Saturday, May 08, 2010

Stock Market and Currency Update 08 May 2010

Stock market and currency update as of the week ending Friday, 07 May 2010.

A huge down week in the markets. The decline to alleviate the overbought conditions I have been discussing for weeks finally came. The question is where do we go from here?

Fundamentally the key issue is Greece and it's debt issue. It is not that Greece is unto itself a big deal (the GDP of Greece is about the same size as the GDP of the City of Philadelphia); it is the possibility of the contagion spreading beyond Greece to Portugal, Spain, Italy and be followed thereafter by the U.K., Japan and then back to the U.S. (which has been out of the "debt" spotlight recently thanks to the good work of the Greeks).

Essentially there is a battle going on between the ECB/Jean-Claude Trichet and the debtor nations. The debtor nations would like to receive a "substantial" monetary ECB handouts combined with them applying "limited" structural reforms to their economies . Trichet/the ECB is dead set against this and would like the debtor nations to make "substantial" structural reforms to their economies combined with providing "limited" ECB monetary relief (600 billion Euros has been announced). This has created tremendous uncertainty in the markets as to the future of not only Greece but the Euro and European Union itself.

The problems in Europe are spilling over into the rest of the world. If the Greece situation had been handled sooner we would probably be up another 2000 points in the DOW.

Fundamentally in the U.S. there appears to be the perfect combination of factors to promote an ongoing stock market advance:

-stable earnings growth
-low inflation
-low interest rates (with the FED on hold for probably another year +)
-high worker productivity
-unemployment starting to improve (hiring appears to have begun; the unemployment rate should come down soon).

The liquidity is being gradually drained from the U.S. system and, while still fragile, it appears there is a good chance the U.S. may actually experience a "V" shaped recovery.

I am confident if the ECB announced their commitment to provide unlimited liquidity to backstop the European Union there would be a a huge market advance. Whether that will happen or not remains to be seen.

There are times in the market when a combination of factors leads to excessive moves in prices. At times like these, I have found it necessary to take a step back from the day to day action and look at the big picture. That is what this blog will be about today.

Click on all charts to enlarge:

Stock Markets:

SPX 11 year monthly:

The first chart is the 11 year chart of the S & P 500 Index. As I have mentioned previous, this is one of my "long term view" charts. This chart turned bullish in July, 2009 when the months closing price closed above the 12 month simple moving average. It has remained bullish ever since and continues to be so as of today.

Note that during the past bull market there were numerous months where price mid-month crossed below the average (shown as "tails" on the candlesticks) yet by the end of the month price continued to hold above the average (April 2003-Dec 2007). I count 13 months where these "tails" broke the moving average line but in all cases they closed above the line by the end of each of those months.

As can be seen on the chart, we are in the same position again. This bears watching as price may continue to decline but it would take a closing monthly price at the end of May below the current 12 mMA (currently at 1073.07) to turn the chart bearish.

As such, the long term view of the markets remains BULLISH.

SPX 3 year weekly:

The next chart is a 3 year weekly chart of the SPX. I have shown the previous 2 market corrections since the bull market began in March, 2009. In each of those declines, the length of the decline was 4 weeks and the decline was 9.1% each. The current decline is 2 weeks in length and has been 8.9%. As such, it is too early to "panic" and think the world is coming to an end. We need to give the market a little more time to prove itself before we start to make drastic changes to our portfolio's.

A reminder those 2 previous corrections turned out to be excellent buying opportunities. Might this be another one? More on this below.

The weekly chart remains BULLISH.

SPX Point and Figure Traditional:

The SPX point and figure chart cuts all the noise. It turned bullish on a price print of 935 and still projects a target of 1295.

I've included the volumetric levels on the chart. It can be seen there is a strong level of resistance at the 1090-1100 level. This was tested this week and held.

The PNF chart remains BULLISH.

SPX Daily with Volumetric:

The daily volumetric chart from the March, 2009 bottom shows the strong level of support between 1040-1120 (strongest @ 1080-1120 with the next level @ 1040-1080). A break below 1040 would be cause for real concern.

Note price broke the uptrend line on Thursday. This is common during both bull and bear markets and it can be seen we have had numerous breaks of previous trend lines during the current advance. Therefore, breaking a trend line does not mean the start of a downtrend; it means the market has turned neutral and could go either way.

As such, this chart is neutral until either:

-price exceeds 1219.80 resulting in a newly established uptrend with a re-draw of a new support line (and the continuation of the bull market advance); or

-price breaks 1044.50 resulting in a newly established downtrend (and perhaps the 1st indication that the bull market is over). Only the price action going forward will determine which it is.

The daily chart is currently NEUTRAL.

CBOE Equity Only Put/Call Ratio:

I spoke previous about panic. One of the most important things you learn when investing is the tendency for the general public to panic. The ability to act counter to the masses (contrarian investing) can result in above average gains.

When within a bull market, panic selling can be used to buy shares at a tremendous discount. And just the opposite, during a bear market panic buying can be used to short shares at a tremendous discount.

One of the charts I use to monitor "sentiment" is the Chicago Board Options Exchange (CBOE) Equity only put/call ratio. Without getting into too much detail, a "call" is an option bet that the price of stock/commodity/currency/etc will rise in the future. A "put" is an option bet that the price of the stock/commodity/currency/etc will fall in the future.

Options are used in a variety of ways by professionals as "portfolio insurance" (hedges) or as bets on the future direction of the market. These same instruments are also used by individual investors to speculate on their perception as to the future direction of the market.

Ironically approximately 90% of all individual purchases of these options result in losses for the individuals. As such, they can be used as an contrary indicator (along with many, many more I follow) to judge the degree of fear in the market.

On Friday individuals buying "puts" (bets the market will decline in the future) vs those buying "calls" rose to an extremely high level.

As can be seen on the chart (which unfortunately only goes back to 2003), there have been very few times when the ratio of equity puts to calls has risen to the 1.15 ratio or higher. In fact, Friday was only the 6th time in the past 6 1/2 years where that has happened and only the 3rd time it has happened during a bull market (twice during the 2003-2007 bull market). Both times turned out to be excellent buying opportunities.

Given there are approximately 250 trading days/year, that is only 6 times in the past 1625 trading days where that has happened (0.3692%). In short, it is a rare "panic" occurrence.

In a bear market it makes sense to have "panic selling" on occasion but during a bull market many times these "panic sells" lead to excellent buying opportunities. This may be just such a time.

I am watching close for the open Monday and may add to my positions.


USD 2 year daily:

A nicely established up trending channel in the USD. It has gotten a little ahead of itself so it would not be unexpected to see a pullback to the bottom of the channel and the support around 83.

The USD remains BULLISH.

Euro 2 year daily:

The Euro continues to get hammered on the uncertainty surrounding Greece. It is at the bottom of it's channel and it would not be surprising to see a rise back up to 133 before the next decline. It remains on track to test 124 and below.

The Euro remains BEARISH.

British Pound 2 year daily:

The Pound continues to struggle as a result of the election and the resultant political uncertainty associated with the hung parliament. Unlike the Euro, there is some support at current levels and significant support down to 137. As shown on the chart, the area between 137 and 156 is a "chop zone" where directionless trading could be expected to take place.

The Pound remains BEARISH with a bearish, choppy trading bias.

Australian Dollar 2 year daily:

The Aussie has been unable to break above the 93.67 level. It has now broken below the uptrend line from the March, 2009 bottom and the 50 and 200 day moving averages.

The area between 86.21 and 93.67 is another "chop zone" with no clear direction. However, given the technical break of the 200 day moving average, there is a bearish bias to the Aussie.

The Aussie Dollar is currently NEUTRAL with a bearish, choppy trading bias.

Gold 2 year daily:

Gold continues to perform extremely well and should be a part of every one's portfolio. The chop zone between 1063 and 1150 has been broken to the upside and gold closed at a new all time high weekly close this week.

It has yet to break the all time high but now wants to challenge it. I expect some pullback near that level which might set up the "handle" of a "cup and handle" formation I have tentatively put on the chart. Should this occur the price target on a break above 1216 would be 1369. I have a different pattern I have followed for some time that projects a target of 1333 so those are the areas I am looking at for this move.

Pullbacks towards 1150 would be excellent buy opportunities in my opinion.

Gold remains BULLISH

Bottom Line:

As per a previous blog, I added an additional 15% equity exposure to my Provident Fund account. This currently has me at a 75% equity/25% USD cash position.

I have been holding back on going to a 100% equity position for months based upon the markets being overbought and overpriced. The overpriced is still here but the overbought has been eliminated.

I remain long term bullish on the markets. There is nothing in the longer term charts that indicate we have begun a new bear market decline. As such, until they do so I remain in "Buy" mode.

Should there be any resolution to the European crisis (via any hint from the ECB that they will stand ready to backstop Member countries), I am expecting a tremendous boost to the markets. Should it not come I think we continue to drift lower on debt default concerns.

Given the Put/Call ratio on Friday, any hint over the weekend of a softening of the ECB stance and I will commit to a 100% Equity position in my Emirates Provident Fund A and B accounts on Monday. Barring that, I will sit on my hands and remain at my current holdings until the dust settles.

The ECAM Asset Allocation Fund (my personal C account) currently stands at a 45% invested/55% cash position as of this weekend. It is strictly technical analysis driven and wisely moved it's non-U.S. and Emerging markets exposure to cash several weeks ago.

Emirates Provident Fund:

As of today my "strategic positioning" within the Emirates Provident Fund A and B accounts is a 75% Equity/25% USD cash position.**

Current positions as of 07 May 2010:

-Equities: 74.8%

-USD Cash: 25.2%

** "Strategic positioning" percentages are as per how funds were originally allotted. Due to daily market price fluctuations and ongoing equity monthly purchases within the provident fund account these amounts will vary several percent from that posted. Consult "current positions" for updated actual positions held.

Emirates Capital Asset Management (ECAM) Asset Allocation Fund:

The ECAM Asset Allocation Fund is currently 45% invested (40% core holdings invested + 5% discretionary invested) and 55% cash.

The fund rotated recently, having taken profits on it's Developed Markets (non-U.S.) and Emerging Markets positions. I am comfortable with it's somewhat defensive positioning at this moment given current market conditions.

Biotech funds were sold early last week and currently only gold stocks (GDX) are held in the discretionary portion of the fund.

Current holdings:

Core (90% of holdings):

-U.S. Large cap equities:10% (VTI)
-U.S. Small cap equities: 5% (VB)
-U.S. Real Estate Investment Trusts (REITs): 10% (VNQ)
-U.S. Domestic bonds: 10% (BND)
-U.S. Inflation protected bonds: 5% (TIP)
-Cash: 50%

Discretionary (10% of holdings):

-Gold mining stocks: 5% (GDX)
-Cash: 5%

Legal Disclaimer: The content on this site is provided without any warranty, express or implied. All opinions expressed on this site are those of the author and may contain errors or omissions. NO MATERIAL HERE CONSTITUTES "INVESTMENT ADVICE" NOR IS IT A RECOMMENDATION TO BUY OR SELL ANY FINANCIAL INSTRUMENT, INCLUDING BUT NOT LIMITED TO STOCKS, OPTIONS, BONDS OR FUTURES. The author will reveal his current market positions and holdings but actions you undertake as a consequence of any analysis, opinion or advertisement on this site are your sole responsibility. The author is not licensed as an investment advisor in the UAE and therefore cannot provide individual account advice to individuals and/or institutions.


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