In spite of last week's pullback in the stock market many of the US market averages, and especially some sectors, have had a pretty good year, so far, with several showing double-digit gains in 2014.
Ever since George Soros reportedly made $1 billion in his bet against the British pound, many investors have wished they were able to invest in a hedge fund or like one.
Many would be surprised to learn that for the fifth year in a row, hedge funds have underperformed the S&P 500. In 2013, they returned an average of 7.4% according to the Bloomberg Hedge Funds Aggregate Index. This was 23% below the gain in the S&P 500.
There are several reasons why most investors should not invest in hedge funds or use their strategies. Many hedge funds invest based on their "macro view" of the stock market, economy, or interest rates. This investment approach does not generally employ any risk management strategy and is often based on a fundamental outlook. Fundamental changes generally take much longer than anyone expects.
The failure to factor the risk component into any investment can often have disastrous results as I have pointed out many times in the past. The failure to limit the risk on any one stock or ETF can endanger your entire portfolio as it is very tough to recover from a 20% loss on any one position.
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This year has been a very difficult one for several well-known hedge funds as they are down 4-5% in the first five months of the year. The lack of any predetermined level to get out of a losing position and bad timing helps to explain this poor performance.
The asset class performance for 2014 illustrates the risk of investing too heavily in any one asset class. Many of the funds have been hit this year by their bets against the bond market. The % change chart of the iShares 20+ Year Treasury Bond ETF (TLT) shows a solid uptrend since the start of the year. Those who shorted TLT based on their macro call for lower bond prices and higher rates are down over 9%.
There are now some signs that the bond market rally may be ending as I discussed in last week's On the Lookout for a Bond Market Top. Many of the hedge funds have already closed out their bets on higher rates and have already booked their losses. Though I was also surprised that the bond market rally lasted so long, I never went short.
Those who were long gold did well until March but have since given up over 60% of the year's gains. The sharp drop in the emerging markets also hurt many of the hedge funds, some of which had been bullish since early 2013.
On February 11, it was announced that Brevan Howard's Emerging Markets Strategies Fund was closing down after losing 15% in 2013. As the chart indicates, this was just one week after the Vanguard FTSE Emerging Markets ETF (VWO) bottomed out. It is now up 9.4% for the year and has equaled the performance of TLT.
The US market, as represented by the Spyder Trust (SPY), has performed about the same as the Vanguard European Stock Index ETF (VGK). This was one of the three well-diversified ETFs that I recommended in A Portfolio That Won't Ruin Your Summer. It has a very low expense ratio and has holdings in 505 stocks.
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Many of the global markets have been focused on interest rates after the recent action by the ECB to lower rates. They are hoping to weaken the euro and stimulate an uptick in inflation as deflation is their main concern. Last week, there was a surprise rate hike in New Zealand, so the currency markets have been active.
The weekly uptrend in the euro, line a, was broken five weeks ago after it briefly moved to a high of 1.3986 as many on the short side were likely stopped out. There is important support now in the 1.3480-1.3500 area, line b. A weekly close below this support will complete a more important top, which would be positive for the Eurozone economies.
The weekly on-balance volume does look negative as it shows a pattern of lower highs and is now testing key support at line c.
The comments on Thursday from the Bank of England's Mark Carney that an interest rate increase "could happen sooner than markets currently expect" also caught the markets by surprise. The pound shot up to a high 1.6920 but it closed well off the highs. The daily OBV does look positive but a drop below the support at 1.6680 would be negative.
The lowering of the 2014 global growth estimate by the World Bank was blamed for last Wednesday's drop in the stock market. The increased tensions in Iraq also had the equity markets concerned as crude oil prices closed the week sharply higher.
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The economic calendar last week was light and most of the data was disappointing. The Retail Sales last Thursday showed a lower than expected 0.3% increase. The prior month's data was revised from 0.1% to 0.5%. Some areas, including auto and miscellaneous store retailers, did show nice growth. It will be important that we see stronger numbers on July 15 when June's data is released.
Then on Friday, we got the preliminary reading on consumer sentiment from the University of Michigan. It came in at 81.2, while the market was looking for 83.0, but it is the final reading on June 27 that will be more important.
This week, the calendar is full with the Empire State Manufacturing Survey, Industrial Production, and the Housing Market Index on Monday. This is followed on Tuesday by the Consumer Price Index and Housing Starts.
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I expect the CPI to get more attention this month as it was higher than expected last month. The chart shows that the downtrend from 2013, line a, has been broken. The Fed's favorite inflation indicator is the personal consumption expenditures deflator. It was up 1.6% in April, which was the largest increase since the end of 2012. The Producer Price Index will be out on Friday.
The FOMC meeting starts on Tuesday with the announcement and Fed Chair Janet Yellen's press conference on Wednesday afternoon. Many are wondering if the Fed will speed up the tapering process, which could hit the bond market hard.
Along with the jobless claims, Thursday, we also get the Leading Indicators, which is one of the most reliable economic indicators. The Philadelphia Fed Survey will also be released and the quadruple witching Friday will likely trigger more volatility.
What to Watch
The major averages, other than the small caps, made further new all-time highs last Monday before correcting. Most have just pulled back to the minor 38.2% Fibonacci support and their 20-day EMAs.
If the correction is over, then we need to see a strong close above last Wednesday's high to confirm. For the S&P 500, this level is at 1950. On the upside, the cash S&P has monthly pivot resistance at 1966.70 with the quarterly projected pivot resistance at 1977.48.
Many are wondering if we will get a test of the 2000 level before a correction. It is a possibility especially as we get towards the end of the quarter as many fund managers are underinvested in stocks.
Though the individual investor became more bullish last week at 44.7%, up from 39.5%, the TV financial pundits do not seem that bullish. The recent rally caught most by surprise and they seem skittish at best. Therefore, those on the long side do not seem to be in the majority as last week I pointed out in Why Following the Crowd Can Be a Bad Idea.
As pointed out by Larry McMillan in his excellent Option Strategist, it has been 741 days since we have had a 10% correction. You might find it surprising that there have been nine periods when there has been a longer gap between 10% corrections. The record occurred from August 1990 to the summer of 1996 when there were 2,154 days without such a correction.
Though many stocks are extended, some are not, as the three material stocks I recommended last week were well below their 52-week highs. Many websites have this data available and this is not the time to be buying stocks that are making new highs as very wide stops would have to be used.
The Arms Index closed at 1.69 last Thursday and turned lower, Friday, which likely marked a short-term low.
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The five-day MA of the % of S&P 500 stocks above their 50-day MAs hit a high of 79.2% last Wednesday but turned down Thursday. This was within the target range of 79-82% that I mentioned last time. It was one standard deviation above the mean but it could turn back up with a strong close early in the week.
For the Nasdaq 100, the percentage of stocks above their 50-day MA is still rising, and as of Thursday, was at 75% which was well above the March high.
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On the daily chart of the NYSE Composite (NYA), one can see that, so far, the pullback last week has not even reached the 20-day EMA at 10,771. The monthly pivot and the uptrend, line b, are in the 10,678-10,700 area. The monthly projected pivot support is at 10,578.
Last Monday's high at 10,941 was just above the monthly pivot resistance at 10,920. The daily starc band is now at 10,981 with the weekly at 11,125. This is just above the quarterly pivot resistance is at 11,087.
The NYSE Advance/Decline made a new high last Monday but has since declined close to its rising WMA. It is clearly positive, but it is always a good idea to know what it would take to change your outlook.
For the daily A/D line to turn negative, I would look first for a drop well below its WMA and the early June low. This should then be followed by a failing rally back to its WMA before a top was complete.
The daily OBV also made a new high at the start of last week, and by Friday, had dropped back to its rising WMA.
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The Spyder Trust (SPY) pulled back to its daily starc- band last week but has held so far above the 20-day EMA at $192.59. The breakout level, line a, is now in the $191.50 area. The monthly pivot stands at $190.50.
There is short-term resistance now in the $194.80 to $195.12 area with the daily starc+ band at $196.96. The monthly pivot resistance is at $197.29 with the quarterly at $199.06.
The daily on-balance volume (OBV) also made another new high last week, and despite the pullback last week, is still well above its rising WMA.
The daily S&P 500 A/D, after making a new high, turned up Friday after testing its rising WMA.
The SPDR Dow Industrials (DIA) reached its daily starc+ band last Monday and dropped back to the lower band last Thursday. It appears to have held the short-term 38.2% retracement support at $167.05. The daily uptrend, line e, is now in the $165 area with monthly projected pivot support at $164.09.
The monthly projected pivot resistance at $169.69 was almost reached last week with the daily starc+ band at $170.13. The quarterly projected pivot resistance is at $172.01.
The daily OBV is still in a solid uptrend and its WMA is rising, though the early 2014 high, line f, has not been reached.
The daily Dow Industrials A/D, after making a new high, has dropped back to test its WMA and looks ready to close the week back above it.
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The PowerShares QQQ Trust (QQQ), after exceeding the March 7 high at $91.36 (line a), has had a very shallow pullback, so far. The 20-day EMA is now at $91.08 with the monthly pivot at $89.38.
The breakout above the resistance at $89.73 (line b) confirmed that QQQ had completed a bottom and allowed us to raise the stop on long positions. The daily starc+ band is at $94.05 with the monthly projected pivot resistance at $95.16.
The daily OBV has moved back above its WMA with Friday's close generating an AOT buy signal.
The new high in the Nasdaq 100 A/D confirmed the price action, and it turned higher at the end of the week. There is major A/D line support at line d.
The iShares Russell 2000 Index (IWM) is starting to look better after closing above its quarterly pivot at $114.53 the prior week. There is next strong resistance at $118.59 and then at $120.
IWM held well above the rising 20-day EMA on last week's pullback, and it is now at $113.89. The daily starc- band is at $113.23.
The daily OBV is still well below its previous high but does seem to be forming a solid, short-term uptrend. It will need to move above last week's to confirm the bottom formation. The weekly OBV (not shown) is above its WMA and closer to its all-time highs.
The Russell 2000 A/D moved above its downtrend, line g, over a week ago and is now testing support (line h) and its rising WMA.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.