Market Warning Signs

As I've spoken of before, in this day and age, there are many many correlations between all the markets around the world. One of the more popular talking points in the media has been the "risk on/risk off" trades. One reason for the popularity is the extreme correlation between pretty much all assets denominated in dollars. One such extreme correlation is the S&P 500 to Junk Bond Index.

Looking at the below chart, it is easy to see the similarities...they basically do the same thing every day.



However, notice that in early March, the stock market was pushing new highs as JNK did not. This trend continues and I believe is a warning sign to market bulls. I fully expect these two to meet back with each other which would likely mean a market sell off.

Below is a more detailed chart showing the roll over action of JNK including Fibonacci resistance points between $39 and $40 as well as a forming head & shoulders pattern. Also notice the recent disconnect between the rising S&P500 (orange line) and the JNK index (candlesticks). This is a warning sign.



Good Luck!

Robert Prechter on the radio - Summary

Today Prechter was on the radio which I captured below. Most of it is the same ole same ole, however his comments at the end struck me as interesting. He said that making finance the center of a family's life may be the biggest social mistake humans have made in a long time. He suggests not following the markets 24/7, to step back, take breaks, don't focus on your family's finances all the time...basically don't get burned out in the markets. He also makes reference to the markets practically being 24 hours a day with a lot of movement lately overnight (which I have noticed recently). The rest of his conversation was basically his same ole same ole. He admits to being early on this rally but is sticking to his guns expecting a big selloff.

Summary Notes on the fly:

-Most extreme Optimism in NAII, extremes in put/call, Not necessarily a signal of the top, but a warning
-"Don't want to listen to people telling you good earnings, europe is fixed, unemployment, etc"
-"We are bearish...However, I have been thinking short for last 50 s&p points, so I may not be the right person to talk to right now chuckle....metals may have ended their rally this morning...91% daily sentiment bulls on gold"
-deflationary...central banks continue to struggle keeping bad debt available...conquer the crash called it yaddy yadda...bond run has gone on so long though def want to stay on short end of the curve...so close to switchover in bond yields
-bonds should be good for intial decline of stock market but will be bad once it gets going...
-Volker years completely different environment today...yields at opposite extremes
-Despite optimism the last 3 years, borrowers still havent come out of woodwork=deflationary
-Deflationary drop Prechter sees is larger than the one most others are expecting...a little early to be talking about bull market on other side
-Socionomics... waves of social mood direct societal actions and thus news
-Europe in late 90's form union, was not a cause, but was a result of the extreme positive social mood of the 80s/90s...always thought it would fail b/c it was a result of not the cause of social moods therefore when social mood falls EU will fail as a result
-Asia is starting to show similar social changes...relatively extreme optimism in the 2000's
-If we were at an extreme bottom already we would see extreme pessimism...but we are at the opposite end of the spectrum
-Bottom will be like 1942 or 1972?...that's what we will loook for
-A lot of things/companies wont be standing (junk bonds/companies fail)...wait til people are disgusted and dont want to talk about the markets anymore...great buying opp
-Between now and that bottom expect riots and protests to continue and get worse...there will be hotbeds that trouble will come from...incidents will increase in volume and intensity....unsure where it will occur, just need to watch those areas that pick up
-Very difficult to predict in 1920s where WW2 spark would have come from...similar to today...easier to see in the 30s...unsure where to pinpoint hotbeds
-"Im a broken record...short term debt, Swiss govt, New Zealand, Singapore....stay away from Junk/munis/stocks...not a commodity buyer....2008 was high....62% correction (fibo)" cash is good too
-Time to buy latin america is when they are in trouble not when things seem rosy, thats when prices are highest
-Weve done a lot of studies on elections...as stock market goes, incumbent will remain in power...right now looking good for Obama...if market falls (is more likely) then he might be in trouble
-"Be safe, be worried, dont let the markets wear you out"
-Running finance into the center of everyones life I think is one of the worst things our society has done
If would have done that in the 20s and waited had it much better....cant do that at these price levels.

I missed a few things due to bad internet connection, but got most of it above...one thing seems for sure, they are very good at not being scared out of positions.

What is up with Volume?

There has been a lot of discussion on lower volumes in the media and elsewhere. I too am seeing lower volumes recently. Clicking on the link above or looking at the first chart below there are a few key things to notice. Also, Blogger changed its format so it may be best to right click on charts and open in new tabs or screens...pain in the butt, I know!



1) The volume coming out of the '09 bottom was the highest of any of the major up moves at well over 3B shares/day (averaging around 4B). The volume coming out of the 2010 lows was around 3B shares/day. The volume coming out of Oct 2011's lows has steadily declined from around 3B to now well below it. This looks like classic waning volume as prices rise and is bearish longer term. Technical Analysis 101 states that rising prices with lowering volume is a bear sign whereas rising price and volume (such as early 2009) is bullish.

2) Volume on selloffs is significantly higher than volume on advancements. I am not sure what this guy with his CFA is talking about. He must be looking at something different than me. Financial Sense Volume Article

3) The 50 day volume moving average is now clearly in a downtrend since the October lows. That means volume is falling as price has risen. The volume 50 day moving average is now lower than it has been in the past few years at well below 3B shares/day. Zero Hedge put out an article about that as well. Zero Hedge Article

4) On top of volume we have a price momentum indicator (MACD) showing big divergence with October's price highs. Even though price has made a higher high above October, momentum indicators are showing warning signs about the last month's moves.

5) Price is setting up a classic rising wedge pattern. Typically these break down. The pattern has a lot of overlap and moves at a slower rate than the previous trend (which was August's down move). Watch the red dotted trendline for a breakdown. If so, get out.

6) Below I also have a longer term volume chart with a few different indices. You can see on everyone that they are all falling in volume (as prices rise) and currently sit at multi year lows. This chart is on a weekly basis with the volume lines (yellow) the 6 month moving average (26 weeks).


I think the point can easily be made that something is up with volume, especially when compared to recent history. Looking at the second chart, some volume is back to late 90's levels!!!

I saw this interview today which I found interesting for a few reasons. 1) The man has been in the game as long as anyone. 2) I have studied his On Balance Volume Indicator and found it interesting to hear him talk about it. 3) He agrees that volume is not supporting price and we should be falling soon as a result. Joe Granville Interview

Current Technical Viewpoint

This is a chart I did yesterday outlining the two major things I see in the market's technical structure. It is actually pretty exciting because trades like this don't come around that often. There are a few key places that stops can be set to help make this trade a 4x+ reward/risk!

1) In green we are consolidating after a very quick bull move in October. This triangle could be considered a bull flag with an expected move north once the triangle is complete. This should occur in the next few days/week, if so. A solid break above the green upper trendline would give more confidence in this count. We were very close today. Watch out for a potential trendline backtest if the breakout does occur.

2) The potential bearish head and shoulders set up is equally apparent on the chart. This expectation would take the probabilistic lead with a breakdown below the uptrend of the last few months (currently around $1240). Watch for a backtest here as well (of the lower trendline).

These two scenarios are basically polar opposites, but can still be taken advantage of. One way to do this is to sit on the sidelines until such break occurs (either up or down) out of the triangle. This should allow a potential 30 pts+ in expected profit. Another way is to buy a straddle (if you are into options). This will allow you to capitalize no matter which way the market goes (you just want to make sure that it in fact does move).

Of note too are the indicators at the bottom of the chart. Both of them are showing bullish signs by making higher highs (not highlighted, but apparent). A breakdown of this could help signal an upcoming trend change and preempt a break of the price trendline...just something to keep an eye on.

Finally, volume isn't on this chart, but it has been falling somewhat during this triangle period. That supports the triangle theory. However, volume has been heavier on the down days (such as Nov 8).

Good luck!

MTA webcast series summary: Intermarket Relationships

Below is an email summary I prepared of the latest MTA webcast presentation by John Murphy from October 19 2011.
__________________________________________________________________

Hey all. Today I attended a webcast presentation by John Murphy (of stockcharts.com & MTA). John has been around a long time and is famous for his intermarket relationships analysis (one of which is required reading for the CMT). http://en.wikipedia.org/wiki/John_Murphy_(economist)

If you are at all interested in the macro environment or economics and how it ties to the stock market, then his intermarkets book, may be for you. It is great at tying together the financial markets, business cycle, and technical analysis all together.
http://www.amazon.com/Intermarket-Analysis-Profiting-Relationships-Trading/dp/0471023299/ref=sr_1_1?ie=UTF8&qid=1319048257&sr=8-1

I have attached the slides, which are pretty self explanatory and an easy flip through to see what's going on with a lot of different markets (contact me to obtain). You likely have already recognized some of them, but it helps to put correlations in easy to read charts. Below is a short summary of the slides in pretty much order with the presentation...

Intro: "You have to go back to the 30's to find similar correlations as today". Most "traditional" relationships have broken down in the last decade (starting with the Asian Crisis). The reason behind this is the deflationary theme we are currently in compared to the primarily inflationary period of the past. He cites 3 major deflationary events recently, the Japanese bubble bursting (1989), the asian contagion, and the US property bubble burst.

Slides 4&5: There was a paradigm shift around the time of the Asian Crisis. Bond yields and stocks started to move together. He cites a deflationary environment as the primary reason. He doesn't expect this relationship to revert back to the "norm" until deflation is out of the picture. Slide 5 shows that same relationship in 2011. In august 2011, bond yields didn't confirm the rally, which gave a hint stocks would see new lows.

Slides 6&7: Stocks and Commodities are positively correlated (extremely). This has not occurred since the 1930s. There is no other real good example in history and is one of the reasons he sees us in a deflationary environment. Commodities, like yields, seem to be leading stocks. He comments simply that Bernanke wouldn't talk about it so much if it wasn't a concern and prevalent.
One of the most reliable inverse relationships is the dollar/commodities; Recently a similar relationship has occurred between the dollar and stocks.

Slides 11&12; Stocks peak when energy outperforms...This occurred through the summer 2011. Rotation into safety, also has occurred...too early to tell if rotation into safety is over and downturn is "complete", but that cycle is longer term. Stocks are in red on slide 11 and the business cycle is in green.

Slides 14+; US stocks outperform foreign stocks when the dollar rises; however, they both fall. The Euro is something like 56% of the US Dollar Index and the majority of the 5 components.

Euro stocks are leading the US stocks right now

Ratio charts are a great way to see what is really happening and driving prices (I agree).

Q&A session...
-A China revaluation would result in inflation in America & decline of the dollar

-Use the 10 year bond when comparing across countries because most others don't have 30 year bonds.

-Expects "deflationary environment to continue until proven otherwise". Will look at bond/stock relationship to help tell.

Take care everyone and good luck! Let me know if you have any questions.
Chad

How Technical Analysis helps when Fundamental Analysis cannot. A look at Amazon's earnings miss.

This afternoon after the market closed Amazon reported earnings that were well below expectations. Guidance also was lowered with a potential negative earnings in the 4th quarter as part of that theme. As a result no doubt there will be countless analysts coming out tomorrow and this week to lower Amazon's price target and/or their recommendations. Most of these analysts had price targets well above today's pre-announcement price of $227.15 and almost all had buy ratings (most of the others that did not, had hold ratings). I didn't come across any "sells". I mean who saw this coming?!?!?! Amazon had been one of the cream of the crop stocks over the past few years with its "cloud computing" stronghold (forget its 70+ forward P/E and 27% average annual earnings growth expectations. Right now Amazon's price is below $200 @ $199.01 as of 6pm central time. Can you chalk this one up as anything besides a massive fail by wall street analysts??? This seems to be a theme that continues to play itself out year after year when dealing with fundamental analysts. I would be very interested in studying the amount of luck (Beta) that the analysts benefit from versus the analysts that go against the market's beta and go out on a limb to actually predict something.

Every earnings season this is the typical charade. Analysts have price targets and if the company reaches that price target, the analysts increase their target price; if the company's price becomes too far below that target, they lower the price target (almost always after a major setback in price when it is too late for you). Essentially the analysts are backing into the price that the market sets by adjusting multiples, etc in the models to get to the current price, with a typical "buy" premium. They basically let the market tell them how to plug their models so that they can give never-ending buy/hold signals to their customers.

To me the best way to describe it is the infamous chicken and egg scenario. What/who is really predicting the price? Are the analysts actually predicting the stock's price or are they more or less just following the stock's price? Time and time again it seems they are just followers, like the rest of us. They assume the market is always right and efficient. That is the main problem with fundamental analysis. That is why you rarely see a price target significantly lower (or higher) than current prices (usually within a 1-2 standard deviation range), yet time and time again this strategy is wrong, often during major inflection points (like tonight with Amazon).

However, technical analysis can be used to help identify such points in time when analysts are likely too bullish and should scale back their estimates. The amazon chart below shows a very nice ending diagonal triangle. This is a technical pattern that occurs at the end of bull trends. It shows weaker and weaker momentum as price struggles to make higher highs. This pattern showed overlap in all the down moves into previous major price high territory. Where I have labeled 2 and 4 both encroached (greatly) on the 1 and 3 price highs. This shows major overlap and lack of conviction in the uptrend. There are other structural points with an ending diagonal, such as the 3 wave moves I have labeled A and B that help to identify this structure, as well.

Below the price chart are two measures of momentum, the relative strength and the MACD. The RSI (relative strength) shows the difference between changes in today's price versus a set period in the past. This helps identify the slowing of momentum, or the second derivative of price. The MACD is the Moving Average convergence/divergence and show the difference between trailing moving averages of the price. This helps show the difference above and below historical average prices. It too shows relative strength signs. Both of these indicators topped out on the way to the Sept $244 top. Notice that the $246 top coincided with both an RSI and MACD that peaked lower than where they were during the $244 top. This was a major warning sign, especially when price fell back below $235.

Another piece to the puzzle was the volume. Volume tells you a ton! For instance on most of the up moves, volume would decline from the initial thrust to the top such as the lower volume in the first half of September versus the higher volume at the end of August. Volume also helped to show the bottoms, with it usually weaker near the bottoms with a pickup when buying started.

Finally, we can use volume to help us find support areas. Notice on the left the "Volume by Price". This helps show that in the $190-$200 area, there has been a lot of volume. This is where the majority of people bought (and sold). This also is likely where a lot of people will "breakeven". I expect it to show support during this pullback on earnings. It may even provide another buying opportunity for the rebound that will likely occur to backtest the 2 to 4 trendline in the $215-$220 range. Notice too that there was relatively little volume at the peaks in price and above $200. To me this shows more interest in AMZN at the $200 price than at the $240 price.

Amazon is a great example of why I trust technical analysis more than fundamental analysis. Fundamental analysis helps provide a rear view mirror as to why price did such things, but technical analysis can help get you in front of that trend and help raise red flags in price action. After all, at the end of the day, the price action is what makes you money, not the company's fundamentals or some analysts's backed into expectations.

The S&P Currency Ratio Charts

After my posting yesterday I was thinking again about how much currency affects stock prices (answer: a great deal much!). To prove the effect, I came up with the attached chart which measures the performance since the October 2007 top of the S&P500 as well as its performance based in other marketable goods other than the US Dollar. The way to think about the chart is the conventional S&P 500 measurement is 1 S&P500 priced in $1 US Dollar or $SPX/$1. But, you can swap out the denominator in the equation to compare the $SPX in other liquid assets such as 1 canadian dollar, or one euro, or one barrel of oil, etc.

The reason this is relevant is because the markets are global. People from all over the world invest in the United States and vice versa. As such, people like me in the United States are affected by currency fluctuations. As a net importer most of the products purchased are from other countries (oil, electronics, many others). The exchange rate affects us more than we likely even know as a result. A truly localized economy wouldn't be affected by such things and would have a rather constant exchange rate, but that just isn't the world we live in.

In the attached chart I show the S&P500 in solid blue which is the S&P chart most people are familiar with. However, all the other line charts are also the S&P500! But, how can that be?!?!?!



The difference between the blue line and the 5 others is the blue line is the S&P500 as measured in US Dollars, the typical view found everywhere. The dashed lines are the S&P500 measured in other currencies (Red=Euro, Pink=Yen, Purple=Canada), an atypical view rarely if ever viewed or talked about. The thin black line is the market priced in a barrel of Oil and the Gold line is the market priced in an ounce of Gold. As you can see there are some major differences in price when the measurement tool is swapped out.

From a currency standpoint, the market priced in Yen (purple dashed) is only up about 20% since the March 2009 $730 equivalent level. Compare this to the S&P in dollars (blue line) which is up over 50% since then and sits at over $1200. The S&P/1 Canadian Dollar is fairing a little better, but still below the US Dollar priced S&P. The Euro is most similar to the USD based S&P, just slightly below, which means the Euro since then has behaved similarly to the US Dollar.

The S&P priced in oil is the outlyer of the group with wild swings. From the October 2007 high, the S&P priced in Oil is also lower at around $1075 from $1350...so still down around 20% which is similar to the S&P priced in dollars.

The final line in gold is the S&P priced in gold. This is currently making a new low below that of March 2009. Another way to think about it is this is how much 1 S&P500 is worth per 1 ounce of gold. This is very telling and means that Gold has significantly outperformed the US Market since the 2007 high and that priced in gold equivalent the S&P 500 is actually lower than it was in 2009. The next chart (below) is even more telling and shows that ratio since the year 2000 top.

There are many inferences one can draw from these graphs, but the primary theme is that a major reason the stock market is even as high as it is, is because of the weakening US Dollar and as a result a significant decline in the purchasing power of the American consumer. So, the stock market is up, but the American consumer's purchasing power has fallen, thus leaving them with less money at the end of the day. Just because the S&P is at a certain level, that same level doesn't buy you near what it used to and doesn't mean things are "better".

Another way to look at this is from a constant dollar perspective. The market's are quoted at current currency rates, but an investor who invests in the year 2000 invests in year 2000 dollars and is then at the mercy of both the numerator (stock performance) and the denominator (currency) over time. Therefore performance could and should be measured on a constant dollar basis (also known as purchasing power).

On that same chart from 2000 (below) that shows the S&P500 priced in gold, I also track the USD's trade weighted performance.

In March 2000 the trade weighted dollar index was around 106. Today it is around 74. Suppose that someone bought at the top in March 2000 when the S&P was at $1500 and the dollar was at 106. Now suppose that person sold today at S&P $1200. That would be a loss of $300 or 20% on the S&P...not that horrible on the surface. So that person cashes out and now wants to buy something with his $1200 cash, but he finds that his $1200 is not near what it was in 2000. In fact, on an average basis it now buys 30% less (106-74=32/106=30%) than it did in the year 2000. So in reality that investor has likely actually lost around 50% in their purchasing power over the 11 year period. They would have been much better off buying something that held its value better, however, they lost on both fronts.

This is best shown on that same chart with the S&P priced in Gold. That ratio has fallen a staggering 87% from a ratio of 5.3 S&P's per 1 oz Gold in March 2000 to only .66 S&P's for 1 ounce of gold today. Assuming Gold is a good measurement of purchasing power (which I do not totally agree with, but I think directionally it provides a good starting point), this shows that investing in the stock market since 2000 has actually set you back SIGNIFICANTLY...a lot more than the surface 20% decline implies!

Current Elliott Wave Count and Japan 1989 Comparison

Well, it looks like it is finally here. The next leg of the biggest bear market in most people's lifetime may finally be upon us. However, for most investors the probabilities are not yet high enough to justify a short position...not yet, anyways...there should be plenty of opportunities.

Attached is the latest wave count I am following. Encroachment into the Flash Crash territory of 2010 killed a lot of the bulls's hope of this being a new bull market up from the March 2009 lows. However, I would like to see a monthly close below $1190 to give even more probability to this count being correct from a longer term perspective. A new low around or below $1100 is needed before I can fully get excited about the new leg down. Once that occurs we should see a big rally back to where we are around now. At that time will be a good spot to get short and close longs. The market will have revealed more cards to us by then.

From a near term perspective I equate August's action to that of January 2008. Both of these months saw "hammer" candlesticks and ended big moves down from multi-year highs in the indices which subsequently rebounded some of that move. They also both occurred 4 months after the respective recent price highs. The first and last weeks of February of 2008 were strongly down with the culmination of that move down occurring March of 2008. If things are playing out similarly, then I expect September to be pretty volatile as well.

Linkable Real Time Chart : http://stockcharts.com/h-sc/ui?s=$SPX&p=M&yr=5&mn=0&dy=0&id=p72172925866&a=242864511



Finally, I would like to use Japan's last 3 decades as a roadmap to our current situation (some of the reasons I lay out on the chart below). Japan is the only major example of a deflationary environment in recent history and its size, importance, etc mimic the US's situation fairly well with some supporting arguments on the chart.





The key to me in the whole deflationary scenario is the country's currency situation. Just like the United States, Japan's stock market exploded as its currency declined in the 1980's...this makes sense as I have laid out in other postings about the $USD (see list of $USD labels to the right). Also, Japan's market peaked roughly when their currency bottomed. Since then, the market has declined significantly, deflation has taken hold, and its currency recently made new highs near all time stock market lows. Boiling it down to one point, I expect the US dollar to rally for the distant future keeping a lid on stock prices, supporting the deflation and low interest rates argument, and behaving similarly as Japan did the last few decades.

Keep in mind, one days volume on the foreign exchange markets is around $4 trillion...it absolutely trumps the stock market.

Why this "downdraft" can get worse

The put call ratio is a contrarian indicator often used to help mark extremes in sentiment. The thought is that when people buy more puts than usual (and more calls than usual) then sentiment may be at an extreme. Right now a lot of people are looking at the spike up in put buying and concluding that the market's selloff may be extreme. They also may conclude as a result that the selloff will soon be over. However, I have other thoughts.


Im not that concerned about the put call from a bear perspective for a few reasons...

1) We aren't near 2008 panic levels from both an actual and a moving average standpoint. The 75 day Moving Average (blue MA line) is at .71 and it peaked above .8 during 2008 a few times. It stayed above .71 for over a year then. The actual put/call of 1.11 and 1.08 thus far was seen back in 08 and peaked even higher at 1.35, 1.18, 1.16 then in April and December of 2008. Notice the recent spikes were even higher than the Flash Crash telling me this is something worse.
2) The rise of the ratio has been faster than in '08, but our starting point was a lot lower (complacency a lot higher it seems). Also, the fall in stocks over the past month was extremely fast...much faster than the kickoff after 2007's top. The fact that the put/call ratio was so low in the first place were warning signs that bulls were getting too comfortable.
3) Some of the highest put/call ratio readings were actually nearer to the highs than the lows. Maybe this hints at some major smart money bets as some have discussed yesterday/today.
4) Where we are currently from a moving average perspective is mid 2009 as well as all of 2007, so not that high. The point being we may be extreme from a short term perspective because of the quick rise and very low starting point, but it doesn't look so bad to me on a longer term and leads me to think that the Moving Averages of this ratio could stay here (and likely go higher) for quite some time. This would imply a high vix and continued stock sell off.

I would like to see this index come back down below .5 a few times before I would get comfortable being a bull. Notice that in all of 2008 and most of 2009 this index never went below .5...fear was present the whole time.

Good Luck.