Wednesday, March 30, 2011

Divergence

A quick intraday update, considering the charts are revealing some divergences about the market in here. Apologies if I am simply applying the KISS method of TA for these charts. However, I do believe Einstein once said, "Everything should be made as simple as possible, but not simpler". Here's hoping to finding that balance. 


Click here for intraday charts. 


Tuesday, March 29, 2011

Finding Your Bearings

I'll be the first to admit that finding causation for the reflexes in the market is typically a fools game. If you give enough of them, you are bound to be right from time to time. Heck, they are still arguing over what caused the Great Depression - with each side claiming victory based on their own predisposed biases towards the events. 

With Investing, dogma tends to pay very well if you subscribe to the right line of thinking over time. 

With trading, dogma only pays for a relatively short period of time (if at all) where the market overlaps with your own beliefs. It's rarely a straight line.

As a trader, it's best to keep an agnostic perspective while you navigate the markets. That doesn't mean that you trade without a ballast of understanding where you sit in the broader scheme of things, just that you are open to shifting your position before the boom comes across and knocks you unconscious. 

The best traders dance gingerly from position to position, all the while keeping an eye on their course. 

Finding our Bearings in Equities (Short term)

  • Equity markets are in the middle of a trading range (loosely 1350/1250) trending higher - with a potential pivot right above us at 1320 (spx). Neutral
  • 10 year note yield is towards the middle of the range (3.7%-3.2%). However, the yield has increased nine consecutive days (next closest parallel is eight consecutive 3/2002 & 2/1997). Bearish
  • Dollar index is right above the yearly low set on March 21st. However, it has been trending higher with the equity and commodity markets since. Bearish
  • Oil is close to its yearly high and is possibly putting in a double top from early March. Several negative divergences in the charts. Bearish
  • Gold is close to its all time high and trading in a tight 3% range (loosely 1435/1395). It failed to stay above the early March high. Possible double top in the short term and a possible broadening top in the longer term. Bearish
  • Investor Intelligence Bull at 50.6 (previous week 52.2). Neutral
  • Investor Intelligence Bear at 22.4 (previous 22.3). Neutral
  • Volatility is trending lower towards the February lows. However, momentum indicators are indicating a possible trend reversal. Neutral/Bearish

I classified the dynamic in the oil and gold sectors as bearish towards the equity markets, because they have generally been trading in sync since the March 2009 lows. 

I am also closely watching the financial sector as it struggles to shake off the bearish news in housing and generally just an apathetic attitude by traders into more momentum driven stocks. This is not necessarily as bearish as it sounds and it has more relevance in the intermediate to long term time frames. Think of the rally out of the March 2009 lows as a relay race. The financials ran the lead off leg in record time then passed the baton. If the rally passes the baton back to the financials and they lead the market lower from here - then I would consider that bearish towards the trend. But for now the jury is still out.  

Overall, the market rally out of this months lows seems to be at an inflection point. The next day or so should give more clarity.

Monday, March 28, 2011

Topspotting

As a trader, I am always on the lookout for another perspective on things. Ratio charts can provide greater context than just the commodity or stock that you are trading. And just like any data source - there are a variety of ways to interpret the results with vastly different conclusions. It is quite beneficial to keep in mind the backdrop in which your trading thesis is playing out against. Those winds are always shifting - and it is especially the case with the gold/silver ratio. 

Have gold and silver been trading in sync or have there been factors disproportionately influencing one commodity more than the other? What is the economic backdrop, the currency impact - the political backdrop? Is the commodity at the start of an uptrend? It can be a mix of quantitative and fundamental analysis in getting it right. 

Despite what the gold bugs will force down your throats (go ahead and fill my mailbox folks), precious metals have been trading for more than a year against a backdrop of improving economic conditions and against a currency that is basically where it was at the start of the financial crisis in 2008. Furthermore, gold and silver have primarily been trading in sync with one another other and have been by far the strongest trending asset class to be invested or trading in. 

For that reason, I am utilizing the ratio (inversely applied) as really just a measure of relative strength or inertia of the trend itself. As an exercise, I overlaid a Nasdaq/SPX Index circa 2000 market (1 year) over the SLV/GLD (1 year) ratio chart for this past year. The analogy and logic seemed too appropriate to ignore and the ratio correlations indicate very similar momentum signatures. 

You could say that I was searching for an artifact of a top.  


Perhaps the correlations here are just an anomaly - statisticians will be the first to point out that if you torture the data long enough - it will confess to anything. With that said, it is an interesting analogy to consider - with results that are more than just cute or simplifying.


Full disclosure, I neither have a financial interest or trade in gold and silver, or the miners - but I am watching them very closely for the next pivot. 

Friday, March 25, 2011

the next Big Trade

At some point in the near future, the next BIG trade will likely come from a leveraged short position of the precious metals sector. With proper execution, it could easily exceed the record Paulson short of 2008. Unlike the Paulson trade, where he actually had to create the trading vehicle to perform his thesis of thinking - there's a line around the block waiting for someone to take the other side of this market at a moments notice. 

Generally speaking, the criteria for an asset bubble in Gold and Silver have been met: 
  1. Explosive & exponential gains (>400% gains w/Gold & >700% gains w/Silver since 2002)
  2. General public participation (is MC Hammer the general public?)
  3. Everyone's a winner (how could Glen Beck and Laura Ingraham both be wrong?)
  4. People who did not participate before - participate now (insert your personal anecdote here)
  5. "This time is different" syndrome (the financial system is broken, therefore...)
This trade is no different than Paulson's short on the housing sector - or Buffet's short on the dollar. They did their due diligence - recognized an asset class that was so historically stretched in relation to the mean and waited for their ship to come in. It is most similar to the Paulson trade - because everyone believed that the housing market was infallible to the kind of declines Paulson recognized as inevitable. 

Today, everyone believes the inverse relationship to be true. That the financial system is broken, that the Fed has lost control and that Islamic Jihadists or a Middle Eastern state(s) will bring us to our knees. While there is some truthiness in shades of that - it's more hyperbole than reality. 

It was the confluence of the Tech Bubble bursting in 2000, the events of 9/11 and a commodity sector that was overdue for outperformance - that gave birth to this bubble. As with every bubble - it starts with a legitimate thesis for outperformance - and then runs away with emotion. It is only after we reach the dizzying heights of the sun that we realize the danger we so confidently embraced. 

That moment seems imminent. 


The Unified Field Theory - Where Reflexivity Meets Equilibrium

Here are a few charts of different asset classes with my Meridian Theory applied through their respective trends. Each chart utilized the same reference dates as crosses to establish the meridians. 


In essence, the shading represents time periods where the markets are at a disequilibrium with the trend. In my unified theory (tongue in cheek once more), the meridian represents an equilibrium, which could be construed as the overlap between Soros's theory of reflexivity and traditional equilibrium thought. This makes rational sense, since it has typically represented where the market has either found equilibrium - or lost it altogether. In 1987, it represented the top of the trading range out of the historically depressed markets of the 1970's. The gains were steep, the programs misfired, mass psychology took over and the rest is history. After the 87' crash, the market eventually made its way back to equilibrium and crossed the threshold right before Greenspan invoked the self fulfilling prophecy that was Irrational Exuberance. In 2002 and 2003, the market found its balance at the meridian and started its reflationary ascent to the 2007 highs. In 2008, it represented the threshold where the markets lost their footings - due to the financial crisis, and crashed. Today, with the exception of the commodity and gold sectors, these markets have worked their way back to equilibrium - as represented on the charts. Click to enlarge the charts. 















Assuming all things are relative, and the kinetic intra-market/asset class relationships still apply - you can see why George Soros believes that the gold market is the largest asset bubble of the day, and by extension the commodity complex as well. 


These charts illustrate that thought rather profoundly. It would be an excellent time for him to put his money where his theory applies and dwarf the gains he reaped for breaking the British Pound. Ironically, the catalyst this time may be realized when the financial system and the global economy are found to be in better shape than most suspect, and that once the stimulus is slowly removed... surprise, surprise - life goes on and the markets function. 


With that said, a dislocation of this magnitude would likely have negative impacts to the equity markets in the short to intermediate time frames. So stay frosty. More to come in this line of thinking. 

Thursday, March 24, 2011

Wednesday, March 23, 2011

Constructive Interference

The key ingredients for this bull market began 40 years ago when Nixon abruptly abandoned the gold standard in 1971 and gave birth to the fiat monetary system that currently exists. Without the unfettered and conscious free reflationary policies set in motion by Nixon - the world would look vastly different than it does today. For better or worse, Tricky Dick set us on course. He also brought us to China - another key ingredient for this bull. Ironically, a brash politician gave birth to this market and an impotent one will likely kill it. There may be credit expansion available for the corporation today, but there is certainly no political capital left over from the stick save of the financial system in 2008. So enjoy it while it lasts. 

But alas, I digress. The Constructive Interference Market Theory. 


Tuesday, March 22, 2011

Dow 20,000?

Question: What created the Nasdaq Bubble?
Answer: Unfettered, cheap and conscience free capital + creative accounting.  

Question: What created the Housing Bubble?
Answer: Unfettered, cheap and conscience free capital + creative accounting. 

Question: What's creating the next bubble?

Answer: Unfettered, cheap and conscience free capital + creative accounting.


When I think about the Big Picture and forming guesstimates of the future - I like to look at the proportions of the contributing forces. The chart below provides an excellent example contrasting the two most recent recessions and reflations and their effects to the low-grade corporate credit markets.  






"HYV - The fund invests in the fixed income securities of the United States. It invests in bonds of companies operating across diversified sectors. The fund invests in high yield bonds that are rated in the lower rating categories of the established rating services (Ba or lower by Moody's Investors Service, Inc., or BB or lower by Standard & Poor's Corporation)."
Sure I'm taking the liberty of extrapolating past performance to shape my future expectations. But what has really changed here - except for weakening the accounting standards and increasing the velocity of stimulus by the Fed?  The Fed has really just moved the Credit Bubble from real estate speculation over to the corporate ledger side of business.

Is that a healthier bubble? Probably. Will that put a strong bid under the market going forward over the next few years? Probably. But they are still altering the time continuum and who's to say if they got the memo to wear the bullet proof vests when the Libyans come calling...


Monday, March 21, 2011

The Trend is Your Friend

From a trend perspective, there's still a lot to like about the equity markets here. The Bulls are suckling in the sweet marrow of disbelief with the ever growing Wall of Worry (that seemingly builds higher by the day) to the underlying momentum associated with those left behind or scrambling to cover. Throw in some improving structural developments, such as the declining trend in unemployment (tailwind), surging growth in industrial production (tailwind), and a very accommodative Fed (gail force tailwind) - and you arrive in a trading environment that is largely benevolent to the bulls, frustrating for the bears and reinforcing to the trend. 


It's really that simple. 


Surely, the skeptics could argue quite rationally (like any good economist that inevitably becomes a horrible trader) that these structural improvements are being felt from such depressed and catastrophic depths - that the recovery will eventually falter and reassert itself. However, as a trader I know it's more important to look at the markets inertia, its reflexes and its emotionalities - that are driven vastly from disparate perspectives to what's occurring on Main Street. 

It is why the markets leads the economy and why most investors miss the meat of the trend.

Friday, March 18, 2011

The Meridian Market Theory

The Meridian Market Theory - is a long-term (monthly) trend line of the S&P 500 that is comprised of a 'Who's Who' list of memorable market moments and pivots of the last 25 years.  

• the 87' Top
• the starting gate for Irrational Exuberance
• the 2002' low & 2003' retest
• the technical break and October 2008 crash
• and Febuary 2011?

Now before I get ahead of myself, I am not your father's technician - I use TA as a guide primarily for resistance and support and listen to the tape when it's trending in between. From the perspective that the trend line has intersected so many crucial moments in recent market history gives this chart more weight than others - and I'm sure the machines are watching it closely as we have tested and was rejected by it. In fact it delineated the recent market highs in February so precisely that it will embolden the bears to press the downside in the near term. 

I suppose the bulls could argue that the Prime Meridian - as it stands today, marks the threshold where the reflation story either finds another gear and gains legitimacy within the market zeitgeist - or just becomes the upper limits of the market trend as it did back in the early 1990's. 

Then again, we may have just made a major market top last month. Lest we forget what happened in Japan and to the second largest equity market this past week. Oh and there's this thing with oil...

With that said, and with a variety of conditions satisfied – both technically and sentiment wise – I am cautiously running with the bulls here and taking notes along the way. 


“It's these changes in latitudes, changes in attitudes 
  
Nothing remains quite the same. 
  
With all of our running and all of our cunning 
  
If we couldn't laugh, we would all go insane.” 

– the great poet philosopher James Buffett

Thursday, March 17, 2011

Fat Tails & the Gold/Silver Ratio

Thursday Morning - March 17, 2011

I have been closely following the gold/silver ratio as it cascades lower in 2011. For me it's another barometer of risk in the system - or lack there of. Basic thesis being that the silver market speculates with greater velocity than the gold market during times of exuberance and captures the underlying animal spirits of the marketplace. Of course there's more nuance to the ratio than that - but let's keep it simple stupid (KISS).

Some interesting things to consider here.


Before the tragic events of last week in Japan and even during the contentious times in the Middle East - the equity markets as well as the gold/silver ratio were trending very similar to the 1997/1998 market. The markets back then were getting themselves into a momentum frenzy until the fat tail of the Asian Currency Crisis set things in motion that eventually cratered the US stock market (albeit short lived) in the summer and fall of 1998.

Today we have instability in the major energy complex of the Middle East and a exogenous shock to the worlds third largest economy. The tail risk from this crisis at the moment appears much greater than in 1997 & 1998.

Why?

The Japanese equity markets were perceived before the disaster as undervalued with relative value to risk metrics. For this reason alone it is quite likely that leveraged funds were heavily invested in Japan as either a hedge on their primary investments or as a primary investment thesis itself. Considering the Nikkei's greater than 20% decline in the past week, the collateral damage to world markets is just being felt today or will likely not surface for many months (see 1998). 

The Yen carry trade is unwinding with great velocity. Considering it was one of the cheapest recurring sources of funding speculative assets - it has broad implications to liquidity within the global financial system.

With that said, there can be a significant lag in any downside fallout to the broader trend,  especially if the market was strongly trending higher with high relative strength - as exemplified in 1998.