Wednesday, March 3, 2010

The Bullish Case For Equities

The bullish case for equities is best summarized by some of the price action that I am seeing especially in the retail, home building, financial and energy sectors. Leadership provided by these sectors would be the right kind of leadership for a broad market rally.

Before I get to the charts, let me state - tongue and cheek mind you - that the equity market never goes down and don't worry the Fed has your back. This seems to be a pervasive and prevailing attitude so these are just 2 reasons to keep buying. But on a more serious note, it is very clear to me that so much of this country' s collective psyche relies upon higher stock prices. Our home values depend upon it and our 401 K's depend upon it. We cannot afford another stock market calamity. The stock market should go up and after all, why are companies in business? But prices don't go up forever.

But there other reasons for higher prices including the notion that this is a low inflationary environment, and with prices above the 40 week moving average and with trends in gold, crude oil and yields on the 10 year Treasury bond having moderated, stocks are likely to find support. See this recent article for research behind this claim.

Figure 1 is a weekly chart of the SPDR S&P Retail ETF (symbol: XRT). The pink bars on the price chart are negative divergence bars between price and a momentum oscillator; the recent cluster is inside the gray oval. As we know, negative divergence bars indicate slowing upside momentum. This has been the case over the last 4 months as XRT consolidated into a range. We know it is a trading range because of the indicator in the lower panel. This looks for statistically significant consolidations in price or decreasing volatility. Being that volatility is mean reverting, low volatility begets high volatility or range contraction begets range expansion , which is the break out.

Figure 1. XRT/ weekly

I have defined a breakout in the following manner: 1) prices must consolidate into a tight range such that the price consolidation must be statistically significant; 2) prices then must break out over 2 pivot high points. You can see this set up in figure 1, and the break out has already occurred. A weekly close back below the most recent pivot high point would be reason to exit the position or consider this a failed breakout.

A similar set up is seen in figure 2, a weekly chart of the SPDR S&P Homebuilders (symbol: XHB).

Figure 2. XHB/ weekly

A similar set up is seen in figure 3, a weekly chart of the S&P Select Financial Fund (symbol: XLF).

Figure 3. XLF/ weekly

A similar set up is seen in figure 4, a weekly chart of the United States Oil Fund (symbol: USO).

Figure 4. USO/ weekly

In this article, I have presented the bullish case. In several key sectors, prices are breaking out from prolonged consolidations. This is bullish price action, and the presence of such breakouts in these leading sectors should not be ignored. I have already presented the other side of the story in "The Bearish Case For Equities", and this is one of context. The "smart money" and "dumb money" have earned their monikers for a reason. Prices can move higher within theses parameters, but buying power on the sidelines appears to be limited.


Luv them Waves said...

A (continued) discussion of buying power on the sidelines would be of interest, should you decide to write about it.


Guy M. Lerner said...

The buying power on the sidelines issue was used as an argument why the market is going to move higher back in October and November; over at ZeroHedge blog and David Rosenberg basically showed that this was a fallacy: 1) the money that went from the Fed went to the banks and not into the market; 2) investors are putting money into bonds and out of equities.

The question has been where is this mountain of money everyone is talking about?

I am using those words in the sense that investors are already all in or almost all in and don't have any buying power left to support the market; this can be seen in the Rydex data where we can assess the amount assets in the market v. those in money market funds

D-man said...

"The question has been where is this mountain of money everyone is talking about?"

exactly here as you mention it

"...don't worry the Fed has your back"

and in the margins which are expanding at NYSE.

It seems the amount of money coming into the markets are unlimited as we move only up and that must come from somewhere (it's not me for sure as I'm all in :))

Anonymous said...

So the price should go lower before it goes higher based upon nit enough retail nearishness is toast ?
Guy, it looks increasingly to me like you are as confused as the rest of us ... LOL don't worry it just hard for any of us to really say we subject to the whims of so many unknowns all is really left for us to control is to decide what to put on the table.
trouble is no one's going to pay the industry and it's shadow industry of bloggers et al to learn that that is what it comes down to.
FWIIW you're no worse than the thousands of others out there doing the same thing.

Guy M. Lerner said...


I don't know if you can call it confusion but the range certainly has made it difficult to ascertain a particular side of the market to be on; so this is why I have presented two sides -the bullish and bearish cases.

Also the two sides are there! I didn't make this stuff up.

Anonymous said...

So we actually have "two sides" a "bullish and a bearish" case for going either way. I know I've heard of this somewhere ,aha it's a market...a little more seriously now ,when it becomes transparent which of these is going to be right then I'd suspect that would be a good time to be thinking about going the other way ;)

I sympathise ,right now we are in a range which means we are going nowhere ,but sideways ,and that's probably the best probability for how we are going to continue until the next game change arrives.

Guy M. Lerner said...


Actually, I know you know it all and have a great handle on "everything" market, but the reality is that the range bound trading will likely lead to a big move in either direction. So you don't have to be early. You just cannot be wedded to anyone position for too long if you are wrong.

One of the purposes of presenting the bullish v bearish cases was that if you are bearish and flip to the bullish side, then you would know what sectors to go to. But since you got it all figured out, I guess this is not the kind of thing for you.

Goatmug said...

I'm more inclined to be on the bearish side at least for a short term position simply due to the fact that the VIX again is going sub 20. I posted a chart showing the last 3 years

Timing may be a little early, but then again it is about making good risk/reward trade offs. I'd rather be getting short with new positions when the VIX is 18.7 versus putting on new ones when the VIX is 27.


Anonymous said...

"All figured out" ..ooh have I stepped on your toes. Must have as you have already forgotten I earlier said "confused as the rest of us",but please do not listen to what I have posted ,by all means construe it to be what you want it to be if it eases your sensitivity.

The most prescient comment of the day comes from Goaty with which I agree completely and he donesn't even charge for it ;) .

Guy M. Lerner said...

Charge for it? The blog is free!!!

My point is even if you have a point of view (i.e., bearish) it doesn't pay to be wedded to it. I have a bias but it may be different from the plan that I execute. I am not holding anything back here but I follow what I write about on the site, so you can figure it out.