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.

 

 

 

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…

 

 

Market- Quadruple Witching Expirations Cycle.

Market- Quadruple Witching Expirations Cycle.

The quadruple expiration cycle is going keep markets pegged to levels between 1450 and 1460 heading into tomorrow, and we should see real volatility pick up a bit into next week as we get past this cycle. We should get a better idea next week whether or not real money is ready to come into this market following the QE3 announcement or if the extended nature of the rally will force weak hands to back away and bring markets out of this very overbought near term condition. My take is for this to resolve in favor of a moderate move lower before an eventual reversal.

There are several indicators/studies out that strongly suggest bullish sentiment, particularly retail level sentiment, is at extremely “giddy” levels which historically suggests a move lower is eminent. Some indices are more overbought than others such as the Russell 2000 Small Caps index (RUT/IWM) and sectors such as the homebuilders (XLH) and broad industrials (XLI). In contrast, the transports which should be accompanying the rally have diverged in a major way over this past week. The rails in particular have been very weak following major downward revisions and lower guidance from several of the big players. The energy complex has also reversed course this week and is leading the move to the downside. Crude oil in particular has been wacked this week in a very strange tape.

So lots of mixed signals! What usually accompanies these times of conflicting messages is volatility which has been missing in action. The reasons for this lack of volatility in my opinion is that current market participants are confident that markets are out of the woods because of the Fed QE announcements as well as the ECBs Open Market Transactions (OMT) plan. Like I said the other day, I think the bulk of the Initial reaction to these announcements has already been priced into the market and this last gasp higher is part of a blow off move which needs to be digested. As always is the case, these last few “stragglers to the party” get caught behind and left to clean up the mess!

With that being said, the price action of late has to be respected and the consequences of what the Fed has proposed to do need to be properly digested by investors. Make no mistake about it, the Fed is going to do whatever they can to deflate the dollar versus the major currencies and that will in turn boost the precious metals, materials and commodities in general. Housing related stocks will do better in this environment which in theory should stimulate overall economic activity. We have to keep in mind that this plan of action has not worked so far, (the Fed themselves will agree on this point) after several attempts over the past 4 years and it is very likely that this will not have the desired effect as well. Perhaps the Fed knows this as well and is just buying time till after the elections for lawmakers to try (key word) and get fiscal policy right. If you read my updates regularly, you know what I think about those odds… Nonetheless, considering the time of year, when we clear the elections cycle, there could be a huge “Beta Chase” move higher into year-end as money managers and portfolio/hedge fund managers try to catch up to their benchmarks. The major pit fall to this scenario is the so called “Fiscal Cliff” and how that battle shapes up into year end.

So to recap, my favorite sectors here are the mega caps versus small caps and in particular the large cap material plays and the global commodity related plays in general. I also like the home builders on the Fed’s focus on buying MBS (mortgage backed securities). Not liking the action in the rails, energy, financials and emerging markets in general. The weaker dollar could have very detrimental effects on emerging markets as the Fed attempts to export inflation.

 

Market-Equity Rally All About Short Covering Of The Euro

Market-Equity Rally All About Short Covering Of The Euro

So the Fed has come and gone and bestowed on us a mound full of “QE” to juice up our equity markets. Probability was great that they were going to do something but I think they may have managed to exceed the expectations of the market. It is an interesting dynamic for markets these days as we get more excited about the “band- aid” than the cure itself. So what does this mean for the market? Major sugar/caffeine high for risk assets and a major shellacking to the dollar. Precious metals like Gold and Silver are expected to surge higher as are commodities in response to the weakened dollar.

There are plenty of economist that can do a better job than I at detailing the effects of this action and for those interested, I recommend Cullen Roche at the Pragmatic Capitalist www.pragcap.com who does a great job highlighting the pitfalls of some of the recent actions taken by the Fed. My take on it is that it was coming like it or not but certainly not to the scope of what was unleashed yesterday. The initial reaction from the market was also certainly more robust than I expected but considering what was proposed, not really surprising. The action was punctuated by extreme short covering action and piggy back momentum trading.

Today we are seeing more short covering along with quite a bit of profit taking which isn’t unusual after a sharp move higher into the weekend. So where to from here? The usual reaction to these announcements mean a few days of “blow off” moves as those who placed short term bets take their profits/losses followed by a natural period of consolidation which doesn’t necessarily mean a big drop in the averages but instead consist of sideways trading for a period of time.

There are many calls on the financial channels and other social media outlets for traders to just hold their nose and not fight the Fed which is generally good advice in my opinion. The problem is that this Fed action has been largely priced into the market. The general consensus has been tilted to the Fed easing for some time now since June 4th at SPX 1275 or so when markets turned on a dime after reports from journalist John Hilsenrath over at the WSJ stated that the Fed was leaning heavily towards easing at its next FOMC policy meeting. The market has since rallied nearly 200 SPX points or around 15% and in my opinion, quite a bit of this Fed induced move has been priced into the market after this week. Could we keep going parabolic here? In certain areas yes such as precious metals, materials and commodity related stocks but in other areas I am of the opinion we may have some trouble pushing higher without some consolidation. Problem is that we are not the only ones to see/feel this so the possibility sure exists that we push straight higher from here without a thought!

Here is why I think we are near the end of this extended summer rally and some profit taking is ahead. The sentiment towards the $USD has reached pretty extreme bearish levels and there has been a substantial amount of short covering of the EUR following the ECB announcements. These short term extreme swings in sentiment almost always revert to a mean and I believe this time will not be different. The chart below is of the DXI (US dollar Index) which measures the dollar against a basket of major currencies. At the current reading of 78.86 , we are very near to levels where we have seen a reversion to the mean in the past. I like to use the 55 period moving averages on a 2 day timeframe on the DXI and since 2009 the DXI has rebounded at (around) 2 standard deviations below its 55 period MA several times as circled below. These aren’t exact entry/exit set ups but they simply tell us that the dollar may have fallen a bit too much a bit too fast and a reversion is likely in the short term.

The FXE which is the Euro Trust ETF is also another one I keep an eye on for these reversals. It is extremely overbought in our daily charts. The action this week did force a breakout to the upside (short covering) on the weekly studies but as I mention above, perhaps too fast, too soon and a reversion to the mean is warranted. A move back to around FXE 125 or so is likely as this massive short covering push unwinds. These currency dislocations should in all likelihood help markets consolidate some of the gains. My risk ranges on the SPX is 1417 to 1483 which is pretty wide after the major one way push higher. We will continue managing trade opportunities as they unfold taking some bullish and bearish trades within this risk range. In plain English, we could trade a bit higher before lower and I want to capture both moves.

 

Markets- To QE or not QE

Markets- To QE or not QE

The Federal Reserve’s FOMC is really walking a tight rope on additional QE at this juncture. There are several reasons why the Fed could introduce a new easing program based on pure economic indications particularly in regards to the recent employment figures but there are are also several important considerations for not moving at this upcoming meeting. The reasons why have been talked about at nauseum over the past several weeks and months by yours truly and many others so let’s consider why they may not move here even if their recent “modis operandi” suggest they will.

The most glaring reason would be the proximity of the Presidential elections. The Fed, as a supposedly non-political entity, needs to worry about being perceived as partisan and many analysts and economists say that a major announcement of monetary policy this close to the elctions would perhaps cloud the issue particularly when the challenger has made no bones about the fact that he is opposed to the current course of action. In my opinion this is an issue that could weigh on the decision simply because the economy while not robust and gangbusters, is not in crisis mode. The Fed may opt to instead adopt even stronger dovish language and extend the timeframe for an exit of ZIRP well into 2015. Considering that they are still in the middle of their last TWIST operation, the Fed may decide to wait until after the program ends in December before announcing any additional measures

Another possible consideration is that the Fed may want at some point to throw the ball back to the lawmakers. The Fed knows that they will not be able to do the heavy lifting alone without fiscal policy measures and staying on the sidelines for a few months may send the message that lawmakers need to get their act together. The gridlock in Washington is an issue that the Fed has repeatedly warned about and at some point, they are going to run out of monetary policy options. The Fed has warned that the efficacy of these programs are dimished with each additional traunch. The Fed has to be concerned about the “addictive” nature of these stimulus measures on the market.

The S&P 500 is trading at near 4 year highs. If the Fed was planning on disappointing the market due to any of the reasons above, would they not perhaps choose to do it while there is ample cushion to the downside? Don’t forget that the Fed has managed to pile on about 160 S&P handles simply jawboning this market higher over the past 3 months. If the Fed wants to send a first shot across the bow of  lawmakers, this would be a good opportunity to do it.

The Fed could decide that if the German courts rule in favor of the ESM, the program would remove quite a bit of the uncertainty currently plaguing the Euro Zone which obviously reflects back to our economy. The ECB policy announcement was the big market mover last week and if markets could hold on to these gains, the fed may feel some more time is warranted before announcing additional easing measures here at home. The US dollar took a beating with the ECB policy announcement which sort of does the job for the Fed.

Finally, the Fed may choose to keep powder dry for any fallout from the Fiscal cliff later this year. Should they announce a program now and juice markets higher, they will be hard pressed to adopt any additional measures should President Obama win the elections and be at laggerheads with congressional Republicans on issues of sequestration and the expiration of the Bush era tax cuts at year’s end.

So while many economists and analysts feel the likelyhood of a robust QE program this week is a “done deal”, I am not so sure. Is it probable that they move here? Perhaps, but it is certainly not a done deal. Caution is advised.

 

Market- “Sterilized, Conditional and Unlimited ECB Bond Buying Program”

Market- “Sterilized, Conditional and Unlimited ECB Bond Buying Program”

I had high hopes for today’s ECB announcement and I was disappointed that Mario Draghi and the ECB central bankers chose to use a sterilized bond purchase plan and failed to lower rates. A sterilized purchase plan, particularly one that is conditional, even if “unlimited” in size, is basically taking from “Peter to give to Paul”. Because they are not expanding their balance sheet, the ECB is basically going to divert funds away from the performing countries to support failing ones.

The German courts will decide on the legality of the ESM (European Stability Mechanism) in the next week or so. I am not an Economist nor do I play one on TV but in my humble opinion, the EU needs to allow the ECB to expand their balance sheet. Europe needs growth and they need both monetary and fiscal actions that support economic expansion. To tie these emergency efforts to austerity is not going to help get these economies moving which is what is desperately needed across the European continent .

The market’s initial reaction primarily focused on the words “unlimited” and “bond buying” and risk assets took off to the races. I had anticipated this initial reaction yesterday and reason why we added the bullish call spread on the DIA and It may very well be that we rally for a couple of days. The mega caps of the DOW should outperform if that is indeed the case. The weaker shorts are covering positions in mass today and it remains to be seen if there is some “buy in” from investors over the next few days. From a technical standpoint, I still think there may be some downside ahead before the next major leg higher.

We have not made a test of support at the bottom rails of this channel since early August and we are very much short term overbought with the SPX well within 3 standard deviations above its 40 period MAs on the hourly charts. It remains to be seen if the “conditional” and “sterilized” terms which in my opinion are bearish aspects of the ECB announcement, get some more play over the next couple of sessions.

Headlines abound with the NFP (Jobs report) out tomorrow, the Fed next week along with the German court decision on the legality of the ESM which could theoretically put all of today’s gains in question. Tomorrow’s NFP number is expected to come in at around +120,000 jobs. Again it is very much a day by day market as traders react to the headlines “du jour”.