10.5.2011
The eight-week trading range from early-August to late-September was finally breached the first two days of October. The move came to the downside, which was the most likely scenario. Our call for a very brief dip below the August 9th lows turned out to be correct. Last week we outlined a likely breach lasting several hours to no more than a few days – as it happened, the S&P500 remained below the August 9th low for a total of seven trading hours before a tremendous late-day rally on October 4th brought the index back above the August 9th low.
As the market has behaved just as expected, given the influences of current long-term and intermediate-term downtrends, clarity on the likely path of the market for the coming weeks and months has increased. There are four likely scenarios from here:
1. Market reverses down immediately, breaches the October 4th low, continues lower for a couple of days more, then rallies for several weeks to a month or two
2. Market rallies for several more days, perhaps a week or so, then retests the October 4th low
3. Market consolidates sideways for a few days, nears or retests the October 4th low, then rallies for several weeks to a month or two
4. Market continues to rally strongly off the October 4th low for several weeks to a month or two
We see Scenario 2 or 4 as most likely, Scenario 3 slightly less likely, and Scenario 1 as the outlier.
As the long-term downtrend that began on May 2nd remains intact, all rallies are likely to fail at some point. The key will be to determine when and where the failures are likely to occur. As the market continues to digest ongoing news flow regarding the economy, corporate earnings, and sovereign debt in the months ahead, the likelihood of a ‘surprising’ rally lasting several weeks to a month or two is now high. However, the rally is unlikely to breach the 2011 highs before failing and perhaps testing the October 4th low.
Markets tend to move relatively smoothly in long-term uptrends and choppily in long-term downtrends. This is due to the fact that downtrends trigger heightened emotional responses, which lead to markets overreacting to the downside, which leads to violent swings back upward. The very long-term tendency for money to generally flow into the equity market is another factor that creates choppiness during downtrends, as underlying long-term buyers do battle with cyclical sellers. We have seen this battle play out the past two months, and it will be ongoing for the foreseeable future.
In summary, there is a high likelihood that a multi-week rally has begun or will begin sometime in October. If the advance continues in a vertical fashion the next few days, there is a greater likelihood that the market will retest the October 4th low before any multi-week rally can occur. However, once the market does pivot into an intermediate-term uptrend, the rally may extend for a month or more thereafter.
Wednesday, October 5, 2011
Tuesday, September 27, 2011
The Fight Continues
9.27.2011
Since our last post here two weeks ago, the S&P500 has had a large trading range of 9.5% top to bottom, yet has moved a net sum of .3% higher in that time. The market remains in the same ‘fight zone’ referenced two weeks ago. However, we now have more information on which to base our outlook.
Two key events have occurred just in the past week in the US equities market: a significant lower high and a significant test of the August low. The lower high made on September 20th was significant because it did what was expected of an intermediate-term downtrend within a long-term downtrend: buyers stalled, then aggressive sellers returned before the market could pivot above its prior swing high which was made on August 31st.
The second event, the test of the August low, was significant for several reasons. The first is the fact that the test occurred so rapidly after the swing high – there was true seller aggression all the way down to the closing low of August 8th, and it got to the low in only two days. The second important aspect of this test of support was the fact that the selling dried up very quickly – within one day – upon testing the low. Clearly there is some level of value there, as buyers are able to gain control from the sellers when the market is at the level of the August low. The third important point is the fact that the market rallied vertically the next two and a half days with very little in the way of selling. This presence of buyers remaining in the market at the low end of the now eight-week trading range means that the trading range will remain intact indefinitely.
However, as last week’s test of the August low was the third such test, any subsequent arrival there in the short term is likely to frustrate the buyers, who will likely dump stocks in an emotional, capitulative move below the August low. The likelihood of the market remaining below the August low for more than a few days remains quite low, as bullish divergences continue to proliferate. Therefore, a significant intermediate-term, and possibly long-term, bottom would be likely after any multi-day cascade down below the August low.
The action in the VIX has provided little useful information the past few weeks, as it has simply traded inversely to the equities market. However, the VIX remains anomalously high, currently in the mid-upper 30s, and has not confirmed a new intermediate-term downtrend. One bullish element of the VIX is the decline in the average movement of the measure itself since late-August – this indicates relative comfort with the current level of volatility.
In summary, the market continues to coil sideways, likely in advance of a large move out of its eight-week trading range. With such elevated volatility and emotion continuing to build, a decisive directional move becomes more likely with each passing day. Though the intermediate- and long-term trends favor the downside, signs of underlying strength are increasing. The short-term lines in the sand are now drawn at 1120 on the downside and 1220 on the upside. A breach of this range will likely lead to a significant move in price in whichever direction it should break.
Since our last post here two weeks ago, the S&P500 has had a large trading range of 9.5% top to bottom, yet has moved a net sum of .3% higher in that time. The market remains in the same ‘fight zone’ referenced two weeks ago. However, we now have more information on which to base our outlook.
Two key events have occurred just in the past week in the US equities market: a significant lower high and a significant test of the August low. The lower high made on September 20th was significant because it did what was expected of an intermediate-term downtrend within a long-term downtrend: buyers stalled, then aggressive sellers returned before the market could pivot above its prior swing high which was made on August 31st.
The second event, the test of the August low, was significant for several reasons. The first is the fact that the test occurred so rapidly after the swing high – there was true seller aggression all the way down to the closing low of August 8th, and it got to the low in only two days. The second important aspect of this test of support was the fact that the selling dried up very quickly – within one day – upon testing the low. Clearly there is some level of value there, as buyers are able to gain control from the sellers when the market is at the level of the August low. The third important point is the fact that the market rallied vertically the next two and a half days with very little in the way of selling. This presence of buyers remaining in the market at the low end of the now eight-week trading range means that the trading range will remain intact indefinitely.
However, as last week’s test of the August low was the third such test, any subsequent arrival there in the short term is likely to frustrate the buyers, who will likely dump stocks in an emotional, capitulative move below the August low. The likelihood of the market remaining below the August low for more than a few days remains quite low, as bullish divergences continue to proliferate. Therefore, a significant intermediate-term, and possibly long-term, bottom would be likely after any multi-day cascade down below the August low.
The action in the VIX has provided little useful information the past few weeks, as it has simply traded inversely to the equities market. However, the VIX remains anomalously high, currently in the mid-upper 30s, and has not confirmed a new intermediate-term downtrend. One bullish element of the VIX is the decline in the average movement of the measure itself since late-August – this indicates relative comfort with the current level of volatility.
In summary, the market continues to coil sideways, likely in advance of a large move out of its eight-week trading range. With such elevated volatility and emotion continuing to build, a decisive directional move becomes more likely with each passing day. Though the intermediate- and long-term trends favor the downside, signs of underlying strength are increasing. The short-term lines in the sand are now drawn at 1120 on the downside and 1220 on the upside. A breach of this range will likely lead to a significant move in price in whichever direction it should break.
Tuesday, September 13, 2011
Hurry Up and Wait
The US equities market has continued to experience elevated volatility the past few weeks. It is quite rare for volatility to remain as high as it has since early-August for as long as it has. Other similar periods occurred in late-2008 and early-2009, as well as in 1998 during the Russian debt default /Long Term Capital Management debacle. We are therefore not anywhere close to uncharted territory in terms of volatility, though, certainly, such periods are uncommon and therefore poorly understood.
The VIX volatility index topped out this year at 48 on August 8th, a day before the S&P500 made its intraday low of the year. Since then, the VIX has seen successively lower highs, yet remains above its 30-day simple moving average. During the same time, the S&P500 has seen successively higher lows (with the exception of 9.12’s slight breach below 9.6’s low), and remains below its 30-day simple moving average.
The analysis of such moves in the broad equity market and the VIX shows that the market has been coiling for the past few weeks with roller-coaster moves that have left prices net flat since mid-August. Such indecision on the part of the markets often precedes a large directional move one way or the other. Since the long-term and intermediate-term trends are down, according to our work, the likelihood of lower prices must be weighted as the higher probability.
However, as bullish divergences have already occurred in many stocks and foreign stock indices, the likelihood that US equity indices will breach their August 9 lows for any great duration is quite small at this point in time. Should such a breach occur, it may last only minutes or perhaps as long as a few days. On the other hand, should the market close above its August 31 highs in the next few days or weeks, there is a high likelihood of higher prices thereafter.
As for now, the market remains in the thick of a ‘fight zone’, where buyers and sellers duke it out, and nobody wins for more than a few days. Time to hurry up and wait.
The VIX volatility index topped out this year at 48 on August 8th, a day before the S&P500 made its intraday low of the year. Since then, the VIX has seen successively lower highs, yet remains above its 30-day simple moving average. During the same time, the S&P500 has seen successively higher lows (with the exception of 9.12’s slight breach below 9.6’s low), and remains below its 30-day simple moving average.
The analysis of such moves in the broad equity market and the VIX shows that the market has been coiling for the past few weeks with roller-coaster moves that have left prices net flat since mid-August. Such indecision on the part of the markets often precedes a large directional move one way or the other. Since the long-term and intermediate-term trends are down, according to our work, the likelihood of lower prices must be weighted as the higher probability.
However, as bullish divergences have already occurred in many stocks and foreign stock indices, the likelihood that US equity indices will breach their August 9 lows for any great duration is quite small at this point in time. Should such a breach occur, it may last only minutes or perhaps as long as a few days. On the other hand, should the market close above its August 31 highs in the next few days or weeks, there is a high likelihood of higher prices thereafter.
As for now, the market remains in the thick of a ‘fight zone’, where buyers and sellers duke it out, and nobody wins for more than a few days. Time to hurry up and wait.
Monday, August 29, 2011
Late-Summer Reassessment
As it has now been several weeks since the August 9th low in the US equity markets, it is appropriate to take stock and reassess. Our determination that the market would rally for days or weeks off of the August 9th low turned out to be a good one, as the market remains over 8% higher. The NASDAQ100 did test its August 9th low on August 19th, but it never went below and has rallied quite strongly five of the past six days since then. So the crash is over and the market has spent the past few weeks chopping up and down in very high volatility, trying to find a level of value.
While it is heartening that buyers have returned and halted the early-August cascade down, the major indices have, nonetheless, entered into a long-term downtrend. While this new long-term downtrend can only be ‘confirmed’ upon the market breaching the August 9th lows, the general mode hereafter will likely be rallies that fail after a few weeks to a month or two, then lower lows. Strong rallies like the one(s) we have seen since the August 9th lows are typical of bear markets, as they indicate instability. Sustainable rallies are associated with declining volatility as well as intermediate-term moving averages pointing up, neither of which has occurred the past few weeks.
So far, the two scenarios we believed were most likely in our last post are both still in play, while the two outliers have, indeed, failed to materialize. From this point in time and price, the market may or may not continue going higher before testing the August 9th lows. The choppy rally higher is perhaps the more likely continuation for the short term. Regardless, the further in time we progress without a test of the August 9th lows, the greater the likelihood that, when tested, it will fail.
While it is heartening that buyers have returned and halted the early-August cascade down, the major indices have, nonetheless, entered into a long-term downtrend. While this new long-term downtrend can only be ‘confirmed’ upon the market breaching the August 9th lows, the general mode hereafter will likely be rallies that fail after a few weeks to a month or two, then lower lows. Strong rallies like the one(s) we have seen since the August 9th lows are typical of bear markets, as they indicate instability. Sustainable rallies are associated with declining volatility as well as intermediate-term moving averages pointing up, neither of which has occurred the past few weeks.
So far, the two scenarios we believed were most likely in our last post are both still in play, while the two outliers have, indeed, failed to materialize. From this point in time and price, the market may or may not continue going higher before testing the August 9th lows. The choppy rally higher is perhaps the more likely continuation for the short term. Regardless, the further in time we progress without a test of the August 9th lows, the greater the likelihood that, when tested, it will fail.
Wednesday, August 10, 2011
A Clear Vision of the Markets
The price action in US equities on August 9th strongly suggests that a short-term bottom is in place. After buyers appeared at the open, the market drifted around into the FOMC announcement at 2:15pm. Then sellers tore the market down to a new 11-month low in the S&P. From 2:45pm-4pm, the market then rallied over 6% (!!), finishing the day up 4.7%. While there is no magical formula that reliably catches market bottoms 100% of the time, the most important factor is the activity of buyers. In the downtrend that began in late July, there have been buyers, sometimes very aggressive buyers, at several levels. They appeared for several hours on August 3rd, 5th, and yesterday, August 9th.
The reason that the August 9th buying was significant was due to the aggressiveness, the fierceness of the buyers. There was an all-out rush back into equities for the final 75 minutes of the day, immediately on the heels of a new low for 2011. The market closed at the exact high of the day and had managed to close above the August 8th low as well. This buyers’ rush put an end to the cascading move down in the market. While it is possible that an even larger, scarier move lower is near, the more likely scenario is a continuation to the upside for days, possibly weeks.
Pick your asset class of choice and you can probably make the argument that its price movement in 2011 indicates that the world is imploding. While the markets are trying to keep up with major rapid-fire news (US debt downgrade; FOMC declaration of easy money through mid-2013; Europe backstopping Italian and Spanish debt; etc.), markets tend to overshoot both to the upside and the downside. Since there is an anomalously high level of uncertainty right now across many different strata of market influences (politics, economy, sovereign debt loads, banking system), deleveraging of risk has been the primary reaction by market participants. Because of the existential nature of the problems at hand, the move away from perceived risk and towards perceived security has been extreme. There are now two likely scenarios for equity markets in the upcoming months:
1. Market trades in choppy fashion generally higher, fails to breach the 2011 highs, then heads back down for a test of the August 9th low
2. Market trades in choppy fashion higher for a few days to weeks, then heads back down for a test of the August 9th low
Two outlier scenarios must also be considered.
1. Market rallies in ‘V’ formation back up near the 2011 highs and then goes higher with no test of August 9th low
2. Market continues to drop vertically below the August 9th low
In summary, the short-term looks bullish for equities, the intermediate-term looks bearish, and the long-term is murky but increasingly bearish. One caveat: if the market closes below the August 9th lows, all bets are off and a reassessment is necessary.
The reason that the August 9th buying was significant was due to the aggressiveness, the fierceness of the buyers. There was an all-out rush back into equities for the final 75 minutes of the day, immediately on the heels of a new low for 2011. The market closed at the exact high of the day and had managed to close above the August 8th low as well. This buyers’ rush put an end to the cascading move down in the market. While it is possible that an even larger, scarier move lower is near, the more likely scenario is a continuation to the upside for days, possibly weeks.
Pick your asset class of choice and you can probably make the argument that its price movement in 2011 indicates that the world is imploding. While the markets are trying to keep up with major rapid-fire news (US debt downgrade; FOMC declaration of easy money through mid-2013; Europe backstopping Italian and Spanish debt; etc.), markets tend to overshoot both to the upside and the downside. Since there is an anomalously high level of uncertainty right now across many different strata of market influences (politics, economy, sovereign debt loads, banking system), deleveraging of risk has been the primary reaction by market participants. Because of the existential nature of the problems at hand, the move away from perceived risk and towards perceived security has been extreme. There are now two likely scenarios for equity markets in the upcoming months:
1. Market trades in choppy fashion generally higher, fails to breach the 2011 highs, then heads back down for a test of the August 9th low
2. Market trades in choppy fashion higher for a few days to weeks, then heads back down for a test of the August 9th low
Two outlier scenarios must also be considered.
1. Market rallies in ‘V’ formation back up near the 2011 highs and then goes higher with no test of August 9th low
2. Market continues to drop vertically below the August 9th low
In summary, the short-term looks bullish for equities, the intermediate-term looks bearish, and the long-term is murky but increasingly bearish. One caveat: if the market closes below the August 9th lows, all bets are off and a reassessment is necessary.
Tuesday, December 29, 2009
Know What Can Destroy Your Account...and also What Can't
At any given point in time, there is a myriad of potential causes for your investment account to get destroyed. This is no reason to seek shelter and reduce risk, however, as it is the very presence of risk that brings with it the potential for high returns. Investors frequently remain underexposed to market rallies, sometimes lasting years, because they do not have a system of identifying the true risks to their particular trading style and portfolio. Just as knowing the capabilities of your enemies will prepare you in battle, focusing on what may hurt your wealth is the best way to prepare and defend it.
The years 2007 through 2009 will stand in the memories of a generation of investors as proof that stocks can go down a lot further and for a lot longer than seems reasonable. The emotional scarring caused by these losses caused many market participants to sharply reduce their equity holdings in 2009 – after all, there’s nothing more humiliating than being burned twice by the same flame. In fact, stock funds have seen net outflows from retail investors so far in 2009, while bonds have seen net inflows – this is a clear sign of risk aversion. However, these same market participants had yet to formulate a plan to increase their risk exposure before a massive rally brought the market roaring higher off the bear market lows. Now, 2009 will also stand out as the year that proved that stocks can go up a lot more for a lot longer than seems reasonable.
Many market participants got caught flat-footed in the face of the now nine-month, 65%+ rally off the bear market lows because they have not properly assessed the inherent risks to their trading styles or portfolio. Right now, for example, there are plenty of people who have made some money back in 2009, but who are now selling or will sell at the first sign of trouble because they feel the market has simply gone up too much too quickly. While this may in fact prove to be true, they have failed to assess what this means for their holdings. Does it mean the market will go down 50%? 30% 5% Does it mean the market will go sideways for several months? How will this affect their positions?
Just as a bear in the woods must distinguish between the sound of shotgun versus a crash of lightning, stock market participants must distinguish what to fear and what not to fear. After all, if you recognize that the market is overbought and due for a rest or pullback, selling may not be a good idea, as the likelihood of just a mild, countertrend pullback may be quite high. Selling in such a situation would simply reduce your exposure during a healthy trend that is merely experiencing some consolidation, a pause of short duration – the risks of getting out too early cannot be understated, as a low-risk re-entry may never appear until the trend is over, and, as 2008 and 2009 have shown, you never know how long a trend will run.
Wednesday, November 11, 2009
Uncertainty is a Constant
The past few months there has been plenty of talk about uncertainty in the future of corporate earnings and the US economy. Since the market lows in March, skepticism about the market rally has been aided and abetted by these arguments (high unemployment; fears about a commercial real estate crash; ballooning government deficits; lack of real economic growth after government stimulus is stripped out; fears about a weakening US dollar). Prior to the start of the rally, the market declined in very volatile fashion for almost a year and a half, again, amid uncertainty (bursting of the housing bubble; seized up credit markets; massive losses at banks; massive financial institutions failing). Prior to that, stocks rallied for over four years without a 10% decline in the S&P 500 amid uncertainty (skyrocketing oil prices; wars in the Middle East; rising interest rates; fears of the housing bubble collapsing). Before the 2003-2007 rally, the market declined for two and a half years after the turn of the millennium due to uncertainty (bursting of the internet bubble; massive corporate corruption – Worldcom, Enron, etc.; Wall Street analyst fraud; terrorism in the US). The only time in recent history that there has been ‘certainty’ in stock investing was the late-1990’s, nearly 20 years into a secular bull market. By 1999, after multiple currency crises, Russia defaulting on its government debt, and Long Term Capital Management nearly unhinging the world financial system, the market continued to make new all-time highs, as everyone ‘knew’ that we had entered a new economic era driven by the untold wonders of internet technology. This brief period of 'certainty' led to massive declines that still have yet to be recovered. After more than doubling in the final seven months of its push to all-time highs reached in March 2000, the NASDAQ remains 58% below that high, and it has never gotten within 40% of the high since its post-internet-bubble low in October 2002.
The point is that trading the market is nearly always fraught with uncertainty. If the future were certain, there would be no purpose to the market, as everyone would simply calculate where earnings were going to be in X number of years and discount those earnings back to their present-day value. There would also be no premium in stock prices, as premium is derived precisely from the uncertainty inherent in the future. Those who are waiting for certainty in the market should never put a dime into any investment except US treasury securities, as uncertainty is a constant in risk assets.
Further, certainty is a feeling, not a fact. Therefore, market participants at all times have varying levels of certainty, which is why the market fluctuates. Going into this week, for example, many market participants felt certain that, due to a lack of upcoming economic and earnings data, there was little to prevent the market from going higher for at least a few days. Others now feel certain that there is no way that the government will be able to successfully mop up all the liquidity that they have let loose, so they are certain that the market will go lower from here for months on end. Others, still, are certain that the economic recovery will be much stronger than the consensus estimates, and that the market will rally into the first quarter of 2010 at least. And some believe that, until the FOMC begins hinting at an impending rate hike, the market will continue to rally.
All of the aforementioned ‘certainties’ can be boiled down to an individual’s feeling about the facts, and about the relative importance of various facts. Of course, it is a flawed strategy to say, simply, “I am going to buy stocks today because earnings next year are going to beat consensus estimates.” Even if you are 100% correct, and earnings do beat the estimates, what if there is a big, perhaps massive, exogenous market event? Take Apple (NASDAQ: AAPL) in 2008 as an example. The company beat earnings estimates in all four quarters of 2008. AAPL also beat fiscal year 2008 estimates that analysts made in late-2007. However, the stock was down 57% in 2008, which was even worse than the S&P 500’s 38% loss and the NASDAQ’s 41% decline. As foolish as it is to look solely at individual data points when making investment decisions, this is how many investment decisions are made, and it is the reason why the market is in a constant state of motion. The fact is that just about everything affects stock prices – each factor just waxes and wanes in importance over time. While aggregate corporate earnings have the highest long-term correlation with aggregate stock prices, the swings in the price-earnings ratio, which is largely influenced by sentiment, make this correlation useless for trading the major stock market indices in timeframes of less than a year or so.
Whether or not the big rebound in corporate earnings that has been predicted by the stock market continues, sentiment remains divided going into the end of the first decade of the new millennium. Perhaps the only certainty is that uncertainty will remain, regardless of which direction the stock market goes from here.
The point is that trading the market is nearly always fraught with uncertainty. If the future were certain, there would be no purpose to the market, as everyone would simply calculate where earnings were going to be in X number of years and discount those earnings back to their present-day value. There would also be no premium in stock prices, as premium is derived precisely from the uncertainty inherent in the future. Those who are waiting for certainty in the market should never put a dime into any investment except US treasury securities, as uncertainty is a constant in risk assets.
Further, certainty is a feeling, not a fact. Therefore, market participants at all times have varying levels of certainty, which is why the market fluctuates. Going into this week, for example, many market participants felt certain that, due to a lack of upcoming economic and earnings data, there was little to prevent the market from going higher for at least a few days. Others now feel certain that there is no way that the government will be able to successfully mop up all the liquidity that they have let loose, so they are certain that the market will go lower from here for months on end. Others, still, are certain that the economic recovery will be much stronger than the consensus estimates, and that the market will rally into the first quarter of 2010 at least. And some believe that, until the FOMC begins hinting at an impending rate hike, the market will continue to rally.
All of the aforementioned ‘certainties’ can be boiled down to an individual’s feeling about the facts, and about the relative importance of various facts. Of course, it is a flawed strategy to say, simply, “I am going to buy stocks today because earnings next year are going to beat consensus estimates.” Even if you are 100% correct, and earnings do beat the estimates, what if there is a big, perhaps massive, exogenous market event? Take Apple (NASDAQ: AAPL) in 2008 as an example. The company beat earnings estimates in all four quarters of 2008. AAPL also beat fiscal year 2008 estimates that analysts made in late-2007. However, the stock was down 57% in 2008, which was even worse than the S&P 500’s 38% loss and the NASDAQ’s 41% decline. As foolish as it is to look solely at individual data points when making investment decisions, this is how many investment decisions are made, and it is the reason why the market is in a constant state of motion. The fact is that just about everything affects stock prices – each factor just waxes and wanes in importance over time. While aggregate corporate earnings have the highest long-term correlation with aggregate stock prices, the swings in the price-earnings ratio, which is largely influenced by sentiment, make this correlation useless for trading the major stock market indices in timeframes of less than a year or so.
Whether or not the big rebound in corporate earnings that has been predicted by the stock market continues, sentiment remains divided going into the end of the first decade of the new millennium. Perhaps the only certainty is that uncertainty will remain, regardless of which direction the stock market goes from here.
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