support level (125.70) talked about at length in previous posts. This trade (that lasted about 10 months) equated to more than a 13% return on invested dollars in a little less than a year. Considering that the long term historical average return for stocks is about 11%, our 13% beats that number comfortably. Consider too that this return does not take into account any dividends paid while holding the position (add another 2%) and one can clearly see that this was a very profitable position to take. 

So where does this leave us now? The market is heading down - and rather quickly at that. Political rhetoric is at a fevered pitch and there have been no clear indications of the beginnings of a QE3 program by the US Federal Reserve Board. Additionally, the debt situation in Europe is still dominating the headlines suggesting that there ought to be some sort of climatic finish to that problem before it goes away in earnest. Ironically enough, the best thing the market has going for it is that corporate earnings are still ok and the yield curve is still supportive going forward. This indicates to me that there probably won't be a 'crash' but rather a normal 'correction' in the market going forward. So where might prices go over the coming period. As the chart above suggests, there are three significant technical targets I have in mind going forward. Firstly, a 50% retracement of the 10 month bull run ought to bring prices back into the 117 area. Secondly, the breakout high from April, 2010 was near the 119 area. And lastly, the weekly 200 SMA currently sits near 111.5. This all suggests to me that the market will take a run into the 111-119 area before this correction has ultimately run its course.

So lets review the to major investor groups and how they ought to be currently positioned:

Traders: those that are nimble enough to be able to move in and out of the market quickly would have been well advised to be short from the recent daily double top breakdown which occurred when the market moved back below the weekly 13 EMA (129.63) just last week. As the market is in 'free-fall' at the moment, profits should be taken whenever possible.  Picking an exact bottom is never easy and the recent volatility suggests we could bounce right back up top. So with this in mind, I myself have covered my shorts (long put option position) and am sitting comfortably in cash for the time being.

Investors: because our time tested 'investor' signal has officially rolled over, investors would be best to sit in a cash position. They should have exited their long position on SPY (and the broader market in general) on the break of recent support (at or near 125.70). Since the market is in flux at the moment, one would be best to put that money into a 90 day t-bill and just sit back and enjoy the rest of the summer.

So in summary then, the bull run that began last fall has come to an end. the break of recent support (125.70) represents a significant breakdown in the market and it will take some time to clean up the mess. One can't know for certain exactly where the bottom of this move shall be so for safety sake, cash is king!

That's all for this week,
Brian Beamish FCSI
The Canadian Rational Investor
the_rational_investor@yahoo.com
the-rational-investor.com