Stock Market Updates – Quantitative, Fundamental and Technical Analysis… In That Order!

Stock market updatesIt has been some time since I wrote a Stock Market Updates blog post and it feels good to share my opinions in this format again!

Today’s post deals with my “order of analysis” and it stems from a conversation I had with a colleague regarding how I approach the myriad of investing and trading decisions in the course of trying to narrow down the best possible vehicles where to deploy capital.

Stocks go up, go down or stay flat in price. If you are long (own the stock) and the stock goes up, you are going to make a profit. If you are long and the stock goes down in price, you are going to incur a loss. If what you own stays stagnant in price you will lose the opportunity cost of allocating your capital elsewhere but in real dollars and cents, beyond the transaction costs, you will not have incurred a gain or a loss. Simple right?

Well it is! What is not simple is this:

How do I know what and when to buy a stock and when to sell it?

First let’s consider some well know facts. Stocks in the long run have about a 70% to 75% chance of being higher or flat on a daily basis. That is a very powerful statement of fact and the primary reason why most individual investors should stay far away from shorting stocks. Shorting stocks is when you borrow shares on margin in hope of closing the trade at a lower price point. Or simply stated, when your bet is that the stock will go down.

So if we agree 75% of the time stocks go up or stay flat, then it follows that our job as investors and traders is to choose those stocks that have a better probability of going up! Of course easier said than done… and in there lies the topic of this post.

 

Quantitative, Fundamental, Technical…

As a market participant I always chuckle at those debates of who is right or wrong or which discipline is “best”, Quantitative Analysis, Fundamental Analysis or Technical Analysis. If you click on the links, you will get a more in-depth description of  each but for the purpose of this article, lets look at it as such:

Quantitative analysis, tries to arrive at an answer by evaluating questions of “How much”.

 

Real buy and sell figures at various price points over time. Some folks out there have begun calling this “evidence based” investing. I am good with quantitative analysis. No need to rename something that has been around for many years just for the sake of launching a new marketing campaign.

This is a factor that I consider paramount. I want to buy a stock that is in the beginning of an accumulation phase. No matter how good a stock may seem from a fundamental or technical basis, if no one is buying the stock, it will languish and remain flat. Do we want our limited allocation of money to be deployed to a stock that will more than likely remain flat? The answer is definitely no. As individual investors we have a limited amount of cash to deploy to our investment positions and a flat stock does us no good.

Many so-called “value” stocks fall under this criteria. Often a stock looks great from a fundamental point of view but for some reason or another it goes unnoticed by the market. If no one is buying it does it matter if it’s a great fundamental story? What is the point of holding a stock for years with the hope that the market will eventually recognize what you have?

Once we find stocks that pass our quantitative analysis and screens, the next thing we look at is the fundamental merits of these stocks. In other words we look to answer the following:

Do I agree with the fundamental reason behind the quantifiable buying of the stock?

Fundamental analysis refers to a company’s business metrics. Is the company earning a profit? is it over valued versus its peers? does it have a price to earnings ratio above the broad market benchmark and so forth. I want to own stocks that are beginning to move higher whose fundamental story makes sense to me. Does the company make a product or offer a service I support and believe in?

Some traders will say this doesn’t matter. “who cares if it’s a “good” company or stock…it’s moving so just buy it” Well this may work in the near term but a stock will eventually trade-off of reality. A hyped up stock with poor fundamentals may fly high quickly but will fall just as quickly. I for one prefer to own stocks I believe in and understand from a fundamental point of view.

 

Technical indicators and pattern recognition

Lastly and least important of all in my opinion is technical analysis. Technical analysis is esoteric in the sense that it can be referred to as art just as easily as it could science. Patterns and the action of traders, (buy or sell) when these patterns are recognized in charts can and do move markets.

Over the years, many quantitative indicators have been lumped into the broad category of “technical analysis” incorrectly. At its pure sense, technical analysis is the study of price action. Technical analysts use price charts to try to determine when both short-term and longer term price inflections are about to occur. In the near term, an understanding of technical analysis can help better an entry or exit point once you are ready to place your trade.

So there you are! Quantitative + Fundamental + Technical analysis. All three have their place, some more so than others. Keep your analysis to this order and watch your profits grow !

 

 

 

All About the Brightest, Tastiest Fruit of Them All … Apple!

All About the Brightest, Tastiest Fruit of Them All … Apple!

Apple (AAPL) is obviously the most systemically important company on the planet today. The bull market over the past couple of years has been predicated on two very clear factors, one is quantitative easing by the Fed and the other is Apple continuing its meteoric success. Take one or the other away and we have to ask much different questions in order to formulate an investment opinion in the current market.

The Fed has promised QE for as long as is needed

This action has masked some real “sins” in today’s market while the Fed’s “grand experiment” unfolds. With this onslaught of liquidity, anybody managing money has bought shares of the most hyped (for good reason) company in the history of companies! The growth in Apple’s market value over this year alone is staggering and generally speaking its success is also based on two factors.

The first is the fact that the company puts out great products that everyone wants to own and the second is that it has been one of the better managed corporations in modern financial history. Add beta chasing liquidity to the mix and you have an explosive combination.

Recently the stock has faltered.

It is down nearly 10% from its high of the year and some are rightfully questioning its staying power. The launch of the iphone 5 has been lackluster (from the perspective of what we expect from Apple) and there have been some technical gremlins which are unusual for this company. For traders, even for traders who do not trade AAPL (me) the performance of this stock is crucially important because of its weighing in the broad indices and the impact that this company has on peripheral names, those companies whose business model is dominated by supplying Apple with components and services.

My take is that if Apple doesn’t work in the current market environment, the market in general doesn’t work. Like I mentioned above, the bullish thesis here is a double pronged spear, take one out and the other falters. It won’t be the case forever, but it is the case now.

Looking at a price chart of Apple

reviewing the past couple of years of price action, there is a clear pattern of sharp pushes higher followed by periods of choppy consolidation or as some call digestion. These have invariably been periods where weaker hands handed over shares to stronger hands at lower prices only to see sharp continuations of the upward momentum move. Nothing wrong with this action whatsoever.

Those trading, speculating on short term moves will be much less tolerant of price swings against them and are going to be the first out the door. That is trading 101. Those with a longer timeframe will revert to the fundamental argument that Apple stock is “cheap” and use weakness to build positions.

Since 2011 we have had 8 such periods where shares changed hands, from weak to strong, in this profit taking/shake out action. All eight times the stock managed sharp rises while trying to lasso the runaway train and catch the corrective downturn has been difficult (putting it mildly).

We are at another important juncture with Apple.

There are many questions regarding the potential for a more structural change in the fundamental outlook for Apple and end of year profit taking from those managers heavily invested in the name is a strong possibility. So far I don’t see it. There has been very little selling pressure in the name beyond what we would characterize as normal profit taking by small specs. From a quantitative perspective, the stock has not traded beyond 2 standard deviations from its 40 day moving average for very long before a sharp reversal.

Could this be the “IT” moment? Of course it can, but it has been an unwise bet for some time and in my opinion one that has major implications for the broad market.

 

 

 

Wide Angle Lens Look At The Upcoming Quarter

Time to take a “wide angle” view of this market to get our bearings on where we stand heading into this last quarter of the year. It has been a tough trading year for most hedging strategies as the “one way” up market has, so far this year, made alpha generation a very tough affair and beta chasing the order of the day. The outlook heading into year-end is book cased by two very strong arguments. As I mentioned above, there is no denying that many money managers are going into this quarter behind their benchmarks and the scenario for a year end “mark up” in equities could be a real catalyst for the bulls. The resolution of the extreme uncertainty that will come about by the outcome of the elections should also be supportive of a push higher no matter who wins the election. Business and markets in general can deal with a tremendous amount of obstacles but one thing that it often has trouble with is lack of visibility or uncertainty. Make no mistake about it, the outcome of the elections will make a huge difference in the market environment going forward but the difference is from “good to better” as opposed to “good versus bad” in my opinion. The effect on the economy going forward by which side wins the elections will be drastically different in my opinion but the market will deal with that in due course. The ever more dovish Fed stands ready with gazillions of dollar at the beckon call of financial markets and the “Bernanke Put”, which investors have come to rely on so heavily, stands ready to bailout markets. The recent throw the kitchen sink announcements of QE should provide ample liquidity which banks will gladly throw put to work in the stock market.

Against this rosy backdrop lies the ever worsening domestic and Global economies. The slowdown that started to rear its ugly head back in March of this year has escalated and the recent economic data points have been worsening. Today’s Chicago PMI was one of the worst reports I have seen in a while. The Fed had reason to go so big and if the data points are any indication, we may be headed to another recession in 2013. Corporate earnings are also on the downside and many companies have slashed earnings outlook for the 4th quarter which was heavily weighted in the overall projections for the S&P 500 year end EPS targets. This fundamental slowdown in earnings growth will weigh on a market trading near multi year highs.

Headline risks abound. The situation in Europe is far from over and markets are vulnerable to shock events from this crisis. Like it or not, this risk premium will be with us for a while and will keep multiples pegged to the lower extremes of the recent trend. The political brinksmanship we are sure to see in dealing with the fiscal cliff later this year will augment that headline risk premium as I am fairly certain it will be a drawn out affair particularly if President Obama wins re-election and the Republicans maintain control of the House.

Finally from a technical standpoint, markets are going into the quarter somewhat overbought. The one way move higher since early June had pushed the S&P 500 into real overbought levels at 3 standard deviations from its 34 week moving averages. This had not happened since early April of 2010, a period that was soon followed by a sharp pullback. We have backed off of this extreme over the past 2 weeks but could very well consolidate some more. From a price perspective we are right at the midpoint on the 1 standard deviation regression channel from the March 2009 lows and the recent highs. From this vantage point, a move lower is very probable and my first major downside target here would be 1375 on the SPX. The stochastic oscillator and the accumulation/distribution histogram have shown some signs that support this thesis.

So, from a broad perspective, there you have it. There are several compelling reasons to be either bullish or bearish here. Figuring out when to be either is the name of the game.

C.J. Mendes

cjm

Trading Options For Income
8770 Sunset Drive 201
Miami Florida 33143

http://www.tradingoptionsforincome.com

 

Earning – A Wide Angle Lens Look At The Upcoming Quarter

Wide Angle Lens Look At The Upcoming Quarter

Time to take a “wide angle” view of this market to get our bearings on where we stand heading into this last quarter of the year. It has been a tough trading year for most hedging strategies as the “one way” up market has, so far this year, made alpha generation a very tough affair and beta chasing the order of the day. The outlook heading into year-end is book cased by two very strong arguments. As I mentioned above, there is no denying that many money managers are going into this quarter behind their benchmarks and the scenario for a year end “mark up” in equities could be a real catalyst for the bulls.

The resolution of the extreme uncertainty that will come about by the outcome of the elections should also be supportive of a push higher no matter who wins the election. Business and markets in general can deal with a tremendous amount of obstacles but one thing that it often has trouble with is lack of visibility or uncertainty. Make no mistake about it, the outcome of the elections will make a huge difference in the market environment going forward but the difference is from “good to better” as opposed to “good versus bad” in my opinion.

The effect on the economy

going forward by which side wins the elections will be drastically different in my opinion but the market will deal with that in due course. The ever more dovish Fed stands ready with gazillions of dollar at the beckon call of financial markets and the “Bernanke Put”, which investors have come to rely on so heavily, stands ready to bailout markets.

The recent throw the kitchen sink announcements of QE should provide ample liquidity which banks will gladly throw put to work in the stock market.

Against this rosy backdrop lies the ever worsening domestic and Global economies. The slowdown that started to rear its ugly head back in March of this year has escalated and the recent economic data points have been worsening.

Corporate earnings are also on the downside

many companies have slashed earnings outlook for the 4th quarter which was heavily weighted in the overall projections for the S&P 500 year end EPS targets. This fundamental slowdown in earnings growth will weigh on a market trading near multi year highs.

Headline risks abound.

The situation in Europe is far from over and markets are vulnerable to shock events from this crisis. Like it or not, this risk premium will be with us for a while and will keep multiples pegged to the lower extremes of the recent trend.

The political brinksmanship we are sure to see in dealing with the fiscal cliff later this year will augment that headline risk premium as I am fairly certain it will be a drawn out affair particularly if President Obama wins re-election and the Republicans maintain control of the House.

Finally from a technical standpoint…

markets are going into the quarter somewhat overbought. The one way move higher since early June had pushed the S&P 500 into real overbought levels at 3 standard deviations from its 34 week moving averages. This had not happened since early April of 2010, a period that was soon followed by a sharp pullback. We have backed off of this extreme over the past 2 weeks but could very well consolidate some more.

From a price perspective…

we are right at the midpoint on the 1 standard deviation regression channel from the March 2009 lows and the recent highs. From this vantage point, a move lower is very probable and my first major downside target here would be 1375 on the SPX. The stochastic oscillator and the accumulation/distribution histogram have shown some signs that support this thesis.

So, from a broad perspective, there you have it. There are several compelling reasons to be either bullish or bearish here. Figuring out when to be either is the name of the game.

 

 

Markets- The “Nothing Matters” Equity Markets

The “Nothing Matters” Market

The “nothing matters” calls from pundits seem to be picking up steam. Low volume? doesn’t matter, low VIX? doesn’t matter, participation rates? doesn’t matter, market structure issues? doesn’t matter, corporate profits?? Doesn’t matter…. According to what many pundits out there seem to be saying, none of the above matters because the Federal Reserve has said they will ease for as long as necessary to get unemployment to 5.5% and the economy moving again…

In general terms, fighting the Fed has been a losing proposition going back to the period following the Great Depression but in all fairness, we have not seen Fed intervention to this magnitude before. Fair to say that we are in unchartered waters in this regard and while future generations will be able to look and analyze the “causes and effects” of these extraordinary economic times, we, at the present moment can only define the “causes” and speculate on the  “effects”.

Nonetheless, I am not ready to buy into the “nothing matters” argument.

Trading volume for example has been on the soft side for some time now. There are many reasons for this such as the higher average price of stocks these days but the real issue when considering volume is its composition and general participation.

In the past, market volume was comprised of much more retail based, individual investors along with traditional institutional volume and since the early ‘00s, the high frequency and algorithmic traders. Today the retail investor is missing in action, institutions are trading much more in Dark Pools of liquidity outside of the NYSE and high frequency and algorithmic traders make up between 60 and 70% of all trading volume. No matter how you slice it, volume and participation matter.

I think corporate profits also matter

as do the multiples that investors are willing to pay in this environment. I think we are living in a “show me market” where higher valuations will only come about through profit expansion. Analysts and investors will be very careful to pay much higher multiples in this environment of uncertainty and lack of visibility.

While there is room for some multiples expansion and I do think investors will pay slightly higher multiples soon, I don’t buy the “parabolic” move higher in equity prices many are forecasting. I think the fact that we are still fighting to ignite some measure of inflation after so many of these easing programs should raise a red flag that investors are not going to drink the “magic potion” and buy risk assets indiscriminately as perhaps the Fed wants them to.

Market structure matters. Although I think I am pretty well versed in these structural issues, there are many out there that are much more in tune to the pitfalls of these deficiencies. If you are on Twitter, I strongly recommend you follow Eric Scott Hunsader @nanexllc for real insight into the issues plaguing the market today in regards to structure.

Complacency also matters

when complacency reaches extreme levels, the market tends punish those who disregard it. When too many participants forget that markets can go also down , the market has a way to remind folks of how things work.

There are several ways to measure complacency in the market place but the simplest yet effective method is to analyze the action in the cash VIX over the near and intermediate timeframes. Comparisons to periods too far in the past are meaningless because of the many other variables that need to be considered.

The cash VIX gives us a good picture of investor’s appetite for protection using SPX near term put options (30 days out). The VIX presents a picture of what investors are willing to pay in premium over historical volatility for the next 30 days. Complacency is subjective. One trader may look at a VIX reading of 15 and compare it to an actual statistical volatility reading of 10 and have an opinion that markets are not complacent while others can view it as the market discounting the importance of risks ahead.

One objective way to view this

is to take a historical view of how markets have performed at different VIX readings over a specific period of time. Again we want to stay within an intermediate timeframe to get an accurate picture and I like to compare cyclical periods within established longer term trends.

The most recent cycle comprises the bullish period from 2009 to the present. Below are charts of the SPYs and the VIX, weekly charts going back 5 years. So in brief, the VIX is another one of those indicators that shows true trader sentiment because it is backed by up with actions and not only words.

Within a look back period of five years, these levels below 14 have meant complacency and the market has punished that complacency by backing away every single time. Why does it back away? Because when traders are not properly hedged, they are apt to sell positions quickly at any sign of trouble. When traders are properly hedged, they are apt to be more patient with their thesis before changing course. Can the VIX push even lower ? Absolutely yes .

Historical volatility

(real, actual vol) has been very low and many interpret this as a confirmation that volatility is properly priced or even perhaps expensive at these current levels. By this definition, they could be correct. My take is that within this specific look back period, it is undeniable that the market has had trouble dealing with volatility at these low levels. Could it be different this time? Yes but I don’t believe so.

Markets are extended here and the market is complacent to risks. Volatility is very underpriced and the market may be under hedged to deal with a very weak earnings cycle ahead or any shock event. The bullish technical regression channel from June 4th is intact and we should eventually resolve higher, but I am not yet convinced that everything just doesn’t matter anymore…

 

 

Markets- Held Hostage By The Central Bankers

Markets- Held Hostage By The Central Bankers

There is an incredible amount of anxiety in global financial markets in regards to what the central banks of Europe and the US have in store over the next 2 weeks. Earlier in the summer when the S&P 500 traded at 1280 and unemployment seemed ready to turn higher once again, the probability of more stimulus from the Federal Reserve was high.

As the summer comes to an end, the Fed through its use of the bully pulpit and timely comments via its “voice” at the WSJ did succeed in buying time to analyze the incoming economic data points. Over in Europe, the head of the ECB, Mario Draghi managed the same with very strong indications that the ECB was going to do whatever it took to ensure the survival of the Euro.

The result of these promises simply stated are 140 or so S&P 500 points and some euro stability. I am not going to present exact figures on this but suffice it to say that this is quite a substantial move on a “promise” to do something rather than the actual delivery of action. The market as a discounting mechanism has already priced in some additional easing at this point, exactly how much obviously depends on what comes forth from the central bankers but I am of the opinion that there is better than fair chance that the market will be somewhat disappointed by what is actually delivered.

Ben Bernanke has an unbelievably difficult job. In no way do I fault him for what ails our economy or stock market at the moment but a review on the effectiveness of these quantitative easing program down the road will arrive at the conclusion that it has been a failure. It has failed because the initial program was not nearly large enough in scope and because it was not accompanied by fiscal policy. Because of this piece meal approach, the market begged and got QE2 and is now begging and will probably get QE3 which will be even more short lived in effect than its predecessor.

It’s somewhat disingenuous of me or anyone really to critic this Fed. I doubt many could have done a better job in dealing with the crisis from a monetary policy standpoint than Ben Bernanke. Nonetheless, it has failed in its purpose of stimulating economic activity and spurring job growth. The fiscal policy issues facing the nation and the stubbornly partisan politics in Washington which refuses to put country first and ideology second in order to address them, has to bear a huge chunk of the blame in this failure.

The end result for us (the American taxpayers), the ultimate losers in this mess, is that we are now at a serious crossroads having mortgaged a good chunk of our children’s future economic health in this exercise. Will more QE “work”? of course it won’t in the sense that liquidity is not the problem facing this economy, It’s the confidence, the visibility, to put this liquidity to work in the economy for more than 5 minutes.

The uncertainty we hear so much about is very real and it does affect how businesses plan for the future. The fact remains that corporate America has done a remarkable job managing through this period and turning over a profit to shareholders. The problem is that they have done this through cost management and through very favorable refinancing of their longer term debt, as opposed to growing business holistically.

This along with favorable currency exchanges over the past several years have allowed companies to plug along and survive if you will, in a very treacherous environment. The fact remains that at some point, folks have to get back to work. Companies have to implement longer term investment plans and have the confidence that the available liquidity will be supported by clear and competitive fiscal policies. That is certainly not the case at the moment.

While QE will not achieve these goals, it will provide another expensive, provisory “kick in the behind” to risk assets. The reason for this is that it will stimulate flow of cash to the stock market and provide another round of artificial thrust to risk assets. Borrowing cash at .25% to invest in the market is a no brainer when everyone is doing the same. The effect is an artificial push higher in asset prices until the “drug” wears off and the addicted party comes back to beg for more. No matter your views on this, if you are in the “stock investing business”, you have two choices, play along or get out. You can’t fight the Fed when these programs are enacted, especially in the short term.

The case for the ECB is even more complex than what we face in the US. It is involves factors that we do not have to deal with, well, at least for now, which are factors relating to sovereign issues and in the actual structure of the European financial union. The demise of the US dollar is nowhere near the “edge of the cliff” as is the Euro. The ECB however does have the ability to learn from the Feds missteps with its QE programs and not make the same errors. A Band-Aid approach by the ECB here would be very damaging to that “confidence factor” I mentioned above.

I read a very simple and concise commentary today from an analyst referencing sentiment as measured by asset flow within the Rydex family of funds. The two basic takeaways is that although many of the traditional metrics we use to gauge the market’s next directional steps are pointing decidedly bearish, the next directional steps are going to be decided by a group of bankers meeting in Jackson Hole, Wyoming and another set meeting in Brussels. What ensues next is anybody’s guess.

 

Markets- All About The Central Bankers These Days

Markets- All About The Central Bankers These Days

Residents of South Florida dodged a bullet with tropical storm Issac. The storm jogged just slightly west after crossing the eastern portion of Cuba which placed its trajectory just outside of the Florida Keys into the Gulf of Mexico. The storm brought plenty of rain and some strong gusts but in the scheme of things, South Florida can breathe a sigh of relief. The storm is now heading NNW and on track to make landfall in the Louisiana/Alabama Gulf Coast in an area that has had more than its fair share of natural disasters over the past 10 years.

Markets opened this morning in a relatively subdued fashion with really very few sectors showing definitive relative strength. Apple (AAPL) shot higher after its win in the court battle with Samsung over patent infringement and that seemed to be enough to at least early on, keep markets slightly positive. Breadth at midday is terribly narrow and perhaps as expected, many traders are going to take a wait and see on what comes out of the Fed this coming Friday when Bernanke is expected to make comments following the symposium at Jackson Hole, Wyoming. The ECB is also potential on the verge of announcing easing measures at their next scheduled meeting of September 6th.

My take is that markets may go into this volatile period of headline risk at the midpoint of the regression channel from the recent lows of June 4th at about SPX 1400. We are trading at around 1413 at the moment so we will probably chop lower over the next few days on an absence of buyers and in extremely light summer volume. Support at 1400 should contain any downside push as participants take positions ahead of the Central bank announcements.

Additional QE may or may not be in the works for next month. The probability of more easing has certainly dropped over the past couple of weeks as opposed to earlier in the summer as economic indicators have suggested that perhaps the economy is weak but not at the pace yet where the Fed will take a very heavy handed approach additional easing particularly so close to the elections. It really is a 50/50 probability in my opinion and good arguments are being made on both sides of the spectrum.

As I have mentioned before (and often) what the ECB does here over the next couple of weeks is much more important for the immediate well-being of the equity markets than what is announced by the Fed. The ECB is reaching the end of the rope as far as market confidence is concerned and they need to bring forth a very strong and credible plan to stem the rising of sovereign interest rates for the periphery countries. The ECB needs to send a clear message that they have the will and firepower to stem the crisis. Failure at this juncture could really bring forth an acceleration of the euro crisis. On the other side of the coin, should they (ECB/FED) wow the market and succeed in keeping the bond vigilantes at bay, the equity market should again kick into high gear.

With growth slowing across the globe, the prospects for higher equity prices are tied to the hip of more central bank intervention and fiscal reform. In the near term at least, the likelihood of the former is still better than the latter.