"Water shapes its course according to the nature of the ground over which it flows; the soldier works out his victory in relation to the foe whom he is facing. Therefore, just as water retains no constant shape, so in warfare there are no constant conditions."
Sun Tzu

Wednesday, September 29, 2010

Reminder: Long Term Trends

Even as a short term trader, it is sometimes important to be reminded of the long term trends. I know I'm showing the obvious, but the following 10 year charts are painting a somewhat concerning picture:

US Dollar: on a long term decline, but stabilized recently:

Treasury yields: creeping lower:

Gold: as Sorros said: in a bull market:

US Stocks: sideways for the last decade:

It'll take strong, multi-year moves in each of these asset classes to change these long term trends. I'm not an economist, just a trader who's job it is to make money, but by simply looking at these charts, I can see, where guys like Nouriel Roubini are coming from.

Tuesday, September 28, 2010

Why European Sovereign Debt is Currently not a Topic for the Markets

There is a simple barometer, which shows how concerned markets currently are when it comes to European debt issues: the "TED Spread", which measures Bank's willingness to lend to each other. The Spread hit 46 during the peak of the financial crisis in Greece this summer (and 450 during the Lehman crash). Currently the Spread hovers around 16, barely a concerning level:

How Useful is NYSE Advanced -/Decline on a Daily Basis?

Traders often use the NYSE Advanced/Decline line in order to evaluate market breadth and the strength of a move.The middle pane of the following chart depicts this indicator with a superimposed 4 DMA to smooth out its volatility:

Divergences between market index and advanced/decline line would indicate fewer participating stocks and a weaker market. As you can see, such a divergence just showed up recently. Corey Rosenbloom discussed the conditions in his last post.

I believe, however, that the advance/decline line does not give us any new information: take a look at the lower pane of the chart, which shows the one day rate-of-change (ROC) of the market index. I also added a 4 DMA to make ROC and A/D comparable (a ROC (4) would be fine too). It turns out that ROC also declined and runs parallel to the breadth indicator. What does that mean?

ROC shows us that Index price momentum has been declining in the last weeks. Since the A/D line is showing the same action, it therefore delivers the explanation for the decline - fewer participating stocks. So a declining A/D only tells us that price momentum slowed down. You can get to the same conclusion by basically looking at the price chart alone. However, it would become interesting if price momentum accelerates with fewer and fewer participating stocks. We therefore have to look for divergences between ROC and A/D. Unfortunately, I haven't found a single one in the last years.

Friday, September 24, 2010

Spain: Bullish or Bearish?

There have been a couple of negative news out of Spain popping up recently . The price chart speaks a mixed language: on one hand, a bullish inverted "head and shoulder pattern" can be identified.
On the other side, I like to look at relative strength vs. European stocks: is Spain able to pull down the rest of the continent? Recent action is showing some weakness. The situation looks similar to the price action of Dec 2009/Jan 2010. I'll keep an eye on the developments:

Market Commentary: Short Term Bearish, Longer Term Bullish

September has been a impressive month so far. The S&P 500 gained over 9% in three weeks. Yesterday, however, I took some long positions off the table and hedged the portfolio with two short ETF on the S&P and the Financial sector. I expect these shorts to be very short term positions.

I do not expect that the market will test the August lows again. Sentiment became too positive in a very short amount of time. In particular concerning is the price action of stocks in the Financial sectors, which underperformed the broader market since April:

Market leadership came from the Technology sector and I currently own momentum plays such as AAPL, FFIV, SWKS and ASYS. So far, we are seeing Tec stocks holding up well and I plan to add to these positions if the market should keep on pulling back in an orderly fashion. Another 2-3% decline would be very healthy to reduce overbought conditions.  

Yesterday, however, I also closed my trades in the Real Estate sector: NNN and AVB. I initiated these positions just recently, but price action in the entire sector has been very bearish: stocks not only sold off on high volume, many stocks also broke the positive trend in relative strength:

Finally a bullish sign: the daily trading range has been declining since the initial sell-off in April, indicating more price stability and reduced impact of negative news:

Friday, September 17, 2010

Exploring Themes With PowerShares

I would like to share with you one of my methods to explore trading themes: PowerShares offers a great variety of very specialized ETFs. Even though, some of them are almost untradable due to low liquidity (I have some restrictions for obvious reasons with the Covestor Model Portfolio), I like to go over these ETFs and look for upcoming or ending trends. I assembled over 100 of their funds in a watch list, which I browse regularly. As usual, I'm looking for relative performance vs. the S&P 500. Some of their sector funds are quite funky and were probably established at times when the topic was hip. For example, there is a "LUX Nanotech Portfolio" ETF (NYSE: PXN), which obviously focuses on emerging Nanotech companies. Approximately 20k shares trade each day, so I would never invest in something like that.

My goal is to uncover themes, so let's look at some examples:

Internet stocks have been driving the NASDAQ higher (relative strength plotted in the background). Remember: there is always a bull market somewhere:

Building and construction: not a place to invest right now despite all the Obama talk of Infrastructure spending. Relative strength remains weak:

However, emerging markets infrastructure looks like a much better theme:

These were just a few examples, there are some interesting developments in other PowerShare funds as well.

Thursday, September 16, 2010

New Position Covestor Model Portfolio: Avalonbay Communities

Avalonbay Coummunities (NYSE: AVB) is a residential REIT, focused on rental apartment communities. I believe that AVB is currently in a sweet spot of the market and should continue to outperform:

  • More and more individuals are choosing to rent instead of owning and apartment due to tighter credit standards.
  • Declining housing prices have created uncertainty among Americans. Even if they have the money to buy an apartment, it is psychologically difficult to invest after three years of declining property values.
  • Employment has at least stabilized, people are moving to new regions to find jobs. Renting an apartment is usually preferred when starting a new job.
  • Construction trends suggest tight supply situation.
  • AVB is one of the strongest companies in the outperforming REIT sector.
  • AVB is yielding 3%. Investors are currently showing increased appetite for dividends.
  • Real Estate as a sector is widely hated by analysts, which is bullish from the contrarian point of view.
  • Positive earnings momentum: AVB raised guidance at their last quarterly meeting.
  • Highly shorted REIT: 11% of float held short, which could fuel further gains.
  • Analyst trend is positive: two months ago 3 analysts maintained a buy rating.This number grew to 6 in August and 8 in September. Still, 16 analysts are neutral or negative on AVB, which leaves enough room for further upgrades.
  • Positive chart trend: AVB just broke out to new heights from a five month consolidation .
I added a small position to the portfolio and plan to add more shares on pullbacks.

Wednesday, September 15, 2010

Will the S&P 500 Break 1130 this Time?

Many traders are watching the 1130 level in the S&P 500. Should the index break out of its summer range, a larger move to the upside can be expected.

How likely is that scenario? Let's compare the latest price action with the prior swing high around the beginning of August:

Note that I'm looking at the S&P Futures to get a better picture. By comparing the July and September rallies, it becomes obvious that the recent move has been much stronger. A bearish "rising wedge" was shaping up in July, indicating decreasing momentum of the rally. You could argue for a rising wedge in September as well, but its shape is less defined and the slope significantly steeper.

Let's take a look at market breadth: one of the indicators I'm usually looking at is the percentage of stocks above their 50 DMA:

Two observations:
even though the S&P is obviously at the same level compared to the beginning of August, more stocks are running above their 50 DMA, indicating broader participation, which is bullish.
The second point however is the high amount of stocks above their 50 DMA: 80%. Readings above 90% have been an indication of a short term market top during the last one and a half years, so there is a little bit of bearishness hidden in this chart. A possible scenario could be that the market will break to new heights, but also correct significantly after the melt-up due to overbought conditions. This type of price action would cause the maximum damage to investors, something the market usually likes to do.

Tuesday, September 14, 2010

Hedging my Long Postions

US equities rallied in the last two weeks on declining volume, which is a negative sign:

Given that the S&P closed at key resistance levels yesterday, I hedged my long positions with short a trade on the index. The rally has been strong, but the market needs a brake. A 2-3% decline would be very healthy and create additional opportunities on the long side. My Covestor Model Portfolio composition looks like this:

67% long
16% 3X leveraged short (NYSE: SPXU)
17% Cash

Monday, September 13, 2010

Gold: my 2010 Trades & Outlook

Before presenting my outlook for Gold, let me highlight the trades I made in the yellow metal this year:

I indicated my positions on the chart. Marked green are long positions, red indicate short trades. As you can see, I have been long most of the time. I closed my only trade on the short side with a small loss at the beginning of August. In fact, I reversed the position and raked in a nice 6% gain. I became bearish on Gold in June, after price momentum weakened and Gold seemed unable to break resistance at $1250. Overall, my trading activities in Gold outperformed a buy-and-hold strategy. Note that I used a 2X leveraged ETF with some of the trades.

Moving forward, I find it compelling to go short again at this point. The trade offers a very nice risk/reward ratio: I would close (or even reverse) the position when the yellow metal breaks $1250. On the other hand, we could easily see a drop to levels below $1100 without breaking longer term trend lines:

I do not question the general uptrend of Gold, but the asset is extended and lost steam short term. Should the global recovery gain traction in the coming months, investors will move into riskier assets and possibly away from Gold. The only short term bullish argument I can see is seasonality, but this could be priced in at this point.

Market Commentary: Playing the China Theme

Futures are strong this morning since it looks like China engineered a soft landing of its economy. In hindsight, the action in various asset classes starts to make sense: Basic Material has been outperforming (see post from last Fridays), Copper rallied the last weeks and agricultural commodities acted strong as well. All this despite the struggling US and European economies.

Going forward, the Asian Growth theme could lead global stocks higher for the rest of the year. I'm therefore focusing on investing areas, which benefit from the recovery of Far East economies. Obviously, the Basic Materials sector is a good place to be, but also US stocks with strong exposure to China should do well. For example, Yum! Brands (NYSE: YUM) is one of my newer holdings. The company is expanding heavily in Far East and belongs to a sector, which has been very strong recently: Restaurant stocks. The technical picture looks very compelling: YUM recently broke important resistance on heavy volume:

Other stocks on my watchlist are more directly linked to Asia. Take Chunghwa Telecom (NYSE: CHT)  for example, a telecommunication company in Taiwan. CHT is trending very nicely, but unfortunately a little bit too extended at this point. I'm waiting for a pullback to get a better entry:

Friday, September 10, 2010

Possible Swing Trade Today: Basic Materials

Basic Materials have been strong throughout the last two months and are about to break above August heights, maybe even today. So I'm might enter a swing trade with price target around $35. I'll probably use the 2X leveraged ProShares ETF UYM.

Thursday, September 9, 2010

New Covestor Model Portfolio Position: National Retail Properties Inc.

I have been looking into Real Estate for quite some time. Yesterday, I added National Retail Properties Inc. (NYSE: NNN) to the portfolio. It seems puzzling that retail property owners outperform in the current environment, but REITs have done a good job controlling their costs and the current investor appetite for yield favors the sector. NNN is yielding 6% and actually raised its dividend last July. The company has been raising dividends for 19 consecutive years.
The stock recently broke to new heights and I was waiting for a pullback to initiate a small  pilot position. Should the stock decline further in an orderly fashion closer to $24, I plan to add shares as long as the chart looks strong:

Tuesday, September 7, 2010

Somehow it Feels Like 2007 Again

I can't help myself, but somehow the market feels like 2007 again. Stocks have been moving up since March 2009, emerging economies outperformed the US and the general theme seems to be that we are growing again.

However, let's take a look at 2007:

The chart depicts three sectors besides the general US market (grey area). It shows very nicely, how stocks finally collapsed after certain sectors gave warning signs.
Let start with housing stocks (the blue curve): home builder stocks actually topped quite early, around 2006. ITB, the homebuilder ETF, developed a nice multi-year downtrend. However, the general market kept rising.
Early 2007, Regional Banks topped out (ETF KRE, green curve). Investors started to figure out that regional banks might get in trouble first if home prices keep declining.

Half a year later, the weakness in Regional Banks spilled over to larger banks (red curve). Investors now concluded that bigger institutions also were in trouble because of the general housing and mortgage situation.

Finally, at the end of 2007, investors had the brilliant idea that the housing problem could maybe cause the entire economy to slow down: the S&P showed its highest reading at 1576 on October 12 2007. From that moment on, everything basically tanked.

2010 feels like 2007 because some experts are predicting an additional 15% decline in housing prices and many won't believe it. In 2006 institutions were warning of a housing crash, not many believed it.

2010 feels like 2007 because housing stocks already started to underperform. Not dramatically yet, but noticeable:
If we get another leg down in housing, the lessons of 2007 could provide a playbook: home builders fall first, next comes regional banks, next are big Financials and finally the entire stock market. 15% decline in housing prices would have a significant impact on the entire economy. At this point, maybe an even bigger one than before because households are already cash strapped and we now have 829 "problem banks" according to the FDIC report. In the 4th quarter of 2007 the FDIC classified only 74 of the banks as being problematic.
I'm sorry to sound so gloomy, but we might be just at the beginning of the second inning here.

BTW: maybe needless to say that I shorted Regional Banks today.

Industries I'm Watching

Some industries have been acting quite strong lately  and I'm looking for a pullback to set up long positions:

Global Gaming (NYSE: BJK)

65% of revenue of companies in the global gaming industry ETF BJK is generated outside the US. BJK is therefore rather a play on the recovery in Asia than the US. Gaming companies are sensitive to the price of Oil, so investing into BJK could also be a bet on lower crude prices ahead.

Real Estate (NYSE: IYR):

Despite a bleak job picture and GDP downward revisions, Real Estate stocks outperformed the broader market. One of the drivers has been investor's recent appetite for dividend yield. (IYR is yielding around 3.5%). In addition, commercial real estate seem to be a turnaround story, since occupancy rates are up compared to a year ago and companies have been able to reduce debt. I expect more negative surprises on the economic front, the sector could be an interesting buy candidate if prices hold up.

Saturday, September 4, 2010

Covestor Position Update: Gold

I currently own the 2X leveraged Gold ETF UGL since the first week of August. Last Friday, I sold 50% of the position to take some profits. Gold currently trades at its 2010 high, so its a good time to take some profits:

Two things can happen from here: Gold will either break to new highs, in which case I will add to my position again, or consolidate lower. In that case, I would increase the position again should Gold gain positive momentum. Longer term, I'm still bullish on the yellow meta;.

Keep an Eye on Basic Materials

Since July, the Basic Material Sector has shown great relative strength vs. overall market. A lot has been written about the current trading range of the S&P between 1020 and 1130. Every major cyclical sector had been operating in their own range. Basic Materials are not only very close to breaking out, but also recently started an intermediate term uptrend, indicated by the rising 20 and 50 day moving averages:

The sector has been very volatile, but I would new sector highs, which we could even see next week, would be bullish for the overall market.

Covestor Portfolio Commentary

It has been a crazy week: US equity markets rallied from completely oversold to slightly overbought within three days.
The S&P is now approaching the upper boundary of its latest 1020-1130 range, which means I had to scale back on my long positions. Of course it is not fun to sell winning trades, but letting profits run simply doesn’t work in the current news-driven market environment. Let’s keep in mind, that despite the impressive recovery in the last three days, the market is not healthy. I want to see a robust market, where negative news are absorbed and reaction is muted. The real test will come in the next two weeks: markets need to consolidate and the if equities can manage to work off overbought conditions in an orderly fashion, we might see great high probability setups in a lot of stocks.
Until we get into a more healthy environment, we need to grind out returns. MercardoLibre (NASDAQ: MELI) is an example of my last weeks swing trades:

The stock is in a nice uptrend with rising relative strength vs. the S&P. Actually, this is a perfect swing trading condition: we buy the pullbacks to the 20 day MA and sell the new highs (“buy the dips, sell the rips”). Not very exciting,  but that is what’s currently working.
What makes me a little bit more excited is when bigger underlying themes start to emerge. I’m especially monitoring the metal and agricultural commodity sectors, which have acted very strong lately. Two positions in the portfolio are the Agribusiness ETF MOO and Cliffs Natural Resources (NYSE: CLF). I took partial profits in CLF last Friday, but plan to increase the position again on any weakness.
In terms of Gold, I took partial profits in my long position after a nice run. Gold is now at resistance at $1250 and either a breakout or an consolidation would prompt me to increase the position again.
Key to all the price action might be the Dollar next week:

It looks like the Greenback changed direction and the Dollar Index is heading to the  80 level. Such a move would support higher equity prices and indicate increased risk appetite of investors.
Also note that Treasuries are about to break their intermediate term uptrend:

Further weakness in Bonds could indicate that investors have started to move back into equities.
Another “indicator” I’m looking at is the relationship of cyclical to defensive stocks to gauge investors risk appetite. I’m looking at the ratio of Financials to Utilities. In fact, any combination is currently telling the same story (e.g. Industrials to Consumer Staples, Technology to Utilities, etc.):

I want to see these ratios to break their downtrends or at least get into a bottoming process. The XLF:XLU might be close.
Overall, we are about 50% long, 50% cash at this point with positions in BIDU, NFLX, FFIV, MOO, CLF and UGL and I’m planning to add to the long portfolio after some consolidation.