Stock Market Update October 27, 2016

It has been a while since my last post, but since then I have learned a lot abut technical analysis. With new techniques in mind, lets take a look at where the market is now, and the possible path it will go.

Now, it is important to keep in mind that the election is influencing stock, foreign exchange, and bond prices. In fact, people have been using the USD - MXN (Mexican Peso) exchange rates as a proxy for the election. The Peso would weaken every time Donald Trump seemed to be pulling ahead, but it would strengthen when Hillary Clinton seemed to take the lead. This influence on the capital markets is justified by the uncertainty of the election. Investors are not willing to take big bets until they have a better grasp on the future.

Lets take a look at the S&P 500:

Over the last couple of years, the S&P 500 had been in a range between 1815 and 2125. This range was finally broken, and now the resistance has turned into a support. However, once it broke past 2125, it has not done much. The indicators below the graph are not giving any god signs either. Momentum has fallen, and is becoming more and more bearish. The ADX line (middle indicator), is showing that the trend is strengthening, and it is strengthening downwards.However, the support at 2125 is working rather well. It could be a good sign if the S&P 500 is still above the 2125 support when the election results are realized.

What are the headwinds for the S&P 500? Besides the election, earnings are also holding the index back. High valuations, on an absolute basis, is causing more people to keep there cash, rather than buying stocks. The fear of buying into an expensive market is worrying. However, on a relative basis, the S&P is not that expensive. With interest rates so low, the stock market could have higher valuation. Using regression analysis, the P/E ratio could be somewhere around 22, rather than the 18 it is at currently. The historical average P/E is not as useful in these abnormal market conditions.

Next, we will take a look at the NASDAQ Composite Index:

A similar setup is occurring in the NASDAQ Composite, as the S&P 500. You can see that it has
recently moved past the range, and is testing the support. Also, the momentum readings are similar, in that there is none. Investors are likely waiting for the election, before putting more money to work.

Now, lets look at the transports. This index has been used as a leading indicator for a long time, and can give some insight on the direction of the market.

The transports are a good leading indicator because companies need to transport materials and goods to customers. So, if the transports are making money, it means companies are transporting their goods. What we are seeing in this chart is a correction. The blue dashed line was the uptrend, then it broke down and followed the red dashed line. Now, there is a bullish formation called an ascending triangle. The ascending triangle has a flat top, with an angled bottom support. This is bullish because the support keeps moving up, which means more an more people are willing to buy at higher prices. Now, it may be a bullish formation, however, it is still possible for the index to break downwards.

What makes this chart great, is that it shows, just like the previous two indices, that the market is waiting. This pattern shows, that people are bullish, but they are waiting for a catalyst to really push the index up. Could the catalyst be the election?

Conclusion
For the moment, it seems that investors are waiting for a catalyst before they start moving into the markets. Even though normal valuation metrics put the market in an expensive range, it is important to realize that we are not in a typical market environment. On an absolute basis, the market is expensive, however on a relative basis, stocks have some room to grow. With low and negative interest rates around the world, the stock market could see a big gain as people are looking to put their cash to work.

What is that catalyst? Well, it seems to come down to two options, earnings and the election. Now that oil has stabilized, earnings are on pace to be positive for the first time since the first quarter of 2015. Which, could finally put fears of a recession away, for now. Without the fear of a recession, investors could be willing to put their sidelined money back into the markets.

The other catalyst could be the election. When the election is over, analysts, and investors will finally be able to change their expectations of the future. They will have a better grasp of future fiscal policies, and economic plans. Which of course, means they can implement their plans and strategies accordingly. Really, the catalyst is more likely a combination of the two. A strong quarter of earnings, and a more certain future could be great for the markets going forward.

Technical Damage from the Brexit: Indices

The UK Referendum to leave the EU has large and far reaching implications. Something like this has never really happened before, and it is generating vast amounts of uncertainty in the world financial markets.
It has only been a couple of days, but we can already see some technical damage being created on the charts. In this post, we will be looking at the major US indices. I will be writing about the US sectors later.

First, we will take a look at the S&P 500:

The first thing you will notice is that we are still range bound, and have not made a new high since May 5015. It looks like we were going to try to test those highs again, but the outcome of the vote sent the markets falling. The first support was around 2040, but that has failed to hold. The next price we will look for is 1950, which has never been tested as a support. However, it seems more likely it will fall to a support level in the 1800-1899 range. This is because of the similarities between the three previous crashes: a major event occurred outside of the US, panic, then the realization that the US is fine.

Next we look at the Dow Jones Industrial Average:

The chart looks pretty similar to the S&P 500, however, you will notice there isn't a support level between 17400 and 16400. This helps give credence to an S&P 500 support around 1850. Because the DJIA and S&P 500 follow each other pretty closely, you want to look for common areas on the chart. In this case the common supports are 1825 for the S&P 500, and 15,750 for the DJIA.

Now we look a the NASDAQ Composite:

As with the previous two indexes, you can see the common support is around 4200 for the NASDAQ Composite. It is also the next likely support for the composite, since it has fallen through the 4700 level.

Lastly, we look at the small cap stocks in the Russell 2000:

This index takes a life of its own, so we cannot really compare it to the other three indices. However, we can see that it has tried to leave the 1080 - 1210 range that it was in, in 2014. It fell out of the range at the beginning of the year, but fought back in. Now, we are testing that support once again, so we will soon see where the index goes from here.

To conclude, the Brexit caused a lot of damage to the charts. I believe that we were on the brink of starting a new bull, but it would have required the UK to remain in the EU. Now that we know they are leaving, the uncertainty the future holds is enough to scare investors away from stocks, and force the markets back down. Now the only catalyst that can bring us to a new bull is this quarter's earnings, but those do not seem to be good either.

Stock Market Update, End of May 2016

We will begin this analysis by looking at the most basic Dow Theory component, which is the transports must confirm the industrials. Take a look at the Transportation average below,

You can see that the transports are in a bear market. They did have a great bounce off the February low, with 22% gain. However, the trend is still pointing down.

Now, let’s take a look at the industrial average,

As you can see, there are quite a few differences in these charts. First off, the peak of the transports was near the end of 2014, while the peak in the industrials was around May 2015. Also, after the peak, the transports have had a bearish trend downwards, while the industrials have stayed pretty flat. Since the transports are in a bearish trend, we will wait to see if the industrials follow.

Next, we move on to the S&P 500, and the NASDAQ Composite Index.

A lot like the industrials, the S&P 500 is also moving sideways. There is a support just above 1,800, and resistance around 2,100. Right now, the S&P is testing that resistance, so it will be important to see what happens in the near future. If we can get a significant breakout, we can see the S&P to new highs. However, the breadth of the market does not show such strength.

In this chart, we have three indicators under the price. They are the MACD on top, the S&P High-Low Index in the middle, and the number of stocks above their 50 day simple moving average. All three indicators show bearish divergences.

The vertical blue line shows where the peak of the MACD was, across all indicators. We can see that the MACD has diverged from the price action. This is a bearish sign that the rally should be reversing. The recent peak and subsequent fall, illustrate the predictability of the MACD. Now that the MACD is back to 0 (the middle line), we will need to see where the index goes next. As we can see, the price is starting to move up again. However, this is not showing the breadth we would like to see in a rally, in fact the other two indicators are implying a reversal is on the way.

When an index moves in a bullish or bearish trend, you want to see the underlying stocks moving up as well. That is what the two lower indicators are designed to do. The High-Low Index shows whether or not stocks are making new highs or new lows. When the indicator moves up, it shows there are more stocks making new highs, than making new lows. When it moves down, there are more stocks making new lows, than there are making new highs. The number of stocks above the 50 day moving average is self explanatory.

You want to see these indicators following the market, but because the indicators are moving down it shows underlying weakness in the index. This is true for the other two major indexes. The NASDAQ Composite and the Dow Jones Industrial Average. These charts show weakness in the market, and that the recent rally is not likely to break to new highs.

Lastly, lets leave the US and take a look at the MSCI EAFE, and the MSCI EM charts.

This is a 10 year chart of the MSCI EAFE. Most recently, you can see a nice double top. This is a bearish formation, and implies a reversal. As you can see, the index fell 15% from the highs, and have fallen to the blue support line. I think this support line is just supporting prices for now, but when the US indices break downwards, this index will as well.

This emerging markets index is also on a 10 year chart, and shows a massive symmetrical triangle. This formation doesn’t tell you whether the move should be up, or down. What it does tell you is when price breaks out of the formation, the trend is most likely to go in the same direction. Based off of this chart, we would look to see the index continue to move lower.

In conclusion, it looks like the recently rallies are not sustainable. The weakness in market breadth is the major concern with these rallies. The underlying stocks are not showing the same strength that the index is showing, which is a problem. It means the indexes are relying on fewer and fewer stocks to push the index higher, and the recent rallies are not sustainable. Weakness in the EAFE and emerging markets indices also show that there is weakness around the world.

Predicting 2016, From a Behavioral Standpoint

The S&P 500 has had the worst start to a year in its history. Investors are worried about China, and the strength of the dollar. The first day of trading, in China, showed the first use of their circuit breaker system. This led to a global sell off of risky assets. Two days later, there circuit breaker system was used again! The market was only open about a half hour, before shutting down for the day again. On Friday the US had a exceptionally strong jobs report, but the trading day still ended up down around 1%. So, what is going on? Why are US investors selling their stock?

To understand why the market is selling, we need to look at the market behavior. We need to take a look at the market participants, and evaluate their reasons for selling.

The first thing you learn in your fundamental economics class is that in order for any theory to work, market participants are assumed to be rational. However, when you look at the stock market, you quickly realize that this assumption is about 50% false. Let us take a look at the rational side of things first.

The market has been on a tear since the Great Recession. It has been uncharacteristically good. If you bought in 2009, 2010, 2011, 2012, 2012, or even at the beginning of 2014, you likely saw some nice gains. So, you have some strong gains, in an uncharacteristically risk-less market. Now comes along 2015. The market does not move. There is the first correction in 3 years. First there was the Grexit, where everybody was uncertain about what would happen in Greece. Then there was the Chinese slowdown, where everybody was scared that a slowdown in China meant a slowdown in the global economy. On top of that, the bond market went into its first bear market in over 25 years. Commodities have plummeted, and oil just kept on falling. Earnings have been weaker and weaker. To top it all off, we had the first rise in interest rates in eight years. Even though all of this was thrown at investors the S&P held its ground. That is pretty remarkable. Now let's look at December 2015. Everybody is expecting this "Santa Clause Rally." Analysts everywhere, on every channel are predicting this rally to come, late into the year, but it never comes. Where does this leave investors?

With the memories of the Great Recession in the backs of their minds, they decide to take what they have gained. They are scattered, and jittery. They want to protect their gains, and make sure that they do not lose everything in a recession, or a big sell-off. With the recession in everybody's minds, they realize the risks of losses, and they remember that the stock market has its risks. The market will always go back down, so protect your gains and sell.

On the irrational side of things, people are actually wanting to buy stocks. They ignore evaluations, and believe the market is going to keep going up. This is entirely possible, but why would you want to risk it? The risk reward ratio has gone up significantly since 2015. You do not take the same risks for 3% growth, that you would with 14% growth. The stock market was not as risky in the previous years, not because the risk was not there. It was just less likely to occur. The Fed basically wanted to improve the economy by pushing up stock prices. With all the economic fundamentals going against the market, coupled with a negative year, it makes the likelihood of a downturn much more reasonable. At the very lease, investors should be rebalancing their portfolios to at least lower some risk.

That is right, it is irrational to believe the market will continue with its previous years strength. In prior years, the confidence of the stock market was strong. Interest rates were as close to zero as possible. The Fed was doing its best to propel the market up. All this has changed though. Interest rates have been raised, and the market is concerned that earnings are starting to slow. Sure you can miss a few percentage points of growth in your portfolio, but at what risk? Especially when you look at a typical portfolio. Even an average 60/40 portfolio, a 3 percent gain in the stock market only translates to a less than 1.5% increase in the portfolio. So instead of 60/40 portfolio, you would expect rational investors to lower stock exposure, and move to less risky assets.

With all of this, you would want to see a gradual step lower in the overall stock market. You should not see a huge drop, or panic selling (until maybe the end). There will be a gradual decrease in stock prices, and we have a well mannered bear market for a little while. At least until valuations decrease, and stocks become cheap again. When earnings show strength again, and global uncertainties start to go away again, people will gain their lost confidence back in the market, and move back into the more risky assets.

Disclaimer: At the time of publication the author is long RWM, DOG, SPH, PSQ. Inverse ETFs of the major US indexes.

What's Going on in The Stock Market

The stock market has rallied from it's August low, but can we expect it to keep going up from here? I don't think so. Let's take a look at the graphs.

First, we will take a look at the three major indexes.

All three indexes had a rounding top, a bearish sign, before the drop in August. None of the indexes have made new highs since their peaks in mid-July, this would imply weakness in the markets. When you look at the volume, you can see that there has been a lot more stocks changing hands, but there is little movement in either direction. That could tell you that the market is waiting. People are waiting to see if the bull will continue, or will the bear win the fight.We could think that the bulls are stronger, because the prices came back after the drop, but that may be a mistake as the comeback has weakened, and prices have failed to reach a new high.

Now let's take a look at the indicators. Looking at the MACD, you can see a bearish sign. as the MACD did not make a new peak, next to the previous peak, as price has. The RSI has that same issue, and shows a bearish sign as well. 

I believe that a bear is coming, and it will come in one of two ways. The price will continue to show weakness, and the overall trend will continue down. As for the other way, I think the price could get close to reaching its peak, forming a double top, before prices will drop again. 

Now we will take a look at the transportation average, which is used as a leading indicator in Dow theory. 

The transportation average is trending downwards, with indicators showing more downward pressure. There has been a rally that coincides with the rally that came after the August sell-off, but as you can see there is still weakness.

I believe the market is weak. It is hard to find a reason to buy stock, as earnings were weaker, and demand seems to be weakening as well. I think profit taking has occurred in the August drop, and now the current rally is a weak attempt to keep the bull going. Very few stocks are propelling these indexes higher. The Dow only has five or six stocks pushing it back up. Also, when you look at the industry leaders by market cap, only a few stocks are making new highs, the rest have been falling since before the index peaks, and a lot are in confirmed bear trends. The best strategy may be to hold cash and wait for a trend confirmation.

Stock Market Thoughts

If the stock market were to go into a bear market, we can look for key price levels that can help determine where the bottom is. We will look at the Dow Jones, S&P 500, and the NASDAQ Composite.

The S&P 500

There are two key levels to look at here. The higher one, is around 1,500. In the early 2000’s the dot com bubble peaked around there, and the bubble burst. During the housing bubble, the index made it to about the same level, and the bubble burst. However, since then we have gotten to a new peak around 2,100.

1,500 was a resistance level, meaning the price reached it then fell back down. After it passes through resistance you can begin to look at that level as a support level. So, that is why this is the first key price to look for.

The second level is the support level that was created after both of the bubbles both popped. That level is 700 – 750. This level is a strong support because both of the bubbles ended at this level. So, if the index falls through the 1,500 level, we would look for it to keep going to about 700-750.

The Dow

The Dow looks a little different. It does not have a key resistance level like the S&P 500 does. We can look at the previous peak before the housing crash for a key level that may be tested, and that is about 14,100. However, that level has not been tested yet, so the real level to look at is around 6500 – 6650. I think it is more likely to go down to this level, for reasons I will explain after we talk about the NASDAQ Composite.

NASDAQ Composite

The Nasdaq is actually a different ball game. It has actually just reached its peak from the dot com bubble this year. So, this means that there is a resistance around 5,000. The key level to look at here would be 1,300. That is the bottom of the dot com and housing bubble.

Price Conclusion

I believe that the lower levels of support are where we are headed. The reason is because that is where all three indexes have a support. They all have the same support level at the bottom of the bubbles. It is because all three agree at those levels that makes the support so strong, and a likely place for it to stop.

There are many reasons why this bear market can cause these prices, but here are a few key reasons:

•     China slow down
•          National economies across the globe are on the brink of recession
•          Commodities prices are falling: Oil, metals, food, etc.
•          The Fed

China

The Chinese economy is shifting from a manufacturing economy, to a services/consumption based economy. This has led to a slowdown in the Chinese economy, which means that international US companies are losing sales in China. China has tons of people, so companies were doing well there, so lower sales mean lower profits.

International

Around the world, economies are on the brink of recession. By definition a recession is two consecutive quarters of negative growth. This means that people are not spending money, like they should, in order to keep the economy afloat. Of course, less spending leads to lower profits and lower stock prices.

Commodities

Commodities are all falling, which is actually putting us at risk for deflation. Companies that sell commodities are losing lots of money as the prices fall. Mining companies and things of that nature will lose money because the prices are cheap. They lose money because the cost to mine does not change, but the price they can see at does.

This also can lead to deflation, as it becomes easier to buy more things with less money. This is a problem for stock prices because they act the same as buying a loaf of bread. They become more expensive or cheaper based on inflation rates. If everything goes on sale, so do wages and so do stocks.

The Fed

The problem with the Fed, is that they have built this economy on a false foundation. They have kept interest rates artificially low, which has spurred growth, but that’s the problem. They interacted into a natural process and have only prolonged the bubble. They have essentially expanded the economy, and fought against previous bear markets. If you look throughout history, you will notice that you cannot prevent a crash, you just prolong it and make it worse. I believe that is what the Fed has done.

The stock market has been pushed up because of low interest rates. The low interest rates have made bonds look like lackluster investments, and has made other investment vehicles look bad as well. Because of this, people have taken money out of those investments and put them into stocks; the more money in stocks, the higher the prices go.

Now, remember this is not natural. So, we can expect that in order for things to be natural, they need to take money out of stocks to put back into bonds and other investments. Once rates go back up, people will start looking for bonds and stuff. This will take money out of the market, which is why I think it will fall to the lower levels. The higher levels were the highest the market has ever been naturally, so I do not think falling to previous highs will be good enough for the market to bottom.

Check out my blog

Brandonrossta.blogspot.com

Making a Case for a Bear Market, pt. 2

In part 1, we looked at fundamental reasons why the stock market can become a bear. Here, we will look at technical reasons. We will look at the Dow Jones Industrial Average and its relation to the transportation sector of the economy.

Background
The Dow Jones Industrial Average (DJI) and the transportation average (TRAN) should be correlated. This is from the Dow theory. The Dow theory states that a strong economy would be shown through the TRAN and the DJI. This is because the industrials need to get their products to places where they can be sold. If transportation companies are being used, then companies are shipping products to places where they are sold. In theory, if the TRAN were to go bear before the DJI, then it represents less sales, and less profits.

DJI

Here you can see the DJI peaked in mid-June and has been down since.

TRAN

The Transportation average began to fall in mid-March, about three months before DJI began its descent. You would expect DJI to follow. 

However, the TRAN is made up of different types of shipping methods. We can take a look at individual sectors and see what is happening, and what it implies.

DJUSTK

This is the trucking sector. It has a bearish pattern, a double top and it has fallen around 17.5%. The trucking sector will give tell you about domestic shipping. It will tell you about shipping from factories or ports. The lowering price implicates the outlook of the trucking sector will fall, which means products are not going to be shipped.

DJUSRR

The railroad sector has fallen at a very rapid rate. This is correlated with domestic shipping as well. The sector has fallen about 35%, starting in March.

DJUSAF

The delivery services has fallen about 17% from peak to trough. The falling prices in this sector imply that people are not shipping goods, or ordering goods to be shipped. This is more correlated with consumers, not so much industries.

DJUSMT

This is the marine transport index, and this has fallen 48% since mid-October. This index will tell you about imports and exports internationally. With this index you can see that global production has slowed.

DJUSAR

The graph here does not look like much has happened, but the index has actually fallen about 26%. This is actually counter-intuitive to what you would be expecting. With falling gas prices, airlines should be generating more profits. However, we can read this as people are choosing not to fly as much anymore. Which would mean people are starting to save money. When people decide to save, the economy gets weaker. Less spending means less GDP.

Conclusion

As you can see, the transportation sector tells a different story of the economy than the DJI does. Imports and exports have fallen, showing that global producers are not selling as many products internationally. The domestic shipping industries are not transporting as many products within the US, which signals a slowdown in the domestic economy. 

A global slowdown in shipping can signal a global economy slowdown. As you read stock charts, it is important to look for these types of connections. Technical analysis assumes that the market discounts all available information. This means that when a sector falls, it can have other implications, rather than just the transports are going down. Making these connections will allow you to read into the economy. Rather than waiting every quarter to run the fundamentals of each company, you can look at sector price action, and gauge things for yourself, before the fundamentals come out.