A New Leading Indicator

During my daily routine the other day of researching companies and analyzing various charts, I noticed a peculiar relationship with one particular equity and the S&P 500. This company is a credit-sensitive entity. In light of that, I wanted to see if it had any ability to “foresee” potential moves in the larger stock market. It turns out it does.

The relationship may not work forever as nothing ever does in speculating, but its efficacy since the end of the recession in 2003 is evident. The correlation coefficient is set at 40 periods for a monthly chart. I tried 10, 20, 30, 50, and 60, too, but 40 seemed to have the most telling relationship. Call it massaging the chart analysis if you will, but the relationship is undeniable. Observe the chart below. The S&P 500 is the candlesticks and the “indicator” equity is the solid blue line.

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It took a little while coming out of 2004 as credit conditions really started to loosen to accommodate the explosive real estate market, but correlation to the S&P 500 finally reached 90%. Since the market peak in 2007, each time we’ve seen a deviation below 90% correlation then it was a clear indicator that something negative was on the horizon for the equity markets.

You can see that the price action is telling in and of itself despite the correlation data. Of course breadth readings are just as indicative. If you would’ve listened to the message breadth readings were sending well in advance of the current market action, then you could’ve easily sidestepped making poorly timed and silly purchases.

And no, the equity is not Sotheby’s (BID). Sotheby’s has a well-documented relationship as a major-market-top indicator so feel free to parse the web for additional details. For now I’ll continue to gauge the action in this new leading indicator(new to me at least) as the market progresses over the rest of this year and the next. Bear in mind that any one indicator is but one simple tool in what should be a well-stocked toolbox for the purpose of speculating.

As for the upturns in the “indicator” equity, they are not as foretelling as the downturns. The upturns seem to almost always occur right along with the S&P 500 so we can’t count on it right now to help guide us in the current bounce. Just my own current quick & dirty read, I’d say the S&P 500 could possibly bounce all the way back up to about 2,040. That’s a very obvious point for all chartists to see. However a retest of the recent lows or even lower-lows is very probable over the next several weeks so employ patience out there.

Prediction Record Thus Far and a New(er) Observation

Thought it might be a good idea from time to time to review the MarginRich prediction track record. Not every post has a prediction included, but for what has been put out there, I might as well provide a quick once over on the results. It’s not something one see’s too often from un-skin-in-the-game blogger-types who simply publish their thoughts and then move on to the next prognostication. As previously stated, I don’t profess to have any clairvoyance. I simply read the tape and share my thoughts. With that being said, the MarginRich site is currently 4-1-1 (with the oil call being essentially flat). Here’s the exact record:

1. TM – Winner
2. EEM – Winner
3. GLD – Winner
4. SPY – Winner & Loser: Predicted a correction in the S&P 500. It corrected approximately 3% but then went on to make a new high, and yet here we are in slight correction mode again. The downward energy is being stifled and that can be a dangerous thing to contend with.
5. WTIC – Flat for the most part; ostensibly range bound with no hard breakouts to the upside or downside since the post
6. FXA – Loser: However, may have just been early…aka wrong. Believe me, I know.

And as for Japan’s equity market and gasoline, there weren’t any predictions made in regards to their price movements. There were only simple observations put forward for the reader to consider. So to recap, 4 out of the 6 were in the money while oil and the Aussie dollar still present opportunities. Now onto another opportunity…

Once upon a time, long, long ago before the price discovery mechanism for virtually all markets was distorted beyond belief, there was an index that credibly served as a sort of “canary in the coalmine.” It’s canary-like qualities have ceased to function as a viable predictor of economic direction but there are still opportunities to be garnered from the late, great shipping index known as the Baltic Dry. Now even if the index is less than robust in providing leading intel on economic direction, a parabolic move is still a parabolic move, and one can see in the YChart below a rocket ride in index pricing. The breakout occurred during the week of August 23rd, but the real upward explosion occurred about a month ago exactly.

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Now gravity has a funny way of bringing rocket rides back down to earth. The Baltic Dry may be legitimately breaking out as supply/demand fundamentals across the pricing space in shipping may warrant a move higher. My guess though is that a little steam is going to have to be let out first. This will of course affect the shippers, whose own shares have enjoyed nice upward movements as well by riding the BDI rocket. Observe the following YTD charts of a few prominent shipping companies (for the record I suck at inserting small, clear snapshots but the companies are EGLE, GNK, & DRYS):

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We’re talking over 100% moves in a matter of weeks. Now the average speculator probably missed these moves which have no doubt been driven to the extreme by every investor’s best friend to true price discovery…the high frequency trader. It makes no difference. The algo’s are programmed by humans and extremes have been reached. So if you missed out it appears we now have the BDI beginning to peter-out a bit, and the opportunity to go short has presented itself. For myself, I played DRYS cold off the charts because it went from heavily range bound, unlike the other two, to an absolute take-off. As luck would have it, they announced a financing and thus the market sold it off bringing the play into the green before any true downward momentum can truly factor into the trade. The BDI has been covered extensively around the web for the past 4 weeks so anybody looking in the right corners (hint: links under Some Favorites) could have easily joined in on the fun, even if you weren’t scanning via your charting software or subscription.

It’s a bit tricky to be trading right now off the tape. There’s nothing wrong with sitting on the sidelines in cash while the action defines itself…but where’s the fun in that? Oh yeah, it’s in the protection of your capital and safety in principal. Naturally, there’s money to be made long or short but just to help disperse a little more fear for the long-only’s, here’s a few charts courtesy of CitiFX, Kimble, and ZeroHedge that communicate a message of caution.

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Zero Hedge:  Top Chart – 2007, Middle Chart – 2011, Bottom Chart – Currentclip_image013

Now that you’re sufficiently scared of a major market correction, understand that now may be an appropriate time to take some risk off of the table or add additional hedges where appropriate. In a previous post, I had stated it appeared as if a 10% to 15% correction may be in the cards and it doesn’t seem as if we’re quite out of the woods yet. The big debate on the debt ceiling in conjunction with comments from bankers and financial thought leaders has helped to produce even more fear. Stay sharp.

Read, Read, and Read some more. Good luck out there.