"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

Tuesday, November 30, 2010

The Euro Making a Major Move?

The Euro is currently the #1 battleground for most investors. The currency offered a nice shorting opportunity between $1.35 and $1.40. Take a look at the following chart:

Since 2008, the Euro has demonstrated its capability to decline over 20% over a period of one or two quarters twice. By going short, I speculate that we will see a similar move, which would bring down its value to around $1.10 in the coming months.

What would this scenario mean for US equities?

The first 20% decline (which of translated to a stronger Dollar) was accompanied by  a (global) stock sell-off. The second trip down between October '09 and July '10 was initially ignored by equities, but eventually led to a substantial decline in stocks as well.

Recently, stocks ignored the weaker (stronger) Euro (Dollar), but the question is how much longer will they be able to do so?

Disclosure: I'm long EUO (inverse Euro ETF) and DXD (inverse DJ ETF) in the Covestor Model Portfolio

Friday, November 26, 2010

Why I have been Shorting German and Spanish Banks

Covestor Model Portfolio clients currently own two short positions in their portfolios: Deutsche Bank (NYSE: DB) and Spanish Banco Santander (NYSE: STD). I have been shorting the institution since last week. The following chart from the German "Wirschaftswoche" summarizes my rationale:

Translation non German natives: the chart displays the debt engagement of national banks for the PIGS countries.German banks are heavily involved in Ireland and Spain, Spanish banks are ranked #1 for Portuguese debt.

So shorting German and Spanish bank seems like a  natural trade here. Both banks are down almost 4 percent pre-market this morning and I don't even think about covering yet.

Disclosure: I'm short STD and DB

German Stocks: Another Decoupling Play

A frequent reader might have noticed by now that I'm a big fan of intermarket analyses. It is sometimes astonishing, how these studies reveal underlying strength and even create compelling pair-trading opportunities.

So here is an interesting pair: German stocks and the Euro. The German economy is one of the strongest, if not the strongest, economy in Europe. Smart labor market reforms in the last years as well as the dependency on exports to Asia are some of the success factors.

There has been a relatively strong correlation of the German ETF EWG to the Euro in the last years. However, stocks managed to decouple from the Euro in 2010 because of the strong fundamental factors mentioned above:

The relationship is not intuitive: German companies should benefit from a weaker Euro because of their dependency on exports. However, note that  EWG is priced in Dollars, which changes the relationship a bit (Plotting the German DAX index would give you the same basic message, though).

In any case, note how EWG held up quite well in recent weeks despite the Euro drop:

The lower pane actually sketches a nice hedged play on this theme ("Germany outperforming the rest"): long EWG, short FXE would have yielded a nice 15% return while the German ETF alone would have rewarded you with just 7.5% with even larger drawdowns.

Currently; I'm waiting for weaker prices in order to get into EWG in the Covestor Model Portfolio.

CF Industries: a Decoupling Trade

I recently added CF Industries (NYSE: CF) to the Covestor Model Portfolio. When I researched the stock, I was surprised of the high correlation to the prices of agricultural commodities (not that I didn't know that, I expected the correlation to be at least a bit weaker):

The dependency shows that it almost doesn't make sense to analyze CF by itself. The more important question is, where are prices for corn, wheat etc. heading to?

Another piece of inter market analysis comes into the game: commodity prices are inverse correlated to the Dollar. The following chart depicts the value of DBA, the agricultural ETF, and UDN, the inverse Dollar ETF:

The longer term correlation is pretty clear. The situation becomes interesting when Ags can decouple from the Dollar, like in the fourth quarter of 2007. In such a case, we can infer that commodities are driven by some strong underlying fundamental factors.
So how did the correlation look like in the last months?

Quite strong. However, note how commodity prices held up compared to the (inverse) Dollar in the last weeks. It looks like the Greenback has changed direction and I expect him to rise in the light of the situation in North/South Korea. By going long CF, I'm speculating that agricultural commodity prices are currently driven by some strong fundamentals and can decouple to a certain extend from the Dollar.
I'm running the same trade with the coal sector. Check out the chart of KOL/Dollar:

Metals, on the other side, don't seem to be able to loose their Dollar dependency:

Disclosure: I'm long CF, KOL

Wednesday, November 24, 2010

A Look at Major Indicees: the Risk Trade is on Again

By looking at a recent SPY chart you might conclude that stocks are trapped in a short-term trading range between 118 and 120:

However, the S&P doesn't tell the full story. More speculative Small Cap and  Tech stocks are on a different trajectory: price has left their trading ranges to the upside, quite a bullish sign. Riskier assets seem to attract the money:

Sunday, November 21, 2010

Why I Like Coal Stocks

Coal is currently probably one of the most exciting investment opportunities besides Gold. Despite all the hype around Green Energy and the global revival of nuclear power plants, coal has some very compelling fundamentals playing in its favor:
  • China: sure, the country is investing into alternative energy sources, but the immense economic growth can only be fueled by coal in the short term.
  • US: coal is a winner on the US election results because it has become quite unlikely that the "cap and trade bill" will pass legislation.
  • Merger activity: there is chatter that Massey Energy could be taken over. Recently, Caterpillar acquired Bucyrus, who does a good part of its business in the coal mining sector.
  • Technical reasons: energy stocks have been outperforming the broader market recently and coal industry stocks have even been stronger than the underlying energy sector (see chart below).
  • Surprisingly low Dollar impact: coal did not participate in the recent commodity sell-off, which was triggered by a stronger Dollar.

Disclosure: Covestor Model Portfolio is long KOL

Covestor Model Portfolio: Back into Silver

Silver recovered nicely last week and the move prompted me to go long again. Note how the metal has not only been outperforming stocks but also Gold, sign of a healthy trend:

Keep in mind that the commodity has the ability to "go vertical" and I would hate to miss such a move. On the other hand, volatility increased in recent weeks. Therefore, my portfolio is less exposed now because of smaller position size. The $24.50 level defines a natural stop level at which I'll intend the close the position to cut potential losses.

Disclosure: Covestor Model Portfolio is long SLV

Wednesday, November 17, 2010

Chart of the Day: EWG:EWP - a European Debt Crisis Proxy?

I'm a big fan of all kinds of inter market analysis. What about this one: take the stock markets of one of the strongest European countries - Germany - and one of PIGS - Spain - and plot the quotient. Now you have a psychological barometer for the current European Sovereign debt issue (brown curve). The chart becomes even more interesting if you superimpose the Euro:

Note how the Euro turned much weaker during the last peak of the crisis in June. Even though the EWG:EWP ratio is on a similar level - indicating weakness of Spanish stocks - the Euro decline hasn't been that dramatic so far. I don't know if my conclusion is correct, but at this point market participants might be less concerned of the severity of the Irish situation.

Market Commentary: It's the Dollar, Stupid!

How long can equities keep selling off? A look at the Dollar might help to answer this question. It is amazing these days to plot the Greenback with the S&P on the same chart. Note the almost perfect inverse correlation of both asset classes recently:

From a technical standpoint, the Dollar is running into strong resistance around 80 (trend lines and 50% Fib retracement), so equities could see some stabilization soon:

However, it doesn't mean that prices have to reverse at potential resistance areas . The level around 80 is just a potential battle ground between bulls and bears. Beyond that, the Dollar could experience the next major resistance at 83.

Part of the the Dollar's strength is the Euro's weakness. The European currency is rapidly approaching major support:

Conclusion: I wouldn't be surprised if the major part of the declines is behind us. It seems likely to me that the Greenback will resume its way down since this is what the FED is trying to engineer.

Since I'm currently short Euro in the Covestor Model Portfolio, it will soon be time to take profits on the position. Also, I am short US Financials and Basic Materials. I consider both positions "rentals" and will be closing them probably today.

Sunday, November 14, 2010

My Favorite Chart for the Week of Nov 14: 10 Year Treasuries

OK. There was a little sell-off in equities last Friday, but the story is currently written somewhere else: in the Bond market. Maybe there is something I don't get since I'm just a rocket scientist, but shouldn't Bond yields fall when the FED is buying aggressively? By now, even the last Mad Money watcher probably understood that last Friday was a POMO day. If the 10Y yield keeps rising next week despite FED intervention, we could experience a major shift in market sentiment, which could result in significant pressure on equities. In that case, QE2 would be dead before it even went into full throttle mode because markets start to worry more about inflation instead of cheering the easy money. I will keep a chart of IEF, Barclay's 7-10 Year Treasury Bond Fund on top of my watchlist:

On the other hand, we should also see Gold rise if Bonds would indeed signal inflation fears. It'll be interesting to see how fast the yellow metal can stabilize in such a scenario next week:

Finally, we have to recognize that the Dollar did NOT have a major move last Friday, but is currently struggling with resistance around 78.5. In order for equities to recover, we'll need the Dollar to resume its decline soon:

Wednesday, November 10, 2010

My Favorite Chart Right Now: 60min Silver

Silver experienced a heavy volume selloff yesterday, which prompted me to close my swing position. In fact I managed to sell half in the morning and the rest in the afternoon.
I'm carefully observing the 60 min Futures chart for a re-entry opportunity. I would like to see a successful test of $26.50. Dip buyers will come back in, the question is only at which point:

A Couple of Shorts...

I have been looking into some potential shorts to play a couple of developing themes: higher commodity & input costs, European debt issues and weakening low-end US consumers. My goal is to balance out my portfolio beta, which currently is slightly elevated at 1.4. I'm not short in any of these names yet, but keep them on top of my watchlist:

Lumber Liquidators: hardwood floor maker reported weak earnings and is suffering from Lumber prices:

Big Lots: was catching some downgrades after disapointing earnings:

Kellogg: my favorite short candidate. Prices seem ready  to break down. Impact from higher corn prices:

Kimberly Clark: reported weak earnings.

 Deutsche Bank: proxy for issues in Europe.

Tuesday, November 9, 2010

Silver: How I'm Trading the Vertical Move

One of the reasons I like to trade commodities is their ability to produce "vertical moves", where prices rise sharply over a period of weeks. Recent example is Silver:

Popular lingo would probably describe these moves as "fat tails". I characterized them by looking at the 12 week rate-of-change" (ROC), on of the simplest technical filters (as you know I hate the word "indicator", but that's a different story): there have been three occasions over the last five years, when Silver rose over 40% in a three month period. From that perspective, buying after such a move seems risky since prices tend to collapse extremely fast.
However, I believe there is some money to be made if we trade carefully:

I went long AGQ (the leveraged Silver ETF) last Thursday after Silver broke out of a two week consolidation. Prices moved much faster than I expected, rising the risk of a "blow-off" top.My next step, probably today, will be to take 50% of my initial investment off the table and let the remaining position run until we see some "toppy" price action.

Disclosure: I am long AGQ in the Covestor Model Portfolio

Thursday, November 4, 2010

Headline Risks: Why Swing Traders Need to Monitor Fundamentals

This morning, the Canadian Government rejected BHP's takeover bid for Potash Inc. The stock is trading 3.5% lower as a result.

The action is a good example for why it is important for a technical swing trader to monitor company fundamentals. The goal is simply to assess headline risks. Certain events can kill the best "chart pattern" and it is therefore a good idea to only swing-trade stocks with minimum headline risk. The takeover situation was one example. Other situations are upcoming earnings reports, pending lawsuits or industry characteristics. I'm therefore reluctant to trade certain biotech stocks because drugs can fail during the approval process and have significant impact on stock prices. Mining stocks are subject to above-average headline risks because accidents or strikes can stop production from one day to another. Massey Energy is a recent example.

You can (and should) not eliminate all headline risks, but it is important to manage them. So how do I find out if a company is subject to higher risks? There is no way around it: it is crucial to read as many headlines and reports as possible in order to get a feeling for the situation. Even though these informations do not influence if I buy a stock on a certain day, they determine if I trade the stock at all.

A final example is Countrywide Financial. The company is now owned by Bank of America and I frequently shorted the stock during the financial crisis. However, some of my trades were extremely short term because headline risks were significant: I was aware that Countrywide could be taken over any day during the crisis, so I was taking (partial) profits quickly. Same story with other major banking stocks during that time.

Covestor Portfolio Commentary: Post-FED Plays

The market's reaction to yesterday's FED announcement paints a very clear picture and Futures this morning tell us where the money will be made in the next weeks: the Greenback is breaking down and the USD Index is heading to the 2008 lows around 72. Crude seems to break out and run towards 100. Commodities and US equity futures act strong as well. We are off to the races and I will use the momentum to put up Dollar-related macro trades. It almost doesn't matter, what you buy, since everything is benefiting from the weakness of the "leading" currency. In particular, I'm looking into Materials (IWM/UWM), Silver (SLV), Crude (USO/USO).

Equity-wise, I like Alcoa (AA), Apple (AAPL), Blackstone (BX), Cummins (CMI), McDermott (MDR), Precision Castparts (PCP), Limited (LTD) and Siemens (SI).

The FED is pushing hard to inflate equity prices. Don't fight the FED!

At one point, the markets (and the FED) will wake up and realize that Crude at $100 might actually curb consumer spending. Until then: enjoy the party.

Disclosure: I am long UWM, AAPL and PCP in the Covestor Model Portfolio.

Monday, November 1, 2010

Why I Went Into 100% Cash Last Friday

Last Friday, I tweeted that I moved the Covestor Model Portfolio 100% into cash. Since I received some comments, I probably should explain the move.

Let's start simple & take a look at the obvious: the S&P500 price chart.

I'm using charts in a pretty simple way and don't like to "over-interpret". The message is quite clear, though: stocks had a great run in the last months, but momentum, as measured by the 12-day rate-of-change ("ROC"), has been constantly declining throughout the rally. So the only message I get from the chart is that fewer and fewer buyers (or more and more sellers) have been coming in. Does that mean prices will decline from here? Not at all. The market needs a new impulse to bring in new buyers or sellers and push him in either direction.
As a trader, I could anticipate a direction or (and that's what I prefer at this point) simply wait for the impulse to happen and then trade in that direction. Remember: small investors have an incredible advantage over big money managers: they can move funds very quickly. Let's assume we break to the upside: I will loose some basis points in outperformance, but I'm happy to pay that toll to get a lower risk entry. Good trading often means to wait and do nothing.

Obviously, there are two events this week, which will have a strong effect on stock prices: election results and FED meeting. If you want to trade these events, you need to be right four times since outcome as well as effect on the markets has to be estimated for each of the events. Has "QE2" been priced in? Maybe. But what if the FED turns out to be less aggressive than the markets want it to be? Recent economic numbers haven't been too bad and probably do not justify heavy intervention. If the FED will make any comments in the direction of "recent economic developments justify flexible (instead of aggressive) use of monetary tools', the Dollar will rally.The big question is how stocks will react. Recently, there has been a strong inverse correlation between both, so equities could sell-off.  Unless this correlation changes (which it did in the past).

This leads to the core of my current market thesis: the US economy is indeed recovering and we start to see this in some of the leading indicators (for example, the ISM showed a better than expected reading today). If the markets start to turn its focus from "we need more QE" to "the US economy is getting stronger", stocks could rally while the Dollar is getting stronger and Bonds decline. This shift of sentiment would create the "impulse" I was talking about at the beginning of this post and could fuel a strong rally until the end of this year.

We could see signs for the validity of this thesis very soon and  I will aggressively go long in that case. At this point, it is important to keep watchlists up to date to be able to act quickly.