Monday, March 05, 2012

Market update 05 March 2012

From my last update 21 February 2012:

The short term and intermediate term charts are bullish. The long term chart is bullish but needs a monthly close to confirm.

The markets are currently overbought on a short term basis. I am expecting a pullback imminently (based on my cycle analysis in the next 8-10 days). Should price remain bullish on that pullback in all 3 time frames (daily/weekly/monthly) I will increase my equity exposure to 75%. Alternately should the anticipated pullback be more severe in nature than the previous ones (as indicated by an RSI(2) close below 5) then I would be forced to assume the short term trend has turned down and will wait for the shakeout to occur before committing further capital.

In either case, my baseline strategy has turned moderately bullish (with 1 hand on the ejection seat handle!). I will view any positions as speculative given the current environment and be prepared to adjust as necessary.

Since that update the markets have changed very little. As we ended February the monthly chart was confirmed bullish so now I am looking to add to equity positions as there is every indication we have entered a confirmed cyclical bull market phase (within an ongoing secular bear market that I believe will last until 2014 to 2015). However, in the short term the markets are still overbought and I am looking for a pullback imminently.

Click on all charts to enlarge:

ACWI Monthly Chart:

The ACWI monthly chart finished February with a close above its 10 month simple moving average (blue line) along with confirmation on the RSI(14), Full STO and FORCE Index. The MACD has yet to cross but the histogram (blue bars)continue to rise towards zero.

The monthly chart is BULLISH.

ACWI Weekly Chart:

The ACWI weekly chart turned bullish in early Jan, 2012 and remains so as of today.

There is good price support at the 44-45 area so any pullbacks should be limited to approx 3-5%. I would expect this would be a good level to initiate further purchases.

The ACWI weekly chart remains BULLISH.

ACWI Daily Chart:

The daily chart turned bullish 22 Dec 2011 and remains bullish. It currently remains overbought so a pullback is expected.

There is very good price support at the 45.17 level so a 3% pullback from these levels would be very encouraging. This sort of move would turn the daily chart bearish while the weekly and monthly remain bullish; allowing for an increase in current holdings.

The daily chart remains BULLISH and overbought.

ACWI Point and Figure Chart:

The point and figure chart turned bullish on a price print of 42. Based upon the structure of the chart it targets a bullish price objective of 62.

The PnF chart remains BULLISH.

Correlations and the "Equity Table"

When trying to decipher the direction of the markets most participants rely upon price to make decisions. This is a mistake as often intermarket correlations can give clues as to the strength of a given move.

Based upon this, I developed what I refer to as the "Equity Table". Essentially market action is best judged upon a combination of the structure of the "table top" itself (which most look at) but also based upon the "supporting legs" that give "foundation" or "strength" to the table. The stronger the "legs" the stronger the "table".

In assessing market action I look at the following:

-the strength of the "tabletop" as determined by price being above or below the 200 day simple moving average.

-the strength of the supporting "legs" as determined by the following:

a) US Dollar correlations
(based upon the USD spot price)

b) US Bond correlations
(based upon the US 30 year Treasury Bond price)

c) Volatility correlations
(based upon the VIX Volatility index)

d) Risk ON/OFF carry trade correlations
(based upon the Australian Dollar:Japanese Yen trade)

SPX Correlations:

This is a 2 year daily chart of the S&P500 index (the tabletop) along with its 4 supporting legs.

The key to intermarket relationships is a need to identify the extent to which the "legs" are either supportive or not of the table (as they change constantly in the course of a typical business cycle). To do this, I use a correlation matrix based upon a 50 day moving average of the price correlations of the "legs" to the price of the "table".

These correlations are shown on the chart above. A correlation of 1.00 means that leg currently moves 100% in the same direction as the SPX. A correlation of 0.00 means that leg is currently moving totally independent to the movement of the SPX. A correlation of -1.00 means that leg currently moves 100% inverse (opposite) to the direction of the SPX.

As can be seen on the chart, as of March 01 the following correlations were present:

USD: a -0.72 inverse correlation to the SPX (normal historical correlation)
USB: a -0.38 inverse correlation to the SPX (normal historical correlation)
VIX: a -0.86 inverse correlation to the SPX (normal historical correlation)
XAD:XJY: a +0.93 positive correlation to the SPX (normal historical correlation)

Using these correlations we can assess the "validity" of what the leg is trying to tell us. When they are all aligned (and confirmed by correlation), the table is strong. When they are not all aligned (and confirmed by correlation), the table is weak.

As can be seen, currently the strongest intermarket correlation (strongest leg) is the +0.93 correlations between the stock market and the Aussie Dollar:Japanese Yen carry trade (Risk ON). This is considered a "normal correlation" as when the carry trade is positive this supports the price movements on the stock indexes.

Next is the -0.86 inverse correlation of the VIX volatility index to the stock market. This is a normal standard inverse correlation as volatility tends to decline during market advances and rises during market declines.

The third strongest leg is the USD -0.72 inverse correlations to the stock market. Over the past few years stock prices have moved inverse to the US dollar. When the dollar rises, stocks fall; when the dollar falls, stocks rise.

Lastly is the weakest "leg"; the -0.38 inverse correlation of US 30 year bond prices to stock market price. Normally there is a much stronger inverse correlation because as stock price rises investors tend to sell their bonds (moving out of "safety") into the riskier stocks.

The "Equity Table"

This chart shows the table top (SPX price) along with the supporting legs. Here is the breakdown:


The SPX price is above the 200 day simple moving average so the "tabletop" is solid,

US Bond prices are equity bearish (not supportive) as price is above the 200 day moving average. This is not what we want to see; we want investors to dump their bonds to flock to equities to confirm the equity price movement. Currently they have not done so for 2 reasons:

1) the US FED is manipulating bond prices via "operation twist" until June, 2012, and
2) many investors are still not sure this equity rally is for real and are continuing to hold onto "safe" investments such as bonds.

Volatility is equity bullish as the VIX is currently below its 200 day moving average and supportive of an equity advance.

The Risk carry trade is equity bullish (RISK ON) and supportive as the Australian Dollar:Japanese Yen trade is above the 200 day moving average.

The US dollar trade is equity bearish and not supportive as price is above the 200 day moving average. Given the inverse correlations, we would want to see the USD fall to confirm the equity move upwards.

Given the above, it can be seen we have a strong table top but only 2 legs of the table are clearly supportive of the current rally. One (US bonds) is being manipulated until June so cannot be relied upon. A drop in the USD would be beneficial but has yet to confirm.

A fall in US bond prices along with the US dollar would be VERY equity bullish.  I have yet to see it but am watching closely.

EK Provident Fund Weekly Comparison chart:

This is a weekly comparison chart of the various asset classes available in the A+B accounts.

It clearly shows stocks are outpacing all other asset classes (Bonds, USD, Australian Dollar, Euro and British Pound).

Bottom Line:

In my last update I indicated my intention to switch out of BlackRock funds due to the company imposed lock in for almost a full month. This was done at the end of February.

As there was not a significant short term pullback into the end of Feb I did not increase my equity exposure as I am expecting a market pullback at any time. As such, I switched my funds into a 50% Equity/50% USD Cash position as I indicated in my last post:

-Russell Global 90 Fund: 40%
-Fidelity International Fund: 10%
-Russell USD Liquidity: 50%

I will hold these "market neutral" positions until a market pullback and then look to increase equity exposure.

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