One day, it’s QE2 that will be the financial market catalyst of all catalysts. The next day a Euro member bank is melting down. Commodities are flying higher on the back of QE2 perceptions the next day and then a few days later they crumble based on the need and near term actions of China to quell internal inflation by raising rates. Fed POMO’s and QE activity are coming hot and heavy and can easily influence prices on a daily basis. The risk trade is on, and then it’s off, and then it’s back on again…all in one week. The HFT crowd is surely reinforcing short-term price movement and volatility in both directions. And as always, a lot of price action in the major indices really takes place prior to the open in the futures markets and the cash market remains in a mind numbing incredibly narrow range for hours on end. Sound familiar?
Sometimes I find it helpful to simply sit back and “listen” to the messages of the market and try to observe its character. Have we doubled topped on an index like the S&P near 1225, or are we just storing up energy to vault higher? Maybe there are some technical perspectives that can help. Always tough to know in advance of reality. I’m personally a huge believer that the marriage of fundamental and technical analysis is a must as opposed to some type of analytical luxury. Moreover, integrating the behavioral is becoming ever more important into investment decision making, especially within the context of HFT that is in one sense a “crowd” in and of itself. So, rather that looking at economic or fundamental market stats, I thought I’d simply share a few perspectives that have caught my eye recently that happen to be in chart format. In no apparent ordered fashion mind you.
One last personal comment. We are all aware that a lot of technical “rules” of prior periods and market cycles simply seem not to work these days. First, the markets are ever-changing beasts. We need to approach technical analysis as such. What “works” can often be a moving target. Secondly, although this may sound conspiratorial, never has there been this high a level of market intervention probably in our lifetimes. Whether it’s Fed printing or the government offloading corporate bailouts in the form of new IPO’s, there are a lot of short term “agenda’s” shaping daily market activity that have absolutely nothing to do with a free market, per se. So as promised, as I sit back and try to listen in, here are a few highlights that have caught my eye over the recent past.
Although scenarios like this can take a darn good long time to play out, one of the hallmark technical fingerprints of financial markets approaching potentially important turning points is that they narrow in terms of participation. Think back to the late 1990's. By the time the equity market peaked in early 2000, it was just about all tech and dotcom, and not much else moving higher. Sector by sector had fallen by the wayside as the equity market approached its terminal peak. In a sense we can get the same feel watching the character of new highs on an ongoing basis. Without question investors have been emboldened and increasingly trusting of the fact that the Fed is about to embark on another round of meaningful printing. From the short attention span theater of life, investors were "taught" in 2009 that Fed money printing means equity prices move higher. But have a look at the chart below and ponder conviction, or perhaps lack thereof. Using a 25 day moving average to smooth out the wiggles and jiggles, you can see that new highs on the NYSE as we ended Thursday of this week were not only meaningfully lower than when price was roughly equivalent in April of this year, but those current new highs are also lower than the interim S&P new high peaks in January of 2010 and October of 2009 when the S&P price was much lower than is the case today.
Lack of conviction? A narrowing market? Or both? It simply tells us to be careful and watchful. IF there is to be a year-end rally, as so many expect, taking the S&P and equity index friends to higher price highs for the year, I believe the above will be a key chart to monitor. For the supposed bull to truly continue into the end of this year and on into 2011, I'd expect new highs to expand relative to prior highs, not contract as has been the case up to this point. It’s a point of divergence as you listen to the message of the current market.
And it’s interesting that the recent rest stop has come at this juncture. What could not be clearer on the charts is that the rest point at least for the S&P occurred at the prior April highs. But there’s more. Last year and continuing into this, I have contended while writing Market Observations pieces that history tells us the 200 week moving average is a natural cyclical bull market attractor, if you will. After large bear market plunges, one of the first stopping off points for new cyclical bulls is the 200 week MA. It does not get a lot of airplay in the mainstream financial media. And wouldn’t you know it, this is exactly where the S&P stopped in April of this year. And so we find ourselves here once again.
If we look back to the prior equity bull that began in 2003, you can see below that the S&P went straight up until it met its 200-week MA in early 2004. From that point on, and a bit like the present year, the S&P consolidated around its 200 week MA, ultimately breaking northward in August of that year and never seeing that line again until the post 2007 peak period. The 200-week MA is not only an attractor, but an oasis point rest stop in many a bull market journey. IF indeed the equity bull is to conitue into 2011, I’d expect the S&P to leave the 200 week MA in the dust looking ahead. Is that how it will all play out? If indeed the SPX can trade sustainably above the 200 week MA, it will be “telling us” the bulls will have the upper hand.
If there is to be any difference at all between the prior 2003-07 cycle and that of today, it’s that at least so far the SPX has consolidated below its 200 week MA. Exactly the opposite of the 2004 period were consolidation occurred above this important line.
A week or so back we watched many a financial issue pop a bit in price. Part of this was due to the announcement that the Fed was considering allowing a number of banks to increase/up their dividends. How nice of them. Maybe banks can fund this with even lower loan loss reserves moving forward, do you think? The financials have been horrible performers this year. It has recently been disclosed that a fair number of hedge luminaries extolling the incredible investment virtues of the large TBTF financials have sold out of their positions as of the end of Q3. This includes both Mr. Paulson and Mr. Tepper. Although I'll spare you the charts, the financial sector ETF "broke out" as did a number of other financial related vehicles/indices. But I continue to believe a key relationship to monitor is that of gold relative to the financials. A symbol of paper versus hard assets? Indeed. And isn’t this at least one of the key tensions in the current macro financial environment? For that I use the broad NYK - the NYSE financial index. As you look at the chart below, you can see we are near yet another technical breakout point. But this go around it's the breakout of gold relative to the financial index itself. And this is after the recent correction in the price of gold. This is important why? The blue lines drawn in marked the spots where gold last "broke out" relative to the financials. When that happened, equity prices singularly broke down. Is past prologue? Just stick around and find out. At least over the last number of years, the relationship between gold and the financials has been inversely directionally correlated with the S&P itself. History tells us that what happens to this relationship between gold and the financial stocks will be meaningful ahead. Let’s see if history is to be on the right side of the next trend/trade.
Certainly the equity rally of the last few months has changed very near term investor perceptions. The fear we all saw in late summer market action has given way to QE induced dreams of just how high trees may indeed grow toward the sky. The Fed has literally painted themselves into a corner as Bernanke singled out equities in his WAPO op-ed piece and has done absolutely nothing to dispel the popular notion that the Fed is in part targeting equities with QE. Quite the dangerous set of circumstances. And as night follows day, a good bit of complacency has followed summer time fear. At least as of now, the 25 day moving average of the equity put to call ratio is resting near what has been an important low in the past. Every time we've come down near the current level we have been near an interim peak in the S&P. Will it be so again? Or can we come up with at least 900 billion reasons why this indicator may not be helpful? We'll have to see, but this is an example of what I’m talking about when I suggest we need to watch for divergences. Additionally, as is clear in the bottom of the combo chart, we're right back to a price level of technical importance that just happens to very approximately coincide with the 61.8% retracement level of the entire 2007-2009 S&P downturn (for Fib followers). Remember, as mentioned above, this coincides with the 200 week MA resistance level. It has been very tough to trade the technicals in the current cycle. Every time it appears as though a tried and true technical signal is suggesting a good trade setup or exit, the market simply blows through it. The dominance of HFT changes the technical game over the short term. That and the rocket fuel of Fed sponsored monetary debasement simply remind us to remain flexible in outlook and accepting of near term market outcomes.
For now, a number of what I consider to be important financial market “fingerprints” are telling us to keep risk management as a discipline at the forefront of our thinking (actually, it should always be at the forefront of our thinking). As we move into year-end, without question the Fed sponsored QE and POMO activity will need an ultimate destination at the time when the list of acceptable rate of return vehicles is narrowing (think fixed income). Couple this with the outright human fear of institutional investment underperformance and really anything can happen.
I’ll save this for a future discussion, but we need to be mindful that the tsunami of money coming into fixed income and the bond fund complex itself has been incredible over the past few years. The easy money has been made and forward rate of return possibilities are now accompanied by meaningfully increased risk. The macro issue of the weight and movement of money broadly will be important as we move ahead. As will the whole concept of money gravitating between public investments (government bonds, muni bonds) or private investments (equities, corporate bonds, etc.) Will a growing distrust of public investments, per se, mean we see capital gravitate back to private investments at the margin? A lot to think about and monitor in this very special cycle.
