Category Archives: Stock Market

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.

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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.

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.

1000 Point Rally Coming

SPX

SPX

CBOE Volatility Index

CBOE Volatility Index

 Even though the DJIA has rallied just over 1400 points off of the March lows, the markets are setting up for another 1000 point run. The rally off the bottom was just under 22% in 30 trading days. Bears that are building short positions, are doing so under the false assumptions 1) the market is overbought 2) it cannot go any higher. These two delusions couldn’t be further from reality. Markets are never overbought or oversold. Maybe relatively overbought or oversold, but you show me a time period we are overbought, and I’ll show you a different time frame where we are oversold. For example, many bears argue the markets are severely overbought. I might agree that they are relatively overbought, but in the last year, they are most definitely still oversold. Saying the markets cannot go any higher is the same mistake many people made on the way down from 14,000. At 10,000 I heard many people saying, no way we can go any lower. Wrong. This time is no different.

The SPX chart above illustrates the markets are in the middle of the channel, and currently neither too “overbought” or “oversold.” This chart illustrates why the markets are headed much higher: higher lows and higher highs. The pattern of higher lows and higher highs is extremely bullish. In keeping with this pattern, the next time the SPX touches the top of the channel, it will happen above 875, I expect this to happen around 900.

The CBOE Volatility Index chart above supports the uptrend. The CBOE Volatility Index is commonly referred to as the fear index as it reflects the implied volatility of the S&P 500 index options. The down trending channel suggests fear and uncertainty are leaving the markets. It should also be noted that the index typically trades within a channel, usually a horizontal channel. The fact that the index did not breach 40 today is extremely bullish. Previously 40 had been support. Now 40 is resistance. The translates into further extensions of this rally. Today’s market movement was healthy and very indicative of bull markets. Bull markets see many smaller up days and few larger down days. Until early March, the scenario was reversed. Before March, up days were large and there were many more down days. The Fibonacci retracements show 33.22 as the next support level. On Friday, the index traded very close to this without closing below it. Based on the retracement pattern, if the index closes below 33.22, it will trade towards 17. If the index touches 17, I will guarantee the DJIA is at least 1000 points higher.

Lastly, for those who do not believe in technicals, I can show fundamental support of this prediction. Dating back to 1959, the 7 recessions that have occurred have lasted on average just over 1 year. The current recession is in its 17th month. Of the 7 recessions that have occurred since 1959, only 5 are technically recessions. Economists will generally agree that recessions are defined by two consecutive quarters of negative growth. Only 1 of the last 7 recessions had three consecutive quarters of negative growth. The current recession has had two. The economic data is showing empirical support that the economy is improving, or at the very least, that housing has bottomed. Considering the level of government spending coupled with quantitative easing and the significantly increasing money supply, once growth begins, it will explode. Although most of this growth can be attributed to inflation, it is growth nonetheless. Once the all clear signal is given, the unprecedented level of cash on the sidelines will pour into the equity markets causing a huge rally.

This is extremely bullish

SPX

SPX

The uptrend is not over! The markets are adjusting perfectly for the next move higher. In the chart, the SPX is trading in an upward trending channel. The downside resistance in the channel is SPX 820 in a worse case scenario today.  It is very likely we will close much above this as closing at 820 would be almost a 6% slide. The horizontal line on this chart illustrates former resistance becoming support. If the SPX retests 820, it will make a double bottom. Not on this chart, Fibonacci retracement levels for 3 month time frame are: 875 and the March lows of 667. It’s no coincidence the SPX retraced after touching 875, this is very healthy. If Fibonacci retracement lines are drawn on this chart, in this time frame, the next support level is at SPX 832. As a result, I am not surprised that currently we are trading at 836. I do not expect the day to get much worse. In the recent uptrend, down days have been violent and on low volume, and today is no different. There has not been more than two consecutive down days since the March lows. Although it is possible for us to be down again tomorrow, I do not expect this, unless there is a negative earnings surprise.

Unfortunately, people forget quickly and have unreasonable expectations. Many bears are coming out of the woodwork, saying “I told you the markets were due.” They proceed to suggest that now the bulls are “bottom fishing.” I find this very ironic since most of the bears have been top fishing for the last six weeks. This time, the bears who went short on Friday, got lucky. There is no real catalyst for today’s downward price pressure other than the fact that markets do not move in a straight line. It is terribly wrong to try to short this rally. Eight months ago I traded by the saying “don’t be caught wrong long.” All this simply means is that if I’m going to be wrong, I might as well be wrong short. Since I was fairly certain the economy was getting worse, this was a safer bet. Now the economy is improving, and the saying has switched. Being wrong short is a recipe for disaster. It’s clear the government will do whatever it has to for the banks to succeed. Do not try to get cute and attempt to time this perfectly. If you are uncomfortable with today’s down move, close your long positions, but do not try to short this. I will almost guarantee, all else equal, the market closes on Friday higher than it closes today.

Pre-Market Buzz

Futures showing the markets to open lower by about 1.5%. Foreign markets rallied overnight while commodities were hit hard. Crude opened lower in New York by about 6%. This morning Goldman Sachs has come out with a sell recommendation on Citigroup (C) saying its overpriced and gave a target price of $1.50. The government has shown some inconsistency by telling the 9 banks ready to pay back TARP that the government would like to convert to shares of the companies instead of receiving a cash payments. Bank of America (BAC), the largest bank by assets, reported first-quarter profits that more than tripled on gains from mortgage refinancing and trading.

My gut is that this gap down is very healthy for the markets. We needed a small pull back to continue to the push higher. Markets can only consolidate sideways so long before they must retrace. I feel like this will be a capitulation of sorts. Not the traditional capitulation, but I think we could see the markets trade higher the rest of the week following this huge gap down. I remain very bullish on crude and equities, particularly small cap, tech and the banking sector. I’m building positions in these on pull backs.