Time For an Energy Release

The S&P 500 is up 8% on the un-abating bounce off the lows in the 2nd week of February. Were you able to participate or were you too scared?

Regular readers will recall that I suspected we could see action like what has occurred in my previous post. That’s 2 for 2 in my last two major market calls. Don’t get used to that sort of accuracy. Right now I’m in a zone. Regular speculators understand that zone. Sometimes you get in it and you take on risk, fitting moves together as if breezing through a Rubik’s Cube. These times are fleeting though as the HFT shops will be sure to remove any edge you perceive yourself as having and cold water will be splashed on my zone. Make hay while the sun shines.

I suspect the current bounce has utilized most of its positive energy and the market will need to take a little break. It doesn’t necessarily need to correct but just work off some of the speculative energy that has driven its 8% gain over the last month. If I had to guess, I think we see about 7 weeks of sideways consolidation and then a catalyst at the end of May or beginning of June will present itself to drive the S&P 500 back up to the old highs.

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Don’t discount the positive effects of the ECB’s expansion of it’s QE process. The TLRTOs have been released for potential use in investment grade assets plus they’re able to plug another €250 billion annually in the EU on top of current output. The media creates narratives with potential false attributions so be careful how you position your capital. Don’t be a sucker and necessarily fall for all the misleading accounts of spurious correlations like oil and short covering which were the du-jour narratives last week.

In stale and tired fashion, I want to reiterate that I believe we are currently in a topping process which began last October. That doesn’t mean that we can’t see new highs on the S&P 500, so for longer term capital it still would probably behoove you to significantly liquidate in preparation. But if you fashion yourself a trader, there’s potentially still money to be made opening new long positions.

Lastly, gold related equities have just been playing in another universe in relation to any other sector since the start of 2016. One of the stocks from the J-perp Watchlist is up 600% over the last 9 months. Have a read of the original post and the portfolio update page for more info.

Update 3/29/2016:

Ignore that 600% nonsense from the previous paragraph. PLG had a reverse split that I somehow missed. The position is actually showing a loss and I have corrected the tracker to account for the reverse. PLG is on the watchlist, however, the actual J-perp portfolio has had a great run to start the year so go have a read anyways.

Some Musings About Q3

Musing 1. Why do new home sales data releases by HUD possess any significance?

Maybe so that the HFT houses have a headline for an algorithm to pump millions of unfilled bids into a market. It’s baffling. For me, the most important part of a release by HUD regarding new residential sales is the Explanatory Notes. In this section they tell you how wrong their data could be and they lay out all the statistical errors that could be occurring due to things such as “bias, variance from response, nonreporting, and undercoverage.” Reported numbers are consistently displayed with standard deviations of plus or minus percentages in the teens or twenties. For example, September’s results show a 0.2% (+/- 15.7%) above revised August new home sales.

That means the actual number may have been as low as -15.5% or as high at 15.9%. The dispersion is so wide as to render the results effectively meaningless, which is why there are always revisions. But why would revisions possess any more statistical relevance when weighed against the potential of HUD’s self-reported surveying errors? Observe the median sales price from August to September. It went from $275,600 at the end of the summer to $259,000 in the beginning of the fall. While the average price of a new home sale dropped from $348K to $313K. Drops of that magnitude have to make you question the credibility of the August new home sales pricing data. Did prices for a new residence actually drop that much in a single month or was it that the data was massaged to begin with? Not even the Census Bureau will provide a quality answer. I know the confidence level of the statistics is at least 90% but c’mon. Honestly.

Can you imagine if other industries were allowed to utilize such wide standard deviations in their statistical reporting. Take biotech. “Each participant that takes the pill in the study has approximately a 50% chance of increasing their lifespan by 12 more years…plus or minus 40%.” Or how about plane engine manufacturers. “We believe this critical engine component will operate in extreme conditions with a failure rate of 0.03% (+/-72.7%)” These are extreme, outlandish examples to be sure, but you hopefully get the point. Admittedly, my statistical skillset is decidedly above the average dolt off the street, but assuredly below regular practitioners such as finance & economics professionals or academics. The book is still open on whether or not to reject the null hypothesis that MarginRich is actually just one of the said dolts off the street.

Musing 2. What’s the big deal about oil reserves vs. oil resources?

This musing stems from an article I read at Bloomberg that was titled, We’re Sitting on 10 Billion Barrel of Oil! Ok, Two. The theme was expanded on at Zero Hedge that potentially the whole petroleum renaissance is nothing more than smoke and mirrors. Now I enjoy Zero Hedge as much as the next bloke, but I wouldn’t expect them to so quickly jump on the extremist bandwagon when it comes to E&P’s sharing their opinions on resources.

The basic gist of the Bloomberg piece was that oil and gas companies are grossly irresponsible in reporting resource potential in their corporate presentations versus the actual reserves they are filing with the SEC. However, before they get into the meat and potatoes of the article they share a giant caveat about investors and the differences between reserves versus resources. The authors quote Scott Sheffield, CEO of Pioneer Resources, one of the largest players in Texas with significant rig counts in the Permian and Eagle Ford. Sheffield states that experienced investors know the difference between the two numbers. Specifically, “Shareholders understand. We’re owned 95 percent by institutions. Now the American public is going into the mutual funds (or ETFs), so they’re trusting what those institutions are doing in their homework.”

Precisely. Experienced and sophisticated investors know that resource potential is not the same as current, existing barrels of oil in ground. That doesn’t mean that through innovative techniques that a high percentage of those resources cannot be converted into reserves. Patience and demand are the keys to the development of refined exploration techniques that can continue to expand the US energy base. The article implies that the shale boom is potentially a large scandal waiting to blow-up with Enron-like repercussions. That is an epically gross exaggeration. E&P companies have time and again improved or grew reserves at rates consistent with estimates. Additionally, we’ve seen the oil and gas players consistently beat reserve estimates established by the EIA for various geographic areas.

Bloomberg provided a snapshot of companies to graphically show the disparity between the two numbers:

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Any speculator in hard assets, knows what the steak and the sizzle are in natural resources. The reserves are the steak. The resources are the sizzle. It would help if more of the E&P players would utilize the P’s more in their presentations for the retail players who want to get in on the action. The P’s stand for proven, probable, and possible. Proven or 1P reserves have a high probability of being produced and you can count on the number. Then there is proven and probable, which is 2P; and then proven, probable, and possible is 3P. The higher the number of P, the less likely the company can produce the reserve. However, that doesn’t eliminate the current or future viability and economic potential of the resource. These P-designations, standard nomenclature in the industry, are easy to understand and not nearly utilized enough in company presentations. Oil and gas are no different than gold, silver, platinum, copper, or any other natural resource. All natural resource companies report reserves and resources and it’s up to the speculators to conduct their own due diligence.

Musing 3. There’s some serious Kool-Aid drinking at First Trust

First Trust is an investment advisory firm founded back in 1991. They’re fairly sizeable in that through their assortment of ETFs, mutual funds, and other various products; they’ve been able to garner $32 billion in assets under management. A hefty sum by any measure, but very small compared to the biggest players in the game.

The Monday Morning Outlook is a weekly little opinion piece that First Trust puts out that also includes a schedule of important economic releases for the week. Content is hit or miss with this shop, however, there was one piece from last month that struck me as an egregiously, cowardly article. You can have a read for yourself to see if I’m out of bounds in my assessment. I admit that based on my own opinions shared at this site, that I could be labeled a doom & gloomer, but I simply refuse to un-acknowledge the current and future distortions that have and will occur in asset markets around the world thanks to central bank interference.

The piece titled Why Do Stocks Keep Rising?, from September 8th, pumps First Trust’s fist in the air behind a sis-boom-bah of how the markets have continued their upward ascent despite the steady flow of negative-impact events over the last 5 years. They don’t understand how pessimism can remain so ingrained for certain pockets of investors under such conditions. I know it’s a quick 1-page offering that they throw up every Monday, but you can’t just break out the pom-poms and then stick your head in the sand without truly acknowledging the reasoning of the very parties you are criticizing. Amateur hour!

They don’t touch on how central banks have kept the cost of capital at virtually zero for longer than any period in history despite an “improving” economy and “improving” employment. They extol the virtues of the rising profits across industries but share nothing on top-lines and how that will affect profits going forward. Or how slashing SG&A and CapEx in combination with share repurchases has significantly affected stated earnings to the positive. Nor do they expound on how these behaviors are unsustainable. They fail to acknowledge that the current situation of central bank involvement in the developed nations has absolutely no precedent, and thus, no back-testable strategy for when the house of cards begins to wobble.

As an investment adviser it behooves them to cheerlead so as to grow assets under management higher and higher. That’s fine and they have a right to share a one-sided puff piece. They should just try not to be so damn cowardly the next time they want to cheerlead investing in a rising market right before a 7%(which I stated will not be the low) haircut commences.

Before signing off, I wanted to touch on the current action in the S&P 500. In my last article, I had stated that if the price action is simply a bounce within a larger correction that I thought the 1,950 area to be a solid resistance point before turning down again. Today’s close at 1,964 is still around 1,950, so we’re not quite out of the woods just yet. If we move onto sustained new highs then I will offer a mea-culpa, but I continue to think that caution is warranted. I’ll leave you with a chart shared by Lance Roberts at STA Wealth that displays the price action in the S&P 500 during the last two corrections that reached a depth of 10% or more.

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A Read of the Tea Leaves and an Update to the ETF Portfolios

Well how about that correction in the S&P 500? Everyone suffered the 6% downward move and now we can all resume earning wealth…or can we? Is there some negative energy left in these markets? The tea leaves tell me that the corrective move is not over. As a reminder, just reading the tea leaves is about as antiquated as can get for a method of analysis. Looking at some squiggles on a chart and then making wholesale investment decisions is dangerous, but still, I think it’s one of the practical components on the speculator’s tool belt.

Let’s start by taking a look at the S&P 500, using SPY(weekly) as our proxy, and then we’ll move into some complimentary areas that may help shape the analysis. Bear in mind with Plunge Protection out there and HFT pace-setting through momentum ignition, all analysis is completely nullified should new highs be strongly set and the uptrend is fully resumed. Now prepare to be over-charted.

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I think when this correction resumes, we’re looking at an endpoint underneath the 50-Day EMA(blue line). I think it’ll kiss that into the 165ish area before bottoming out. I just don’t believe that a 6% move down is the end of it. In 2013, all the corrective moves capitulated at the Bollinger mid-point. From the wide ranging fear that I observed, that just doesn’t feel appropriate for the correction here to start 2014.

Take a look at the VIX for moment. Yeah, yeah, I know the VIX is played out but it still provides clues as just one chart of many in attempting to get a better feel for market action.

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The markets haven’t seen fear like that since 2011. Another one of my favorite indicators, the NYMO, is indicating some further weakness. I’ve previously commented on the NYMO’s ability to help traders get positioned for market action. It’s hitting not one, but two indicators providing a signal for a resumption to the downside. Observe:

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I have no worries that the major uptrend will resume after the corrective washout. These markets have been in need of a steam release for some time, but the obvious path of least resistance is upward. Those little exhalations near the end of 2013 essentially counted as non-moves, so a little fear and loathing is healthy for the uptrend to renew with some vigor going into the 2nd quarter. There are a couple of additional asset classes that may potentially shed a little light as to further direction subsequent to the completion of the corrective move. First, there is the yield on the 10-year Treasuries:

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Okay, all kidding aside on my make-believe and totally fake “Rhombus of Hades” pattern, a downside move in yields in combination with ZIRP will continue to push market players into equities; especially if that yield pushes much lower to potentially 2.4% or even as low as 2%. I’m not saying that yields aren’t going to go higher in the long-term, just that the near-term outlook is presenting a potentially downward path in yields.

The Nikkei has maintained a fairly solid correlation with the S&P 500 and its action looks constructive as it may be basing for a resumption of its own uptrend. The two indicators below are the MACD and Full Stokes.

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One last set of charts I’d like to share is the Equity Hedging Index(“EHI”). The EHI is one of the many proprietary models that can be found at SentimentTrader.com. It’s a contrary indicator, meaning lower extremes in the chart should produce a rally in the markets and vice versa. The EHI aggregates several inputs such as cash raising, Put purchases, and various other factors in order to construct a usable indicator. For more details, visit the site and take a free trial to see if the service is right for you. As I’ve stated on numerous occasions, I do not receive any compensation from them and I’m quite confident they don’t even know the MarginRich blog exists. Fortunately for my readers, Jason Goepfert, proprietor of SentimentTrader, is cool enough to allow people to republish his work as long as it’s not excessive and the work is credited.

Here’s a current read of the EHI.

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And in case you need a visual on how well the EHI has performed in assisting traders see where some of the bigger turns have been occurring, observe the following chart from January 14th, 2014.

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It’s not perfect, but then again, no single indicator is. If using technical analysis, it’s best to observe a wide variety of charts and cumulatively interpret them, so that one may obtain a more productive assessment. But this is all rubbish really because bias inherently sways emotions and thought process, and thus the analytical outcome must be considered questionable. If this sort of analysis is all you rely on, such as what I do here for the blog, then more power to you. For the record, before committing my own capital I analyze a broad swath of data; not just squiggles. Occasionally, squiggles may be all it takes to ascertain that a function-able trade has presented itself, but I like to mix fundamental analysis in combination with micro or macro economic reads.

It is decidedly better to test quantifiable inputs to statistically determine, so to speak, probable outcomes when attempting to make valid trading decisions. Have a read of this Price Action Lab blog entry. Based on his analysis, Mr. Harris states that the market is in mean-reverting mode. Long story short, he basically states that the market is fragile and so any suitable catalyst could cause a correction.

My conclusion is that I wouldn’t pick now to be throwing all my chips into the middle of the table as if everything is all clear. There are enough signals out there stating that one should trade with caution, especially if attempting to position long. It may be best to wait in cash, but if you gots the stones and the know-how, then it appears a nice set-up is forming for shorting or Put option strategies.

Before I bid you adieu, just want to let readers know that I’ve created a new link up top called Portfolio Updates. That’s where I’ll be placing the ETF portfolio updates from the January post titled, A Few Sample ETF Portfolios to Watch. I would describe the results thus far as interesting, but not all that compelling just yet. If you haven’t read the article then click the link and have a read, then check the updates to see how they are stacking up.