Thursday, April 30, 2009

McDonald's: From Market Leader To Market Laggard

Let's flashback to January and February, 2009 when the market was in a swoon and McDonald's Corporation (symbol: MCD) was the market leader.  The CEO was on CNBC, and Jim Cramer was doing his (usual) "buy, buy, buy" thing.  For the cheerleaders at CNBC, McDonald's was that go to stock - the beacon of light in a sea of ugliness.  

As I wrote on  January 15, 2009, I saw things a bit differently:

So why do I call MCD the "last man standing"? MCD remains near its all time high, and it is the only stock in the Dow 30 that really has not been effected by the bear market. It is the "last man standing". I bring MCD up because I believe it is putting in a secular top and on its way to joining its brethren.

Now let's fast forward two months, and we all know that the markets have been on a tear. The Dow Jones Industrials gained 15.65% over this time period.  McDonald's?   McDonald's has gained a paltry 1.99%.  

The 'last man standing" is now trailing the pack - badly. 

And I believe this leaves McDonald's very vulnerable to broad market weakness, which has a high likelihood of occurring over the next couple of weeks.  Figure 1 is a monthly chart of MCD.  The multiple negative divergence bars (labeled with pink markers) and the monthly close below the low pivot at 57.93 signaled a secular trend change for MCD.  This past month, despite the bullish tone of the broader market, MCD closed below another pivot low point (at 53.58).  This is bearish.  

Figure 1. MCD/ monthly


Lastly, let's thanks the good folks at CNBC for providing me with excellent and timely investing ideas.  Also, let's give Jim Cramer an honorable mention for reminding me to do my homework.

Gold: On The Launching Pad

I love to chronicle my follies with gold.  Gold seems so easy.  The Federal Reserve runs the printing presses, and everyone in the world knows this is inflationary, and just like that, gold should be off and running.  But it isn't.  

But in retrospect, my gold exhortations haven't been so bad.  Back in August, 2008, I was less sanguine about gold primarily because I was bullish on the Dollar.  When others were bullish on gold back in February, 2009 -as in we are "going to the moon, Alice!" - I was stating that this was not the set up where gold should go higher.  This too was a good call.  The best I could muster was that gold would remain range bound.  

And range bound it has been, and we can see that in figure 1, which is a monthly price chart of a continuous gold contract.  The indicator in the lower panel measures the degree to which prices have become compressed, and presently, gold prices are compressed to a statistically significant degree. 

Figure 1. Gold/ monthly 


What we do know is this: compressed prices can lead to explosive moves in either direction.

What we don't know is this: what direction that it will ultimately be.

So this period of consolidation in gold (and most other assets) meets my criteria for a set up that can act as a launching pad for higher prices.  But it can also be a launching pad for lower prices, too.  

And that is the dilemma.  I wish I had an answer, but any technical indicator that I have for you would only be curve fitting in my opinion.  But all is not lost as the current set up offers a low risk entry for going long gold.

So let's take another look at the monthly price chart for gold.  See figure 2.  As long as prices stay above the pivot low at $884.80 on a monthly closing basis, I can remain constructive on gold.  Gold is now trading in the low end of its range.  When the bull market in gold began in July, 2001, gold has (almost) always closed above its prior pivot low point; this is a hallmark of a bull market -higher lows.  The lone exceptions to this rule are: 1) highlighted in the oval when the price of gold closed below the prior pivot for only one month before moving significantly higher and 2) highlighted by the red down arrows as this was the close below the prior pivot low point that effectively "killed" the bull market.

Figure 2. Gold/ monthly 


Now let's look at a weekly chart of a continuous gold contract.  See figure 3.  The breakout (price bar with red arrows) above the down sloping trend line has pulled back to support levels of the down sloping trend line and the pivot high.  This looks like a retest of the breakout (inside the oval), and in my "textbook" this represents a low risk entry point.  On this weekly view, a weekly close below $870.70 would like lead to lower prices.

Figure 3. Gold/ weekly

So let's summarize.  Gold is on the launching pad; gold is trading within a range and it is at the lower end of that range.  We accept the fact that we cannot predict the direction gold will take.  Prices could either breakout or breakdown from this range.  Once we accept this condition, I believe that the current price represents a low risk, well defined entry point.  A monthly close below $884.40 is bearish; on the SPDR Gold Trust (symbol: GLD) this pivot comes in at $86.65.  A weekly close below $870.70 is bearish as well; for the GLD this pivot is at $85.12.  

If these levels hold, then gold bugs may yet have their Ralph Kramden moment (i.e., hit the big one). 

Key Price Levels: April 30, 2009

The market continues to move higher, and last week's concerns of being very overbought in a bear market have turned into this week's euphoria.  Yes, it is party like 1999!   The S&P Depository Receipts (symbol: SPY) and i-Shares Russell 2000 Index (symbol: IWM) will be closing the week above the most immediate significant pivot point or resistance level, and this is bullish.  The Power Shares QQQ Trust (symbol: QQQQ) has tagged its 200 day moving average as expected.  The Diamond Trusts (symbol: DIA) remains the laggard and has yet to close above resistance levels.

Please review the methodology and the significance of the key price levels by clicking on this link.

A weekly cart of the S&P Depository Receipts (symbol: SPY) is shown in figure 1. Last week, the SPY closed at 87.08 or 30 cents higher than our key pivot level. Despite my concerns, this has apparently turned into a bullish breakout - overbought has become more overbought.  I would expect the euphoria to linger with the 40 week moving average being tagged at some point in time.  86.78 becomes the new support.

Figure 1. SPY/ weekly


A weekly chart of the Diamond Trusts (symbol: DIA) is shown in figure 2.  The DIA is doing its best to push above resistance levels at 82.64.  A weekly close above this level, within the context of the current euphoria, would like catapult prices to the 40 week moving average.

Figure 2. DIA/ weekly


Figure 3 is a weekly chart of the Power Shares QQQ Trust (symbol: QQQQ).  The down sloping 40 week moving average has been tagged, and we are moving higher.  If bullish price action continues, then I would expect prices to get above $36.  The 40 week moving average becomes support.

Figure 3. QQQQ/ weekly


Figure 4 is a weekly chart of the i-Shares Russell 2000 Index (symbol: IWM).  My goodness don't freak out because it's a breakout.  $50 or the 500 level on the Russell 2000 would be a nice round number to stop at, but why stop there when the 40 week moving average is looming overhead?

Figure 4. IWM/ weekly


There are lots of crosscurrents.  The over bought conditions of a couple of weeks ago have given way to more overbought conditions, and some would call this a hallmark of a new bull market.  I still believe this price move will be a big head fake (i.e., bear market rally) as the structural components to launch a new bull are not in place. Anectdotally, I believe that in the end this idea that the market is all knowing and all seeing will be put to rest before we can declare the bear market over.  Personally, none of this effects anything I do as I will continue to buy fear and sell strength.  

Monday, April 27, 2009

Airlines: Follow This Sector

Last week when the AMEX Airline Index (symbol: $XAL.X) spiked 10% for the day on so so but better than expected earnings out of Delta Airlines (symbol: DAL) and United Airlines (symbol: UAUA), I was so full of myself because just the week before I had highlighted the airline sector as a possible leader in the next bull market.

So let's fast forward to today, and the news that the spread of swine flu could lead to a decrease in air travel has crushed the airline sector.  Last week's 10% gain was eclipsed by this week's 10.62% loss.  Whether true or not, this was the "reason" given for the drubbing.  Let's not forget that this is still a bear market, and today's thrashing after last week's gains only highlights this fact.

When I highlighted the sector as a possible market leader in the next bull run, I felt that it was important to have the overall market move higher in concert as a necessary tailwind to the development of this secular story.  As I stated in this week's sentiment outlook, it is my belief that the market is putting in an intermediate term top.  So maybe this is just profit taking in a bear market as selling fear is never a good strategy.  Personally, I never put much credence in the "reason".  

Regardless of today's action, the airline sector remains extremely important to watch.  See figure 1 a monthly chart.  A monthly close over the prior pivot low (noted with down red arrows) at 16.08 would be bullish.  This would also be a close over a down trend line formed by two prior pivot highs.  The "next big thing" (not shown) is in the zone where we expect a secular trend change.

Figure 1. $XAL.X/ monthly


In summary, today's action in the airline sector reminds us that we are still in a bear market. However, all is not lost as it will be important to see where the airline sector closes by the end of the month.  It is my belief that a failure to make an end of month close above 16.08 would be an ominous sign for the sector and the overall market.  A close above 16.08 would be a positive, and it would make this sector worth watching when the next bull run comes around.   

Sunday, April 26, 2009

Investor Sentiment: The Same Story

It is the same story this week as last as this is now the sixth week in a row where investor sentiment, as measured by the "Dumb Money" indicator, remains neutral. When we couple this with the fact that prices on the major stock indices remain below their 40 week moving averages, there is a high likelihood that the market will rollover in the next several weeks.

And doesn't it seem like the same old, tired story from the incessantly, perma-bullish high profile analysts -  the same analysts who have been calling a bottom ever since the market fell apart in October, 2007?  Hey, you better jump on board now as the train is leaving the station.

The new bull market that we keep hearing about with every market uptick could have launched already.  Then again maybe it hasn't.  But if you keep pounding the table enough times maybe you can improve your batting percentage and get at least one market "call" right.  

Honestly, no one really knows, but the high odds, unemotional play is to continue to sell strength and tighten up stops.  I have previously discussed these observations in the article, "Investor Sentiment: Some Context". 

From my perspective, this still remains a bear market rally, yet as vociferous as the bulls have become, it would not surprise me to see the market stuck in a narrow range for some weeks to come.  After all, the market will do its best to test the conviction of both bulls and bears before rolling over or moving higher.

The "Dumb Money" indicator is shown in figure 1, and it is in the neutral zone. The "dumb money" looks for extremes in the data from 4 different groups of investors who historically have been wrong on the market: 1) Investor Intelligence; 2) Market Vane; 3) American Association of Individual Investors; and 4) the put call ratio.

Figure 1. "Dumb Money"/ weekly


The "Smart Money" indicator is shown in figure 2 (middle panel). The "smart money" indicator is a composite of the following data: 1) public to specialist short ratio; 2) specialist short to total short ratio; 3) SP100 option traders. I have placed the "Dumb Money" indicator in the lower panel.

Figure 2. "Smart Money"/ weekly

   

Friday, April 24, 2009

Add These 2 Sectors To Your Watchlist

I previously identified "4 Sectors That Could Be The Next Bull Market Leaders", and today I think we can add two more to our watch list.

Figure 1 is a monthly chart of the AMEX Networking Index (symbol: $NWX.X) with the "next big thing" indicator in the lower panel.  The indicator indicates the potential for a secular trend change. The price action has been very strong as this index has broken its down sloping trend line, and the index has the possibility of closing the month above the simple 10 month moving average. Broadcom (symbol: BRCM) and Cisco Systems (symbol: CSCO) are two stocks in this sector that have similar setups.

Figure 1. $NWX.X/ monthly


Figure 2 is a monthly chart of the Healthcare Information sector; this data comes from the Morningstar Industry Groups.  The "next big thing" indicator is in the middle panel, and it is not in the zone where we would expect a secular trend change.  However, the price action has been consolidating for quite some time, and we know this because the indicator in the bottom panel looks for statistically relevant periods of consolidation.  These are excellent launching pads for new bull markets.  As you can see, the price action has been good with a likely end of the month close over both a down sloping trend line and the simple 10 month moving average.  An example of a stock in this sector would be Cerner Corporation (symbol: CERN).

Figure 2. Healthcare Information/ monthly


I have presented 2 more sectors that might be leaders in the next bullish run; certainly, having the overall market move higher would be a necessary tailwind to the development of these secular stories.  Over the intermediate term (weeks), I still expect market weakness.

Wednesday, April 22, 2009

Key Price Levels: April 23, 2009

At the end of last week, the S&P Depository Receipts (symbol: SPY) and i-Shares Russell 2000 Index (symbol: IWM) barely closed above the most immediate significant pivot point or resistance level. In general, this would be considered a bullish development, but let's keep things in context: this is still a bear market and the market is very over bought on an intermediate term basis.

Please review the methodology and the significance of the key price levels by clicking on this link.

A weekly cart of the S&P Depository Receipts (symbol: SPY) is shown in figure 1. Last week, the SPY closed at 87.08 or 30 cents higher than our key pivot level. Normally a bullish breakout, I would still expect the market to struggle at these levels for the reasons given in the article on sentiment. Support on the down side is at 82.61; the SPY made a low at 82.75 earlier in the week before bouncing. A weekly close below this level, then we will be visiting the lows at 70.87.

Figure 1. SPY/ weekly
A weekly chart of the Diamond Trusts (symbol: DIA) is shown in figure 2. The significant resistance at 82.64 remains significant resistance. If the markets roll over, expect the DIA to retest the low pivot at 67.93.

Figure 2. DIA/ weekly

Figure 3 is a weekly chart of the Power Shares QQQ Trust (symbol: QQQQ). It has been my expectation that the breakout above the 30.33 level would carry prices to the 40 week moving average. We could get there, but as time goes by the value of the average should be lower. Regardless, if the QQQQ rolls over, expect prior support levels at 30.33 to be tested.

Figure 3. QQQQ/ weekly

Figure 4 is a weekly chart of the i-Shares Russell 2000 Index (symbol: IWM). My previous comments on the IWM were: "The close above the pivot at 42.38 will likely propel prices to the 47.58 level, which is about 1 point away from the recent close. There is significant resistance in this region - a key pivot point and 2 positive divergence bars." This was correct. I also stated: "A weekly close above these levels would be significant and likely propel prices to the 40 week moving average." Last week, the IWM closed above the key pivot by 17 cents. Once again, context, context, context. Let's wait and see. On the downside, 42.38 should be support.

Figure 4. IWM/ weekly

11 Rules For Betting Trading

A reader e-mailed to tell me that he was unable to access my "11 Rules For Better Trading" from yesterday's article on guidelines.

I have reposted my "11 Rules" at Scribd.com. Please click on this link or below.

11 Rules

Airlines Act Like Market Leader

The AMEX Airline Index (symbol: $XAL.X) was up 10% yesterday on earnings reports from Delta Airlines (symbol: DAL) and UAL Corporation (symbol: UAUA). Delta Airlines is the world's largest airline and UAL Corp. is the parent of United Airlines.

The airline sector is one of the sectors that I highlighted on April 16 in the article, "4 Sectors That Could Be The Next Bull Market Leaders". Figure 1 is a monthly chart of the Amex Airline Index, and as stated in the article:

"The price action has been bullish from two perspectives: 1) it seems likely that price will close the month above the down sloping, dashed trend line; and 2) this will be a close above a prior pivot low point (noted with red arrows). Closes below a pivot or a trend line that quickly reverse are bullish."

Figure 1. $XAL.X/ monthly


Yesterday's price pop was on narrower first quarter losses. Like many fundamental or economic data points over the past 2 months, the news is still bad but less bad than the prior numbers. And this for the most part would summarize the results from the airlines.

Delta's results missed the Standard and Poor's Equity Research estimates and their analysts lowered its full-year earnings estimate from $1.25 a share to $1.00 a share. However, it was their feeling that industry revenue had hit bottom. Adding to bottom line revenues would be an increase in fees charged to international passengers for a second bag. There was no mention of increasing passenger travel.

United's losses were also less than previously reported and analysts attributed this upside result "as better than anticipated cost performance". There was no mention of increasing passenger travel.

In summary, it is my belief that the airline sector has put in a bottom and could possibly be a market leader in the next bull market (that has yet to launch). At present, the news is less bad than before. Fundamentals have appeared to stabilize, and buyers have rushed in anticipating better times. Of course, stabilization only means that "things" are not getting worse. They are not necessarily getting better. Nonetheless, the long term technical dynamics appear to be improving (and changing) for the airlines sector.

Tuesday, April 21, 2009

On Investing Guidelines

Making the rounds last week on the financial blogs is Richard Bernstein's "10 Guidelines Learned in 20 Years". Bernstein was a global investment strategist with Merrill Lynch for the last 20 years.

As a rule based technician or quantitative strategist, I like guidelines. Guidelines are like signposts pointing the way to profits in the markets. I have my own list of guidelines, and I thought I would comment on some of Mr. Bernstein's that are so near and dear to me.

Mr. Bernstein's Guideline #2
"Most stock market indicators have never actually been tested. Most don’t work."

Hallelujah!! I have been saying this for several year now. But what is really amazing is not that most indicators don't work but investors continue to use them anyway.

I have given this a lot of thought as to why investors behave so irrationally. One, they haven't done their homework. Furthermore, it is really difficult to find something that "works" and if you do find something you are comfortable with, it will probably only work some of the time. Two, there is comfort in being part of the consensus. MACD, RSI, etc and all the other dribble is just that - dribble and nonsense. I wish it was so easy. But I think there is more to the consensus issue. To me, consensus also means mediocre and many market participants are mediocre, yet mediocre is great if you are managing tens of millions of dollars. Fund payment structures ensure that you don't have to be great to make money, but you do have to be exceptional to make your clients money. Many money managers have a vested interest in protecting their own interest. So if they do everything just like everybody else and fail, then they can blame the system. This was a refrain often heard in 2008 as "no one saw this coming".

Mr. Bernstein's Guideline #3
"Most investors’ time horizons are much too short. Statistics indicate that day trading is largely based on luck."

I don't know much about day trading, but I would agree that investors want to be investors but they tend to act like traders. And what happens? They too easily trade themselves out of strong trends. Investors should focus on longer term monthly charts and those markets making secular moves. Having the secular winds at your back can cover up a lot of mistakes.

Mr. Bernstein's Guideline #5
"Diversification doesn’t depend on the number of asset classes in a portfolio. Rather, it depends on the correlations between the asset classes in a portfolio."

Agreed! Finding assets classes to invest in that don't correlate is the difficult part. Asset allocation and diversification are very important and having non-correlated assets might even be more important.

Mr. Bernstein's Guideline #9
"Investors should research financial history as much as possible."

If investors did, then we wouldn't have to worry about Guideline #2. But they don't, so a lot of investors use tools ill suited for the job. Oh well. Of course, there will always be the person who says, "Yeah, that worked in the past. How do you know that it will continue to work in the present?" Well, you don't know. But I would counter that if you don't know what worked in the past, then you definitely won't know what works in the future. Do the work and you will be rewarded.

Monday, April 20, 2009

When Signals Fail

In the most recent post on sentiment, I ended the commentary with the following statement:

"If wrong, there is always important information in failed signals."

This was my way of saying that no one really knows where the market is headed, and we always have to acknowledge the possibility of being wrong. Yes, I have conviction in my market research, but I always recognize that the market beast has a way of humbling even the best.

So how will I know if my analysis - that the current rally from the March lows is just a bear market rally that will fail sometime in the next couple of weeks - is wrong? Despite the neutral sentiment and overbought conditions, the market will just keep going higher.

What would be the significance of being wrong? In all likelihood, failure of these signals would signify the start of a new bull market. And to see why I would make such a statement, let's take a look at a few examples.

Figure 1 is the percentage of NYSE stocks trading above their 40 day moving average; this is an indicator found in the popular TeleChart software package developed by the Worden Brothers; the "T2108" indicator is shown in figure 1, and the current value is slightly above 92% -meaning that 92% of NYSE stocks are trading above their 40 day moving average. The current indicator value is the highest reading since 1991 and the second highest reading ever.

Figure 1. % Of Stocks Above 40 Day MA


I showed this graph several weeks ago and stated: "Within the context of a bear market or down sloping 40 week moving average, this is an extreme, overbought number that has typically signaled an intermediate term top." The one noteworthy exception was the March, 2003 bottom. The indicator failed as over bought became more over bought and the bull market was launched.

Another example of failed signals providing important information can be seen in the Rydex asset data. I last discussed the short comings of the Rydex asset data in this article. In figure 2, I present a weekly chart of the amount of leveraged assets in the Rydex bull oriented funds versus the amount of leveraged assets in the bear oriented funds. This is one of my favorite Rydex indicators. Not only can we see how these market timers are betting on market direction, but we can also see if they are doing so with conviction (i.e., leverage). The indicator takes the rate of change of this ratio and then looks for extremes in this value over the prior 52 week period.

Figure 2. Rydex Leverage Bull v. Bear/ weekly


For the most part, the indicator does a reasonably good job of identifying intermediate market tops, and these are noted with the gray vertical bars. The most noteworthy failure (maroon vertical bar) is April, 2003 when the bull market was launched. In other words, excessive bullishness did not lead to an intermediate term top. The signal was a failure as overbought became more overbought, which is the sign of a bull market advance.

I recently saw a lecture where a hometown hero was interviewed about her life and adventures. Tori Murden McClure was the first American and woman to row across the Atlantic Ocean, and she chronicles this effort in her book, A Pearl In The Storm. Ms. Murden actually did this twice having failed on her first attempt being some 300 miles from the shores of Europe. Interestingly and according to Ms. McClure, 80% of her book is about that first failed attempt.

Why was this so? Why write about failure?

As she stated in the interview, it was more important to write about failure because we can learn so much from our failures. What good would a book be if we only presented our triumphs? Good points!

For our purposes here, I expect this rally to fizzle just like the other bear market rallies of the past decade. This is the high odds play. If I am wrong, then it is likely the market is undergoing a secular change. In the markets (as in life), we must continue to learn from our failures.

Sunday, April 19, 2009

Investor Sentiment: Time To Sell Strength And Tighten Up Stops

This is now the fifth week in a row where investor sentiment, as measured by the "Dumb Money" indicator, remains neutral. When we couple this with the fact that prices on the major stock indices remain below their 40 week moving averages, there is a high likelihood that the market will rollover in the next several weeks. I have previously discussed these observations in the article, "Investor Sentiment: Some Context".

The "Dumb Money" indicator is shown in figure 1, and it is in the neutral zone. The "dumb money" looks for extremes in the data from 4 different groups of investors who historically have been wrong on the market: 1) Investor Intelligence; 2) Market Vane; 3) American Association of Individual Investors; and 4) the put call ratio.

Figure 1. "Dumb Money"/weekly


The "Smart Money" indicator is shown in figure 2 (middle panel). The "smart money" indicator is a composite of the following data: 1) public to specialist short ratio; 2) specialist short to total short ratio; 3) SP100 option traders. I have placed the "Dumb Money" indicator in the lower panel.

Figure 2. "Smart Money" and "Dumb Money"/ weekly


The "smart money" remains neutral and this is surprising considering the 20 plus percent run in the major indices over the past 6 weeks. In the prior 11 observations, when the "dumb money" was neutral with prices below the 40 week moving average, the "smart money" was bearish 9 out of 11 times. In other words, the "Smart Money" and "Dumb Money" indicators were pretty much in sync.

In the other 2 observations, the "Smart Money" was neutral to bullish. These were in December, 2000 and September, 2008. Several weeks following this confluence of signals the market were significantly lower. In essence, the "smart money" was wrong. These 2 observations are noted with the teal vertical lines in figure 2. Therefore, I attach no significance to the divergence between these two indicators.

While some readers may interpret these observations on the "dumb money" and "smart money" as an outright sell signal or carte blanche to short the market, I tend to view this kind of market environment as an opportunity to take profits especially on spikes in prices or by tightening stops or as major milestones are made (i.e., a tag of the 200 day moving average). I do not view this as a time to establish new long positions. Typically, market tops are drawn out affairs that could last weeks.

In addition, readers need to understand that ultimately this may not be the correct play, but it is the high odds play. This is not meant to back off from the observations that I have made or to diminish the quality of my work. The prior 11 observations of this set up have been fairly consistent. This is a bear market rally until proven otherwise, and the burden is on the bulls. If wrong, there is always important information in failed signals.

Thursday, April 16, 2009

4 Sectors That Could Be The Next Bull Market Leaders

If I told you that the four sectors with the most potential to undergo a secular trend change are semiconductors, housing, retail, and airlines you would probably say "wow". Certainly, that would be a good broad base rally to get excited about if these sectors could provide leadership. Of course, there is the current dynamic of an overbought market within the context of a longer term bear market, but I believe that these sectors are setting up to be the next bull market leaders.

Semiconductors
I first mentioned the semiconductor sector in the article, "Semiconductor Sector: Potential For Secular Run", back on March 20, 2009. At that time I stated:

"I like to seek out assets or sectors where the secular winds will propel prices higher. In other words, I am looking for the "next big thing", and the semiconductor sector would qualify. From a technical perspective, this sector has all the right attributes to undergo a prolong run."

I went on to say:

"The technical evidence suggests that "the bottom" is in for semiconductors."

Figure 1 is a monthly chart of the Philadelphia Semiconductor Sector Index (symbol: $SOX). The "next big thing" indicator is in the lower panel, and we can see it is in the zone where a secular trend change is typically launched from. A monthly close over the simple 10 month moving average within the context of a new bull market would be a very positive development.

Figure 1. $SOX/ monthly


Housing
Figure 2 is a monthly chart of the Philadelphia Housing Sector Index (symbol: $HGX). Once again, the "next big thing" indicator is in the lower panel, and it is in the "zone". The housing index broke below the lower blue trend line back in October, 2008, but in the past 2 months this trend line was recaptured; this is bullish. Confirmation of higher prices would come on a monthly close over the black trend line or the 10 month moving average especially if the broader market is in bullish mode.

Figure 2. $HGX/ monthly


Retail
Figure 3 is a monthly chart of the CBOE S&P Retail Index (symbol: $RLX.X) with the "next big thing" indicator in the lower panel. It seems very likely that the retail sector index will close the month over its simple 10 month moving average, and I would view this as a bullish development provided the overall market winds are favorable.


Figure 3. $RLX.X/ monthly



Airlines
Figure 4 is a monthly chart of the AMEX Airline Index (symbol: $XAL.X) with the "next big thing" indicator in the lower panel. The price action has been bullish from two perspectives: 1) it seems likely that price will close the month above the down sloping, dashed trend line; and 2) this will be a close above a prior pivot low point (noted with red arrows). Closes below a pivot or a trend line that quickly reverse are bullish.

Figure 4. $XAL.X/ monthly


So let's summarize.

I have given the case for intermediate term bearishness starting next week.

Today I have presented 4 sectors that might be leaders in the next bullish run; certainly, having the overall market move higher would be a necessary tailwind to the development of these secular stories.

Sunday, April 12, 2009

Copper: What's Up?

Over the last 4 months, copper has bounced about 70% from its lows. Yet it is only recently that such a significant price move is beginning to attract attention as pundits try to explain what is going on. With stocks roaring back over the past 5 weeks, the obvious (and wrong) connection is that the global recession is ending. To me, copper's price rise is more technical after a deeply oversold condition, and it appears that the pundits are only crafting a good story to explain its recent price movements.

It is often stated that copper is more like Dr. Copper, the base metal with a PH. D. in economics. If copper, which is used in commercial and residential building, electronics and automobiles, is surging, then all must be right in the world and in the economy too. Copper knows all (sic). But there appears to be a disconnect from reality as strength in copper generally occurs late in the economic cycle, and there is little or no relationship between price rises in copper and the beginning of a new economic cycle.

This can be seen in figure 1 a monthly chart of copper. The indicator in the lower panel is an analogue representation of economic expansions and contractions from the National Bureau of Economic Research; recessionary periods are noted with the vertical gray bars across the graph.

Figure 1. Copper v. NBER Expansions/ Contractions


Of the six recessions since 1974, the current recession would be the only one that would see copper prices acting as a leading indicator. In fact, the most bullish price moves for copper occur late in the economic cycle not at the beginning. These bull markets in copper are noted by the maroon colored vertical lines.

Another explanation tossed about to explain copper's rise is that the easy monetary policies of the Federal Reserve will lead to inflation, and copper is only anticipating these coming changes. While higher copper prices would be expected as inflation rises, the fact remains that there is a very poor correlation between higher copper prices and inflationary expectations. Of the 5 bull runs in copper since 1974, only 2 were associated with any real significant inflationary pressures, and these were in the 1970's. This can be seen in figure 2 a monthly chart of copper; in the lower panel is the inflation rate as measured by a year over year change in the CPI. As before, the vertical gray lines note recessionary periods. Recessions by definition are deflationary, and we should not expect copper prices to rise during the current de-leveraging, deflationary environment.

Figure 2. Copper v. Inflation



So why is copper rising?
Brent Cook at explorationinsights.com has written a very balanced commentary on copper. He states the following:

"What’s behind the current price increase?

Both China and South Korea have been adding to strategic reserves and restocking at what they consider to be much better prices. Copper producers and marketers all down the supply chain are keeping some supply out of the market due to low prices or a complete lack of buyers.

The desire by Asian buyers to turn US dollars into hard assets—a phenomenon we are seeing across the entire hard asset class.

Short covering as the copper price stabilized.

A favorable arbitrage between the London Metal Exchange (LME) and Shanghai Exchange that made it cheaper to import copper cathode into China.
Scrap supplies having dwindled due to the lack of credit, low prices and slowing manufacturing activity. With the exception of Asia’s desire to convert their substantial holdings of US dollars into something of value, I believe all the factors listed above are temporary. Going forward inflation may also play a role. "

If you note, none of Mr. Cook's observations as to what is driving the price of copper have anything to do increasing copper consumption. In fact, he goes on to state that in all likelihood copper utilization will be down for 2009:

"To come to some sort of understanding of underlying fundamentals of the copper market we need to look at where copper actually goes. The retail and commercial construction markets use about 46% of all copper. Another 12% goes into vehicles. These two industries were trashed, to say the least, in 2008; they are not likely to do too well this year either. Without a global recovery in both industries to past levels I don't see how copper consumption can possibly increase significantly. "

The serial bottom callers and those pointing to the magic, predictive powers of copper can always point to China. But haven't we been down this road before? Wasn't decoupling disproved in the summer of 2008? Yes, the Chinese economy might be the world's economic engine, but they don't live in isolation. According to Cook, global demand and Chinese consumption of copper will remain weak:

"Can China save the day?

Most copper imported into China is then reprocessed and extruded as copper wire. When the copper wire is manufactured into tubing, refrigerators and batteries for export it still shows up as internal Chinese copper consumption. There is no way of knowing how much of China’s copper consumption actually stays internal and how much goes back out in other export products. If China is going to save the day for copper we have to approach usage from the perspective of China’s total economy.

China’s GPD in 2007 and 2008 was approximately 6% of global GDP—Europe and USA account for nearly half of global GDP. Based on the most recent World Bank statistics, China’s 2007 total GDP was $3.3 trillion, a full 55% of which was attributable to exports. In 2008 China’s exports were down 28%. This year is not getting off to a roaring start as the Shanghai Daily reports that industrial output is down 12.7% for the first two months of 2009.

China’s building boom is not fairing very well either. Post Beijing Olympics, China’s real estate market has collapsed. According to Jack Rodman, a China real estate expert, in Beijing alone approximately 500 million square feet of commercial real estate was developed over the past few years; this is more than all the office space in Manhattan. Rodman estimates 20% of that now stands vacant.

Similar stories are being reported across Asia as documented by the Asia Property Report which estimates that real estate transactions were down 70% in Q-4, 2008. With Asia and the world’s building boom gone bust or at least slowed significantly, and China’s export markets in a severe and prolonged recession, demand for their products and the copper within is unlikely to recover soon. In the near term at least, increased copper consumption would require a global recovery approaching the levels of a few years ago.

Confirming the obvious: true internal Chinese consumption is much less than many analysts believe and is unlikely to take up the slack in global copper consumption. "

My Take
From a technical perspective I do not believe copper is in a bull market or even poised to enter into a new bull market. In addition and as explained above, I attach no significance to the price movements of copper as they relate to economic growth.

What we do know is this: 1) over 7 months copper dropped 70% from high to low; 2) over the last 4 months, copper has bounced 70%; 3) copper still stands 50% below its all time highs.

Figure 3 is a monthly chart of a continuous copper futures contract. The indicator in the lower channel is our "next big thing" indicator, and the purpose of this indicator is to identify those assets that have the potential for secular trend change.

Figure 3. Copper/ monthly


The first thing we notice is that copper bounced at support or the breakout point (labeled with a "1") of the previous bull run. In other words, copper made a round tripper over the past 4 years. The bounce has carried 70% higher but right into the down sloping 10 month moving average. In other words, copper prices are behaving as they should. There was a breakout of historic proportions. Why did this breakout lead to such monstrous gains in 2005 and 2006? Because the breakout of historic proportions was 12 years in the making. In other words, the breakout was from a 12 year trading range. The current 70% move has the makings of a snapback or countertrend rally.

So the question I want to answer is this: Is copper poised for a new sustainable, secular bull market run?

Based upon the "next big thing" indicator, the answer is no. Based upon the technical setup, the answer is no. Going back to the 1970's, every major move in copper was heralded by the "next big thing" indicator signaling the possibility of a secular trend change. Even though copper has moved 70% off its low, I attach no significance to such a move. From my technical perspective, this is a bounce off of support and into resistance. Copper will need more sideways action and time before another new bull market is launched.