Monday, October 08, 2012

Stockmarket Update 07 October 2012

From my last update 18 September 2012:

Overall Picture:
My take on the proceedings the past 3 weeks is the investment picture is much clearer. It appears obvious both Europe and the U.S. (maybe China soon to follow) are getting more and more desperate by what is unfolding (recessions, unemployment, GDP declines) and feel it is necessary to step in with some MAJOR programs.
Given the amount of liquidity the world will soon be flooded with in the next few months by Central Banks worldwide, risk assets will be bid up higher and higher (equities, precious metals, commodities). Along with this there is a natural presidential cycle whereby the U.S. equity markets generally do well in the Oct-Dec period during a presidential election along with the normal seasonal rise in the same period.
Put it all together and it looks like we go higher from here ........ following consolidation as I will discuss below.

Bottom Line:
Given the above my outlook has changed from neutral to positive. However, the daily charts are overbought so I will increase my equity exposure on any short term pullbacks.
I expect to move to a 100% equity exposure in 2 tranches. I will commit an additional 25% (taking me to a 75% equity exposure) on the 1st significant pullback and commit the additional 25% to subsequent pullbacks.
The 1st pullback appears to have begun yesterday. I expect they will be short and shallow so may not allow for optimal entry but that is the way it is. I will post additional purchases as they occur.

The overall picture since my last update has remained essentially unchanged.  We are in an unprecedented period in history where Central Banks worldwide have determined unlimited printing of fiat currency is the only "solution" to the current economic crisis we face.

We are in uncharted waters dealing with this economic crisis.  It is obvious policy makers are grappling with proposed solutions based upon "models" and "studies" which have never been tried nor tested in the history of economics and capitalism.  Whether their vision as to how best to end this malaise is correct or not, it is important to understand this sort of manipulation puts undue stress and uncertainty into investment decisions.

I normally do not delve into economics/monetary policy in my writing as my emphasis has mostly been on investing (and most subscribers do not really have an interest in such subjects).  However, I feel it is important to pass along to you some of my thoughts that keep me awake at night.

Firstly, it must be understood that modern day economies operate based upon the actions of two entities:


Who are responsible for the FISCAL policies in any given country (revenue and spending) to allow the particular government to run a "responsible" budget and still provide services to the citizens within that country.

Central Banks: 

Who are responsible for the MONETARY policies in any given country (interest rates, money printing) to allow for price stability and employment to the citizens within that country.

When I look from a "top-down" view at where we are at currently, it is clear it is governments worldwide who have not performed their fiduciary role.  As a consequence, we are now in a period where central banks have been put in positions whereby they must compensate not only for their own mandates, but must also attempt to compensate for the mandates neglected by their respective governments.

Historically this tends to occur once every 80'ish years in Capitalist history whereby we experience a deflationary depression brought about by excessive FISCAL (Government) spending.  The result is ALWAYS a period of 15-20 years where governments attempt to deal with excess public debt they have accumulated due to their irresponsible behaviour (historically through massive attempts at creating inflationary pressures to counteract the deflationary forces; or alternately, war).

Currently we are in a position where Central Banks are doing what they can (within their individual mandates) to keep this whole thing afloat.  There is only so far you can go on the Monetary side of the balance sheet (we are there now with the current zero interest rate policies in most countries and various quantitative easing programs having been introduced) before we hit a wall.  At that point Fiscal policy (government) must do something to fix their side of the house.  That would require drastic cuts in spending (unpalatable to a politician as it is virtually impossible to get re-elected in a democracy unless you promise the "sheep" only good; no one is willing to vote in a politician who is responsible and knows the only way forward is cuts to government programs).  The only other alternative (which has worked in the past) is a war.  War generates industrial production and does a wonderful job on focusing the electorate away from the "balance sheet" economics produced by the irresponsible behavior of government and onto a common "US vs. THEM" patriotic group think.

It is obvious the western world (U.S. and Western Europe) have lived well beyond their means for the past 50 years.  It is obvious the politicians we elect to represent our "best interest" have done little to do so in a responsible manner.  As such, we are in for a very long and painful period over the next decade for which I believe the majority of the population are ill prepared financially.  Most are looking behind at the "good times" and think those days will return again soon.  I truly believe we are in for a far more painful future given how little has been done by governments/politicians to address the current problems we face.  We blame central banks but they are only the glue trying to keep this whole mess from falling apart.  Their influence is almost at an end and now it is governments turn to act.  Will their response be responsible deficit reduction, cuts to social services and a decade of economic depression (which is required to deflate the current debt and would ultimately provide the "reset" to allow our Capitalist system to begin anew) or is it war (far easier to "sell" to the sheep and still allow the politicians to get re-elected while achieving the same economic end result)?  If I was a betting man I know where my money would be going.

While living in the present; never take your eye off where we are headed in the future.  The past .......... forget about it.  That was your parents/your parents-parents "great times" party.  You are faced with a much more difficult economic future going forward.

Having said the above, I turn now to the present to update the current market environment.



The daily chart of ACWI continues to be bullish.  The expected decline I discussed in my last blog post did occur but the level of pullback was much more shallow than expected.  My expectation would have been for price to test the previous support at 46.29 but instead price has current rebounded off the lower trend line of the steep price channel (shown in blue). 

It is interesting to note the RSI (2) printed its first sub-5 reading since May and has not been able to print (as of Fridays close) a print greater than 95 on this current advance.  This must be construed as a market that is weakening and therefore I would expect prices to again begin to decline as early as Monday.

The key level to watch will be another retest of the lower trendline.  Should this break I would look for price to decline to the previously mentioned support at 46.26, which should align pretty closely with the lower red channel line currently sitting near 46.00.  In addition, a pullback would tend to flatten the 50 day moving average (currently at 46.15) and provide further support in the same price region.  A pullback to this level would be my 1st target to increase my equity exposure.


The weekly ACWI chart remains bullish with all technical indicators in alignment.

I have drawn the thin level of resistance we are currently experiencing (shown in yellow) along with the price channel discussed above.  In addition, I have drawn a larger price channel formed by the lows in Oct, 2011.

Should a substantial correction begin it could be expected price would target the previous strong support level (shown by the wide yellow area at 44.17-45.02).  A drop to this level would still keep the larger uptrend channel in place and would be a good area to add additional equity exposure.


The monthly ACWI chart remains bullish with all technical indicators in alignment.

Price broke above both the 8 and 10 month simple moving averages in Aug.  Price action in Sep broke the downtrend line as well as resistance at 46.60.  Ideally on any short term pullback price inter-month would break below the 46.60 support level (as discussed previous on the daily/weekly charts) but at the end of the month price would have regained a close > 46.60 (a reminder the validity of the monthly charts is only assessed once the month has been completed).

Ideally we would like to see new highs achieved in ACWI (a monthly close > 49.15).  Currently that is the price target and until a monthly close above that level (which would turn the 49.15 resistance into monthly support) it still is too early to say we are 100% in the clear as far as world equity markets are concerned.


The longer term traditional Point and Figure chart remains bullish.

This chart turned bullish on a price print of 45.0 and has a Bullish Price Objective (based upon the structure of the chart) of 64.0.


The shorter term .10 box Point and Figure chart is currently bullish on a price print of 47.4 with a preliminary Bullish Price Objective (based upon the structure of the chart) of 49.7.

A reminder for those new to technical analysis the Price Objectives calculated on PnF charts are used only as "guides" to assess the risk/reward of entering a trade and must never be used as specific targets.


The daily chart of the Euro (which I still believe is "ground zero" for any problems we may encounter over the near term) remains bullish with all technical indicators in alignment.

A very interesting price pattern has formed on the Euro in the past 2 weeks.  It is known as a "Bull Flag" pattern (which is essentially a tight falling price channel counter-directional to the overall uptrend currently in place).  This pattern broke to the upside 02 Oct through the upper trend line (and after having successfully tested and having held the 200 day simple moving average several days prior).  Based upon the rules of construction for such a pattern, a price target now in place is 139.59 (for those interested, this is determined by taking the height of the "staff" or "flag pole" from 120.42-131.72 = 11.3 points and adding this to the low of the "flag" prior to its breakout; 128.29 + 11.30 = 139.59).  Once again, a pattern does not mean 100% certainty the price objective will be achieved (Bull Flags have a success rate of 64%) but it does give you an idea of risk/reward and trend.

Should the target be met this would result in a further 7% rise in the Euro and subsequently a similar rise in equity markets.


The weekly Euro chart remains bullish with all technical indicators in alignment.

While the Euro has had a stellar rise over the past few months, I still believe caution is advised.  A break above the downtrend channel line and the strong area of resistance (shown in yellow at 133.29-134.54) would be a very bullish development for both the Euro and equities (in fact, all risk assets except the USD).  The previously discussed bull flag target would certainly reduce the risk that this Euro pop is for real and not a head fake.


At the end of Sep price was stalled right at the 8 month simple moving average (and also right at the 10 month simple moving average; not shown on this chart).  The technical indicators are turning but by the end of Oct we would need to see a monthly close above both the 8 and 10 month SMA to indicate the long term trend is up.  As such, currently the long term trend is neutral.


In the course of my work I spend a lot of time looking at "non-conventional" proprietary charts I have developed over the years to assess the underlying strength and risk/reward in markets.

The ideal time to invest additional capital in equities is when there is a high level of fear in the markets. Conversely, when there is a high degree of complacency in the markets it is a good time to be defensive and mindful that the bottom could drop out at any moment.

A good indicator I have used for years is a ratio of the VIX (S & P 500 Volatility Index) to the SPX (S & P 500 Index). The VIX is basically a representation of the markets expectation of stock market volatility over the next 30 days. It is calculated based upon a weighted blend of prices for a range of options on the S& P 500 Index.

A VIX reading of 15 would indicate the market believes the S & P 500 Index will trade in a range of 15% annualized (looking forward 1 year) over the next 30 days (inferring that index options are expected to move +/- 4.33% over the next 30 days).

Common Math:

VIX 10: Expected Index movement over the next 30 days +/- 2.87%
VIX 15: Expected Index movement over the next 30 days +/-4.33%
VIX 20: Expected Index movement over the next 30 days +/- 5.77%
VIX 30: Expected Index movement over the next 30 days +/- 8.66%

The VIX is used by hedge funds, mutual funds, insurance companies and pension funds as a gauge of the current "mood" in the markets. Technically a high VIX indicates the market believes there is significant risk the market will move sharply in one direction (either up or down) but in general a high VIX is normally associated with high market movement uncertainty (therefore it is normally viewed as a "fear" gauge). A low VIX indicates the market believes there will be neither significant upside nor downside moves over the next 30 days.

The key take away is the VIX is useful but often misunderstood. I like to use it in a ratio to the SPX to give me an idea as to when the "mood of the market" might be changing.

 As can be seen on the above chart, over the past 10 years 2 significant areas have defined the VIX:SPX ratio.  Prior to Aug 2007 the ratio stayed in an area defined by the lower pink band.  Since 2007 the upper pink band has defined all areas of "comfort" on the ratio.

Right now the VIX:SPX ratio is right at the same level since 2007 that marked every significant market top.  It has remained within this band for the past month and has yet to reverse to the upside.  A move upwards would be one of the 1st indications we are in for a market correction.

On my chart I use a 20 vs. 200 day moving average crossover to define the transition between "all is well" to "Houston, we have a problem".  Currently we have not crossed over ("all is well") but with the strong downward slope of the 200 dma it would not take too much "concern" in the markets to move this to an equity sell signal rapidly.

As of today we are ok but the market does seem a bit too complacent given its current expectations.  Nothing to worry about (yet) but keeping this one on my radar.

Bottom Line

The markets remain bullish on all time frames (short, medium, long term).  The overbought selling I expected in my last post occurred but was not of the magnitude I expected.

I have not showed these charts before but I use them as a possible "roadmap" for monthly stock market price action.  Each months chart looks back to 1990-Present to chart the average change by trading day within the given month.

As can be seen on the chart, the interpretation of what an "average" October should look like based upon the past 21 years of data is the month should be flat-to-slightly up for the 1st week or so (the 1st data point is the last trading day from the previous month) followed by a decline into trading day 7 (call it Wed or Thur of this coming week).  After that we should be on a nice rise into trading day 15 with some chop back and forth into the end of the month.

I caution you not to use these as a "crystal ball" as doing so will deplete your account very quick.  However, they are useful from a "general market overview" of how the given month has cyclically performed in the past.  Just another tool to add to the investment toolbox.

I am looking for a place to increase my equity exposure (as discussed in the past blog) to 75%.  The forthcoming market weakness I expect combined with my support levels discussed above give me a good indication as to when I might be able to get back in and at what price.  I will be watching closely mid-week for a possible entry and will blog accordingly.

As of today I remain in 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 II Fund: 50%

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