Tuesday, August 27, 2013

Caught in a Trap

While we urge caution with certain causationistas looking to flame the recent geopolitical events in Syria with a particular market bias, the equity markets did find the trap door yesterday afternoon where our 2004 momentum comparative had indicated. 

Here are a few updates from that series. 
  

Monday, August 26, 2013

95' > 04'?

Too early to call, but we still favor the SPX route from last Thursday's note for strength in equities away from the 2004 comparative. Here are a few updates, as well as the 95' comp - including the banks. 

Should the market follow the 2004 momentum profile - equities would likely need to pivot lower right about now (~2PM est). 
Click to enlarge images

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Update - 6:45 PM est: Equities took the pivot lower where the 2004 momentum comp was pointing. The following three (3) charts were all created after the close. 



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Saturday, August 24, 2013

I'm A Geologist at Heart


A journalist asked me recently about my background and the conversation sparked some reflection of why I approach markets the way I do and how my background as a geologist helped develop my somewhat unorthodox approach with markets. With risk of overindulging - as well as alienating my engineer friends (and wife) - here are a few thoughts on the matter.

My education and professional background was in geology and geotechnical engineering - not finance. Conceptually, I’ve always been very visually driven. For whatever reason, spatial logic comes naturally to me. I know that's what initially resonated when I first became interested in geology and hydrogeology in college. Understanding the fundamentals and principles that drove such colossal processes was intriguing, but visualizing how those principles interacted spatially and kinetically was what kept my attention and ultimately led me to the capital markets.

I graduated from Bucknell University with a degree in geology and was a hydrogeologist for about ten years before getting involved in the markets on a full time basis. I managed and led subsurface investigations and groundwater and soil remediation projects for private developers on the east coast. I'm oversimplifying, but if I had to sum up in one phrase what typically occupied my time - I mapped things. From groundwater and soil contamination to fractured zones in bedrock, my job was to assemble and classify certain data sets, cross sections and field conditions and render and extrapolate those conditions - mostly unseen, for the client. 

In groundwater and geologic mapping it's crucial to be able to visualize forces that contributed to the formation processes of the features encountered. The ability to extrapolate a three-dimensional image from data or a two dimensional plan cross section is an analytical perspective I adapted to looking at markets. Broadly speaking, I approach an assets respective psychology and momentum profile as similar to a layer of soil or rock and use different methodologies to visualize where that "layer" will be deposited in the future. It's a different way of looking at things and over the years it has greatly helped in visualizing the potential energy behind where a market or asset will trend.  

The interesting thing about geology and what I believe is also kindred to how I work with markets now is that most geologists develop and practice qualitative reasoning, with quantitative abilities adjunct to those skills. A good geologist relies on his or her intuitions based on qualitative observations within a quantitative framework. The qualitative and interpretive skills that develop over time help navigate the significant gray areas that invariably arise under different conditions. There's a (bad) joke within industry - What's the difference between a geologist and an engineer? An engineer doesn't understand mud.   

Engineers are very structured and quantitative driven professionals. There's a precision and exactness that I suppose is why many firms in finance hire so many candidates with engineering backgrounds. They are by design methodical. Task oriented. Efficient. I'm certainly working with stereotypes here, but in my experience with markets, navigating them successfully is as much an art as a science with as much mud as there is rock. I've always appreciated both and try to keep one foot in each camp. I suppose it’s because I’m a geologist at heart and have benefited from adapting certain qualitative logic to a perceived quantitative system. 

Friday, August 23, 2013

Boom-Bust&Bounce

October 2012
It's been a while, so we thought we'd check back in on our silver:gold ratio comparative with the Nasdaq bust in 2000. Although the performance comp of the ratio did not retrace the entire move subsequent to the October 2008 low, momentum appears to have turned the corner higher where we had expected it would last October (see Here). 

In the end, the bear market in precious metals culminated with a retracement of gains subsequent to QE2. As mentioned in previous notes (see "The Retest & QE2 Retracement - Here), this contributed to us becoming progressively more bullish on the sector. 

Thursday, August 22, 2013

Connecting the Dots - 08/22/13

The SPX continues to follow the 2004 momentum comparative in which the equity markets had four successively larger percentage declines while digesting the Fed's transition to tighter monetary policy. Following this wave structure, the SPX has flirted with the backside of its 50 day sma this week.

Should the SPX continue to follow this momentum pattern, the market will briefly stick its nose above the 50 (~1659) shortly before turning back down next week. 

With that said, we continue to feel risk is towards the upside in the equity markets and work from the perspective that the long-term breakout this March through the Meridian was significant. Our expectations with the current correction has been that it would not violate long-term support on a monthly basis which comes in for August ~ 1565 and September ~ 1570.
On the considerably more bullish side of the comparative continuum and supported by both anecdotal evidence of overt bearishness and heavily lopsided sentiment surveys such as AAII's, equities are rounding out a bottom this week along the line of the 1995 Meridian comp. We favor this performance guide into next week. 
Despite the tumult yesterday, on a comparative performance basis we like emerging markets over developed markets in the back half of this year, and view the recent retracement decline in EEM as a successful retest of the panic lows this June. 

As noted in June at the lows, the last time the Fed pivoted on monetary policy, emerging markets had a similar reaction. Contrasting the most emotional and reactive structure as expressed in the sector's waterfall declines, in the spring of 2004 the EEM cascaded ~ 22% , bounced 14% - before having a 7% retracement/ retest. This spring the EEM had roughly an 18% waterfall decline, followed by a ~ 13% bounce - and a 7% retracement/retest. 

Wednesday, August 21, 2013

Treading Water with the Euro & USDX

Long-term, we remain in the euro's corner until proven otherwise. With that said, they have both treaded water for the better part of 2013 - trading momentum drives while trending in the same direction. If you were to look back over the long-term at the relationship between the euro and the US dollar index, you would note that this year has exhibited the largest and longest correlation drop from the typically strong inverse relationship held between these two assets. 
Our general and simplified take, is that this prolonged period of trending listlessness between the euro and dollar will end with another major inflection point. Until proven otherwise, we see the dollar rolling over into 2014. 

Although the correlation environment between asset classes is invariably unique, we continue to contrast the 2004 timeframe as a reference guide to when the Fed pivoted away from accommodative monetary policies. 

Over the short term, the USDX is currently expressing another positive momentum set-up that may result in a retracement bounce - similar to the rally in the USDX in the back half of July 2004. 

Monday, August 19, 2013

Random Thoughts

We tend to shy away from short term appraisals, but if we had to handicap a few markets on another quiet summer session we would be looking for the equity markets to make a very short term low after today - with volatility pulling back in for a few sessions. 
 Over the short term, this could open the door to retracement declines in the precious metals sector. 

Friday, August 16, 2013

The Silver Linings Playbook

Outsized gains were found in silver and gold this week. By most measures the precious metals sector is firing on all cylinders and continues to reflexively bounce from their respective early summer lows. For context, silver has rallied over 24% since finding a low at the end of June. Gold is up over 13%. The gold miners (GDX) have rallied over 37%, tacking on ~ 15% this week alone. Last, and widely leading the pack are the silver miners (SIL), which have bounced ~ 50% since finding a low on June 26th.  

While surprising as those performance metrics may be, the sector continues to trade close to where we had outlined they would in our note at the end of June: The Case for Buying Precious Metals. Below are few updates from that series.  

Click to enlarge images 
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We've utilized historic momentum breaks and reversals in the financial sector based on two separate time periods - 2009 & 2011. 

The long-term ratio chart below illustrates to a degree the correlation behind those two studies and sectors.  The value trap series (see Here), with the similar structured banking index  BKX (circa 2009 - purple stars) kept us on the right side of the market with its breakdown and currently (chart to the right) in its recovery.   
The 2011 comparative (denoted with blue stars above) with the BKX illustrated similar sentiment, market structure and momentum parallels, that to date has resonated in the precious metals sector - specifically their miners. Below is a brief description from our note in June that illustrates the rationale behind this comparative study. 
"Back in 2011, a similar market and sentiment environment was spawned in the financial sector as the banks careened lower and tested participants moxie in the shadow of the financial crisis. As we recall, the general sentiment at the time - both within the trading and the pundit class, turned overtly bearish on the banks just as they were completing their cycle lows. The thought of buying Bank of America and Citigroup for anything more than a quick trade was seen as reckless and foolish by analysts and pundits so keen on extrapolating current market conditions forward. From a purely psychological perspective,  the retest is often as difficult to navigate and appraise as the initial crisis itself - due to the long tails of the recency effect.  
In terms of market structure and momentum, the parallels are evident in the symmetrical and positive divergent nature of their RSI fingerprints and the deeper imprints they recorded versus even during the crisis lows in 2009.   
Like the financials in 2011, the more emotionally traded miners have exhibited disproportional losses to their denominating asset class. Our expectations - and similar to the financials circa October 2011, is once the retest is successfully completed, the miners will once again lead the sector higher."
Although the bounce and retracement decline from the 2008 lows were both greater for the gold miners than the banks, the price and momentum structure present a similar behavioral arc: There was a crisis/momentum low that was successfully tested several years later that rejuvenated upside momentum for the sector through attrition.  

Below are two additional fractal patterns we had cited for silver and gold. 

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The 2004 analog that presents the previous cycle in which the Fed pivoted away from peak monetary stimulus continues to prove prescient. This study would roughly target the current rally to continue up to ~ 1475 through mid September, before retracing back to ~ 1300 into October.  It has an end of year target of ~ 1600. 
Silver firmly turned up another reflationary road this week. We expect inflation expectations to follow. 
Rounding things out, the equity markets took the audible corrective path we outlined earlier in the week. Despite shouts from the rafters of an impending crash, we think risk is towards the upside - albeit, likely through a corrective consolidation. 
The VIX replicated beautifully with its 2004 comparative outlined earlier in the week. 
Audibling somewhat from the 2004 yield study and warranting attention, rates took a turn higher with equity market weakness in the back half of the week. Our concerns are somewhat mitigated by moves in gold and the dollar. We find it noteworthy that yields are roughly where they were at the trough lows in the precious metals sector this summer - while the dollar is currently ~ 4% lower from a high in early July. Our expectations are that yields will catch up with dollar weakness shortly. 
Also similar with 2004, we expect emerging markets to continue to outperform the U.S. coming out of their second quarter lows. In the near term this would likely result in a narrower consolidation than domestic equity indexes.  
We expect this to translate downstream with a weaker dollar, as illustrated below in the 94' USDX comparative. 
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*  All stock chart data originally sourced and courtesy of www.stockcharts.com 
*  Subsequent overlays and renderings completed by Market Anthropology