ECB Meeting Tomorrow

September 3, 2014

10:20pm CST

To QE or not to QE? How will global markets respond? The bullish case would imply some high level consolidation and not much of an actual market decline. This goes back to what I said about how important 1,160 (and the gap up at 1,160) is for the Russell 2000. If we see much weakness below that level and in particular a gap fill of 1,141 on a closing basis I’d be a bit concerned that we are seeing a bearish scenario play out into October. However, if this did happen it could be the pause that refreshes and sets the market up for its normally strong 3rd year of the Presidential Cycle. Or, will we continue to see that cycle be worthless as it has been for the past 10 years? Should the market continue this stronger than normal second year pace I think the odds are quite high that the 2nd year is pulling performance from the 3rd year for the 3rd consecutive period (2006-2007, 2010-2011, and 2014-2015?)

This should be interesting….

 

8:15am CST

A quick note on part I. In the last paragraph before the link to “the only chart that matters for now” I stated that I was expecting a top in July and a bottom in August. I meant a top in July and a bottom in October. Also regarding the first note from http://www.sentimetrader.com I went over it multiple times and tried to fix it but it seems to like its current form. What it looks like on my side is completely different from what it looks like when I post it.

Now a look at some monthly MACD signals worth noting. See below that the Russell 2000, S&P 600 Small Cap Index, Dow Jones Microcap Index, and FAGIX:VUSTX (measure of risk which was used quite accurate by the late Terry Laundry of T-Theory) are all on monthly MACD sell signals. The Dow Industrials was also on a monthly MACD sell signal at the beginning of August but the recovery over the remainder of the month avoided an official sell signal. All other major indexes remain bullish on the monthly MACD.

Russell 2000

R2KmonthlyMACD

S&P 600

SMLmonthlymacd

Dow Jones Microcap Index

DWMImonthlymacd

FAGIX:VUSTX

FAGIXVSVUSTX

Some other points worth noting on the FAGIX:VUSTX chart above. Essentially this chart measures risk on vs. risk off. The MACD signals have been quite accurate going back to 2000. On the chart above I used arrows to note the buy and sell signals it has given over the past 7.5 years. There have only been 4 signals and all of them have been correct. The current signal would be #5 if it holds

The ADX remains bullish. I also circled the beginning of 2011 and the beginning of 2014. In my eyes these both looked quite similar but thus far the market hasn’t broken down despite numerous opportunities to do so.

These signals drive home my point here that the market is at a critical juncture. Will these sell signals follow through and are they leading the rest of the market (Dow, Nasdaq, S&P 500)? Or are these false signals that will reverse back to the upside over the coming months? The Russell 2000, S&P 600, and Dow Jones Microcap Index have gone virtually nowhere in the past 10-11 months while the rest of the broad market (Dow, Nasdaq, S&P 500) has moved higher. So is this a topping pattern on small caps or was this simply a consolidation before another move higher? We should find out in the not too distant future as it is likely that the small caps and large caps align in trend once again.

One usually sees froth and greed near the end of bull markets. We certainly saw it in various tech, biotech, small cap, and microcaps into the month of March but there was a nasty correction in those names that lasted into May. February and into March were reminiscent of 1999-2000 but not quite as extreme. Back then it was the .com boom. This time it is all about “start ups” and social media. Back then everyone thought they were going to get rich on a .com or by daytrading. Now the craze is “start ups”. For a couple examples of this trend there is now a show on HBO called “Silicon Valley” about young adults getting rich off of start ups in their garage. I also saw a commercial recently for Xfinity where a bunch of kids ~7 years old were working on a start up in their garage. Before the end of the commercial one of the kids gets off the phone and yells “we’re going public” and the rest of them cheer. My point is that we are seeing a lot of valuations and attention towards that sector that are quite bubbly. So is the real froth and greed yet to come or has it moved from where it is normally seen near the end of bull markets (tech/small cap/microcap) to the IPO market? Note that the # of money losing IPO’s today is very similar to 1999-2000. Also note that the trend has really accelerated again since the beginning of the year.

moneylosingipos

Alibaba is expected to IPO in a little over two weeks. It will be the biggest IPO since Facebook. I’m guessing that it prices near the higher end of the range which would be ~$200 billion. Their sales and earnings for the FY ending 3/31/14 were $8.5 billion and $3.75 million. So at the low end of the range ($150 billion) it would trade at ~40x last year’s earnings. At the high end it would be over 50x last year’s earnings. Those multiples are high but not as extreme as we saw in Facebook just a little over 2 years ago. Something to keep in mind is that this IPO is going to suck up over 20 billion worth of capital. It isn’t uncommon to see market weakness just before or just after IPO’s like this due to the amount of capital being extracted from other parts of the market.

http://www.usatoday.com/story/money/markets/2014/09/01/alibaba-group-ipo-comes-with-unusual-structure/14928685/

A few weeks ago I noticed something very interesting regarding the US Dollar. For the first time in ~15 years it is going up relative to all major currencies while the US equity market is in an uptrend. This trend has really taken hold since the 4th of July and in the process has taken the last commodities that were still standing (oil, gasoline, hogs, and cattle) and knocked them down quite a bit. There are two potential takeaways here. One positive and one negative.

1. Potential precursor to deflationary wave. If this is the case we are seeing the early stages of it over in Europe with the German DAX and French CAC. Treasury market seems to be suggesting this possibility.

2. If the US Dollar is about to enter a long term uptrend relative to other global currencies it could be a true game changer. Essentially this would be the best house in a bad neighborhood type of scenario. Regardless, it would logically bring global investment funds to the US and lift all boats. Stocks, bonds, and real estate. As long as the Dollar remains strong foreign investors are winning on the exchange rate alone. So as long as asset prices are flat to up all is well. This could explain the concurrent bids in US Treasuries and equities over the past month.

Our 10 year yield at ~2.34% is actually quite attractive at the moment with the US Dollar in an uptrend relative to all major currencies. If I were a conservative fixed income investor I think the US market is hands down the clear choice given the currency picture right now. The only other one to even consider would be Australia at 3.3%.

Competing 10 year yields:
Japan- .5%
Germany- .9%
France- 1.3%
Canada- 2.0%
Spain- 2.2%
Italy- 2.4%
UK- 2.5%
Australia- 3.3%

A stronger Dollar likely means declining commodity prices. This would be great for the US consumer. If they spend less on food and energy they will have more discretionary income to spend elsewhere. The only negative of a Dollar rising would be a weakening of US exports.

A quick note on oil here in light of the stronger Dollar. The weekly and monthly charts had the perfect setups for oil to explode on the upside back in June/July. At the same time we have seemingly had the perfect setup of geopolitical events to drive oil higher yet it has moved down about 15% from its peak in June to its recent low in August. When seemingly bullish news fails to move an asset class north it is often a sign of a top.

A few notes on seasonality. Namely the January Barometer, Sell in May and go away, come back after Labor Day, and the Presidential Cycle.

January 2014 was a down month so the January Barometer suggests that 2014 will be a down year. That means the S&P 500 would have to end below 1,849. The key to watch is the 150 day simple moving average. It currently stands around 1,909. If that is broken to the downside it wouldn’t be hard to envision a close for the year below 1,849. For now, one has to give the trend the benefit of the doubt. I will also say that it isn’t wise to t live and die by the January Barometer. It tends to be right about 2/3 of the time and it has been right the past two years, almost 3. In 2011 the market was up in January but the market finished flat for the year. Thus it was not technically wrong but more of a wash. If the January Barometer was wrong this year it wouldn’t be out of the norm considering that it is usually right about 2/3 of the time and this year could easily be that 1/3 that doesn’t work.

Sell in May and go away, come back after Labor Day really hasn’t worked for 3 years now. Thus I may be looking a bit far in the future but the odds of this happening 4 years in a row aren’t very good. On top of it I also have a 9 month cycle hitting in April 2015. Thus a top in April of next year and an ugly summer wouldn’t be that crazy. The upcoming 9 month cycles are October 2014, April 2015, July 2015, and January 2016. The last one was in July and thus far it hasn’t really meant very much.

The Presidential Cycle is all screwed up and frankly it deserves its own blog post. From 1961-2005 the cycle worked pretty well. Since then it has been worthless. Up until 2005 the best performing year was the 3rd year followed by the 4th year, then the first year, and then the second year in last place. Generally the first two years of a Presidential term are the weakest for the market and the last two years of the strongest. Well take a look below. The last time we actually saw a really banner year in a 3rd or 4th year was 2003. 11 years is a long time.

The cycle appeared as though it just strayed for a couple of years in 2006-2007 in which it was very much like 1986-1987. The second year pulled performance from the normally strong 3rd year. But then the 4th year which is normally good was absolutely awful. Starting with 2006 we have seen two banner first years, two much better than normal second years that pulled performance from the normally strong 3rd year. This led to consecutive 3rd years that were essentially flat. Then we have seen a really bad 4th year (2008) and an okay 4th year (2012). So what happened around 2006 that threw this normally accurate cycle off? The Federal Reserve has become increasingly involved in the picture since then so I would suggest that they are the likely culprit.

prezcycle

At 2,035 on the S&P 500, it would offiicially be up 10% for the year and in my opinion would likely be pulling performance from the normally strong 3rd year of 2015. If this were to happen it would be the third consecutive 2nd year that pulled performance from the normally strong third year. Note that the only 3rd year performances that were up less than 10% followed second years that saw gains in excess of 10%. The last point I would make regarding this cycle is that we have seen at least an 8% correction in every second year going back to 1962. This is known as the 4 year cycle low and we are due for one here in 2014 but thus far it is nowhere to be found.

The last time the market ended near the highs going into Labor Day was in 2012. Market topped in mid-September and fell ~9% over the next 2 months. This fits with the theme that the pieces from http://www.sentimentrader.com were suggesting in that returns generally aren’t very good over the next 2-3 months following strong performance into Labor Day.

So the January Barometer, Presidential Cycle/4 year low, strong performance into Labor Day tends to skew towards weakness in September and the next few months after that. These would agree with the negative divergences and suggest that we are going to see some market weakness into October and possibly a bit longer.

On the flip side, has all of the price action over the past 10-11 months in small/micro cap been a topping process or is this simply a consolidation before higher prices?

Everything I have looked at suggests caution right now. The most logical plan of action is to  wait and see if the past 10-11 months in small/microcap have been a topping process of simply a consolidation.  The market has had quite a run in the past month and at the very least it would seem logical that we should at least get some consolidation of the recent gains. So a little bit of backing and filing would be normal and could be a health restoring event for this market. Some small backing and filling could set the stage for a breakout on the upside. Regardless of how this pans out, we shouldn’t have to wait long for the market to show its true colors.

Something else I just noticed is that while the Nasdaq Composite and Nasdaq 100 have made new recovery highs, the Semiconductors ($SOX) has yet to better its high from July 2014. A warning? Semiconductors and financials tend to be market leading sectors so it is definitely worth noting.

 

 

 

2:00pm CST

As I mentioned in my post on August 13th, the months of September/October combined have marked a key turning point for the market in 13 of the past 17 years. Seems quite fitting that as we begin the month of September the market appears to be at a critical juncture and its fate should be decided over the next 1-2 weeks. Unfortunately I can make both a bullish and bearish case for the market here. What it primarily boils down to is the Nasdaq Composite, small caps, microcaps, and Europe (German DAX and France CAC in particular). How they play out over the next few weeks should tell us what we need to know about the broad market here in the U.S.

Interestingly, I think this may all come down to what happens when the ECB meets on September 4th (this Thursday). Mario Draghi has been a big talker for the past 2 years but he really hasn’t done much about the deflationary pressures in Europe. He offered some dovish comments recently at Jackson Hole but I think the market is ready to see action instead of talk. Does Europe have the political will to do QE? Thursday and Friday of this coming week could be quite telling.

Here are some interesting pieces from http://www.sentimentrader.com this past week regarding the possibilities for the month of September following a strong August. Generally not so great.

From 8/26/14:
If the S&P 500 closed August with a gain of 3% or more, then it added to its gains in September 36% of the time. If it also closed at a 12 month high in August, then September was positive only 1 out of 12 times, averaging -2.6%. If August closed with a gain of 1% or more, and a 12-month high, then September was positive only 3 out of 19 times, averaging -1.6%. All data since 1928.
My Commentary: S&P 500 did close August with a gain of 3% or more. This is essentially saying that following such events on a historical basis, September only posted gains 1/3 times. The rest of the data speaks for itself.

From 8/29/14

This is the fifth time since 1950 that the S&P 500 closed at a 52 week high on the day before the Labor Day holiday (1951, 1963, 1979 and 1989 were the others). The days and weeks ahead were mixed, but stocks did struggle afterward. Over the next three months, the S&P’s maximum loss was -3.8%, -4.2%, -9.4% and -7.4%, respectively, and its maximum gain was no more than +2.6% in three of those years and +3.7% in the other.

My Commentary: The # of data points here aren’t nearly as plentiful as they were in the prior observation. Hard to give too much to this data with only 4 points to go on but the fact that the returns seemed to be skewed to the downside relative to the upside over the next 3 months is worth noting.

So why do I believe that these particular sectors/indexes are so important? While the major indexes (including the Nasdaq Composite) have recently hit new bull market highs, small caps (Russell 2000, S&P 600), microcaps (Dow Jones Microcap Average), the German DAX, and France CAC are well off of their highs for the year. This price action combined with negative divergences in the market internals of the Nasdaq Composite and small caps since late last year have led the market to this apparent fork in the road. Either the small caps and microcaps are going to start moving higher with the broad market or they will break lower and more than likely take the big caps with them.

See the internals of the Nasdaq Composite below. Note that while the index has consistently hit new highs since the beginning of the year, the % of components in bull markets themselves (% of stocks over 200 day EMA) have consistently been falling. Essentially participation of individual components has fallen off since the beginning of the year. Fewer and fewer stocks are carrying the index higher. The large cap Nasdaq 100 (led by AAPL) continues to do well. However, the rest of tech has largely been lumped in with the small cap and microcaps which haven’t fared as well since the beginning of the year. The bullish argument here is that the % of stocks above their 20 and 50 day EMA’s hit levels in April/May and recently in August that have marked bottoms on the Nasdaq Composite for the past 3 years.

Naz%

Here is the same chart for the S&P 600 Small Cap Index. Note the activity in the price action of the index relative to the % of components above their 200 day EMA since the beginning of the year. At each new high there were less stocks above their 200 day EMA’s. At the same time the 20% mark on % of components above their 50 day EMA’s has marked some key bottoms over the past 3 years including the recent low in August. Question here is the same as it is for the Nasdaq. Will the negative divergences on the 200 day EMA lead the index lower from here or was the bottom in August a kick off to another leg higher? This is very important here for both the Russell 2000 and the S&P 600 because both are testing the 62% retracements from their highs reached around the 4th of July to their recent lows in August. This isn’t visible on this longer term chart but if these indexes are gong to start breaking down, this would  be the spot to do it. The exact 62% retracements are 674 on the S&P 600 (696-639) and 1175 on the Russell 2000 (1214-1107). Keep a close eye on those #’s because both indexes closed just below those #’s on Friday.

SML%200dma

Here is the new high/low data for the Nasdaq Composite. Note that the # of stocks hitting new 52 week highs actually peaked in October 2013. Since then it has steadily declined despite the index still hitting a new bull market high just this past week. This isn’t healthy action.

Nasdaqnewhighnewlow

Here is the new high/low data for the S&P 600 Small Cap Index. The readings here are almost indentical to the Nasdaq Composite. This is primarily because once you get beyond the components of the Nasdaq 100, most of the components of the Nasdaq Composite are microcap-mid cap. At the most recent peak heading into the 4th of July weekend only ~75 components of the index hit new highs while the index was hitting a new high. Late last year the new highs were accompanied by 150-200 of the components hitting new highs.

SP600newhighnewlow

The S&P 500 has also seen some erosion of internals but nothing like the Nasdaq Composite and small caps. As you can see below 89% of the S&P 500 is above their 200 day EMA vs. only 53% for the Nasdaq Composite and 61% of the S&P 600 Small Cap Index.

SPX%stocksover200dma

The new high/low data for the S&P 500 also shows some erosion of internals but nothing like the Nasdaq Composite or S&P 600 Small Cap Index. The # of new highs actually peaked in May 2013. For the rest of 2013 there were consistently about 140 components hitting new 52 week highs with the index. At the most recent spike in early-June only 125 components made new highs. Since then there has been a pretty big negative divergence with just 50 components making new highs with the index this past Monday.

SPXnhnl

The Russell 2000 remains above the critical 1,160 line in the sand I have been discussing for a while. Above 1,160 is bullish, below is bearish. There are two gaps on the Russell 2000 to watch. The first is at 1,160 and the other lies at 1,141. The gap at 1,160 could be filled without much technical damage. However, should the gap at 1,141 be filled on a closing basis that would be a bit concerning.

The Russell 2000 headed into this holiday weekend on the upside. It wasn’t as pronounced as it was around the 4th of the July and I detect that bullish sentiment is much more muted now than it was then. The beginning of the month has a tendency to mark the beginning and end of prior trends. This likely has to do with fund flows and fund managers coming back from vacation. With volume as light as it was it will be interesting to see what kind of mood they are in when they come back from Labor Day weekend. Based on the anemic volume over the last two weeks of August I would venture to say that some fund managers have been on vacation for a pretty good while.

As for the beginning and end of the month being important just look at the chart of the Russell 2000 below. It has had a tendency to reverse trends near the beginning of the month. Bottom February 2014. Top March 2014. Top July 2014. Bottom August 2014. September 2014? Watch out for a potential spike tomorrow morning that fades for the rest of the day or a spike tomorrow and then no follow through after.
monthbeginningR2k

 

The only indicator that has worked consistently in this bull market has been the size of the Fed balance sheet relative to the S&P 500. They rise and fall in tandem. When the Fed was planning on ending QE I and QE II (flattening out its balance sheet as opposed to continued expansion) the S&P 500 topped out about 2 months ahead of that date. These led to the good sized corrections in the summers of 2010 and 2011. Will it follow suit this time? Thus far the market has been a little late in topping. With QE slated to end in October I was looking for a top in July and a bottom in August. However, as I mentioned on August 13th this became what the majority were expecting and thus it was unlikely to play out. Has the window of peaking before the end of QE just become smaller or is it no longer applicable? My last two 9 month cycles were in January and July. Both marked very short term peaks in the market. In fact, my 9 month cycles really haven’t meant much since 2012 because the market hasn’t really had any corrections. Looking forward, things could always change so I think its worth keeping in mind that my next 9 month cycle is hitting in October.

http://equitybriefcapital.wordpress.com/2014/06/28/the-only-chart-that-matters-for-now-revisited/

I have more thoughts to post but I think it would be best for me to split it up into two different pieces. So welcome to the end of Part I. Part II will be posted later this afternoon or evening.

8:10am CST

The market always does what the majority aren’t expecting. So what would be the max pain trade at the moment?

I have been expecting a market peak around July and thus far we have one. Of what degree is up for debate. We also got some kind of a bottom late last week but I need to see some more strength in the market before confirming that it is a bottom of great significance.

From a July peak I was expecting a decline into a 4 year cycle low and my next 9 month cycle in October. However, it seems as though this has become the scenario that the majority are expecting.

So what would be an alternative that nobody is really expecting? I mentioned in some recent posts that it seems the masses went from mega bullish about 6 weeks ago to the point where as of a week or two ago I would say about 90% of the headlines/forecasts I have come across don’t think the market can go up and in fact we are headed for a 10-20% correction in the coming months.

From the end of my post on 8/4/14:

“I still think there is some more turbulence ahead this summer but near term I think the market is due for a bounce here. I have been quite bearish this year but one observation that has given me a bit of pause in the past few weeks is that I haven’t seen a single market forecast of anyone actually saying that the market is going up. Meanwhile I have probably seen 10+ headlines saying that a 10-20% correction is on the way. Let’s see how the bounce plays out and go from there. I still see a lot of headwinds for the market this summer but the sudden shift of headlines going from bullish to bearish in the past few weeks has given me some pause.”

So what if the market runs up into October and puts in a major top? Just some food for thought. October has historically been a turning point for the market. In fact, in 13 of the past 17 years the market has put in a major bottom or a major top in the September/October time frame. Tops in October are unusual but not impossible. October 2007 was clearly a major top. September/October 2012 was clearly a top but only led to a ~10% correction into November. The year 2000 also saw a secondary peak (the peak was actually in January/March but the last hurrah and lower low came in September). The 1929 peak came in September. The 1937 secondary peak came in August (similar to 2000). 1973 saw a secondary peak in October followed  by a brutal decline into late-1974.

In the vast majority of instances October produces a market bottom but not all the time. One has to admit that we haven’t been dealing with what would be considered a normal market so all possibilities need to be entertained. I have noted before that the second year of the presidential cycle is by far the worst performing on a historical basis. We are in that second year right now and both 2006 and 2010 were much stronger than normal second years. Both cases led to weak 3rd years (2007 and 2011). The same cycle also hit in 1986-1987 after a very strong second year in 1986 pulled the returns from the normally strong 3rd year of 1987.

2,035 is the mark on the S&P 500 would officially be up 10% for the year. Thus far the high for the year is 1,991. I have previously stated that if the S&P 500 reaches that 10% threshold of 2,035 the odds heavily favor that the index is once again pulling returns from the normally strong 3rd year of 2015.

More on this later. Just wanted to get the thought out for people to ponder.

 

 

7:40am CST

The expanding triangle on the Dow dating back to the October 1998 lows is no secret. It has been well talked about which likely means it isn’t going to play out. However, there was something very interesting about the most recent high at 17,152.

Dowexpandingtriangle

I had actually come up with this number earlier this year or late last year as a potential high. Why? As you can see above the Dow recently peaked at the upper end of the expanding triangle and has failed to close above it on the monthly basis. But take note of this. The 2007 peak of 14,198 was 20.8% above the previous high of 11,750. 17,152 is 20.8% above the previous high of 14,198.

It is hard to say if this means much yet. Just something to keep an eye on.

 

Bottom at 1,908?

August 7, 2014

12:10pm CST

Back on Monday I mentioned that I thought the market was due for a bounce. It did bounce but I thought it would last a bit longer than a day. Was expecting more like 2-3 days and then another leg down in the market to 1,880-1,900.

Sentiment has been quite bearish since last week, the market is quite oversold, and I’m seeing some positive divergences. Notably small caps, which have been the leaders on the downside since the beginning of July, made their lows on Monday while the S&P 500 just made a fresh new low today.

At today’s low of 1,908 the S&P 500 is down 83 points from the recent high of 1,991. Why does this matter at all? The last correction back in April was exactly 83 points. 1,897-1,814. Believe it or not these kinds of relationships work more often than one would think.

There is still a gap open on the upside at 1,900 on the S&P 500 which dates back to the first trading day after Memorial Day Weekend. From a bullish perspective I would much rather see the market bounce between here and ~1,900. At the very least a bounce up to ~1,950 or so seems doable here. If there isn’t a good bounce between now and the end of the day I will go into more depth on potential scenarios.

83points

 

Note that the Russell 2000 bottomed on Monday and is higher since then while the S&P 500 makes a new correction low today. Key resistance levels are 1,131, 1,148, and 1,160. 1,160 is literally the line in the sand. Note that 1,160 held as key closing support until 7/15/14. Since then it hasn’t closed below it. This same level is associated with a key pivot from early-April. The equivalent level above for the S&P 500 from the same date is 1,875. 1,160 is a VERY important level for this index.

R2K1160

Let’s see how the rest of the day plays out.

 

 

8:40am CST

I have been quite vocal about my bearish stance on the market here in 2014. The cycles are against the market with 2014 being the second year of the Presidential election cycle, the market is due for a major 4 year cycle low this year, valuations are pushing the upper boundaries of historical measures, and QE is slated to end in October of this year and the market has corrected both times previously when the Fed tried to cut off QE (in both the summer of 2010 and 2011). After a banner year in 2013 some kind of pause was due and after last week that has become apparent to most with the Dow Jones Industrials now down for the year and the Russell 2000 going essentially nowhere dating back to last October.

I have discussed the weakening breadth (less new highs in individual stocks as the indexes make new highs dating back to late last year) as well as less stocks trading above their 200 day EMA’s at each successive high. This is most apparent on the tech heavy Nasdaq and the S&P 600 small cap index. These were the biggest out-performers last year so it shouldn’t be much of a shock that a period of digestion is needed but it is also worth noting that both of these sectors tend to lead both on the way up but also on the way down. The internals of both indexes are breaking down but it isn’t as apparent in the price action of the Nasdaq Composite/100 yet because stocks like AAPL, GOOG, INTC, and MSFT make up such a large weighting of the two indexes and those stocks have all been out-performers this year.

As for why I think a near term bounce is due it essentially comes down to some key closing levels holding on the Nasdaq Composite/Wilshire 5000, some extreme short term sentiment indicators, and some breadth readings that typically occur near market lows.

The Nasdaq Composite held 4,350 on a closing basis.

Naz4350

The Wilshire 5000 held 20,250 on a closing basis.

WLSH20250

While many were shocked at the price action last Thursday in the large caps, the Russell 2000 has already fallen 8.8% from peak to trough (1,214-1,107) in just over a month. It is quite oversold here.

Sentiment

The CNN Fear/Greed Indicator hit 5 as of the close on Friday. That is the lowest reading since 2011. Just a month ago it was the polar opposite with a reading of ~95. This is reflective of the weakness in small cap stocks that wasn’t visible in the larger cap indexes until last Thursday.

 

 

 

 

CNNfeargreed5The Equity and CBOE put/call ratios had notable spikes last Friday. The Equity put/call ratio hit its highest level since the summer of 2012. The CBOE put/call ratio spiked to its highest level since last October.

rawputcalldumbmoney

On Thursday the SPX Participation Index hit a reading of -78. I like to see readings below -80 for more confidence in short term bottoms but this is on par with readings that have marked bottoms over the past year. This reading is indicative of a market that is washed out on a short term basis.

SPXparticipationdownside

The T2106 McClellan Oscillator on TC-2000 almost hit 300 on the downside last Friday. Note that the 15 day moving average is now below -100 and moving towards -150. These levels have typically led to at least near term bounces.

T2106oversold

The percentage of stocks on the S&P 500 above their 20 and 50 day moving averages has fallen to a level that has marked short term bottoms over the past 18 months or so.

SPX%

Same goes for the S&P 600 Small Cap. Stocks above the 20 and 50 day moving averages is down near levels that have marked bottoms over the past 18 months. Also note that while stocks above their 200 day EMA’s here is near the same level as November 2012, the S&P 500 is still coming off of high levels.

SML%

I still think there is some more turbulence ahead this summer but near term I think the market is due for a bounce here. I have been quite bearish this year but one observation that has given me a bit of pause in the past few weeks is that I haven’t seen a single market forecast of anyone actually saying that the market is going up. Meanwhile I have probably seen 10+ headlines saying that a 10-20% correction is on the way. Let’s see how the bounce plays out and go from there. I still see a lot of headwinds for the market this summer but the sudden shift of headlines going from bullish to bearish in the past few weeks has given me some pause.

3:45pm CST

Since I was getting new internet today and it took much longer than expected I actually watched some CNBC today (which I normally don’t do). Both Marc Faber and Bill Fleckenstein were on at different times in the day. Both suggested that there was a lot of risk in the markets at current levels and that the longer the market moves up without a correction the bigger the eventual downside reaction. Every single panelist and anchor essentially laughed at them and said the Fed wouldn’t let it happen (reporter Scott Cohn of CNBC was honestly laughing, no joke). Shows you where sentiment is.

So the Fed can print money forever and there are no consequences other than the stock market going up? Valuations? Who cares, all is good in Never Never Land seems to be the mantra. The clowns at CNBC have your back. The Fed minutes disclosed today that they intend to stop QE in October and since March 2009 any time QE was slated to end (summer 2010 and summer 2011) the market corrected. The only thing different now as opposed to then is that valuations are much higher. Why should we expect a different result this time?

Very reminiscent of 2007. Interestingly Marc Faber compared this market to 1987 as I did just yesterday. What makes it more interesting is that he correctly called the crash of October 1987 ahead of time. Another tidbit of information: Bill Fleckenstein ran a hedge fund that specifically shorted stocks. He closed it down at his discretion in March 2009 because he knew the bottom was near and the opportunities for shorting were nil. Now he is looking at re-opening his fund.

I really believe that a pretty good sized decline is on the way. Right now (July 2014) is one of my 9 month cycles, the Fed is going to see if the market can stand on its own two feet without QE (which hasn’t worked in the past and and the only difference is that stocks are more expensive than they were in 2010 or 2011), sentiment is extremely complacent (see above), the January barometer suggests that 2014 will be a down year, there has been at least an 8% correction in every mid-term election year dating back to 1962 (and it hasn’t happened yet this year), the average mid-term correction is 18%, second years of the Presidential Cycle are notoriously bad performers (See BIS Warning post from yesterday), and the potential upside in the market relative to the potential downside makes absolutely no logical sense at current levels.

My next 9 month cycle is due in October 2014 and I honestly expect it to be an important low. As I have mentioned before I think we have to see how big the decline eventually is, how the market reacts, and how the Fed reacts. If the market has a 10-15% correction I think the Fed stays on the sidelines and does no more QE. If we see a correction of 20%+ I think the Fed goes right back to QE and makes the bubble in equities even larger. That would suggest a market peak in the 2016 time frame and at that point it is QE or bust for the Fed.

The 32-35 year cycle is now in play from August 1982 as we are only a month away from an official 32 years from that low. Important market turning points have occurred in these 32-35 year windows. I will go more in depth on this cycle in another post as it deserves specific focus.

 

 

12:15pm CST

Looks like the BIS was reading my blog on Saturday (6/28/14) when I said that the gap between the equity market and the true underlying fundamentals today is the biggest it has been since 1999-2000. Same can be said for much of the world but I was simply speaking for the U.S. Of course all of this is being led by financial repression which is when central banks keep interest rates artificially low (far below the level of true inflation) which forces investors out on the risk spectrum. In other words a retired individual in their 80’s that may have once expected to live on risk free returns of 5% per year now has to go into the equity market or real estate to get those kinds of returns.

The only time I have seen anything like the market over the past 19 months was 1999-2000. The Dow nor the S&P 500 have seen more than a 7.5% correction since November 2012. The most amazing part to me is that 70% of the equity market gains in 2012 and 2013 came from the expansion of P/E multiples and only 30% came from actual earnings growth.

http://www.bbc.com/news/business-28081771

Note the following from the article:

“Growth has disappointed even as financial markets have roared: The transmission chain seems to be badly impaired,” the BIS said.”

And it warned that taking too long to do this could have potentially damaging consequences, by encouraging investors to take too much risk.

“Over time, policies lose their effectiveness and may end up fostering the very conditions they seek to prevent,” it said.

“The predominant risk is that central banks will find themselves behind the curve, exiting too late or too slowly,” it added.

Of course Alan Greenspan warned of “Irrational Exuberance” in a famous speech on 12/5/96 and the market continued to run for another 3 years beyond that. I just know that the risk levels are getting quite elevated with the market at current levels.

Note the presidential cycle below. These are the annual returns for the S&P 500 dating back to 1960. As you can see below, the second year of the cycle is by far the worst performer of the 4 as the uncertainty of the mid-term elections looms and policies enacted since the last Presidential election are implemented. Prior to 2008 the evidence was quite clear that the first two years of the cycle tended to be the weakest and the last two years tended to be the strongest with year #3 by far posting the best gains with an average return of 17.1%. However, note the extreme distortion of the numbers we have seen with the past 2 first years. The returns were 23.5% and 29.6% which is extremely unusual and has actually brought the average 1st year return above the average 4th year return (2008 badly distorted the average 4th year return). Something else worth noting is that the past two second year cycles (2006 and 2010) have been unusually strong. Aside from the second year kickoff of the secular bull market in 1982 (so 1986, 1998, 2006, 2010) the second year performances of greater than 10% had a tendency to steal gains from the normally strong 3rd year. See 1986-1987, 2006-2007, and 2010-2011. The only exception was 1998-1999 which was during another period of “irrational exuberance”. So 75% of the time aside from 1982 gains of greater than 10% in year #2 stole returns from year #3.

prezcycle

Here is another interesting statistic. Add up the returns from 1982-1986 and note the similarities of 2009-2013. Note that 1987 ended up essentially flat after being up big into August.

1982-1986: (14.8+17.3+1.4+26.3+14.2)= 74.0

2009-2013: (23.5+12.8+0+13.4+29.6)= 79.3

The total percentages (added) are almost exactly the same. Even note that there was one year in the middle (1984 and 2011) of each 5 year move that was essentially unchanged. The market then went nuts into August 1987 and then crashed in October 1987. That crash wiped out the prior 18 months of gains. Could we see something similar this year? I’m not counting on a crash but the complacency and extreme valuations relative to history are suggestive that we should be on our toes. See the chart of 1986-1987 below.

1986-1987

To put this into perspective while the Dow did finish 1987 up for the year it had to recover ~20% from the low in October to do so.

November 2012-October 2014 ?? The total % move up isn’t as large as 1986-1987 so the % drop wouldn’t be as large to wipe out the same time period worth of gains. This is just a hypothetical scenario for the time being but it fits my July and October time cycles, would finally set the 2nd year of the Presidential Cycle right, and put in a nice 4 year cycle low. Note that if the S&P 500 was coming from ~2000 a decline to 1,550-1,600 (~18-20 months of gains) would only be a correction of ~20-22.5%. I continue to believe that 1,687 and 1,560 are important levels to watch. 1,687 was the breadth and momentum peak for the big caps in May 2013 and 1,560 not only marks the bottom of the largest correction of the past 18+ months but it is also the breakout point over the highs of 2000 and 2007 (1,553 and 1,576). Equivalent levels in the Dow are 15,542 and 14,198.

potential2014path

Just for reference 2013 ended the year at 1,849. Thus the official up 10% mark for the year would come into play right around 2,035. That is only 75 points or ~3.8% from current levels. Aside from the correction in January/February the big caps have essentially been running for almost 5 months now. Seasonally the market tends to show weakness between May and  October so a correction of some degree should occur over the summer. I have taken note that the Dow is having a tremendous amount of difficulty with 17,000 and the S&P 500 is approaching its own round # at 2,000.

What are the odds that we get a third straight stronger than normal second year of the Presidential Cycle? Not very good in my view. Also worth noting is that dating back to 1962 there has been a correction of at least 8% in the second year of every Presidential Election Cycle. We haven’t seen it yet and we are now in July. Between July and October would be the optimal time period for this to occur.

Another observation is that while there was a nasty correction in techs and small caps from March to May the large caps held up quite well. Should techs and small caps get hit again I don’t think the big caps will be able to continue running against the tide.

 

2:50pm CST

Here is an update from Tom McClellan on the “only chart that matters”. Essentially QE is driving the stock market higher and in my view the gap between where the stock market is relative to the true underlying economic fundamentals is the biggest it has been since 1999-2000.

http://www.financialsense.com/contributors/tom-mcclellan/still-only-chart-that-matters

I continue to believe that the Fed will end QE by the end of the year (likely September or October) and the anticipation of this transition will lead to the biggest correction in the equity market in at least 18 months. How the Fed reacts to that correction will be key.

 

 

 

 

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