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I have been investing for over 40 years, evolving from investor to trader. The bear part comes from my degree from Cal: Go Bears! From 1982 to 2000, I managed a 17% return trading mutual funds on the basis of relative strength. This success was, of course, helped by an historic bull market, but... More
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  • ETF Blog For 10/14: Strong But Fragile Market! 0 comments
    Oct 13, 2013 1:19 PM | about stocks: IWM, XLF, IYR, XLE, TAN, PNQI, SOCL, KRE

    The economic news was light last week, as many important government reports were not issued. In any case, their impact would have been negligible, since the markets are following the shutdown/ceiling crisis. Thursday's rally proved me to be dead wrong on the assumption that the market would sell off until the crisis was fixed. I had a few short positions and didn't think the market would rise 300+ Dow points in a day.

    The market action proved 1) there is underlying strength that should propel the indexes higher when the crisis passes, 2) the big money doesn't believe the debt ceiling deadline will be crossed, and 3) the market is extremely sensitive to the slightest rumors a breakthrough. There are technical reasons to be extremely cautious that I will explain below.

    Market-Moving news: Summary of 14 Articles

    Self-reported daily spending fell from $95 to $84 in September, the lowest level since February, although the average remains above 2009-12 levels. August was the highest of any month in the last five years. The decline was the largest since 2008 and not typical for the September period. The decline was concentrated among the $60K-$90K households, which was previously $122/day.

    Three store-sales reports showed a decline last week and in September; however the effect was more likely from the end of after-school spending, not the shutdown.

    Mortgage interest rates and purchase applications are both down. The average 30-year mortgage fell 7 basis points to 4.42%, the lowest level since mid-June.

    The FOMC minutes revealed an interesting view that even though economic evidence favored continuing the bond buying program, the opposing argument to begin tapering was framed around damage to the Fed's "credibility." The shutdown proved the doves to be right, and the credibility issue harks back to the need a few months ago to arguments that the U.S. should attack Syria to maintain its credibility. The FOMC lowered their GDP forecast. They worried about the increase in interest rates, and confirmed that inflation remained below their targets.

    Between the lack of the Employment Situation report and bad data in the Claims report, there is no jobs data this week.

    Sentiment Metrics

    TD Ameritrade's sentiment metric showed investors dialing back equity exposure in September from positions built in August in anticipation of a rally. The pullback occurred just as the S&P 500 traded at record levels. The IMX measure remains moderately high vs. historical levels. Clients were net sellers of fixed-income funds and ETF's in the past few months.

    Credit card debt dropped for the third straight month in August, the longest losing streak in three years, in indication of trouble for retailers. Small business optimism fell in slightly September, reflecting government dysfunction. The Bloomberg Consumer Comfort Index, a measure of Americans' views of their personal finances, almost fell below lows of the recovery, reflecting anxiety over the shutdown/default crisis, with the worst measurement since late March.

    The VIX spiked on Tuesday to 20, a recent high, but by no means in a panic region, and quickly dropped back to 16 on Thursday and Friday.

    The Market (S&P 500)

    (click to enlarge)

    In the 9-month chart above, the market is showing large cycles of highs and lows, dropping from 7% back in June-July and 4% from September to October in three major cycles. The two-day euphoric rally is lifting off the latest bottom.

    Traders believe that this was a short-covering rally. The only news was the hint that the Republicans were talking to the president, and substance only came late on Friday. Detecting a large amount of short interest, big players bought on the rumor to squeeze the shorts on Thursday, triggering a rally that lasted all day and in a very unusual action continued through on Friday.

    Traders I respect caution that the rise is fragile because it is built on gaps, which means that there are no stock owners at intermediate prices who will buy again when the stock drops. A negative rumor could trigger a sharp sell-off.

    Unless there is negative shutdown/ceiling news, euphoria could carry the S&P 500 above 172.5 in the short term. Bad news in the future could cause a sharp sell-off.

    The Nasdaq 100

    (click to enlarge)

    The Nasdaq 100 has had long stretches of strong rallies year and many people are waiting for a big break. The average was extremely weak on Tuesday and Wednesday when it broke the rising wedge pattern shown in the chart.

    Technically, a rising wedge is a bearish pattern that indicates the exit of long term investors and distribution of stock to short-term players. The two-day rally was clearly short-term action. After the euphoria of a shutdown/ceiling solution, which could take the Q's over 80, there is a strong chance of a nasty break down when the new short term players take profits.

    Small Caps

    (click to enlarge)

    The IWM exhibits something of a wedge, but had a much sharper recovery on Friday. If it continues to be strong, I will probably buy back in on Monday, but I will remain wary of a possible breakdown.

    Core Relative Strength

    (click to enlarge)

    (click to enlarge)

    I took a short term perspective in the core chart, observing the lock-step action of virtually all components. The IWM had both a sharper downturn on Tuesday-Wednesday and a sharper up slope on Thursday-Friday. New leadership is possible in financials (NYSEARCA:XLF) and real estate (NYSEARCA:IYR).

    Key Sectors

    (click to enlarge)

    In the key sector chart, only two funds beat the IWM over the last two days, solar (NYSEARCA:TAN) Internet (NASDAQ:PNQI). I bought TAN on Friday. Of the 18 additional funds I monitor (not shown), only social media (NASDAQ:SOCL) and regional banking (NYSEARCA:KRE) rose faster than IWM on Thursday and Friday.

    Trades Last Week

    I am mostly out of the market, and thus did not participate in either losses or gains last week, but I did make a few small trades, as follows:

    I hold XLV, SMH, with put protection. I sold XLI. I bought TAN and XHB, and added put protection.

    I used weekly puts to guard against a breakdown of shutdown/ceiling talks over the weekend. If there is a strong rally, gains will be only slightly less that if I held the stock only. If the market opens with a big gap down, my maxim losses will be under 1%.

    Guess on Next Week

    I think we will see a big rally that will be fragile after the crisis. A large company negative earnings surprise, geopolitical incident, or negative fiscal news could trigger a large sell-off. My buy candidates next week are IWM, XLF, IYR, XLE, TAN, PNQI, SOCL, and KRE.

    Disclosure: I am long AAPL, TAN, XLV, SMH, XHB.

    Additional disclosure: Longs have put protection

    Stocks: IWM, XLF, IYR, XLE, TAN, PNQI, SOCL, KRE
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