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.

 

 

 

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”.

 

 

Markets – Technicals, Volume, Participation and Complacency Do Matter

Markets – Technicals, Volume, Participation and Complacency Do Matter

August is behind us as is the summer trading season and for 2012, instead of a summer crash, Mr. Market brought us a low volume and low volatility rally. The trading action evolved into a neat trading channel from the lows put in on June 4th through the recent highs put in on August 21st. The one standard deviation regression channel on the chart below tells the story best as we have traded within it for nearly three months now. The narrowing of volatility towards the end of the month really kept the trading action compact and since early August, exclusively above the midpoint of the channel which was only broken again over the past couple of days.

The market should again straddle the 1400 SPX and 13000 Dow levels going into a short holiday week full of economic headlines. The biggie obviously will be what the ECB brings to market to deal with the run on sovereign bonds of countries such as Spain and Italy. These nations cannot endure such high rates for much longer and are in dire need of a bailout. We have already begun to get some details and it seems that the ECB will be buying short term bonds of these nations to keep short term borrowing costs low. There are many hurdles to overcome as the legality of this program will be challenged particularly by the Germans. The details of what these countries are going to have to “give up” to get this ECB assistance is still a huge murky subject . Presumably we can expect the ECB to ask for “the first born” and it remains to be seen if Spain and others are willing to give up so much control. As was the case with the Fed last week, we seem to find “balance” at the 1395 to 1403 level in the broad market SPX going into these headlines.

This weekend and into today we got a very clear look at the ever slowing global growth picture. Pretty much across the board, the economic data is pointing to a pullback in manufacturing. Not exactly what the market wanted to see heading into September… or is it?… The slowing pace of manufacturing should make the case for easing that much more clear for the Fed and ECB which should (in today’s upside down market) be interpreted as bullish for risk assets. Well, today at least, markets are looking at the data very cautiously and perhaps positing that the central banks are behind the curve here as the slowing global economy has picked up some steam to the downside.

The recent global economic data does not portend well to upcoming Q3 corporate earnings season. There appears to have been a strong slowdown in economic activity over the past couple of months and clearly these will be reflected in the upcoming earnings cycle. Over the next few weeks, I expect quite a bit of analysts to come in and adjust earnings expectations lower for the quarter and for year-end.

So, in the very near term, I am still bearish. Not as bearish as I was at SPY 143.09 on August 21st but I think we are certainly headed lower within this established trading pattern to test supports at SPY 137.50 and slightly higher. Where we go from there really depends on very precise binary outcomes to some of these upcoming headlines so to speculate too far ahead at this moment would be just that, speculation.

 

 

 

 

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.