November 2017 – Andrew Thrasher

Large Cap Stocks Versus Everything Else

Posted on November 29, 2017 by Andrew Thrasher, CMT

I’ve said it numerous times in the last few months, 2017 has been the year of setting records. No one said that trading or investing was supposed to be easy. Albeit some have had the false belief that it is drape around them like a warm blanket during the low volatility year we’ve had. Bitcoins have shot up hundreds of percent, U.S. stocks have refused to put in a material decline and we continue to dance as long as the music keeps playing.

One chart that’s continued to draw my attention and fascination is the strength of large cap stocks versus…. well, just about anything else.

This isn’t the first year by any means that we’ve seen focused strength within the market. Just a few years ago in 2013 if you tried to diversify away from U.S. large or small cap stocks you were penalized. Large cap growth was up 33.5% and small caps rose nearly 40%. Even though other markets had a good year, if you went international you underperformed w/ EAFE gaining just 22%, a “diversified” portfolio rose 20% and heaven forbid you owned bonds, which lost 2% that year. (figures from BlackRock). So a year of large cap strength isn’t anything new and shouldn’t cause too much surprise. But it has because we’ve seen a break from commonly health market believes about relative performance and risk-taking

Turning our attention back to this year and more specifically the last two months. The S&P 500, a cap-weighted index of U.S. stocks has continued to hit new highs as the index most recently moved through 2,600. Meanwhile, many of the other indices that often show positive notes of risk taking have been unable to keep up.

When large caps do well typically the smaller, higher beta/riskier stocks do even better, which we would see in the equal-weighted S&P 500 (RSP) outperforming the cap-weighted $SPX. That hasn’t been the case for the bulk of 2017.

What about high yield bonds? If stocks are doing well then junk bonds should be outperforming aggregate bonds right? Not for the last two months.

How about high beta stocks? When the U.S. stock market are hitting fresh highs and investors are ratcheting up risk then high beta stocks should see strength relative to the index…. not for the last two months, no.

Well if large cap stocks are trending higher then small caps surely are doing even better, because everyone knows that small caps outperform large caps in strong up trends don’t they? Historically yes, but not for the last two months.

As a technician and a follower of price supply and demand I find this truly interesting. The market never ceases to amaze.

But is this a concern? yes and no.

When we dig into the internals of the market and look at the breadth of U.S. equities we still have broad participation in the up trend. The various measures of the Advance-Decline Line are still showing confirmation, which means the majority of stocks are still rising – just not as much as the largest of the large caps. As Ari Wald, CMT of Oppenheimer notes with a chart shared by Josh Brown, “Value Line Geometric index, an equal-weighted aggregate of approximately 1,700 companies, has broken above secular resistance dating back to the year 2000.” Many international markets are still in up trends, we continue to see some degree of sector rotation within U.S. equities, a good sign that the baton is being kept off the ground for the current up trend.

So what’s the takeaway? I think there’s a couple points to draw from the chart above. First, understanding that blindly assuming that if the S&P is doing one thing then X,Y,Z, should also be occurring (i.e. high yield, small cap, high beta outperformaning). Being adaptive to the market environments and the ebbs and flows that come with each year is critical to active management within equities. Second, for the up trend to continue it would really be nice to see these divergences in relative performance resolve themselves. As we’ve seen with sector rotation, strength rotating to these other barometers of risk-taking would be welcomed by many market bulls.

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.

A Week in Review: Volatility, Momentum, Breadth, Sectors, Taxes & Sentiment 11/20/2017

Posted on November 20, 2017 by Andrew Thrasher, CMT

As we move into a holiday-shortened week, here are the charts and articles I think worth sharing on this Monday morning. Hope you enjoy and have a Happy Thanksgiving!

Volatility Index
For only the third time this year, momentum for the Volatility Index reached ‘overbought’ levels with the RSI indicator climbing above 70 before volatility reversed back lower, finishing the weak just under 12.

Volatility Streak Below 20
A great deal of attention has been paid to the low-level of Volatility this year. If you’ve followed me on social media, read my Charles Dow paper, or blog posts then you know my feeling on low volatility being useful. While interesting, the predictive value is well overblown. However, I think it’s interesting that while so much focus has been paid to the recording setting low levels, we’ve yet to exceed the prior records of the VIX being sub-20 as shown from this chart from @VIXContango. In fact, the VIX didn’t break above 20 the entire year in 2005, stretching 558 days of “low” volatility.

Momentum of NYSE Breadth
While many traders often view momentum and breadth in two difference lenses, a viewpoint can also be obtained by looking at the momentum of breadth, which is what this chart shows. Below is the Relative Strength Index (RSI) indicator, a measure of breadth, for the NYSE Advance-Decline Line. The slight dip in equity prices we saw last week sent the Adv-Dec line’s momentum down to prior lows which have acted as support this year. Breadth, along with large-cap equities, have since bounced after this support test in momentum held strong.

Market Reaction to Tax Cuts
As Congress continues to progress in seeking to pass a tax cut bill, the focus of Wall Street is on the implications of the cut and whether it will stimulative for the economy and what the market’s reaction will be. Historically, the market’s had a below par performance in the years following tax cuts when looking at the past five instances. Bloomberg notes, “Looking at the S&P 500’s performance during the year before previous tax cuts, the market returned more profit than during the year following the bill signing. That applied to returns before and after tax bills signed by Presidents Lyndon Johnson (thought up under Kennedy’s tenure), Ronald Reagan and George W. Bush. The only time this wasn’t the case was following President Bush’s second bill attempt in 2003, when the market performed better after it was signed into law.”

Sector Relative Rotation
While equity indices saw a dip last week we do have some noticeable improvements in several sectors relative rotations. Tech, Materials, Financials and Energy all saw positive moves in the ‘leading’ category. While Consumer Discretionary moved higher, inching closer to the ‘improving’ quadrant. Health Care and Utilities continued their decline, with $XLV moving closer to the ‘lagging’ category.

Average Relative Strength Index for the S&P 500
With some selling flowing into stocks recently, we haven’t really seen much ground given up in momentum compared to the other mini-declines over the last twelve months. Below is a chart of the percentage of S&P 500 stocks with a 50-day Relative Strength Index (RSI) that was below 30, the often used level of being ‘oversold.’ At the tool’s highest point over the last week, the % didn’t even break 25% of S&P stocks being ‘oversold’ compared to prior recent declines getting above 35-40%. While each dip has been at varying severities, it’s worth noting the resiliency of momentum by traders holding up the bulk of the large cap equities.

Tech Sector Drives Q3 Earnings Growth
As has been the case for equities as a whole for large chunks of this year, just a few tech names have driven the bulk of the earnings growth in the third quarter. With most of the S&P 500 stocks having reported earnings, the index saw YOY growth of 7%. The Financial Times reports that “Outside of the energy sector, which is still recovering from the oil collapse in 2014, the technology sector has posted the best performance by far. Tech sector earnings grew 22 per cent, double the rate that analysts forecast. The industry as a whole has accounted for 90 per cent of the S&P 500 earnings beat rate. Perhaps more impressive, though, is that the four largest tech groups — Apple, Alphabet, Microsoft and Facebook — have driven half of the S&P 500 beat.”

Uptick in Risk Taking
This chart got passed around quite a bit last week. It shows the results of a BofAML survey of fund managers and shows the percentage that responding to a question regarding the level of risk they are taking within their portfolios. With results going back to 2001, a net 49% of fund managers who are taking higher than normal risk has moved to a record high, surpassing the prior high set in 2015. The survey, as sourced by Bloomberg, notes “a mini rotation out of banks, though investors remain overweight the sector, in favor of laggard energy names and Japanese equities.”

Yield Curve Flattening May Be Bullish For Stocks
I’ve shared a chart of the yield curve and the relative performance of the financial sector throughout this year, showing that the financials often follow the direction of the curve, which often has been a headwind for the sector’s relative performance. Ari Ward, CMT, Head of Technical Analysis at Oppenheimer, shared on CNBC that the flattening curve may in fact be bullish for equities as a whole. In a recent CNBC interview Ari said “how we measure it, the S&P 500 has averaged a 16.5 percent gain over the next 12 months based on the current level and direction going back 40 years of history.”

Record Setting Year for Global Equities
In a thanksgiving-themed article, Jeffrey Kleintop, CFA, the Chief Global Investment Strategist of Charles Schwab shared five reasons investors should be thankful this year. One of the charts Jeffrey posted is below, which shows the running streak of positive monthly returns for global stocks, noting this is the first in 30 years every month has been in the green.

A Decline in Equity Shorts
Binky Chadha, Deutsche Bank’s chief strategist, posted this chart as mentioned in a Business Insider article of the aggregate short position in stocks declining to the lower end of its range. While the market on average sees a 2-3% pullback every two to three months Chadha shared, 2017 has been anything but average. While we’ve yet to see any major declines in U.S. equity indices, traders do not appear to be overly concerned as they appear to be holding few hedges or short positions in equities, ETFs, or futures.

Your Time Frame Dictates Your View Point
Morgan Housel is one of my favorite writers and I make sure to never miss a post he puts out – always getting a solid takeaway from what he shares. In Morgan’s recent piece “We’re All Innocently Out of Touch” he discusses that how the market performed in your early years often has a large impact on how you view it going forward, sharing the chart below, which shows the total return of the equities in the U.S. or Japan at various starting points. While the whole article is well worth a read, here’s one of the points Morgan makes, “One quote from the study stuck out to me: “Current [investment] beliefs depend on the realizations experienced in the past.” That’s powerful. Think of the arguments we deal with in investing – over valuation, over expected returns, over moats, over bubbles. Two people with the same education and same data can think bitcoin is either the next tulip or the next internet. The whole reason markets work are because these gaps in opinion exist.” I believe this very much accounts for a great deal of the current market opinions floating around out there and why there’s a growing dichotomy of bulls and bears for U.S. equities.

Growing Spread in Performance for REITS

REITs are also show the growing spread in performance between brick and mortar retail and e-commerce,

“The chart below shows real estate tied to e-commerce continues to have a spectacular year. Data Center and Warehouse REITS are +33% and +24.6% on the year, respectively. Meanwhile, Mall REITs have stabilized but not yet seen a material recovery. Regional mall REITs are -9.6% on the year, shopping center REITs -13.2%.: according to Bianco Research.

The FANG Stocks May Be Shifting In Several Indices
The much beloved FANG stocks may be seeing a shift in their allocations for several major indices, “S&P Global Inc. and MSCI Inc., two of the world’s biggest index providers, plan to overhaul their industry classifications, merging some internet and media stocks with phone companies into a group called “communication services.” It would replace the existing telecommunication sector.” The Bloomberg article notes that Google and Facebook may be leaving the tech industry and Amazon and Netflix may be moving from consumer discretionary to the internet and direct retail marketing category.

Near Record Setting October Temperatures
It seems we are experiencing ‘record’ high temperatures throughout the last few years these past couple of years. NASA, as recorded by MentalFloss, calculated that October of this year was the second hottest on record, “After an unseasonably toasty October, the numbers are in: Temperatures exceeded averages across the globe last month, making it the second-hottest October ever recorded, according to NASA.”

You May Reconsider Your International Overweight
A great post by Newfound Research highlights some considerations that many asset managers may not be taking into account with the global weighting of their portfolios. Evaluating foreign markets may not be a fair apples-to-apples comparison as they have different factors that greatly impact their economy’s growth, valuation, and financial markets.

How Overconfidence Can Wreck Havoc
Nick Maggiulli of the blog Dollars and Sense shared a good point recently with a story of how different aged children have varying success rates of survival when alone in the woods, with younger children capitalizing on their lack of knowledge. Nick discusses how this translates well into financial matters as well, where overconfidence can have a potentially large negative impact on decision-making.

More Americans Hit the Road This Thanksgiving
With nearly 51 Americans traveling for the holiday, Bloomberg reports that “U.S. Thanksgiving travel will jump to the highest level since 2005 boosted by a stronger economy, even as gasoline prices will be higher than a year earlier.”

Off-Topic

Emirates airline offers new £7,000 first class suites on new planes
“Featuring floor-to-ceiling sliding doors for maximum solitude, most of the suites also provide a window view which can be enjoyed with a personal pair of binoculars. […] Customers can video-call the crew for service requests without leaving the comfort of their suite, and crew can serve drinks and canapes through a special service window without disturbing passengers.”

Millennials Love Cold Brew
As a millennial myself, I can vouch for this article as a fellow cold brew fan. Oddly enough, I personally don’t like the taste of traditional hot coffee but do enjoy cold brew. The WSJ reports that “U.S. retail sales of refrigerated ready-to-drink coffee rose 29% in the 52 weeks ended Sept. 10 to more than $289 million, according to market researcher IRI.”

Carving a Turkey
I personally take great pride in my turkey carving abilities, carving up one this past Sunday in fact at a party among friends, but if you need a reminder on how to carve a bird this Thanksgiving, this video by Bon Appetite does a great job on how to breakdown a big bird.

A Week in Review: Volatility, Momentum, Breadth, Sectors, Sentiment, Bonds, & Consumer Spending 11/13/17

Posted on November 13, 2017 by Andrew Thrasher, CMT

Market & Volatility Overview
U.S. markets saw a slight dip in equities last week, something that we haven’t seen very often in 2017. The S&P 500 finished 0.21% lower, the Dow fell 0.5%, Small Caps declined 1.37%, and EAFE closed lower by 0.74%. While stocks were in the red for the week, the large cap indices remain above key support levels. In last week’s note I shared my Volatility Index model, noting that it was calling for a rise in the $VIX, which did end up rising nearly 27% to an intra-week high of 12.19, still well below its historical average but a few points off its recent all-time low that was set just two weeks ago. While spikes in spot $VIX have been fairly rare in the last ten months, I have shared my model a few times this year on the blog, in January before $VIX rose 26% in two days and in June nine days before the massive 50% intraday spike in volatility.

Below are some of the charts, stories, and pieces of data I found of interest over the last week…..

S&P 500 Daily
While it seems we get an overreach on social media and financial news outlets on any kind of weakness in stocks since markets have been so strong this year, even if it’s just lasted two days (so far). The S&P 500 has dipped down to its 20-day Moving Average, which is normal price action and not something to cause severe panic. We’ve seen several moves to at least the 50-day Moving Average earlier this year, and the index is still well above that intermediate-term support level. Looking at volume of the two-day dip it was well below the high we’ve seen in November alone, much less YTD. Focusing on daily momentum with the Relative Strength Index (RSI) in the top panel of the chart we saw a lower high but the RSI still is coming off of being ‘overbought’ which in my opinion disqualifies the labeling of a bearish divergence. In my opinion, a bearish momentum divergence holds more significance when the lower high occurs under 70. Could stocks go lower? Of Course. There’s plenty of things the equity bears could point to that could be catalysts for equities to continue lower, but as of Friday’s close we have just a short-term two-day dip that’s hardly fear-inducing.

Short-Term Bullish Price Pattern
According to Larry William’s book, Long-Term Secrets to Short-Term Trading, the last two days in the S&P 500 have set up a pattern to send the index higher. This chart, shared by @Time-Price-Research, shows the outside price bar followed by an inside day, meaning two days ago price trade above the prior day’s high and below the prior day’s low followed by Friday’s move of having its high and low inside the trading range of Thursday. Williams notes an 85% chance of price moving higher following this pattern according to his research.

Volatility Advances Higher
According to the CBOE, a majority of the Volatility measures moved higher last week. Four exceptions include the VIX for Apple and Amazon as well as the VIX for the Euro and Interest Rate Swaps. The largest percent change of the VIX measurements was the short-term and EFA Indices, rising 31.5% and 24.6%, respectively.

Performance Regimes for Short-Volatility ETNs
The one trade that’s received probably the most attention this year has been short volatility, often through the XIV ETN. Brent Osachoff of The Volatility Advisor, broke down the performance of XIV since its inception based on VIX percentile, noting “The 20-40% quintile and the 40-60% quintile are by far and away the best sub sections of the volatility market when it comes to the inverse volatility ETPs.” This shows that the absolute level of the Volatility Index is less important as a factor for volatility investing than many would have you believe – something I’ve been pounding the table about on this blog and social media.

Deteriorating Market Breadth
Market breadth has often been dismissed this year as equity markets have remained resilient in their advance. However, I still believe that breadth, a measure of broad market trend participation, is important to keep an eye on. We’ve seen several divergences in 2017 that have led to either minor declines that have quickly reversed or have just been straight out ignored. Below is a chart of the S&P 500 in the top panel and the 5-day average of new highs minus new lows on the NYSE. By looking at the one week average of this indicator we’re able to see a more smoothed version that is less volatile to single day swings. Over the last twelve months there’s been a series of higher highs as well as lower highs in this data set. Most recently we saw a peak in October of highs minus lows as fewer stocks were hitting new highs compared to the number hitting new lows in price – all while the S&P 500 marched higher, relying on just a few select stocks to continue to propel its advance. I believe this type of information is important but less so on its own and more so in concert with other pieces of market-related data.

As I noted earlier, momentum has not diverged – if it had, then the combination of diverging breadth and momentum would be more significant of a warning sign than breadth alone.

Stock Gains Since the Election
Last week saw the one year mark since the 2016 election, with many stocks seeing solid gains over the last twelve months. Bespoke Investment Group put together a great table showing the largest market gap gainers, noting that six companies alone added more than $100 billion in market cap to the S&P 500. Apple, Microsoft, Google, Amazon, and Facebook make the top five with the largest increase in their respective market caps.

More Gains Could be In Store For Stocks
Each Saturday Callum Thomas does an excellent job curating ten charts. One that stood out to me this week was this chart showing the average market performance before and after a market peaks. If the ‘market crash’ bears are right, and we do see a market peak within the next twelve months then history shows we could see some solid gains between now and then.

High Yield Divergence
One concern some traders have about the market recently has been the divergence between equities and high yield bonds. Steve Deppe put together a table showing previous instances where the S&P 500 was at an all-time high while the High Yield ETF (HYG) closed under its 50-day Moving Average. Historically the S&P has struggled when this divergence has occurred with average negative returns up to 20-days later.

5-year Treasury COT
Commercial Traders have been aggressively buying up 5-year Treasury bonds. The net-position of Commercial Traders has been hitting highs for the last couple of weeks as the 5-year bonds remain relatively flat in trading over the previous three weeks.

Sector Relative Rotation
The energy sector continues to make improvement in its trend of relative performance, just a few points shy of moving into the ‘leading’ category. The four sectors in the ‘lagging’ category (XLP, XLY, VNQ, XLU) pushed deeper into the red with the remaining defensive sector, health care, working its way closer from ‘weakening’ towards ‘lagging’ as investors risk appetite remains with the higher beta sectors.

Sector Correlation
The top two sectors most highly correlated over the last 20 days to the S&P 500 remain Technology and Utilities. REITs moved to being positively correlated as Industrials shifted to negative, joining Health Care and Consumer Staples.

Equity Outflows
One odd event that’s been taking place recently has been the outflows from the S&P 500 ETF (SPY) while equities continue to hit new highs. This great chart from SentimentTrader shows the number of days SPY saw outflows while the ETF was at a 1-year high over the previous 50 days. We’ve now seen 11 days of outflows, Jason Goepfert notes “Over the past 20 years, this now ranks as the 2nd largest cluster of new highs with an outflow, next to the largest cluster from February 2011. There have been a handful of other times when it reached 10 days, most of them since the 2009 low. Prior to 2007, it was even more rare, likely because there were fewer competitors to SPY compared to what we see today.”

A 700 Study Forecasts Higher Interest Rates
One research from the Bank of England and Harvard University produced a study looking at interest rates going back to 1311. Paul Schmelzing notes that the current down trend is the second longest in the last 700 years. Most notable in his research as cited by Bloomberg is the potential for a quick reversal; “Be prepared though. The data show most reversals of real-rate stagnation periods have been rapid and non-linear. Within 24-months after hitting their troughs in the cycle, rates gained on average 315 basis points, with two occasions showing appreciations of more than 600 basis points, Schmelzing says”

High Yield is no longer that ‘high of a Yield in Europe
As government bonds continue to trade with negative yields throughout large parts of Europe, high yield debt has also been experiencing a decline as investors chase after anything that at least is above zero. Using the CS High Yield Index, the yield on European junk debt is now just 1.95%, hardly what many bond investors would label as ‘high yield.’

And it’s not just the (believed to be) secure debt in Europe that’s experienced a large drop in yield. Greece, who just a few years ago was on the brink of bankruptcy and has required several bailouts has seen its 10-year Yield decline as well – falling from over 18% in 2015 to barely above 5% today.

Christmas Shopping Expectations
Based on a recent poll conducted by Gallup, American consumers are expecting to spend more this holiday season than previous years, surpassing the prior spending average high set in before the financial crisis. Gallup notes, ” That represents one of the biggest year-over-year increases in Gallup’s trend, pushing the spending projection to its highest level in a decade.”
Gallup also found that for the first time in over twenty years, a record low 16% of American shoppers plan to spend less this year than last, the first time since 190 that more consumers planned to up their spending than lower it.

Google Will Be Watching Where you Eat!
If the major tech companies didn’t already have enough personal information of its users, Google will now be able to estimate wait times at restaurants based on user data. (Gizmodo)

Have Bitcoins become an alternative energy source?
CNBC reports that two Russians have begun to rely on their bitcoin servers in order to provide heat for their house. (CNBC)

Isaac Newton learned a financial lesson like many investors after him – the hard way
Jason Zweig wrote a great piece spotlighting the history of the South Sea Bubble and Isaac Newton’s involvement in investing in the stock that ultimately lead to a 70+% loss. (Wall Street Journal)

A $25 Billion Day for Alibaba
This past Saturday was Singles Day in China, similar to American Black Friday and Cyber Monday shopping days. The online retailer hit a new record in gross revenue, making a reported $1 billion in its first two minutes. (The Street)

Rome turns to tourist attractions for revenue
As the struggling Italian city tries to scrape as much revenue together as possible, the Roman city will potentially turn to the Trevi Fountain as a cash source. Previously the coins tossed in the fountain by locals and tourists were given to charities, but as hard times continue to hit Italy that may change, with the fountain collecting millions of euros each year. (The Local)

Millennials prefer bitcoins to stocks
According to a survey conducted by a bitcoin firm, millennials may have a preference for the cryptocurrency over traditional investment holdings. The survey found that 30% of respondents would rather own bitcoins than stocks or bonds (Bloomberg)

Money lessons from a wealthy man you’ve probably never heard of
Do you know who Jacob Fugger is? Me either. But he’s apparently was a German banker and the wealthiest man to have ever lived, with a $400 billion net worth. This article shares seven of the lessons learned from his time.(MarketWatch)

Off-Topic

Champagne taste-tester
If the whole trading thing doesn’t work out, I don’t think I’d mind be a champagne taste-tester. Moet & Chandon’s wine quality manager tastes up to 50 wines each day. (Southern China Morning Post)

Voice-enabled speakers will be in half of households by 2022
In the next five years, according to a report from Jupiter Research, 70 million households will have a voice-enabled speaker like Google Home and Amazon’s Echo. (Techcrunch)

All-electric super car
If this is where all-electric vehicles are headed, then I’m going to be a big fan. This is Lamborghini’s latest prototype, the terzo-millennio.

A Week in Review: Important Charts, Performance, & Interesting Stories 11/6/17

Posted on November 6, 2017 by Andrew Thrasher, CMT

The record-setting by U.S. equities continued last week, with the S&P 500 finishing its eight consecutive weekly positive close, the longest streak since 2013. S&P finished the week up 0.26%, the Dow up 0.45%, Nasdaq up 0.74%, the Russell 2000 down 0.79%, and International markets (EFA) up 0.90%. Now lets look at some of the market data, charts, and news stories I believe to be of some importance or significance going into this week….

November Seasonality
Jeff Hirsch, editor of the Stock Trader’s Almanac, shared the following chart for the Dow, S&P, Nasdaq, R1K, and R2K and their respective 21-year market performance during the month of November. As you can see, the month has historically been bullish for equities, although it typically seen an early-month dip before finishing higher. Hirsch notes, “November maintains its status among the top performing months as fourth-quarter cash inflows from institutions drive November to lead the best consecutive three-month span November-January.” “In post-election years, November’s market prowess is relatively unchanged. DJIA has advanced in 13 of the last 16 post-election years since 1953 with an average gain of 1.8%. DJIA has been up 10-straight post-election year November’s. S&P 500 has been up in 12 of the past 16 post-election years.”

Market Performance Following a new Fed Chair
Last week President Trump put forward his nomination for the next Fed Chair, Jerome Powell. Ryan Detrick, Senior Market Strategist for LPL Financial, ran the numbers for the market’s performance following a new leader of the Federal Reserve. According to Ryan’s research, the market has typically been higher 1-, 3-, and 6-months later but with muted gains compared to the market’s average performance.

Sector Relative Rotation
Last week experienced several improvements in a few of the S&P sectors. Notably, Industrials, Materials, Financials, and Tech moved further into the ‘leading’ category while Energy continues its trend from ‘Improving’ to ‘Leading.’ Utilities have now moved into the ‘Lagging’ category, joining REITs, Consumer Staples, and Consumer Discretionary. To learn more about RRG charts go here.

Sector Correlation
Looking at the 20-day correlation of the S&P sectors, Tech and Utilities moved up to be the most correlation sectors with the overall S&P 500 index. Health Care and REITs have now joined Consumer Staples as being negatively correlated with the index.

Best & Worst Performing Stock Last Week
Here are the top five and bottom five S&P 500 stocks last week.

Round Numbers on the S&P 500
I found this chart from Urban Carmel pretty interesting, it shows the S&P’s reaction to each round number milestone during its climb from 1500 through today. This could potentially be important as we are just a few points away from reaching 2600. As Urban’s chart shows, when the equity index first approaches or reaches a new round number during its multi-year up trend, its first put in a short-term pull back as the market digests recent gains. Commentators often put an over-significant to these round numbers, more so as it pertains to the Dow but nonetheless, seeing how prices react to certain levels it deems important is noteworthy.

Bitcoin’s Assent
Speaking of round number mile-markers, bitcoin is hitting its own at a quickening pace. While looking at the time it takes for a market or security to hit a certain level is not a fair apples-to-apples comparison, as the percentage change is obviously different with each milestone, the speed at which bitcoin has been able to rise in $1,000 increments has gone nearly parabolic – taking just four days to go from $6,000 to $7,000. (Bloomberg)

Stock Market Participation
Jason Goepfert, of SentimenTrader.com, shared this chart on Twitter showing the lack of confirmation in the strength of the S&P 500 based on the number of stocks trading above their respective 50-day Moving Average. In fact, Jason notes that there hasn’t been this small of a percentage of stocks trading above their intermediate-term MA when the S&P was at a new high since 1999.

New Volatility Low
Not only did the Volatility Index put in a new all-time daily and weekly closing low, several other volatility indices did too. Notably, Treasury’s and Gold. The 10-year Treasury Volatility index can be seen below, from Ezra Karhan.

Volatility Performance Last Week
While the Volatility Index made a new all-time low, there were in fact a few volatility markets that did finish out the week in positive territory.The CBOE notes that volatility for the energy sector, Russell 2000, Goldman Sachs, IBM, and Brazil all finished in the green. Also interesting to note that the VIX mid-term and 3-month measures also were positive, while 30-day volatility closed lower by 6%. It appears traders are less concerned about short-term volatility but are bidding up protection on the S&P 500 three and six months out.

Volatility Term Structure
Another view of the changes in volatility can be seen in this next chart, from VixCentral. Compared to last week, we can see the drop in front-month VIX while the rest of the curve rose modestly as we get closer to November expiration.

Volatility Model
I run several different models for the volatility market, one of each examines the current volatility environment and seeks out previous instances where the data has looked similar. Below you can see the model since ’08 and the previous times (marked by red dots) where the data points that make up the model have been at current levels as we saw on Friday. While the components of the model are proprietary, one piece is what I covered in my Charles Dow Award paper, which was a very narrow dispersion of volatility. This narrow range for the VIX has been a theme for large chunks of 2017, which is why I wrote and believe it’s best used when paired with other pieces of market data – which is what my model does. As the chart shows, volatility has risen, sometimes substantially sometimes with a minor advance, during previous occurrences of a similar environment. This, paired with many of the other topics I discuss in this week’s post, lead me to believe there’s a strong bias for the VIX to rise in the coming week or two.

Sector Short Interest
As traders grow more confident as seasonality shifts into what’s historically been the start of the best six months for equities, short-term has begun to decline across several sectors. Thanks to Callum Thomas for sharing this chart from the ETF Research Center. Short interest over the last month has declined in Consumer Discretionary, Energy, Health Care, Industrials, Materials, Technology and Utilities while remained flat in Financials and REITs and an increase in Staples. While bets on the sectors declining have lowered, the two sectors with the heaviest short interest are in the defensive camp, Consumer Staples and Utilities.

Consumer Political and Economic Sentiment Diverge
Jason Goepfert, of SentimenTrader.com also shared this chart via Twitter last week, looking at the large divergence in the U.S. Consumer’s feelings about the economy and towards the President. As we saw in the previous chart, traders have decreased their short bets for most of the equity sectors, a likely sign of growing confidence for the market and economy. That sentiment appears to be shared with the average consumer as well, based on Consumer Confidence Index which has risen steadily this year. However the positive feelings don’t crossover to the President’s approval rating which is at historic lows. It’s unusual for these two sentiment data sets to diverge like this, as many consumers attribute (falsely so) the growth or decline of an economy with the success or failure of the President. We have to go back to the tech boom/bust to find the similar example which hasn’t occurred before then since the last 1960s.

Consumer Spending Accelerates
We can see the confidence in consumer sentiment also in how they are spending their dollars,. as U.S. consumer spending rose by its largest amount in September in the last eight years. (Fox Business)

Lack of Volatility Sends Goldman For the Exit
the recent lack of volatility this year has been the last straw for Goldman Sachs, which announced it will be pullback from the derivatives market, the WSJ reports. Many banks saw revenue declines which they attributed to muted volatility. (WSJ)

ETF Fee Compression
The race by ETF providers to offer the lowest cost products has been a strong theme in 2017 and one that seems to be driving fund flows. With over $300 billion moving into equity ETFs in 2017 through September, the WSJ highlights that “Nearly 75 cents of every new dollar invested in ETFs this year targeted the cheapest funds on the market, a trend that partially highlights investors’ urge to mimic major U.S. equity benchmarks that continue to notch all-time highs. Relentless demand for the cheapest ETFs helps explain why fund companies continue to slash management fees on existing products or rush new, ultra-cheap ones to market.”

Corn COT Data
corn seasonality has historically seen its strength in the first six months of each year but typically puts in a bottom in prices around November and December. Based on the latest Commitment of Traders report, it appears Commercial Traders are making positional bets that corn will follow that seasonal trend. Commercials are currently holding one of their largest net-long positions in recent years. As the chart below shows, when the Commercial Traders have held this type of net position before, corn prices have often rallied in the following weeks/months – as we saw in 2014, 2015, and 2016.

Each week I collect some of the many interesting articles I come across. Below are the ones from the last week I think are worth sharing that may not have gotten as much attention as they should.

Momentum Strategy Strength Continues
The strength in momentum stocks has been a main market driver this year with the MSCI Momentum Index up over 30% YTD and some strategist think it may be time for them to take a breather. “But has the gap between the performance of the two indexes grown too big? MKM Partners technical analyst Jonathan Krinsky compared how big that gap is relative to its 200-day average, and found it’s at a level that often signals a peak in momentum. Sometimes it’s simply a pause—that was the case in 2005—but sometimes it can signal an impending peak, as it did in 2008. ‘Momentum names are stretched relative to the market,” Krinsky says. “But they can become more stretched.'” (Barron’s)

Tech Stocks Led the Way in October
“The technology sector accounted for more than 75 percent of the S&P 500 Index’s return in October, according to a new note from Bank of America Corp. Apple Inc., which reports earnings after the market closes Thursday, was the biggest contributor, accounting for 16 percent of the index’s climb. Microsoft Corp., Amazon.com Inc. and Intel Corp. rounded out the top four, adding an additional 39 percent, according to data compiled by Bloomberg.” (Bloomberg)

Central Bank Governor Issues Warning in China
One story I am surprised hasn’t gotten more attention is an article the head of the Chinese central bank made on Saturday. “China’s financial system is getting significantly more vulnerable due to high leverage, according to central bank governor Zhou Xiaochuan.” Zhou calls for stricter Chinese bank regulation while loosening regulations on non-Chinese financial firms. He also calls certain Chinese internet companies ‘Ponzi schemes’ and that a bubble is being formed in financial markets under the disguised as innovation. (Bloomberg)

Tech Rally Is Juiced by Highflying Cloud Business
The tech sector has been a strong leader in 2017 and many analysts expect cloud-based computing to help continue drive revenue to the major players in this space like Apple, Google, Amazon, and Microsoft, “Big Tech can generate big numbers, but it was fast growth in the cloud business that helped ignite a buying frenzy Friday that drove up market values by nearly $139 billion in 30 minutes.” (WSJ)

Quants Begin to Question Bonds Ability to Act as a Hedge
Analyst at PIMCO produced a study that leads them to believe there may be the ideal hedge as they have been in the past as correlations begin to tighten. “The old recipe of using bonds to hedge against risks from equity holdings may not be a winner anymore, and investors would be better off with a more complex approach that relies on multiple tactics, according to Pacific Investment Management Co. analysis.” (Bloomberg)

The Question of When to Sell
Most investment commentary and advice surrounds the topic of what and when to buy securities, few ever mention the more critical and often tougher trade decision to make: when to sell. This is the topic of Barry Ritholtz’s latest column “The question of when to sell is perhaps the most overlooked and underappreciated problem in finance. It’s worth bringing this up now as markets keep rising. It’s clearly on the mind of more than one investor.” (Bloomberg)

Bitcoin Futures are in the Markets Near Future
“CME Group, the US exchange operator, has announced plans to launch bitcoin futures in the latest sign of the cryptocurrency’s growing prominence in mainstream financial circles. The Chicago-based company plans to roll out the new futures contracts in the fourth quarter of this year, pending ‘relevant regulatory review periods’.” (FT)

The ‘Tulip Fever’ May Not Have Been What We Always Thought
This was a really interesting read and quite a surprise! Thanks to Wes Gray for sharing this piece. “For decades, economists have pointed to 17th-century tulipmania as a warning about the perils of the free market. Writers and historians have reveled in the absurdity of the event. The incident even provides the backdrop for the new film Tulip Fever, based on a novel of the same name by Deborah Moggach. The only problem: none of these stories are true.” (Smithsonian Magazine)

QE Didn’t End the Bull Market & Neither Will QT
Great insights shared by Urban Carmel looking at the impact had by quantitative easing and the potential (or lack there of) of quantitative tightening. “The Fed’s policies have clearly led US equities higher, but not in the way that it has been popularly perceived. The Fed established the conditions for fundamental growth in consumption, investment, employment and corporate profits, creating the confidence in investors to place their cash into the financial markets. All of these factors have a strong causal relationship to share price that long pre-date 2009 and the QE programs.” (The Fat Pitch)

The Savings Rate Continues to Decline
As investors and consumers alike get more confident in the economy and their personal prospects, the feeling of a need to save begins to weaken. That seems to what’s been taking place over the last few years as investment accounts have (hopefully) been gaining value – savings accounts have not. “The personal savings rate fell to 3.1% in September, the lowest since December 2007, the final month of the last economic expansion, when it touched 3%. That also was the average savings rate during 2005 and 2006, the peak years of the housing boom.” (WSJ)

The Power of Compound Interest Made Buffett His Wealth, Not Just His Investment Picks
Anytime Morgan Housel writes something I know without a doubt that it will be well worth the read. His latest piece, ‘”The Freakishly Strong Base” which looks at the power of compound interest and shows in one example how if Buffett had started investing at the age of 30 instead of the age of 10 his fortune would look a whole lot different. (Collaborative Fund)

Mutual Fund Use is Plunging
As ETFs continue to see massive inflows and mutual fund managers continue to fight two battles, one on fees and another on performance, the use of these funds is losing market share. “Just 39% of U.S. households own mutual funds, down from 63% in 2010, according to Hearts & Wallets, a retail investment data and analysis firm. Younger investors especially have turned their back on the vehicles.” (Barron’s)

Off Topic

Steve Job’s BMW Goes Up for Auction
Are you a big Apple fan? Do you have a few extra hundred thousand dollars sittle idle? Well then you could make a bid for Job’s 2000 BMW Z8 that is going up for auction. (Sotheby’s)

Hershey’s Will Release a New Candy Bar for the First Time in 20 Years
Hershey’s has been around for 117 years and hasn’t released a new candy bar since 1995. That changes this December when they release a new candy bar called, “caramelized crème.” (Extra Crispy)

How Much Food Do Cities Waste?
It’s amazing how much we waste as human beings and even more so as Americans. Researchers put on gloves and begun to dig into municipal garbage to see what we were through away and who wastes the most. (Wired)

When States Decided What Stocks You’re Allowed To Buy
Great news clip from Marcelo Lima from the NYT back in 1980 when Apple had its IPO. The valuation was considered too high for Massachusetts residents to buy the stock!

Is Volatility A Good Predictor Of Financial Bubbles?

Posted on November 1, 2017 by Andrew Thrasher, CMT

The answer may surprise you…

Since bubbles in financial assets aren’t something we experience on a weekly basis, there’s not a lot of mental recognition of the environments that surround them. Ask someone a question pertaining to the 2007 peak in stocks and volatility and they’ll likely point to who volatility was well off its low by the time the major stock indices put in their peak. If you were to ask me the same question that’s probably the answer I would have given too. This response is what makes this recent research by three professors in Zurich Switzerland so interesting.

Titled, “Can We Use Volatility to Diagnose Financial Bubbles? Lessons from 40 historical bubbles”, Sornett, Cauwels, and Smilyanov studied the past 40 bubbles in financial history from markets, commodities, to individual stocks in order to uncover if there was any commonalty to volatility before the bubbles burst.

Keep Reading: Is Volatility A Good Predictor Of Financial Bubbles? (See It Market)