Stock Rally Faces Important Test

October 20, 2014

Earnings Help Revive Equity Interest

The market has been looking for some good news. While IBM had a big miss Monday, the overall picture for earnings has been encouraging. From Bloomberg:

Profit for S&P 500 companies probably rose 5.9 percent in the third quarter — a forecast that’s been revised upward from an increase of 4.8 percent as of Oct. 10 — and sales increased 4 percent, according to analysts’ projections compiled by Bloomberg.

Rally Still Has Work To Do

This week’s stock market video examines the question:

Is the current rally in stocks sustainable or will stocks eventually make a lower low?

After you click play, use the button in the lower-right corner of the video player to view in full-screen mode. Hit Esc to exit full-screen mode.

Video

Video

Europe Still A Drag

While stocks popped Monday in the United States, the news continued to be troubling across the pond. In the first session of the week, the German DAX dropped 1.50% and the Stoxx 50 Index shed 1.18%. European stocks are highly correlated to the S&P 500, which is why U.S. investors would prefer to see some stability in that region of the globe. From Bloomberg:

“This correction might be the symptom for something larger,” Benedict Goette, founder of asset-management firm Compass Capital AG in Zurich, said in an interview. “I do not expect a big positive impulse from the current earnings season in Europe. Unless a multi-day upmove develops, people will remain nervous. We’re now in the highly volatile phase of attempting to bottom, but I would expect a final bottom only by the end of October or mid-November.”

Investment Implications – The Weight Of The Evidence

If the concept of a countertrend rally is new to you, this video clip provides two specific examples from 2010. On our investment timeframe (longer), it is important to see evidence of a sustainable turn in stocks, rather than hope the rally will continue. As the market was finding at least a temporary bottom on October 15, we hypothesized stocks might hold at the lower support line in the chart below.

Possible Resistance Ahead

If the market continues to “care about” the blue lines in the chart above, then a good bull/bear test may be coming near points A, B, and C (or between 1920 and 1960ish). Other levels that can be used as guideposts are the Fibonacci retracements near 1920 and 1943. As of Monday’s close, our current mix of stocks (SPY), bonds (TLT) and cash remained in line with the market’s risk reward profile. Should the rally push the S&P 500 above 1943, the improvement would most likely allow for an increase in our equity exposure. The market will guide us if we are willing to listen.

False Rally Or New Bull Trend For Stocks?

October 17, 2014

For reference purposes, the S&P 500 gained 24 points Friday and closed at 1,886, but down 19 points for the week.

After you click play, use the button in the lower-right corner of the video player to view in full-screen mode. Hit Esc to exit full-screen mode.

Video

Video

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October 16, 2014

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Could The S&P 500 Fall To 1,625?

October 15, 2014

A Trip Down Correction Memory Lane

Since the correction-less market theory has been dropping transmission parts over the last three weeks, it is prudent to revisit some topics we have touched on in the past. We will focus on two questions:

  1. How far can stocks drop?
  2. How long can corrections last?

History Says Corrections Can Be Very Painful

Our objective here is not to create fear, but rather to better understand what is in the realm of historical possibility. If we understand the magnitude and duration of some of the sharper corrections (1983-2011), we can better prepare for all possible market outcomes.

S&P 500 At 1,625…Is That Possible?

In the seven historical cases below, the average correction in the S&P 500 was 19.5%. The average length of the seven cases was 114 calendar days (top to bottom). The S&P 500 peaked on September 19, 2014 at 2,019. A 19.5% drop would be 394 points, which would take the S&P 500 to 1,625. A correction of 114 days would end on January 11, 2015. Regular readers know we are not fans of forecasting (rationale here). Therefore, this is not a forecast…it is simply an educational exercise regarding some of the more painful stock market corrections. Admittedly, this is anecdotal evidence, but we can still learn from it.

Sample of Corrections 1982-2014

In 1984, stocks dropped 14.63%. Unlike the multiple-day pullbacks in 2013 and 2014, this correction lasted two hundred eighty-eight calendar days (288).

The 1987 stock market crash occurred within the context of a bull market, and the bull market resumed relatively quickly. Therefore, it is relevant to our correction study and 2014.

In 1990, stocks corrected sharply, dropping 20% over eighty-seven calendar days.

We have covered the importance of the investment landscape in 1994 numerous times, including this March 21 article. Stocks slid just under 10%.

In 1998, the correction may have felt like a bear market based on the sharp declines witnessed on brokerage and 401k statements. The 1998 correction was outlined in more detail on April 2.

The 2010 Flash Crash was quite a bit more than a one-day media event. Stocks dropped 16.71% over sixty-seven calendar days.

A political stalemate in Washington and escalating fears of the end of the euro, helped push stocks down over 21% in 2011.

Corrections Can Be Harmful To Your Portfolio’s Health

The details on the seven cases are shown in the table below. Can corrections be less painful? Sure, there are countless examples of more shallow pullbacks. However, understanding what is possible helps with investment contingency planning.

Investment Implications - The Weight Of The Evidence

Did the evidence in recent weeks suggest something was changing from a risk-tolerance perspective? The tweet below is from September 22. Since noting “the math (evidence) is vulnerable here”, the S&P 500 has dropped 131 points.

As noted in an October 10 video, this is a high risk market until proven otherwise, markets can turn at anytime; therefore, objectivity and flexibility are requirements. When emotions are running high, market levels can assist with decision making. Our market model came into today’s session with a heavy cash position paired with bonds (TLT). We still have some stocks (XLK) left on the books. If the S&P 500 fails to hold Wednesday’s low of 1,820, we will consider cutting the already depleted equity side of our portfolios (again).

Book image (altered) from Chris via Flickr

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October 15, 2014

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The Most Important Chart On Wall Street

October 13, 2014

Foreign Weakness And A Strong Dollar

Stocks have done very little in the “prove it to me” department in recent sessions. Monday’s focus was on slower growth, allowing the string of up and down equity sessions to spill into the new week. From Bloomberg:

U.S. stocks fell, sending the Standard & Poor’s 500 Index below its 200-day moving average after a rout wiped $1.5 trillion from global equities last week. Brent crude dropped to the lowest level in almost four years, while the dollar weakened and gold climbed.

The Most Important Chart On Wall Street

While the S&P 500 is more widely followed, we can gain some insight by looking at the broader New York Stock Exchange (NYSE) Composite Index. Regardless of whether or not the broad NYSE Composite Index can hold above 10,301, we will learn something one way or another about the market’s evolving tolerance for risk. The arrows in the chart below show levels that have acted as support and resistance since 2006. The two blue lines intersect near 10,301. As long as 10,301 holds, the odds of a rally taking place will be higher. If 10,301 fails to attract support from buyers, then the bullish push higher in early 2014 could be classified as a “failed breakout”, which would increase the odds of bad things happening in the weeks ahead. The NYSE Composite closed at 10,172 Monday. The weekly close will provide more information (Friday at 4 pm ET).

Higher Risk Until Proven Otherwise

How much risk is in the current market? You can decide after reviewing this week’s stock market video, which covers large caps (SPY), small caps (IWM), the VIX (VXX), bonds (TLT), the Dow (DIA), and the NASDAQ (QQQ).

After you click play, use the button in the lower-right corner of the video player to view in full-screen mode. Hit Esc to exit full-screen mode.

Video

Video

Dollar Down, Bonds Up

Recent economic data and comments from policymakers gave bonds a boost Monday, while the U.S. Dollar (UUP) weakened. From Bloomberg:

The U.S. dollar fell against a basket of major currencies on Monday on persisting concerns about global economic growth and worries that the Federal Reserve may delay its first interest rate hike. Concerns over the health of overseas economies continued in the wake of last week’s weak German economic data and the International Monetary Fund’s cut to its global growth forecast. Meanwhile, Fed officials said on Saturday that a slowdown in the global economy could hamper a tightening of U.S. monetary policy.

Investment Implications - The Weight Of The Evidence

The “prove it to me” market keeps blowing through areas of possible support. In Monday’s session, several more levels were taken out (see below). Consequently, we reduced our already small stake in stocks (SPY) further Monday, and added to the cash and bond (IEF) side of the ledger.

Video Via Link

October 10, 2014

Weekly video should be available on the Ciovacco Capital Channel on YouTube sometime after 8 p.m. EDT Friday.

Stocks: Bigger Picture Showing Cracks

October 9, 2014

Global Growth And Earnings

Experienced investors know when the market swings wildly from day to day, that looks more like a corrective period than a stable attempt to stage a sustainable rally. Concerns include more than just the Fed. From Reuters:

The S&P 500 on Thursday posted its largest percentage decline in six months on concerns about the strength of the global economy and its effect on corporate earnings. The slide dragged the benchmark to below its 150-day moving average for the first time since November 2012. The selloff, which put the S&P 500 at its lowest since Aug. 7, followed weak data from Germany, Europe’s largest economy, and comments from a Fed official who suggested investors had unrealistic expectations about the Fed’s eventual rate increase.

2008: Low Confidence Period

Using 2008 as a reference point, the slopes of the S&P 500’s 50-day (blue) and 200-day (red) were indicative of concerns about the economy and financial system.

Fast forward to October 2014 and we see small caps are showing a discernible shift in economic and systemic confidence. The profile of small caps is starting to deteriorate in a way not seen in 2013.

The broad NYSE Composite Index has dropped below its 50-day and 200-day moving averages. The NYSE Composite is also testing important support.

European Stocks Look More Vulnerable

Many investors believe the market’s recent bout of weakness is no different than any of the other shallow pullbacks in recent memory. The chart of the German stock market below does not agree with that characterization. The German DAX, which tends to zig and zag with the U.S. stock market, shows waning confidence in the European and global growth stories.

The German Horror Story

The chart above is a way to monitor the market’s perception of the German economy. The weakness in the chart aligns with recent data. From The Guardian:

German exports suffered the biggest monthly fall in more than five and a half years in August, leaving Europe’s largest economy in need of “a small miracle” to avoid recession in the third quarter…Germany’s economy shrank by 0.2% in the second quarter, so a second consecutive contraction in GDP in the third quarter would tip it into a technical recession. Carsten Brzeski, economist at ING, described the current situation in Germany as a “horror story”. He said: “The magnitude of the fall brings back memories of the peak of the financial crisis in early 2009. The economy seems to need a small miracle in September to avoid a recession in the third quarter.”

Investment Implications - The Weight Of The Evidence

The big picture may seem to have an “easy bearish bias” to it. It is not that easy. On one hand, this type of market is vulnerable; thus, the large cash positions we currently are holding. On the other hand, a market with this profile can also rally back toward the recent highs, even under a longer-term bearish scenario, which is why (a) we still have some equity exposure, and (b) have not made large bearish bets of any kind. The tweet below still applies heading into Friday’s session.

If the S&P closes below the recent intraday low of 1925, then our model will most likely call for additional defensive chess moves. From a neutral perspective, if 1925 holds, some patience remains in order. From a bullish perspective, if the S&P can reclaim 1978, and the key Fibonacci level of 1984, the odds of good things happening will improve.

Recent Reference Points - Before And After

October 8, 2014

On October 2, we noted the levels below, including 1979, could be used as bull/bear guideposts. The S&P 500 closed at 1968 after Wednesday’s big rally, meaning it remains below 1979. Our purpose is not to predict whether or not 1979 will be exceeded, but to note that some patience remains in order until 1979 is cleared.

On October 6, we noted the levels below, including 1973 and 1984, could be used as bull/bear guideposts. The S&P 500 closed at 1968 after Wednesday’s big rally, meaning it remains below both 1973 and 1984. Our purpose is not to predict whether or not these levels will be exceeded, but to note that some patience remains in order until we can “see it”.

On October 7, we noted the levels below, including the October 6 high of 1978 (see blue arrow), could be used as bull/bear guideposts. The S&P 500 closed at 1968 after Wednesday’s big rally, meaning it remains below 1978. Our purpose is not to predict whether or not 1978 will be exceeded, but to note that some patience remains in order until the downward-sloping trendlines are cleared.

If stocks can continue to rally (and they may), the evidence/model will most likely allow us to add to our stock positions over the next few days. Keep in mind, the S&P made a new intraday low Wednesday, meaning we remain in “one day wonder” territory for now. We are happy to reinvest our cash when our disciplined system, based on facts, allows.

Most Recent Comments Via Twitter

October 8, 2014

You can access them here (@CiovaccoCapital). You do not need to know anything about Twitter to view our comments or use the links to view charts.