February 2014


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Life is pretty simple: You do some stuff. Most fails. Some works. You do more of what works. If it works big, others quickly copy it. Then you do something else. The trick is the doing something else.
Leonardo da Vinci

The COT index number is +23.2%. The commercials stepped into the market with volume. Last week we had a non-committal market that fell slightly. I was of the opinion that the commercials would not step into the market with the volume necessary to keep it moving higher. Well the volume is there, but we’ll have to wait and see if this is enough to break the market to new highs at a significant resistance point.

On the bull side +23% is on the high side. Usually, barring exceptional circumstances, the COT index declines from around this level. Any declines will likely coincide with a falling market. Bear readings can be higher, rising to the [-30%] levels.

M&A activity is on the increase. This is generally bullish. Also Hedge Funds on the sector-level, [the top 50 hedge funds] added the most exposure to the Energy sector, while Apollo Capital’s sale of LyondellBasell led to a significant decrease in exposure in the Materials sector. The funds added over half a billion dollars in exposure to each of four North American companies related to oil and gas, refining, or energy equipment and services: Whiting Petroleum, Valero Energy Corporation, Talisman Energy, and Cameron International. Of these names, Valero Energy is noteworthy for rising nearly 50% since the beginning of Q4. The most overweight sector continues to be Consumer Discretionary (+8.2 percentage points relative to the S&P 500).

Technical

Assuming a bull impulse on the 5day chart, there is support at $183.50, where, buying support would be expected to enter the market. This would be a place where a trade would offer a good risk/reward.

The trend is bullish on both the 5day and 3day which again is a positive for placing a trade in this area of support.

Trade

If the market trades at $183.5o’ish, then a bull call spread would make sense. So buy $183.oo and sell $183.5o for circa a $0.50 debit. Your risk is fixed at $0.50/contract and would start at $183.oo. Support being at $183.50 should provide that safety.

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The S&P 500 broke out to a new all-time high today but didn’t manage to finish the day above its 1/15 all-time closing high. Nevertheless, the index is pretty much right back where it was on January 15th after experiencing a fall of nearly 6% and a subsequent rally of 6% in between.

Below is a look at sector performance during the market’s recent “round trip” since the close on 1/15. As shown, the overall market is flat with the S&P 500 down just 4 basis points, but there have been clear winners and losers underneath the surface. Interestingly, the two smallest sectors of the market — Telecom and Utilities — are on opposite ends of the chart, with Utilities up the most at 6.44% and Telecom down the most at -3.36%. Keep in mind, though, that the moves in these two sectors have very little impact on the S&P given their extremely low weightings in the index.

Of the sectors that do have an impact on the index as a whole, Health Care, Energy and Technology are higher now than they were on 1/15 when the market made its last closing high. Financials, Consumer Staples, Industrials and Consumer Discretionary, on the other hand, are all lower, and their underperformance is what has held the market back. These sectors have all bounced off of their early February lows, but they still haven’t gained back all of their losses from the 1/15 to 2/3 pullback. Now that we’re right back to prior highs, will the leaders (Health Care, Energy, Technology) continue to lead, or will investors move money out of recent winners and into the laggards?

As shown in the second chart below, breadth levels are elevated for the areas of the market that have outperformed, and they’re just above the 50/50 mark for the lagging sectors. If you’re looking to put money to work but don’t want to chase overbought names, there are plenty of stocks still trading just above their 50-days in cyclical sectors like Industrials, Financials and Consumer Discretionary.

sector change 115

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The S&P 500 is currently trading above 1,850 and is now on pace to close at a new bull market high for the first time since mid-January. With that in mind, the tables below provide an update of where the current bull market stands in comparison to prior bull markets in terms of duration and magnitude. For the purposes of this analysis, we consider a bull market to be any period where the S&P 500 gains 20% or more (on a closing basis) without a decline of 20% in between.

In terms of duration, the current bull market still ranks at number seven on the list. With today’s new high, though, it is now less than a month away from taking out the 1982 – 1987 period as the sixth longest of all time. If the S&P 500 can hit a new high any time after 3/22, the next target will be the bull market of 2002 through 2007. In order to surpass that period and move into 5th place, the S&P 500 has to continue rallying through Memorial Day on 5/26. While the bull market has already been impressive, moving into the top spot for longest bull markets on record is still a ways off. In fact, the S&P 500 would have to go another 7+ years to 6/28/2021 in order to overtake the 1987-2000 bull market as the longest ever.

Longest Bull Markets022414

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Life’s but a walking shadow, a poor player, that struts and frets his hour upon the stage, and then is heard no more; it is a tale told by an idiot, full of sound and fury, signifying nothing.
William Shakespeare

This week’s COT index number is +15.3%, which improves upon last week’s number and suggests that this rally is sustainable.

The thing to note with the COT number is that to show this particular level of expansion [+5%] the volume required in purchases to achieve this was +50%. To find a similar volume of contracts purchased we have to return to September 2013.

That volume was maintained for two weeks, and then the volume dropped off the edge of the cliff. This expansion/contraction in volume gave us a rally and decline in the market [the correlation being high] following the volume and COT index number expansion/contraction.

As we stand today, that volume expansion will need to be maintained at the current volume [or higher] or, we will see another contraction in the COT index number, which will find the double top region, or, false breakout chart pattern in the SPY index.

As we shall see from the short term technicals, there is nothing in particular to indicate one direction or another. However when you look at a 10yr chart, the SPY is hitting resistance. This rally from the lows represents in that time frame, the retest of that resistance. If it holds, the trend that has been in place since 2009 will suffer a far more serious reversal than we have seen to date.

As an indication, the VWAP average sits at $156.56. To fall to that level would have the pundits screaming bear market etc. In the rally from the lows of 2009, the market has returned to the VWAP on five occasions. The last was at the end of 2012.

Technical

This week in all the shorter time frames all are in up-trends. That however is about all the information that is really available. The support/resistance levels are all equidistant, so the price could trade either direction.

The 15day chart is the only chart that displays any support/resistance areas that might prove useful. Resistance is at $187.30’ish.

Based on those two observations, if long, remain long. If short, cover your shorts, and if out of the market, look for a long entry and avoid placing any short positions.

There seems to be bullish noises emanating from the big fund managers as to the state of the economy etc. I’m far from convinced on that point. It is however irrelevant to the point of view of trading unless you are taking a longer view into 2016 or beyond.

10 year bond yields are headed higher. In all likelihood they could hit 4% or slightly higher, depending on whether Yellen and the Fed keep curtailing QE purchases. Generally rising rates are a bad thing for equities. Rising yields from a suppressed point however will not necessarily have that [immediate] effect. But in a rising yield environment simply buying the market will not be as effective as buying individual stocks [that outperform on earnings growth] showing growth through revenues/profits rather than simply share re-purchases.

Summary

Taking everything into consideration, standing away from the market, or market neutral is the two safe options. Initiating short positions would be incredibly aggressive, although potentially lucrative given that markets tend to decline faster than they rise.

I’m increasingly bearish. With the [gradual] withdrawal of QE, which really as far as I am concerned was responsible for the one way market, the one way market could well be coming to an end. Technically we are there. It would require the Commercials to support the futures market with a tremendous volume of buying to keep the COT index number high…I don’t see it. Earnings etc in the SPY constituents as a group need to improve, and to date, they haven’t. EPS have been based on share buybacks. I don’t see that trend continuing. The unpopular view [especially as noted bears capitulated late last year] is that the bull is about to hit a major road bump in the dark.

The last clue is that spreads through the Options markets are tighter, expressing that the market makers have [no view] a lesser view of the market and are keeping it tight. There have been few new trades the last few weeks.

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Chart is still doing the rounds. It has been dismissed by many. But it still remains on the peripheral of trader consciousness. The question is: a bull market built on QE, can that market survive without QE? The 2000 bear market was preceded [by about a year] by deteriorating market internals, but that was a regular sort of bear.

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These are NYSE 52 week High vs Low Ratio averaged over one month, NYSE Advance Decline Line averaged over three months and S&P Percentage of Stocks Above 200 MA.

Interesting observation we can make about the chart above is that during the recent correction, is that over one third of S&P stocks dropped below their 200 MA. This was the first time breadth readings dropped below 75% since late 2012. The question is, was this sell off an indication of something bigger to come or was it just another correction in the uptrend?

While it is difficult to answer that question, the overall breadth indicator complex continues to resemble weakening and declining uptrend participation. In other words, there are bearish divergences between index price and underlaying breadth since May 2013, as taper talk pushed interest rates higher.

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In a new interview with King World News, Cashin warns that financial market conditions remain very risky. From the interview:

What I am saying is: They thought they were going to solve a desperate problem by desperate measures. I don’t believe it’s having the effect they wanted, and it’s building up a very, very dangerous situation. If that money were suddenly to get velocity, inflation could break out.

Conversely, by pushing on a string and not getting anything done, they may wind up being in a spot where, if the economy moves to stall-speed, we’ll get deflationary pressure. Yes, they’ve begun treating the patient with very, very drastic remedies, and my concern is: Is it ultimately damaging the body in a way that will bring back some of the horrors they tried to avoid?

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