Monthly Archives: April 2009

Building a New Foundation

SPX

SPX

The SPX has broken out above the 877 Fibonacci retracement level. This is extremely bullish, and from a technical standpoint suggests the SPX is headed to 934. Closing above 877 is important and will confirm the suspected rally. I expect to see the DJIA test 9000 and the SPX to test 950 over the next couple of weeks. If the markets create support at the current levels, enough consolidation will have occurred to support a substantial rally in the near future. The talking heads on CNBC are finally catching on and have suggested the possibility of DOW 10k by the end of the summer. Please review my archived newsletter http://marketfallacy.com/newsletter/files/Market_Fallacy_%7C_4-7-09_%7C_Cautiously_Optimistic_2009-04-07.html, to see that I have been suggesting this possibility since April 7th, when the DJIA closed at 7790.

Here is one of the articles on CNBC’s website suggesting DOW 10k. http://www.cnbc.com/id/30478135 However, my reference is to the anchors on CNBC’s television show.

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Sell in May and Go Away?

Friday the major indices ended their impressive six consecutive up week streak[1]. During the streak, the SPX averaged 4.15% return per week with the first week boasting a 10.71% increase. Regardless of what the media or the bears are saying, this rally has substance. A rally of this magnitude should not have lasted as long if the underlying fundamentals were not changing. The real question is whether or not American citizens will pay for this rally in the future. The answer is yes, and they will pay for it in the form of double digit inflation. For the future of this country, let’s hope unemployment begins to decrease before inflation begins to increase.
 
The major indices declined Monday and Tuesday on fears that the Swine Flu would turn into world-wide pandemic. As of Wednesday night, there have been 93 confirmed cases in the United States and one death. The one death in the United States was a 22 month baby in Texas, but the baby was not an American citizen. The baby was a Mexican citizen and was visiting Texas to receive medical attention. Although it is suspected that as many as 160 people have died in Mexico only 8 deaths have been confirmed. Swine Flu is suspected of sickening more than 2,500 people in Mexico, but only 99 cases have been confirmed by the CDC[2]. While this could escalate into a world-wide pandemic if the virus is able to spread to enough people, it is likely to be less serious than the attention it is receiving. Only people from Mexico have died, a fact that scientists cannot explain thus far. It is likely that Swine Flu will pass faster than Bird Flu or SARS[3]. Some of the confirmed cases in the United States did not know they had the virus, which may suggest the virus can be controlled with proper precautions.
 
Last Thursday, jobless claims[4] decreased by less than expected, implying an economic recovery. Although the existing home sales[5] were worse than expected, new home sales[6] exceeded expectations. This mixed housing data supports the notion that the housing market is bottoming. On Tuesday, consumer confidence posted[7] the largest one-month jump in four years. This data sparked an early morning rally, but low volume and Swine Flu concerns caused a late afternoon fade. GDP[8] contracted more than expected for the first quarter of 2009. This news, along with the Federal Reserve meeting, acted as the catalyst for Wednesday’s 2%+ rally.
 
The results of the Stress Test will be announced Monday, May 4th. There have been many rumors surrounding the release of these results, specifically in regards to some of the banks needing additional capital. Citigroup will likely announce the conversion of preferred shares for common shares at the conversion price of $3.25 on Monday following the release of the Stress Test results. The conversion will be an attempt to improve their tangible common equity, one of the main metrics of the Stress Test.
 
Market Fallacy expects the major indices to trade significantly higher over the next seven trading days. Current targets[9] for the SPX and DJIA are 950 and 9000 respectively. Following this explosion to the upside, an ensuing retracement is highly probable. The major indices have established new support above the previous resistant levels, an extremely bullish sign. The markets are preparing for a significant move in either direction, with a slightly higher probability for a move higher. It is not impossible for a retracement over the next two weeks, but unlikely. Market Fallacy now has a blog, which will attempt to provide insight into individual questions concerning the markets. Please visit the blog to receive personal attention regarding the markets. http://www.marketfallacy.wordpress.com
 
[1] SPX, synonymous with S&P 500, closed down 0.39% for the week beginning April 20
[2] Center for Disease Control and Prevention
[3] Severe acute Respiratory Syndrome
[4] Jobless claims consensus 651,000 vs. 646,750 actual
[5] Existing home sales consensus 4.72 million vs. 4.57 million actual
[6] New home sales consensus 330,000 vs. 356,000 actual
[7] Consumer confidence consensus 30.0 vs. 39.2 actual
[8] GDP consensus -5.0% vs. -6.1% actual
[9] S&P 500 target 950 and Dow Jones Industrial Average target 9000

7 Weeks?

Nasdaq Composite

Nasdaq Composite

Apple (AAPL)

Apple (AAPL)

Google (GOOG)

Google (GOOG)

Research in Motion (RIMM)

Research in Motion (RIMM)

Russell 2000

Russell 2000

Citigroup (C)

Citigroup (C)

The markets are closing in on the gap between last Friday’s close and the 7th week of consecutive up weeks. Actually, some of the indices have already filled this gap. The Nasdaq Composite, representing smaller and technology based companies, which is positive year-to-date, has already filled the gap. In the charts above, the Nasdaq Composite, Apple, Google and Research in Motion are all currently establishing a new floor or support levels. Similar action is occurring in the Russell 2000. Both the Nasdaq and the Russell 2000 indices have consistently led the rally. Put another way, the Nasdaq and Russell 2000 have foreshadowed both the rallies and the declines for the last couple of months. It is for this purpose, that I reference them and point out the consolidation activity.

I also want to address Citigroup’s behavior. Citigroup is the only large bank that is not taking part in the current rally. Large banks here refer to Citigroup, Goldman Sachs, Bank of America, JP Morgan Chase, Wells Fargo and Morgan Stanley. The days following Citigroup’s earnings announcement, have seen the stock drop by approximately 20%. Citigroup has declined the last couple of days on lower than normal volume. However, yesterday’s candle on Citigroup was a hammer, a bullish sign. If Citigroup closes above $3.30, today’s candle will be a bullish engulfing candle. This would confirm yesterday’s bullish suggestion.

The importance of volume cannot be stressed enough. The higher the volume, the more valid the market movement. If the SPX closes above 870, extending the consecutive week streak, and does so on high volume, this will confirm my expectation the markets are setting up for the next move higher. The 10-day average volume for the SPX is about 6.1B shares. Currently the SPX has traded about 3.5B shares halfway through the trading day.

Volatile Outlook

Early market volatility suggests uncertainty surrounding the Stress Test results. Look for the possible release of this information tomorrow to be a major upside catalysts. For the most part, the results should be within expectations, but any negative surprises will cause an equity specific sell off. By the same token, any positive surprise will provide more momentum for the current rally, as it is being led by the finanials. I expect to see a continuation of the intraday volatility, but do not expect a significant breakout either way. If there is a breakout it will be foreshadowed by the Nasdaq and the Russell 2000. If the markets bounce back to near even, and the Nasdaq and the Russell 2000 lead the rally positive, the rally will have substance. If this happens look for a substantial move higher, particularly if it happens during the late day.

Existing home sales fell more than expected last month, but this should come as no surprise. I find this to be a huge positive in regards to forming a bottom, even though the markets disagree. If the existing home sales increased a second month in a row, I’d be concerned with the results. For this to be the “worst real estate decline since the Great Depression,” bouncing back on consecutive months should warrant concern. This reconfirms that the real estate markets have bottomed. Although, next month’s existing home sales need to be better than March, they do not necessarily need to be positive like February. It should also be noted that while real estate prices have declined nationally, a majority of residential real estate is not losing significant value. The areas losing the most are the areas that had the highest growth potential. In regards to academia, higher growth potential comes with higher risk, or higher risk is compensated with higher growth opportunity. The areas hit the hardest are areas where there was extreme speculation, and real estate was being purchased, with debt, and with the intent to make a quick profit.

Since the beginning of this post, the markets have bounced a little. I expect a progressive increase throughout the remainder of the trading session, with a late day rally of about 1%. The markets are subconsciously thinking about the consecutive weekly gain streak on the line. The streak, currently at six weeks, has been the largest percentage gain streak since the Great Depression. SPX 832 is the current support level to consider. Closing below this support level implies further declines.

Bull Market Rally

Monday the major indices made their largest single day move in six weeks[1]. The decline was fairly consistent throughout the day, and the indices closed essentially at the day lows. Bank of America’s pre-market earnings announcement Monday appeared to be the selling catalyst. Even after Monday’s huge decline, the Nasdaq Composite[2], remains positive year-to-date.

The leading indicator[3] release during the day Monday added to the decline as the indicator lost 0.3% last month. According to the release, “the recession has been long and with no end in sight though whether it is deepening in intensity is still unclear.” The indicators that decreased last month were building permits, vendor performance, factory workweek and jobless claims. It is not a surprise that jobless claims continue to decline as employment is generally viewed as a lagging indicator. The jobless claims report attempts to provide more timely information than the employment situation[4], but neither should forecast the direction of the economy. The two indicators that showed the most improvements were interest rates spreads and money supply which attempts to reflect active government intervention to stimulate the economy. These two factors reveal much more than the other indicators do about the state of the economy. In general governments attempt to spend their way out of economic contractions. Read my blog post for further analysis on the history of U.S. Recessions https://marketfallacy.wordpress.com/2009/04/20/1000-point-rally-coming/. These two indicators suggest the government is willing to do anything necessary to end this economic contraction, even at the possible expense of future Americans. Whether this is the government’s role is topic for another article.

AT&T, Boeing and Apple all rallied following the release of their earnings announcements. Of the three companies, AT&T was the only one to actually beat expectations, but Boeing and Apple provided commentary suggesting the current economic conditions are not as bad as perceived by the majority of Americans. High-end or luxury goods are showing increased sales which implies the wealthy are bargain hunting. This behavior is the pre-requisite to an economic recovery. Spending has to increase, and the easiest market for it to increase in is in high-end or luxury goods. As more companies report over the next two weeks, the outlook for the future will become more clear.

Although the market gapped down huge Monday morning, the major indices showed much resiliency Tuesday bouncing back and reducing significant amounts of Monday’s losses. Until the last hour of trading on Wednesday, the indices recovered most the losses from the early parts of the trading session, but were unable to sustain the rally. However, the Nasdaq did remain positive on the day. Small cap stocks[5] and technology companies[6] will continue to lead this rally.

Market Fallacy expects the major indices to end the week higher and add to the consecutive week streak. From a technical aspect, if the SPX can close above 875[7], the trend will be significantly higher. Market Fallacy expects another 15% increase before any significant retracement or consolidation period. As evident by Tuesday’s movement, this rally is not ready to end. The bears have had every chance to take the markets lower, and have had no such success. Monday’s decline was healthy and extremely bullish. Market Fallacy now has a blog, which will attempt to provide insight into individual questions concerning the markets. Please visit the blog to receive personal attention regarding the markets.

[1] SPX synonymous with S&P 500 lost approximately 4%
[2] Nasdaq Composite is a stock market index of all the common stocks and similar securities listed on the NASDAQ stock market, YTD up approximately 4%
[3] A composite index of ten economic indicators that should lead overall economic activity
[4] Employment situation releases the unemployment percentage whereas the jobless claims reports the number of of individuals who have filed for unemployment insurance for the first time
[5] Small capitalization stocks can be tracked by the Russell 2000
[6] Technology companies can be tracked by the Nasdaq
[7] Intraday high and now upside resistance

Open Down to Close Up

In order for longer term uptrends to be sustainable 2 conditions are necessary: 1) the up days are not substantial enough to make the slope unsustainable and 2) the market needs to consistently gap down to close up. The first condition assumes that there is a sustainable slope for which a security, market or commodity can increase or decrease at for an extended period of time, without requiring additional significant catalyst or corrections. The second condition assumes that given the first condition, the only way the second condition is possible is through gapping down to close higher or gapping up to close down (depending on the overall trend). Empirically, the is a positive correlation between the gaps and the close, but there are not sufficient observations to conclusively conclude this is always true. For example, the data on index gaps only exists for the last 6 years. Since this data begins after the last recession, I do not feel like it is fully representative of the true nature of the markets. Additionally, markets evolve, meaning one should weight more current trends higher. Anecdotally, this trend holds true since about summer 2008 (which is when I started noticing the trend). In the early stages of a trend, the correlation is in fact positive, supporting the empirical data. However, because those trends are longer and more prominent they bias the empirical study. As the trends matured, the correlation switched from positive to negative. This appears as a necessary condition for the trend to be sustained for a pronounced period of time. Finally, as the trends concluded, the correlations were almost always consummated by very strong positive correlation. This as well is explainable.

If an uptrend is just beginning (we will use the current uptrend that started in early March as an example), the correlation is positive, but not large in magnitude. This does not imply that the gaps cannot be of large magnitude, but typically they do not continue at such levels. After the trend has continued for some time, it is necessary that the gaps become negatively correlated with the closes. This happens because by gapping down the markets can continue to trend in the current direction and not outpace the sustainable slope. If the slope becomes unsustainable, by definition, a correction or retracement will occur. As the trend reaches its conclusion, the gaps become strongly correlated and have great magnitude. This happens because the slope of the trend has become unsustainable. Using the current uptrend as an example, when this trend is nearing its conclusion, the gaps down will be consistently 1 standard deviation or more away from the mean. Put more simply, the gaps in the DJIA will be in excess of 80 points. If not, the gaps are not predictive as they are not significantly different from the mean. In a bull market, two standard deviations ranged on average from -30 to +30.

The purpose of this explanation is to comment on the current uptrend. Before AT&T , Boeing and Wells Fargo reported earnings this morning the markets were looking to gap down with significance. However, because the news moved the markets significantly in the direction of the trend, it leads me to believe the trend is not in its mature stages yet. In fact, the increased volatility in the futures suggests that the opposition to the current trend are not truly convinced either.

Another trend involving the gaps and their predictive power revolves around the foreign markets. It is a common joke in the dorm that I am a machine because I willingly sacrifice sleep in order to watch the markets. As a result, I am generally awake when Europe opens. For instance, last fall when the markets were overrun with fear, I returned approximately 60% in the four month ending December 2008. I am not attempting to justify my returns or suggesting that simply watching the markets for an increased number of hours above your normal time will by any means improve your returns. I am saying that by observing the markets reactions worldwide that I ws able to understand and be more in tune with market movements. During the six week period where the fear was at its highest, I rarely slept more than two hours at night. Because of this obsessive behavior, I was able to notice some important patterns in regards to the foreign markets. The first pattern is that there are two major periods when the U.S. Equity futures have the largest move. The first period is when Asia opens, and the second period is when Europe opens. This makes intuitive sense in that at these two time periods, the largest amount of information is being priced into the markets. But even more insightful than this observation is the observation regarding the magnitude of the move of the overseas markets. If Asia was hit hard by a negative shock, and Europe felt the effects, but not to the same extent, it was almost non-existent by the time the U.S. Equity markets opened. However, this is not to say that the effects were not reflected in the U.S. equity futures.

Here is where understanding the gap patterns applies. If the futures were not suggesting a significantly different outcome than the current trend, the trend generally continued. This means that if the trend was higher, the gap would have to be significantly lower in order to confirm a reversal. This is consistent with the anecdotal evidence I observed, and possibly the empirical evidence. It is only possibly supported by the empirical evidence because I have not been able to review the information since understanding the potential cause of the disconnect between anecdotal and empirical evidence. During the time I’ve been writing this post, the DJIA future have gone from -60 to -31 (after the announcement of AT&T, Boeing, and Wells Fargo), and are now -75 (as Morgan Stanley announced worse than expected earnings, missing the Street’s estimate). Again this increased volatility supports my claims, and if we close higher again today, the uptrend will be confirmed. However, since Monday’s futures were greater than -100, another 1 or 2 days of similar action, before Wednesday of next week, will challenge the current uptrend. The reversal is beginning if the gaps get progressively larger and more pronounced. For instance, if we see the markets gap down today about where they are (-69 now), it will require another 2 days before Wednesday of significant gaps lower. We will need another one close to the size of Monday’s gap in addition to one in excess of -100 (preferably in the -120 to -150 range) to suggest a threat to the uptrend. The futures are improving from the lows after the MS announcement, which illustrates resiliency and or lack of conviction from the bears.

Support and Resistance Levels for the SPX

SPX

SPX

 Yesterday’s decline was very misleading to a lot people. The market dropped hard and every sector felt the fallout. Because no sector was left unscathed, the effects were magnified. This distortion caused some people to load up on short positions in certain sectors, particularly the financials. However, today’s rally was led by the same financials. Right now the financial sector is the strongest and most influenced by manipulation (term many bears use to describe the government regulation). Please do not fight this trend, the government has made it clear they will do everything in their power, including implementing legislation to benefit the banks. The name of the game is the banks win. On April 24, banks may receive preliminary results from the stress tests and the Federal Reserve is expected to release the methodology for the assessment. Final results are expected May 4.

Today the Treasury Secretary, Timothy Geithner, implied that the stress test results will indicate that most of the 19 biggest U.S. banks will have enough capital. The banks that require further funds are expected to get a mix of converted government preference shares and private money. It is no coincidence that the following this announcement the markets rallied, and were led by the financials. The three largest banks (Citigroup, JP Morgan Chase, Bank of America), by market capitalization, receiving bailout money all advanced at least 9%.

From a technical standpoint, if the SPX can close above the 877 resistance level, the next technical target is 1,008. Closing above 880 and forming a base will be bullish as it will create a new floor about 50 points higher than the previous (830 range). If the markets can consolidate around this level without any significant retracement or without retesting previous levels, we will see SPX 1000 in the near future. Near future here does not mean next week or even next month, but rather implies the SPX will see 1000 before it sees 800. The SPX is still trading within the uptrending channel, and with each passing day, the top of the channel is increasing.

Citigroup (C)

Citigroup (C)

 In a shorter time frame Citigroup is making a bullish flag pattern. According to the technicals, no breakout to confirm this pattern has occurred. In this chart, today’s candle was almost a bullish engulfing candle pattern. I understand that “almost” is worthless, but the price action reveals bullish momentum. Citigroup also bounced off of its 50 day moving average this morning, which is also bullish. If Citigroup closes above the $4.00 resistance level for consecutive days, a breakout to $5.00 would be immanent. I can see Citi reaching the upside resistance of $7.00 around the time the SPX is approaching 1000. I continue to see huge upside potential in the financial sector. I expect today’s trend of the financials leading the market higher. It should be noted that this is not as bad as some (Art Cashin) make it out to be. For many experienced traders, the consensus is that the sector that led into the recession will not lead out. While I will agree with this statement, it is important not to lose sight of the fact that the financial crisis was a direct result of the housing bubble bursting. The financials are perceived as the sector that led the markets lower, but this is only because they are larger and received more media coverage. The financials can and will lead us out of this economic downturn. They will not be the only sector as I expect tech and small caps to excel as well.