Friday, July 30, 2010

GDP Report at First Glance

The headline number is weaker than expected but looking under the hood there are two positive developments:

- Final Sales to Domestic Purchasers jumped by 4.1% compared to 1.3 and 0.2 in the previous quarters. This is a very good measure of underlying domestic demand

- Imports increased much faster than previously, thus indicating consumer strength and substracting more from the headline number which is making it look weaker.

I will add to longs if the market reaches 1077 ES

Market Rhythm

spx jul01 - today, click to enlarge

In the chart above I have highlighted two types of corrections that occurred recently. The idea is to get a feeling of what the market can do. This way I can get rid of any biases that might cloud my vision.

The green ones are corrections about 24 points long. By this measure, the current correction is over. If the GDP numbers provide a positive surprise (or if the market interprets them that way) the spx will not go under 1093.

The blue boxes measure about 41 points. In this case the market has further to drop to about 1080. I think this comes into play if the GDP report is not clearly positive.

Thursday, July 29, 2010

Update

The market is breaking down hard. Nevertheless I think the downside is over at these levels (about 1094 ES). There have been two other corrections with the same length (24 points) since the 1st of July bottom.

I am holding my longs for a positive surprise from the GDP numbers tomorrow.

Economic Pessimism and the Economic Reports


The most recent durable goods report is taken as a confirmation of the slowdown ahead. Indeed:

click to enlarge

Highlighted with blue are the last three monthly changes in the value of total durable goods new orders. May and June have registered decreases.

However, if we take a look at the details we see that these decreases are mostly due to the non defense aircraft and parts component:

click to enlarge

Note that values for this sub-sector have high volatility from month to month. In April they increased by 215% for example, pulling the total value of durable goods orders up and inducing the feeling that April was a positive report when, in fact, as I remember it, it was not so good.

So, to avoid being mislead I look into detail at economic reports. For this one I look more attentively at non defense capital goods excluding aircraft:

click to enlarge

This is a good measure of business investment. This time June and May do not look so bad.

Nevertheless, the media has taken the opportunity to add this report to the evidence of a recession coming. I think pundits have become sure of this recession and do not abstain to mention it every time. I see titles in the media like: “What will car-makers do during the recession”, or magazine covers like:

click to enlarge

Note the expressions on people's faces.

This suggests the pessimism towards the economy is very high. While pessimism will be an important ingredient in the coming downturn, at this point, from a contrarian point of view, I would expect some positive surprises in the economic data. The surprises seem to have started with the new home sales and they could continue with the GDP report on Friday.

Wednesday, July 28, 2010

Cancelled Limit Order


Yesterday we got a bullish spike, as I like to call it, and the market registered a correction:

Still, the correction seems contained - about 13 points. As stated before this kind of correction has not been out of the ordinary during up moves recently. If it gets bigger I will lighten up and cover.

Tuesday, July 27, 2010

Limit Sell at 1124 ES

Unfortunately I will not be able to see today's session and the open tomorrow so I am leaving a limit order to close the position opened here. This is based on my initial projection for this rally: 1128 SPX.


Fireworks?



The chart above is that of the put/call ratio plotted against the SPX. Note the latest divergence that developed between the two (highlighted by the arrows). It seems that while the market has rallied, bears have added to shorts or bulls are not very confident in the rally. A reason for this behaviour might be the 200 DMA (green in the chart below):

In my experience this kind of divergence leads to fireworks in the next few days. The most recent case is highlighted by the yellow box on the first chart.

For Tuesday, I do not rule out a minor correction (about 10 points), but that would be a buying opportunity. If I were to make a wild guess, I would say that on Tuesday the market opens with a big gap down, but rallies right from the open.

Monday, July 26, 2010

SPX Rhythm

Some analysis, Carl Futia style:

The chart above shows the SPX (click to enlarge, chart courtesy of SaxoBank). During July the index had two sustained moves up. The green boxes highlight the corrections that punctuated these rallies. They are about 10 to 12 points big.

Note that after each such a correction the market moved 22 points in the first case and 29 in the second (purple arrows). If the third box is followed by a move at least 22 points long, the market would have to reach 1110 before a pause of at least 10 points.

This suggests that there is more upside from these levels and that we shouldn't see a correction of 10 points or more before 1110.

Sunday, July 25, 2010

Holding for More Upside

The chart above depicts the total put/call ratio against the SPX. Note that at Friday's close, while the market has made higher highs (above the green horizontal line), the put/call ratio has moved slightly down (up in value but down on my chart).

This suggests this rally will continue in the following days. I am holding my longs until the ratio makes a bullish spike.

Friday, July 23, 2010

Long at 1087.75 ES

will take a loss if the market trades below 1084

Is the Economy Overbought?


In uptrends the overbought condition doesn't mean you should be selling, as the market can stay overbought for a long time. However, in downtrends the overbought condition is the best time to bet against the market. By the same principles, could we say that the economy is overbought and in a downtrend?

The chart above shows the yearly percent change in Industrial Production (purple) plotted against the ISM New Orders Index (green) - click to enlarge. These two series are correlated but the New Orders Index leads Industrial Production by 6-7 months as shown in the table below:


Since the New Orders Index registered its high in January this year, and this reading is about as high as it goes, we can expect Industrial production to reach its high sometime in the middle of the year, which is currently happening since the series for Industrial Production is above the horizontal black line representing a level associated with the highest readings.

So we could safely say that the economy is overbought.

But is it in a downtrend? It would be in a downtrend if it didn't finish adjusting.

The black arrows in the first chart point to past recoveries. Note that usually, after the first thrust up, the series stayed in a range and, as we know, economic expansion continued.

The red arrow highlights the recovery after the recession in 1980. After reaching the black line, industrial production started falling and the economy slipped in a second recession in 1981. This seems to be a time when economy was overbought and in a downtrend.

There is a big similarity between now and then: the financial crisis. As Mr. Bernanke stated recently: "bank lending standards remain tight". Also, from the most recent FOMC minutes: "consumer credit contracted again in recent months", which is particularly indicative of weakness since consumer credit is the first to rebound in a recovery.

Magnifying the perspective of economic weakness, is the austerity hysteria that has hit the Western world, especially Europe. Paul Krugman has been writing a lot about this on his blog.

Consequently, the economy has not finished adjusting and can be considered in a downtrend.

What to do about it? Buy intermediate-term exposure to the market, since the gloomy picture described above is fully discounted by media and investor sentiment. The media pessimism on the economy is so thick that you could cut it with a knife (sentiment play- more in a future post). Also, sell long term exposure as soon as the market becomes overbought.

Thursday, July 22, 2010

It's Time.



The chart above depicts the put/call ratio plotted against the S&P 500 index. I have highlighted by the red arrows the bearish spikes that have led recently to market rallies. Note that they are about 0.3 in length. This suggests a rally from current levels is highly probable.

Given the above and my IT upwards oriented bias I will go long today after a probable initial sell off of 10-15 points. My favorite level to go long is 1060 on the ES but I will adjust depending on where the market opens. I expect a move up above 1100, more precisely to 1128 on the cash index.

Why 1128 as target? Well, for now I will just say this:

click to enlarge


Wednesday, July 21, 2010

Nice Rally, But...


... it has left me in the dust!

Since my intermediate-term bias is upwards oriented, I have to assume we have seen the bottom of this short correction. I will try to take advantage of the first opportunity to go long.

Usually, after a big move down like Friday's plunge the market oscillates for a few days before decisively moving up. Below are some examples of how daily bars looked at some other bottoms. I have noticed that usually there is a big move down after the first big rally off the lows.

SPX daily charts courtesy of SaxoBank. Click to enlarge

december 08 (the scenario I first thought
of after Friday's move)

november 09

february 10

june 10


july 10

As for the put/call ratio:

It has made a bearish spike (red arrow) despite a huge rally. This is a bullish development as it means shorts are confident enough not to cover and even to add to positions. This is what a move up needs!

Wedenesday outlook: I think both sides of the market can be played. I also would not be surprised by a big sell off in the last hour of trading.

Tuesday, July 20, 2010

Outlook for Tuesday


The level of the put/call ratio at yesterday's close is rather consistent with short term tops after a few days rallies than bottoms after corrrections, as seen below:

click to enlarge

Thus, I think more downside is in the cards.

The above is a 30 minutes chart of yesterday's session and after market of the e-mini contract. The black, horizontal lines represent support/resistance levels. My intraday trading ideas:

-depending on where the market opens, sell after a small rally into one of the levels;
-the maximum level I would sell at is 1076; above that I would sit on the sidelines;
-I will target 1048.5 but, depending on where the day's high is made, this might change.

Monday, July 19, 2010

Not There Yet


I stated previously that I was waiting for a correction to reload on longs for a move higher. My trigger for going long again would be the put/call ratio reaching aproximately 1.2 (green line below).

It is not there yet. If it makes an intraday reading today after the lunch at that level I will go long the market. I would also like to see new lows for the spx. Otherwise, I will wait for an end-of-the-day reading of 1.2.

Here is how the market behaved previously in a somewhat similar fractal at the end of november 2008. The context was pretty much the same: bear market conditions.

chart source: Saxobank

Outlook for Monday's trading: I expect an oscillating market. The market can be shorted after an initial rally and can be bought after a sell off of about 15 points. These are intraday plays. I highlighted my areas of interest on the chart below (e-mini september contract).



Sunday, July 18, 2010

Bear Market Kick-off


There is compelling evidence that the leg down that started at the end of April represents the beginning of a bear market. By many measures, it reached levels of bearishness similar to the leg down started in august 2007.

Momentum ...


click to enlarge

The chart above depicts an average of the monthly and bi-monthly ROC (concept insipred from Will Rahal's blog).

Sentiment ...

source: StockCharts.com. click to enlarge

The chart above displays the 5-day EMA of the total put/call ratio. This is a great indicator for timing the intermediate-term swings. While reaching the 1.275 level represented a buying opportunity, it is also the level reached at the last bear market kick-off (red circles).

Breadth...

click to enlarge

Above I plotted the ratio of cumulative monthly advancing volume to cumulative monthly declining volume (concept inspired from Will Rahal's blog). Again, the latest leg down reached a level associated previously only with bear market sell offs. This level is below the one usually touched by bull market corrections (highlitghed by the green line).

Friday, July 16, 2010

Never Mind

The market just went straight down never giving me the opportunity to sell.

Sell After Confidence Number


Given the current connfiguration of support and resistance levels, I will sell a violent rally after the U. of Michigan Confidence number, at about 1090. I would take a loss if the market does not sell off quickly. I expect a trend day down.


Buy the US Dollar

source: ProRealTime.com

Here is a chart of UUP (black), an ETF tracking the US Dollar. Click to enlarge.

The indicator plotted in blue is an average of the monthly and bi-monthly rate of change (comcept inspired from Will Rahal's blog). Note that this indicator reached a level (green horizontal line) that corresponded to turning points in the past, thus suggesting a possible up move for UUP.

The average ROC reaching this level would hardly mean much by itself but there are 2 other developments that indicate a turning point for the US Dollar:

1. The most powerfull one is the shift in sentiment towards unfavoring the dollar. Here is some evidence. Also I have noticed that articles favoring other currencies (like Euro and Yen) have become very frequent recently.

2. Some downside in the stock market would be favorable for the dollar given the recent correlation. As stated in the previous post I am expecting a correction.

Consequently, I think UUP will bounce from the zone delimited by the two horizontal segments on the chart. 23.9 looks like a good entry level. This is a short term play (a few days).

Timing Tool


source: CBOE
The chart above depicts the total put/call ratio. Click to enlarge.

It represents my main timing tool. It is flexible and reliable.
Currently, the ratio settles in the 0.85-0.9 range, an area consistent with previous tops from the beginning of May. This is the main reason I expect a pullback from these levels.

Also, the behaviour of the ratio at these levels points to some downside. As can be seen from the picture, at the previous top the spike up -the scale is inverted- (highlighted by the black arrow) is followed by small moves up and down (highlighted by the red circle) and then by a move down in the stock market.

The level of 1.2 (the green horizontal line) is where I think this ratio will be in a few days. It will represent bearish sentiment prevailing and it will be a great buying opportunity.

Thursday, July 15, 2010

Selling on Weakness vs. Selling on Strength

Today I was forced to sell on weakness. It is the thing I hate most. I only do it when the market proves me wrong.

I was expecting an initial rally towards 1101.25 on the ES and then a big sell off. Instead, the market started falling from lower levels and broke yesterday's low. Since I thought there were great odds of a correction and the market was so weak I had to assume that my initial projection was wrong and sell even on weakness.

Sold longs at ES 1080

I think today will develop into a trend day down. Looking to reload next week.