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Jeremy Frommer, CEO of Hedge Fund LIVE Jeremy Frommer has 20 years of industry experience and is currently responsible for general management and leadership of the General Partner. Previously, Mr. Frommer was a Managing Director and Head of the Global Prime Services Group (“GPS”) at RBC Capital... More
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  • Market Rallying Without the Financials: Not Necessarily Bearish  0 comments
    Mar 30, 2011 8:59 AM

    HedgeFundLIVE.com — After poring over historical market data, I have come to the conclusion that technicals are not signalling anything right now.  Technically, there is no reason for me to be bearish.  I tried to point to low volumes on this recent run up, the recent correction not being large enough, and as you’ll see in today’s blog, I tried to point to the divergence between the market and the Financials, all as reasons to short.  But as I mentioned in my blog yesterday, I am realizing that fundamentals will be the driver of this market and they will be what pushes this market to the next direction.

    If any of the aforementioned reasons were real bearish signs, my recent market models would have shown odds pointing to the downside.  The probability of moving higher would have been low, not 50/50.  I have also been digging deeper than usual into the data by examining each individual instance, looking back historically on daily charts.  I literally have a couple days for my short thesis to come into play as I believed this rally might have been due to quarter end performance chasing.  The market feels strong though, and things are starting to feel like year end in 2010, when everyone and his brother believed there would be a large correction once January came around.

    Anyway, moving on to my analysis for today, I am looking at the Financials through the XLF and their divergence from the performance of the broader market.  Financials have been lagging in the face of this recent market rally.  Look at BAC, GS, MS.  Bearish sign?  I thought so.  But that is not necessarily the case, in my opinion at least.  The 8D change in the SPYs has been +3.8% (as of Mar. 28) while the 8D change in the XLF has been +2.4%.  The divergence here is -1.4%.  In my spreadsheet model, I looked for all instances where the SPYs were up at least 3.5% over the course of 8 days and the divergence between the SPYs and XLF was more than 1.3%, where the XLF was lagging the market.  This scenario has played out 39 times since 2000, or a little over 1% of the time.  In order to derive some tradable value from this study, I took a look at the following 5, 10, and 20 day change in the SPYs.  Below are the probability outputs:

      5D 10D 20D
    SPY 8D Chg 3.50%    
    Divergence -1.30%    
    Next Time Period Pct Chg 0.00% 0.00% 0.00%
    Number of Instances 39    
    Number that Meets Criteria 19 23 22
    Probability of Up >0% Next Time Period 48.72% 58.97% 56.41%

    So the negative divergence in an up market does not clearly signal anything, seeing that the probability of being up >0% in the next 5, 10, 20 day changes are lying around the 50/50 mark.  Below are the average, median, max, and min stats for further color:

    5D   10D   20D  
    Average -0.46% Average -0.99% Average -0.03%
    Median 0.03% Median 0.32% Median 1.38%
    Max 4.75% Max 6.53% Max 8.14%
    Min -7.30% Min -16.96% Min -12.75%

    Averages are being dragged down by the min, which suggest greater downside risk, as usual.  The median number, which is the one typically like to look at, are pointing up, but only very marginally.

    In my pathetic attempt to look for some bearish odds, I built a couple additional factors into my model.  Volumes have been weak in this latest run up.  In fact, on Mar. 28, the SPYs traded less than half its 20D average volume.  On top of my existing criteria to look for 8D changes greater than 3.5% in the SPYs and divergences between the Financials and market being more negative than 1.3%, I specified the model to filter for days on which the volume was 70% or less than the 20D average volume.  Out of the original 39 times, 8 of those days were on “low” volume.  Below shows what kind of returns we saw following those 8 instances:

      5D 10D 20D
    % 20D Avg Vol 70.00%    
    SPY 8D Chg 3.50%    
    Divergence -1.20%    
    Next Time Period Pct Chg 0.00% 0.00% 0.00%
    Number of Instances 8    
    Number that Meets Criteria 6 6 5
    Probability of Up >0% Next Time Period 75.00% 75.00% 62.50%

    So light volumes don’t necessarily mean this rally is a BS, short covering rally as the market tended to trade higher following even light volume rallies where Financials lagged the broader market.

    Conclusion: More importantly to me here, this market feels just like it did back in late December of last year, when there were plenty of reasons to short into January in anticipation of the impending correction.  It felt like the obvious trade, and it never worked.  Shorting here feels like the right trade to me as there is little to no macro news coming out in the world that is positive for the economy.  I mentioned last week that I would have to reassess my thesis after my 5-10d short term bullish view, and now that I am reassessing, I honestly don’t know if shorting is the right way to go.  Technically and historically, it’s a coin toss.  What pushes me slightly closer to the bullish side now is that prior to this latest correction in late February/early March, the market was on a strong uptrend.  I am a believer in the continuation of the trend based off momentum.  Fortunately, my “stops” on my short thesis are very close by.  I’m giving the market a deadline of early April to give us a real pullback, and technically, I am giving the market up to the downward sloping trendline at around 1317 on the ES.  I’ll use this blog to keep me in check, but if the market busts through these mental stops of mine, the bulls will have won me over.

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