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.

Here’s What’s Going to Happen

The S&P 500 is going to test one more time around the recent lows. Then it’s going to climb a wall of worry and easily establish new highs in 2016. How do I know? Because markets don’t enter catastrophic downturns when every investor is expecting it. That’s how you get a correction and then a resumption of an uptrend. There is plenty of technical damage to work off, but look at the facts.

The zero bound continues. Cheap money still exists and that money is going to get spread around in one last gasp to extract economic rents from as many greater fools as possible. The world is drowning in debt but that won’t matter until the last breath is drawn and the final game of musical chairs is played.

Regarding the current situation, 2010 and 2011 illustrated perfectly how the large money will sucker investors twice before supporting the next leg up of this market. Technicians call them inverted heads & shoulders. I call them inverted STFU. Observe.

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Watch for the same set-up before allocating any hard-earned capital. The reason this scenario works and will again is because of good old fashioned herd mentality. Markets correct. The experienced players advise to stay out and expect a rebound with a retest of lows before jumping back in. The low gets retested and everyone rejoices by betting on red and black, then the rug gets pulled out one more time. The strength of the current bounce is prognosticating another dip before the markets put the climbing gear back on.

Bet accordingly.

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.

Short-term Equity Risks Arising

Despite Wednesday’s(3/25/2015) market weakness on virtually nothing but fear, there is plenty of technical action showing that markets appear fine. The question is how reliable is the action. Breadth indicators across multiple indices are positive. Small caps are leading large caps. Consumer discretionary to staples are favorable. Rate sensitive ETFs(TLT & XLU) have been conducting basic retracements which is perfectly natural coming off their hard sell-offs, but I think their selling will resume which will continue to indicate higher risk appetites once stocks take a little breather of their own. If the equity markets do what I think they’re going to do, which is correct a little harder here in the near-term, then I suspect TLT and XLU will chop for a bit while stocks let off of a little steam.

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Everybody has their own methodologies for reviewing the markets to get a feel for the probability of directional plays. I really like to use inter-market analysis to help me potentially sense where the greater market may be headed. I have been watching biotech very closely as it has been the hottest sector and a market leader for some time. Real weakness in biotech may be a precursor to overall market weakness. That action last week in IBB had me suspicious. To me it appeared to be a blow-off. Call it what you want, a throw-over or a bull-trap. Either way the price action raised my hackles and officially put IBB on my radar as a temporary short. Current price action in IBB and the S&P 500 may be proving that out.

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Now clearly, biotech is in a raging bull market and has been for several years now. You don’t want to fight that trend. It’s better just to ride it upwards for continued profit, because it’s going to take a lot more M&A in that sector before we see a top in biotech. However, there was a bit of froth in biotech M&A during the first quarter of 2015. Observe the following chart courtesy of Reuters and just look at Q1’s performance amongst pharmaceutical companies compared to the last 5 years.

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We haven’t seen that kind of aggression since coming off the lows of 2009. There’s been approximately $60B of M&A activity in pharmaceuticals to start 2015, which accounted for 10% of overall M&A activity in the quarter. Twenty-one billion alone of that $60B was done in the Pharmacyclics purchase by AbbVie. That also signaled to me a potential short-term top for biotech as J&J and AbbVie slugged it out for rights to the cancer-fighting company.

So the real question then is how is this information actionable? Well that depends on your appetite for risk and how you’re looking to allocate capital in the short-term or long-term. If you’ve been visiting this blog for a while then you’re well aware I’m always ready to roll the dice based on my ability to interpret market action. I think shorting biotech via IBB or XBI is a good opportunity. I could have positioned earlier, but I was waiting for the price action to confirm so as to hopefully avoid being whipsawed.

If any readers are inclined to risk come capital, I think that IBB’s price action has stated to market players that it looks good for a short-term short. A small bounce at this price point is likely; especially in light of that 4% down day. I suspect the bounce could move the share price back up into the $355 to $365 range giving weak hands sufficient room to liquidate. That liquidation could then kick off the next leg down in biotech. There is a very strong floor at $290 as that is where the current 50-month EMA rests, so any option players will want to factor accordingly. I’m not stating that I think IBB will definitely hit $290, just that it’s a strong price point of support.

If IBB’s share price creates un-compelling options price points for smaller traders, then the XLV is a solid alternative. It has higher relative strength due to the size and various types of non-biotech holdings, but XLV possesses sufficient exposure to biotech that it will correct as well and it’s options may allow for a wider range of speculators to employ strategies.

As for the larger market i.e. the S&P 500, I wouldn’t expect anything deeper than a 10% correction if even that deep. There’s strong support at its 50-month EMA, as well, which is currently at $1,987. A 10% correction would take us down to approximately $1,900, which is also a round-number “power line” that I see providing strong support. I also suspect that any sell-off would result in yet another V-shaped recovery so be prepared to remove any short bias as a new leg higher ensues for the S&P 500 and biotech. Remember, these are interpretations based on my inter-market analysis. There are plenty of breadth indicators putting a more positive spin on things.

The markets are tricky, rigged, and no place for the ignorant. Manage your risks accordingly and utilize any potential correction to get long. There is continued quantitative easing on a massive scale across the world and the Fed is still reluctant to raise rates just yet. Current liquidity levels and yield curves continue to put a wind in the sails of higher risk assets. As Q1 draws to a close, take a moment to review your portfolio and see where you stand in 2015.

Whipsaw, Whipsaw

MAN ALIVE! That action on Monday is enough to make a trader fold up operations and go back to counting beans or selling un-needed crap to folks. That was seriously some hair-raising action. Did you get your stops ran? Did any of you traders get whipsawed by Monday’s action? Rest assured, you probably weren’t alone.

If you’re attempting to go short here across any of the indices and had your stops ran on Monday then kudos to you for maintaining discipline. However, you just may be missing out on more of the fun of a potential downmove. Hard to say because my crystal ball is in the shop and for some unforeseen reason I’m not omniscient. It really makes me mad that I can’t call the exact turns of the market. Oh well. I still think a downward short-term bias is in effect and eventually the perceived risk indexes(Russell 2000 & NASDAQ) will finally pull down the “Great Proxy”, the S&P 500.

So far, so good for the S&P 500 as it set new highs this week…and has promptly come off those highs. Is that strong price momentum? Have a look at the daily action in the VIX. It gapped down to start the week and within 3 days that gap has filled, but still yet, the VIX is still down around all-time lows.

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The MACD has been a pretty simple and fair indicator to clue traders in when the volatility is going to start spiking. Observe at the green lines that every time the MACD turned upwards, the VIX was usually in the early stage of an up-move. Are we at another up-move right now? It feels like it. If things get dicey, a quick move up to 20 on the VIX could easily occur.

A couple of weeks ago, SentimentTrader shared a chart depicting the VIX Put/Call Open Interest Ratio. It puts on full display what the current option action on the VIX is saying about volatility. Judge for yourself:

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There are plenty of messages being communicated very loudly and clearly by the markets. These aren’t esoteric signals that only the true professionals can divine. Anybody with the ability to read and some dial-up internet internet service can see these messages…more power to you if don’t have to result to a screeching connection via Juno or NetZero or whoever the hell provides dial-up these days. Also, to any readers who currently utilize dial-up to access this blog, please excuse my insensitivity.

Things are happening in the markets such as defensive rotation. Utilities have performed fantastically so far the past few months while the rotation to staples vs discretionary appears to have begun. Less and less issues are hitting 52-week highs despite the DOW and S&P 500 sitting near their own highs. Treasury rates continue to drop. Wal-Mart missed fairly big on YoY Q1 income. High-flying tech and small caps have already come off pretty hard and these are where the risk is allocated. Social media sites trading at P/E’s in the multi-hundreds. Biotech stories being sold on a wing and prayer for ridiculous valuations.

High-flying tech and small caps are part of what I call the 3-legged risk stool that are sort of propping up the animal spirits of the entire, current stock market. Two of those legs have been kicked out, so to speak, and yet still the S&P 500 hasn’t really shaken out the bulls. The third leg of the shaky risk stool and thus potentially the ultimate catalyst for a correction in the broader markets is junk bonds, I suspect.

If junk bonds correct here within the next 14 to 60 days, with remaining weakness in the NDX and RUT, then things can get real hairy, real fast for people who are poorly positioned for the move. Have a look at what Kimble shared over at his site a few days ago,

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So then what could be a catalyst besides stiff resistance? Oh I don’t know. Maybe the humongousest junk bond issuance in financial history. Anybody remember seeing this near the end of April?

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The markets have a funny tendency to act a little wonky after the largest-ever of anything occurs.

The action this week has that sort of a backdraft feeling to it. In case you never saw the movie, a backdraft(as defined by the Collins English Dictionary) is “an explosion that occurs when air reaches a fire that has used up all the available oxygen, often occurring when a door is opened to the room containing the fire.” Buyers potentially get a final pull into risk assets before an explosion outwards for a fast and hard move down after the right catalysts make their presence known.

Despite the already well covered move down in the Russell 2000, it appears as if there is plenty of room for a continuation downward. If you’re trading IWM, then keep your stops at an appropriate level. Biotech’s IBB essentially bounced off it’s 38.2% retracement using the week of August 8th, 2011 as your starting point for a quick Fibonacci analysis. A cautious short in IBB with the potential for further selling down to between $200 and $205, may yield a nice return during this summer. In a previous post, I had stated that I thought coffee was setting up for a short but my favorite indicators were not providing a green light just yet. Well those indicators finally gave their green light. If you’re feeling brave you can follow me on a short of JO with approximate targets of $35 and $30, if the selling momentum really gets going.

The list of investing icons who are advising caution continues to build. We’ve had mutual fund heroes like Romick of FPA and Yactkman share their thoughts months ago on building cash levels. Klarman, Marks, and Grantham have given the thumbs down. Now we had David Tepper, Mr. Highest Paid 2013 Hedgie, providing his valued insight on these precarious markets. It may not pay to listen to or heed a blogger like myself. That’s for you to decide; but you can’t dispute that it pays to heed what these most esteemed gentlemen have to share.