Technical Analysis
There will not be a Weekly Market Technical Outlook post this week. I am visiting family and have not had the time or ability to write the post. I will be back later this week with content and there will definitely be a Market Technical Outlook post next week.
Have a Happy New Year!
Today I want to look at the three major asset classes, bonds ($USB), equities ($SPX), and commodities ($GSG) and how they can help us better understand where we are in the business cycle. John Murphy in his book Trading Intermarket Analysis does a great job at highlighting the relationship between these three asset classes and how they function during the business cycle.
Murphy references the following chart of the business cycle and shows that depending on what stage of the cycle we are in, the assets perform differently. Based on this, and I’ll show the chart further down in the post, it appears we may be entering stage four. I’ll explain why later. Here’s how Murphy describes the cycle, ” The business cycle is shown as a sine wave. The first three stages are part of an economic contraction (weakening, bottoming, strengthening). Stage 3 shows the economy in a contraction phase, but strengthening after a bottom. As the sine wave crosses the center line, the economy moves from contraction to the three phases of economic expansion (strengthening, topping and weakening). ”
Before we look at the current market, lets take a look at previous market peaks (no I’m not calling for a market top, keep reading). As Murphy describes, during a normal cycle we will see bond prices top out first and begin a down trend, followed by stocks with commodities being the last to weaken. This is how things played in 2000. As the chart below shows, the top panel is the 30-year Treasury Bond ($USB) which broke its up trend in late 1998 with equities ($SPX) topping out in 2000, followed by commodities ($GSG) in the bottom in early 2001.
Next up we have the market peak in 2007. Price action played out slightly differently leading up the economic cycle peak. While bond prices put in their low in 2004 we began seeing lower highs and higher llows from 2005 through 2007. Equities followed by peaking in 2007 and commodities ultimately toppled over in 2008.
So how do things look now? Not too bad. All three asset classes are still in their up trends; however, bonds are well off their highs. The 30-year Treasury bond appears to have potentially topped out last year as it starts to threaten its trend line off the 2007 and 2011 lows. Commodities, while not a great performer during the current bull market, are still in an up trend. And of course equities continue to make higher highs and higher lows with plenty of space between price and its trend line.
This is why I think we may be getting close to stage four in the business cycle. It’s possible we see bonds break their up trend in 2014 and light the match for economic contraction and ultimately a peak in equity prices. But it’s important to remember that the time between the peak in bonds and the top in equities can be years. Look back at the first chart, Treasury’s hit their high nearly two years before equities topped out.
While each market period is unique and involves different forces and economic environments, I think it’s important to watch these three assets and how they are related to one another. Based on the above chart it seems we are still in expansion phase of the economy and the market. I’ll be watching how things progress as we kick off 2014 and how these three assets perform.
Source: Intermarket Analysis (stockcharts.com)
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Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.
So we got the Taper. Many traders believe that’s the only sentence we would need in evaluating the market right now. All that’s apparently mattered has been the Fed and they have finally begun to ease off the gas pedal. Many expected, myself included, that equities would sell-off on the news of the Fed tapering their bond buying program. This acts as a great example of when the consensus is this strong, the market moves the other way. In this case we saw equities head higher. With that, lets dig into this week’s Technical Market Outlook.
Equity Trend
The S&P 500 ($SPX) continues to look good with the up trend still intact. We hit a new 52-week high on Friday with traders reacting favorably to the Fed’s taper announcement. The major indices (Russell 2000, Dow Jones Industrial, Dow Jones Transport, Nasdaq, S&P 500, and EAFE) all finished the week above their short-term (20-day), intermediate (50-day), and long-term (200-day) moving averages.
Emerging Markets
While the above mentioned indices look favorable, emerging markets have been struggling. Below is a weekly chart of the iShares MSCI Emerging Market ETF ($EEM). I last discussed this chart in October and mentioned the levels of resistance that emerging market bulls needed to break. Since then we have tested both resistance levels, both of which failed. $EEM is now back at its 200-week moving average with Friday’s close resting a few cents under the level of support. The previous low was at $40 and we’ll see if trading this week takes us back to this level and if buyers are able to step back in to stop the bleeding.
Equity Breadth
In a previous Weekly Technical Market Outlook I noted I was watching the 60% level for the percentage of stocks above their 200-day moving average (bottom panel of the chart). Last week we saw a test and slight break of 60%, however we closed the week back above and finished at 63.7%.
In both breadth metrics, the Advance-Decline line and the percentage of stocks above their 200-MA, a short-term divergence is taking place as the equity market hits new highs and breadth has been unable to confirm. I’ve put a red dotted line to show the divergences on the chart below. I’m more concerned with what’s taking place in the Advance-Decline line since it’s helped confirm the up trend for the better part of 2013 while the % above 200-MA has diverged since May. If we see the S&P 500 ($SPX) continue to rise this week then I’ll be watching to see if the advance-decline line can at least takeout its November high to show some level of positive equity participation.
Momentum
It seems the theme for the last several months has been for the equity market to hit a new high and momentum to diverge. This theme continued to play out last week as well. We saw the S&P hit a new high and the Relative Strength Index (RSI) make another lower high. Divergences are also taking place in our two other momentum indicators – MACD and Money Flow Index.
S&P 500 60-Minute
Wednesday’s Fed taper announcement pushed the equity market above our short-term resistance level. While price action was strong, the MACD histogram (bottom panel of the chart) began to make lower highs as it diverged from price. Although this is slightly concerning on the short-term chart, we did see confirmation in RSI (top panel of the chart) as traders pushed the momentum indicator above 70 – showing a strong sign of bullishness. If the divergence in the MACD histogram does in fact win out I’ll be watching the previous resistance level of 1810 and see if it can hold up as potential support.
Last Week’s Sector Performance
Industrials moved into the top spot last week as traders continued the ‘risk on’ rally. Materials also put in a good week after being the second strongest sector two weeks ago. Utilities continued to lag.
Year-to-Date Sector Performance
No change to YTD sector leadership last week, consumer discretionary (cyclicals), health care, and industrials continue to lead the pack. While utilities, materials, and technology are still the weakest performers for 2013.
Sentiment
My friend Ryan Detrick, who I mentioned last week on the blog as well, is the Senior Technical Strategist at Schaeffer’s Investment Research and put up an interesting chart of short interest on his Tumbr page. The folks at Schaeffer’s spend a lot of time looking through a contrarian lens when doing their analysis of the stock market. Signs of large short interest is viewed positively since this is essentially built-in buyers for a market or individual stock. Last week Ryan discussed two charts of Total Short Interest, one of those charts is below (the other was for QQQ and can be found here). What’s surprising is the fact that while the S&P has been rising, so has the level of short interest. Ryan notes that normally we don’t see short interest this high except at market bottoms – not new 52-week highs! As the chart shows, the two previous times we saw short interest this high was at the 2011 and 2012 S&P 500 lows. Ryan makes the argument that the potential short-squeeze could provide the fuel to send equity prices higher.
Major Events This Week
Not a lot of news coming out this week and it’s to be expected that volume will be relatively low as traders take time off for the Christmas holiday.
Monday: Chicago Fed National Activity
Tuesday: Durable Goods Orders and New Home Sales
Wednesday: Christmas (U.S. markets closed)
Thursday: Jobless Claims
Friday: None
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Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.
Many of you are familiar with the event that took place in 1987, now known as Black Monday, when stock markets across the globe crashed. The CBOE credits the 1987 drop with waking investors up to the idea of market crashes and how we view ‘tail risk’ within the options market. The most common tool used to measure fear in the options market is the Volatility Index ($VIX). The $VIX measures the implied volatility of the S&P 500 over the next 30-days. When the $VIX is low, it’s perceived that traders have become complacent, meaning they are not fearful of a market correction over the next 30-days.
While the $VIX measures ‘likely’ moves within one standard deviation for the S&P, it does not capture what traders are pricing in for ‘tail risk’ or 2 to 3 standard deviation returns below the mean. This is where the Skew Index comes in. Skew measures pricing activity for out-of-the-money options. A trader who expects an abnormally large swing in the equity market could use these out-of-the-money option contracts to hedge or profit from the move. Large institutions make up the bulk of the options market, which can imply that the Skew Index is a way to measure institutional fear of tail risk.
If this is true, then it appears institutions have begun growing increasingly fearful of a subnormal swing in the market. Below is a chart of the Skew Index, with the S&P 500 ($SPX) on the top panel and the Volatility Index ($VIX) on the bottom panel. I’ve put a dotted blue line on the Skew chart to show the current level, as you can see over the last 15 years we’ve only had investors this fearful of tail risk one previous time – March of last year.
It’s interesting to note that while the Vix has fallen to a historically low-level, indicating the market has become somewhat complacent, large investors are showing an increase in the fear of tail risk within the S&P 500.
If you spend time looking more closely at the above chart and the previous high levels in the Skew Index, you’ll notice they often come during short-term market peaks. What’s interesting to note however is that the 2000 and 2007 highs both were put in with low levels in Skew and the Vix. As I’ve stated in previous posts, seasonality right now is bullish, but this large move in institutional fear is interesting and something I’ll be watching in concert with other market internals going forward.
You can learn more about the Skew here: Introduction to CBOE SKEW Index (CBOE)
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Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.
I stand here conflicted. The chart setup I’m going to discuss today has led to lower prices each time it’s occurred since 2007 but seasonality and Fed actions appear to favor the bulls. Before we get into it let me say that this is not some magical chart pattern and like everything in the market, nothing works 100% of the time. That’s a critical concept to understand when it comes to technical analysis… perfection does not exist. Now that we’ve gotten that out of the way, lets talk about the slope of the S&P 500.
On October 18th last year I wrote a post called “What The Slope of Equities is Telling Us.” I showed the chart below and discussed the implications it could have on the equity market. This was right before the short correction we had that bottomed in November and lead to the strong rally that’s lasted essentially all of 2013. The setup I’m talking about is the slope of the S&P 500 ($SPX) on a weekly basis. The slope can be used to measure the strength of a trend by looking at the price action over the last 52 weeks. As the chart shows, when slope falls under its 13-week exponential moving average over the last six years, its lead to drops in equity prices. Going forward I’ll be watching to see if slope strengthens and can get back above its EMA (although that hasn’t been the case for the past four occurrences) or if price starts to follow its slope and heads lower.
But let me say this, I am not using slope to call for a top in the stock market. As you can see, in ’07 and ’09 slope fell under its 13-week EMA a few weeks before a long-term (’07) and shorter-term (’09) top was put in. With slope failing to hold above its EMA as of last week, we know that the strength of the trend is degrading.
We must now take this into account with the other information that we have, such as seasonality, breadth, and momentum. Seasonality going into year-end is bullish. Ryan Detrick, the Sr. Technical Strategist at Schaeffer’s Investment Research has been tweeted about this all month (he’s a great follow by the way). I’ve discussed the divergence taking place in momentum in my Weekly Technical Outlook as well as the early warning signs for breadth.
We also can’t forget about the Fed! We get the FOMC announcement this afternoon. Equities are likely to continue taking their cues from the Fed, whether we get the taper announced today or not. No taper would probably be bullish and visa versa. I’m firmly in the camp that we don’t see the taper announced today, but we’ll see what happens this afternoon.
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Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.