Fed May Help Open Crack In Correction Door

July 26, 2014

Debate About First Rate Hike Looms

Even if you follow the markets from a distance, you know the Fed’s near-zero interest rate policies have played a big role in the stock market’s recent gains. Markets get jittery when the expression “first rate hike” starts to make the rounds. The Fed is due to release a policy statement on Wednesday, July 30. From The Wall Street Journal:

While Fed policy makers are unanimous on the bond-buying program, they are increasingly divided on when they expect to start raising short-term interest rates from near zero, where they have been since late 2008. “I am finding myself increasingly at odds with some of my respected colleagues at the policy table,” Richard Fisher, president of the Federal Reserve Bank of Dallas, said in a speech earlier this month. He predicted the Fed could start raising rates by early 2015 “or potentially sooner.”

Investors Having Second Thoughts?

Regular readers know we make decisions based on observable evidence, rather than predictions. The weekly charts of the broad NYSE Composite Index below provide an example of an observable shift in investor conviction.

Can The Fed Keep Stepping Back?

When the Fed considers raising interest rates, or is in the midst of tapering, the question becomes can the economy stand on its own? A mixed report on the U.S. economy Friday did not clarify things for the economic bulls. From Reuters:

Shipments of these so-called core capital goods fell 1.0 percent. Core capital goods shipments are used to calculate equipment spending in the government’s gross domestic product measurement. It was the third month of decline in shipments, prompting some economists to temper their second-quarter growth estimates. “The weak performance in core capital goods shipments during the quarter suggests that this segment of the economy is unlikely to contribute much to economic activity,” said Millan Mulraine, deputy chief economist at TD Securities in New York.

What Is The Market Telling Us Now?

While it is far from time to panic, the market is not as confident as it was 20 calendar days ago. The bulls are still in control, but the odds of a stock market correction have increased a bit. This week’s video compares confidence vs. concern as of Friday’s close.

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While markets tend to get jittery during periods of Fed policy reversals, volatility has been tame in recent weeks. It is important to keep an eye on both the stock and bond markets in the coming weeks. A spike in interest rates could usher in a rough period for stocks and bonds similar to 1994.

Monthly Labor Report Coming Friday

The Fed will not be the only big event for investors in the coming week. The always-obsessed-about monthly labor report is due to be released before the opening bell Friday. From Bloomberg:

Employers probably added more than 200,000 jobs for a sixth consecutive month in July, according to the median estimate of 35 economists surveyed before nonfarm payrolls data due Aug. 1. “The payroll number is going to be strong,” said Phyllis Papadavid, a senior global-currency strategist at BNP Paribas SA’s corporate and investment-banking unit in London, on July 23. “That will underpin shifting expectations around the dollar for the second half of the year.”

Investment Implications - Risk Management

Based on the evidence we have in hand, it is fair to say we remain about 80% confident and 20% concerned about equities. While the 80% figure is still encouraging, it is not as high as it was even a week ago. Therefore, we continue to hold U.S. stocks (SPY), and leading sectors, such as transportation (IYT). However, we reduced our stock exposure Friday and took a relatively small stake in bonds (TLT). Since rising rates are a concern, we kept some powder dry in the form of cash. We will enter next week with a flexible and open mind given the busy calendar of events. If we are willing to listen to the market’s pricing mechanism, and allocate accordingly, managing risk and reward will be much easier in the weeks ahead.

Stocks: Confidence vs. Concern

July 25, 2014

Still Relevant Big Picture Risk Management Articles - Weekend Reading.
More links and charts on Twitter.

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Most Recent Comments Via Twitter

July 25, 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.

Why Higher Stock Market Highs Matter

July 25, 2014

Post with charts is available on See It Market.

Is Investing About Pontification or Profits?

July 24, 2014

Why Do We Invest?

There is not one correct or proper answer to the question of why do we invest? However, if we answer the question honestly, we can possibly improve our investment outcomes. Having worked on Wall Street for over twenty years and witnessed two massive bubbles and subsequent deflating of those bubbles, we have seen every investment mistake in the book. Since our job is to help clients manage risk and reward, our basic approach to investing can be summed up as follows:

Regardless of our age, social standing, or lot in life, we all want to make money and avoid losing money if possible.

You may or may not agree with the statement above, and there is nothing wrong with that. However, you should be able to define your investment objectives in a similar and simplified manner.

Conflicting Objectives

Notice how the statements below do not necessarily help us “make money and avoid losing money if possible”:

  1. The Fed is juicing the markets.
  2. This whole rally is manufactured and fake.
  3. The bad players in the financial crisis were bailed out.
  4. The whole system is being manipulated.
  5. President Obama’s policies are hurting the economy.
  6. The Republicans are to blame.
  7. Geopolitical risks should be our primary focus.
  8. The Fed’s money printing will lead to runaway inflation.

Stay On Task, Not Personal Agendas

Is there anything wrong with having an opinion about monetary policy, politics, foreign policy, bailouts, or inflation? No, it is a healthy and necessary part of a free society. The hard question to ask yourself is:

Are personal opinions making it difficult to invest consistently, successfully, and objectively?

Before you answer, allow us to take a trip down memory lane. Just a few short years ago, many believed the entire global financial system would implode.

Did You Think Stocks Would Rally For Five Years?

Assume we were polled in early 2009 and asked the following question:

What do you think the odds are the S&P 500 rallies over the next five years and surpasses 1,950?

Personally, my answer would have been “the odds are almost zero”. My guess is many readers would have been justifiably skeptical in late 2008 or early 2009 as well. Guess what? The S&P 500 is trading at 1,991 today.

How about if we were asked this question in early October 2011:

Given the financial crisis in Europe, what do you think the odds are that the S&P 500 rallies smartly over the next 34 months?

Again, my personal answer would have been “the odds are almost zero”. My guess is many readers would have been justifiably skeptical in early October 2011 as well. Guess what? Since early October 2011, the S&P 500 has rallied for 34 months.

How Do We Improve Our Odds Of Success?

The examples above illustrate the potential pitfalls of investing based on personal opinions – your own or that of any writer, talking head, or individual. Let’s assume we thought stocks were way overvalued in 1997. Stocks rallied for three more years, illustrating it is the market’s interpretation of value that matters, not our personal view. Therefore, we can improve our odds of investment success by staying aligned with the net aggregate interpretation of all the meaningful inputs (Fed policy, valuations, inflation, earnings, geopolitical events, bailouts, etc.). Were there ways to see that our personal opinions may have been wrong in early 2009? Yes.

Were there ways to see that policy moves by the European Central Bank were improving the market’s tolerance for risk between October 2011 and the present day? Yes.

Are The 50-Day And 200-Day Perfect?

No, in fact, no moving average, indicator, or ratio represents the holy grail of risk management. Since the 50-day and 200-day can produce whipsaws from time to time, we do not recommend building a system based on these inputs only. However, the moving averages shown here do add value and can be used in conjunction with other “this can improve our odds of success” tools to build a diversified risk management system. This flow diagram is an example of using multiple hard and unbiased inputs on numerous time frames in a diversified manner.

More On Risk Management Systems

If you want to get your creative juices flowing and expand on the concepts presented above, the following articles may be of interest to you:

  1. You Will Never Look At The Markets The Same Way Again
  2. Tired Of Missing Rallies? 4 Ways To Improve Your Game
  3. 5 Reasons Your Simple Bear Market Plans Could Backfire
  4. The Most Important Thing For 2014
  5. With The Fed Stepping Back, Your Portfolio Needs You To Step Up And Lead

Investment Implications – What Does The Market Think?

The market’s opinion determines the value of our investments. The previous sentence speaks to how markets work. What is the market telling us right now? We can use 2011 as a reference point for fear (see chart below).

The same chart shows a much more risk-embracing profile as of Thursday, July 24, 2014.

Therefore, it remains prudent to maintain an exposure to U.S. stocks (SPY) and leading sectors, such as transportation stocks (IYT).

Has All The Pontificating Helped?

The financial media is filled with fear-mongering stories outlining reasons to “raise cash” or “prepare for a stock market top”. The public demands these stories and the media has been delivering them for decades. However, it is prudent to ask yourself how helpful have these gloom-and-doom articles been from an investing perspective? Have they helped you move closer to making money and reducing the odds of losing money? Just as a stopped clock is right two times a day, eventually the fear mongers will appear to be correct. Trouble is they have been wrong for several years.

China – Is It All Fun And Games?

July 24, 2014

On July 23, we noted some potentially bullish developments on the chart of emerging markets (EEM) relative to the S&P 500 (SPY). A few hours after the EEM charts were published China released strong manufacturing data.

China Plays A Big Part In EEM’s Play

If we are to put capital into EEM, our odds of success improve when a higher percentage of individual countries within the index look promising. China makes up almost 18% of EEM.

Know Your Timeframes

We see many reasons to keep both EEM and FXI on our investment radar, but we are also aware of possible hurdles. The dashed blue lines below show a bearish trend channel is still in play for FXI relative to SPY. That channel may be taken out in a bullish manner, but that has not occurred yet. Logically, a short-term trader may not care about longer-term charts. However, they are relevant to investors with longer holding periods.

Charts Can Help With Position Sizing

The monthly chart below also shows similar rallies that have been met with resistance in the past. For example, FXI rallied vs. SPY for four months in 2012, only to be turned back near point A.

The chart above is not necessarily a show-stopper, but it may keep us in “prove it to me mode”. As investors, we may (a) not take any position until the bearish trends are broken, or (b) take a smaller position and see how things play out. A trader may hold FXI or EEM for a few hours or a few days, meaning investors need to understand what it means when a trader says “bullish” and what it does not mean.

ETF Leadership

July 23, 2014

Today’s post can be found on Yahoo Finance.

New Highs: What Do They Mean?

July 22, 2014

Homes Sales Help Spark Rally

The S&P 500 posted a new intraday high Tuesday after encouraging housing data was released. From Reuters:

U.S. home resales hit an eight month-high in June, suggesting the housing market was gradually regaining momentum and would help the economy to stay on a higher growth path this year. The third straight month of home sales gains, reported by the National Association of Realtors on Tuesday, added to employment and retail sales data that have indicated economic growth ended the second quarter on a firmer note.

S&P Has Not Done This Yet

While the headlines referenced new highs, the S&P 500 needs to close over 1985 and change to make a new closing high. Tuesday’s close fell just short with the final print for the day coming in at 1983.

As noted on Twitter, investors can gain some short-term insight based on where stocks head next.

Earnings Playing A Big Role

Earnings have been pleasing to stock market bulls thus far. However, less than half of the companies in the S&P 500 have pulled back their quarterly curtain. From The Wall Street Journal:

Eighty three of the 116 companies in the S&P 500 that have reported earnings to date have beat expectations, according to FactSet. For the Dow, 11 companies of the 14 that have reported have topped estimates. There’s been “a really healthy earnings picture for U.S. corporations so far,” said Michael Marrale, head of research, sales and trading at brokerage firm ITG.

Investment Implications – Bulls Still In Control

As noted on July 21, recent volatility can be put into the “normal” basket. How concerned should we be about the failure of the S&P 500 to post a new closing high? At this point, it is not something to lose sleep over. Our concerns would increase if stocks have not posted a new closing mark over the next couple of weeks. The evidence in hand continues to call for U.S. equity exposure (SPY), coupled with leading sectors, such as transportation (IYT).

Is Recent Volatility Cause For Concern?

July 21, 2014

Earnings: A Big Role This Week

Before we get into the subject of recent volatility, it is important to understand the primary market driver in the days ahead – earnings. From The Wall Street Journal:

Twelve Dow industrials components and 146 S&P 500 companies are set to post earnings this week, including Apple, Microsoft and Ford, according to FactSet. “This is peak earnings season week,” said Doug Cote, chief market strategist at Voya Investment Management. “I’m expecting continued good news. My expectation is that we’re going to handily beat consensus earnings.”

Volatility To Ignore?

In the graph of the S&P 500 below, if markets moved in a linear fashion, managing risk would be much easier. It would be easy to leave our investments alone between point A and point B. It would have been easy to spot that something was changing between points B and C, and much easier to discern something had changed for the worse between points C and D.

Unfortunately, markets are volatile. Therefore, from a risk management perspective it is helpful to have tools that help discern between “volatility to ignore” and “volatility to respect. This week’s video covers the topic in the context of recent volatility in the U.S. stock market.

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Good Sign For The Economy?

Earnings are not just about numbers. The market is always interested in forward looking statements regarding the economy. Energy producers may be providing some insight. From Reuters:

Halliburton Co (HAL.N), North America’s top oilfield services provider, said it would add fracking equipment and crew to take advantage of higher demand in the region, signaling an industry-wide recovery after a two-year slump.

Investment Implications – Eye On Conflicts

Even with the S&P 500 down as much as 12 points in Monday’s session, support shown in the chart below remained in place.

The markets are dealing with unrest in the Middle East and Ukraine. From The New York Times:

As diplomatic pressure for a cease-fire mounted on the conflict’s 14th day, the Palestinian death toll topped 500 and the number of Israeli soldiers killed hit 25, more than twice as many as in Israel’s last Gaza ground operation in 2009. Two Israeli civilians have also died from rocket and mortar fire.

From a separate New York Times article:

After days of obstruction, Russia-backed separatists in eastern Ukraine permitted Dutch forensics experts on Monday to search the wreckage of the downed Malaysia Airlines jetliner destroyed by a surface-to-air missile, allowed bodies of the victims to be evacuated by train and agreed to give the plane’s flight recorder boxes to the Malaysian government. The movements, four days after Malaysia Airlines Flight 17 exploded and crashed in an eastern Ukraine wheat field, came as President Vladimir V. Putin of Russia faced a growing international clamor to clear the way for a full and unimpeded investigation of the disaster.

The evidence we have in hand continues to call for a prudent allocation to U.S. stocks (SPY), and leading sectors (QQQ). However, with markets nervous about the Fed, geopolitical events, and earnings, flexibility remains as important as ever.

Tuesday brings reports on inflation and housing. Never a dull moment.

Stocks: Volatility To Respect?

July 18, 2014

Still Relevant Big Picture Risk Management Articles - Weekend Reading.
More links and charts on Twitter.

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