"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

Friday, December 24, 2010

Happy Holidays!

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Happy Holidays Everyone!
I hope you have good times and can enjoy a white season. Looking forward to many (investment) opportunities in 2011.

Wednesday, December 22, 2010

Microsoft: When did Apple Start to Take Over?

Frequent readers of this blog probably figured out that I'm a big fan of relative strength analysis. Here is a 10-year chart of the relative strength of Apple vs. Microsoft:

Based on the relative development of the stock prices of both companies, we can see that Apple's stock started to outperform Microsoft in 2003. Steve Jobs introduced the first iPod in October 2001 and it took the market over a year to realize its potential for the growth of the company. Even though Apple's stock price showed some serious weakness in 2008 and actually broke its long term uptrend, the price relative to Microsoft was not really affected by the weakness.

Going forward, it will be interesting to see if this relative trend can persist. I believe it will as long as Jobs doesn't get a heart attack.

The VIX Below 20: So What?

I sometimes hear analysts raising concerns because the Volatility Index (VIX) lately moved below 20. Their argument: too much complacency of market participants makes prices vulnerable.

Here is a 10-year chart of the VIX. Note how the index traded below 20 for almost the entire bull period between 2004 and 2007. I believe the VIX could act similar in 2011, especially if the economy keeps recovering and stocks keep rising:

As a reminder, what does a VIX reading of 20 actually mean? According to this CBOE white paper, the "VIX measures 30-day expected volatility of the S&P 500 Index". So specifically, the market is expecting a annualized move of 20% of the S&P in January. In other words: there is a 68% (1 sigma) chance that the index will move 5.8% up or down in January. Not sure if we can really infer complacency from that.

Monday, December 20, 2010

Gold: Some Wedges Shaping Up

Interesting developments in Gold: prices started to developed a bearish rising wedge in the last three months (red) and a bullish declining wedge in recent weeks (green). Since the rising pattern still seems in its infancy, I'm actually leaning towards buying Gold at these levels. Both patterns define a nice stop loss at $1360. So even if Gold would test the upper bound of the bearish wedge one more time, this short-term trade would have a very interesting risk/reward ratio of approximately (1450-1384):(1384-1360)= 66:24 ~ 3:1.

However, since Silver has been clearly outperforming the yellow metal in recent weeks, I even lean towards buying into the "poor man's Gold":

Saturday, December 18, 2010

Trading the Secular Trend of Online Shopping

Best Buy's earnings last week disappointed investors big time. The stock opened 15% lower on December 14. The report highlighted once more the major shift to online shopping, a trend, which was highlighted in the recent weekly review of the Bespoke Investment Group.
Let's look at a hedged pair trade to capture this shift: long Amazon, short Best Buy:

Back in 2006, Amazon started to outperform Best Buy. The AMZN:BBY chart shows the long term nature of this shift. If you would have bought Amazon four years ago, your investment would have returned 250%, which wouldn't have been too bad. However, if you would have shorted Best Buy in addition, your investment would have returned 270% with smaller drawdowns.

Here is the catch: based on Best Buy's recent earnings report, I don't think the trend is over. However, this looks like a long-term trade, which I do not want to execute in my short-term Covestor Model Portfolio.

Friday, December 17, 2010

Recent Examples: Weak Relative Strength Preceding Lower Prices

I can't stress enough the importance of relative strength analysis for my trading. The relative price development to an index sometimes precedes actually price strength or weakness and marks major transition periods.

For example, take Apple at the beginning of 2009. The divergence between Oct 2008 and  Jan 2009 indicated that a few investors started to buy the stock, despite the weak overall market:

The pattern also works on the opposite side when trying to determine transitions from up- to downtrend. Here are some recent examples:

Note how the stocks/ETFs where still trending up while relative weakness started to develop.Of course, this phenomenon doesn't show up before every major trend change, but it can be an important hint if it occurs.

Random Morning Market Thoughts

  • Yesterday, I closed the SPXU portfolio hedge position. Even though markets remain overbought and sentiment remains very optimistic, recent price action might indicate a short-term side ways consolidation instead of a major correction. Most important however is recent quantitative research from various sources (e.g. Trading the Odds, Bespoke, Quantifiable Edges, which indicates a positive bias for the last two trading weeks of the year from a historical standpoint.
  • Last week, I closed my long position in AAPL. Even though, analysts have been upgrading price targets in recent weeks, the stock barely moved. Technically, the stock trades at the top of its recent price range, so a good time to take a small profit. A pullback below $310 or a strong breakout above $320 could get me interested in the stock again.
  • Porter Stansberry of Stansberry & Associates released a controversial video "The End of America". The presentation discusses his thesis that America would implode in the next years because of its overwhelming debt problems. The idea is compelling and it is definitely worthwhile to keep this idea in the back of ones mind. However, some of the "facts" in the presentation are pulled out of context and do in fact NOT support his thesis. Example: Stansberry compares gas prices of the US with other countries and makes the point that gas costs more outside America because they "are able to print money, unlike other countries". He takes Germany as one example. However, gasoline in Germany is more expensive simply because there is a 50% tax on it (the US will get there in some years as well IMO).
  • These Moody's European country debt downgrades are a joke. The agency lowered Ireland's ratings this week and put Spain and Greek on the warning list. A little late I guess. Where did they hide half a year ago?

Tuesday, December 14, 2010

Bond Yields: Watch the Long Term Trend

30-Year Treasury yields rallied quite significantly in the last weeks to 4.25%, barely a level to loose sleep over despite all the chatter about a possible US credit rating downgrade in 2011.

Yet, I'm watching yields carefully, because they are approaching an important long term declining trend line. Should yields indeed break the downtrend that was in tact for the last 20 years, I would expect some interesting headlines and stronger headwinds for global equities. The level to watch next year is 5%:

Note that major banks came out with bullish 2011 equity forecasts in recent weeks. As far as I can see, none of these predictions even discussed the possibility of a change in the long term trend of interest rates. So a bearish event would hit bullish sentiment. Not a good combination for stocks.

Monday, December 13, 2010

Extreme Reading in the Equity Put/Call Ratio

Some of the market breadth indicators I'm following are approaching alarming levels. Standing out at this point is the Equity Put/Call Ratio. This indicator usually quite spiky, so I smooth the ratio using a 5-day moving average. The latest reading is at 0.46, among the lowest values of the last seven years. Stocks -at least temporarily- pulled back when optimism moved to these levels, which happened the last time in April this year. Stock declined 3% after that. The vertical red lines in the following chart indicate similar conditions of the last years:

Thursday, December 9, 2010

Random Morning Market Thoughts

  • This is a historic day: Copper possibly closing at 5 year high above $4/LB. And Mr. Bernanke just iterated again that he doesn't see inflation on the horizon.
  • Judgment day for Gold as well. I'm short term bearish, but prices need to break down soon for my thesis to play out. I'm still long Silver though.
  • The risk trade is still on: Russel 2000 keeps outperforming, Futures up 0.6% this morning. Glad we are invested in UWM in the Covestor Model Portfolio.
  • Talking of which: the portfolio outperformed by almost 1000 basis points so far this year. I do not want to risk that in the last weeks of 2010, so I drove down portfolio beta closer to one.
  • I can't believe how much dissense there is among politicians here in Europe.Things will get fun soon: Germany is playing hard ball, Schaeuble (German Finance Minister) talking about the need for a central economic policy while  trying to kill the Euro bond initiative of the other countries. Last to join the party was Deutsche Bank, who proposed to incent the banks to buy sovereign bonds. I thought we were discussing punishing banks for BUYING the bonds ("Hair-cut"). Nice try, though.
  • Talking of Germany: I have no problem bailing out Greece, Ireland,... with my tax Euros. Because behind the scenes, Germany is winning so much control over European policies these days. I love it. Also, it is pretty cool to have a weak currency. Makes our exports so much cheaper for the Chinese...
  • US Stocks strong this morning: my contrarian sentiment indicators keep screaming "Sell". I'm not getting out yet due to the reasons mentioned above, but will stay alert.
  • Even though I'm not a penny stock guy, I subscribed to the "Penny Stock Specialist" newsletter with Frank Curzio. Frank is host of a excellent weekly free podcast, which you can get on iTunes and I have been listening to his show for the last years. I was about time to give something back. I like his approach and could see some of this picks making it into my portfolio. Ultra-small position sizes, though.
  • I'm stalking NLY. I know Cramer is pushing the stock (which isn't per se negative), but I like the business model: borrowing tons of money to buy government backed mortgage bonds and pay out a 15% dividend. Pretty cool. Their only risk is rising short term interest rates. A stock I really would buy on dips.

Financials: is the Sector Turning?

I'm closely watching the Financial sector. So far in 2010, stocks in this industry have disappointed, relative strength vs. the S&P has been on a constant decline.There are some chances this trend could reverse, which would prompt me to invest into this sector. Fundamentals are improving: steep yield curve and the outlook for reestablishment of dividends by the big banks in 2011 could improve stock performance.

Looking at the overall sector by charting XLF, we can see that Financials might be at a turning point since they have been acting strong in the last two weeks:

However, some of the sub-sectors already performed the turn and actually developed some decent industry leadership. Regional banks and Broker/Dealers started to show strength in recent months:

Wednesday, December 8, 2010

Follow My Trades Now on Yahoo Finance

Yahoo came out with a new "Market Pulse" feature with Yahoo Finance. Covestor linked  their trade replication to the streams, so you now see immediately when I made a trade in the Model Portfolio:

Market Theme: Accelerating US Economic Recovery

My current investment thesis is that markets are in the process of pricing in an acceleration of the US economy. If I'm correct, we should see the following:

- A stronger Dollar

- Higher bond yields (and lower bond prices):

- Higher stock prices:

- Weaker Gold ("risk trade"):

The charts seem to speak a clear language, but headlines are still negative. Does the media miss something? Remember: the market is a discounting mechanism.

Gold: Three Technical Reasons to be Bearish

In the last two months, Gold has build up some bearish signs:

1) A bearish "Three Push" chart pattern
2) Price declines came on increased volume
3) Momentum has been declining (MACD divergence)

On the plus side, Gold prices are closely linked to the Dollar and the yellow metal managed to rise despite a stronger Greenback. Yet, a rising Dollar would take its toll and probably drag down Gold prices further.

Stock Market Sentiment: I don't want to Spoil the Party, but...

some of the sentiment/breath indicators I'm watching have started to turn bearish:

1)  Equity Put/Call Ratio: the smoothed ratio is currently at 0.5, which is at the lower end of its recent range.There seems an excess of bullishness in the market. Note however, that the ratio recorded similar levels around September and October, which obviously did not prompt the market to pull back in the short term:

2) VIX: touching lower Bollinger Band boundary, which is short term bearish:

3) McClellan Oscillator: longer term divergence between indicator and Index. This development is concerning, since the oscillator could send out a longer term warning sign:

Monday, December 6, 2010

Covestor Portfolio Snapshot

The market has been incredibly strong in recent weeks, leading stocks held up well and investors have been buying every pullback it seems. Current conditions favor  my momentum trading style. I'm therefore 128% long with 13 positions in the Covestor Model Portfolio as of today and significantly outperformed my benchmark so far this year (Portfolio: +18.9%, S&P: +9.8%). A quick overview of my current trades with underlying themes:

1) Rally in precious metals & natural resources: Gold (UGL), Silver (SLV), Junior Miners (GDXJ), Cliff Natural (CLF)

2) Strong Energy sector: Oil & Gas leveraged ETF (DIG), McDermott (MDR)

3) Strong coal sector: Sector ETF (KOL), L&L Energy (LLEN)

4) American consumer seems to start spending again: Tiffany (TIF), Fossil (FOSL)

5) Mobile computing trend: Apple (AAPL), Skyworks Solutions (SWKS)

6) Small cap stocks outperforming larger peers: leveraged ETF (UWM) 

My strategy is quite simple: buy pullbacks in leading sectors and stocks and gradually sell the positions on market strength. So at this point, the "boat is loaded" and I did start take profits in some of the positions.

The two short-term sentiment indicators I'm following, VIX and Equity put/call ratio have moved to levels, which have often been followed by market weakness, so I'm reluctant adding positions at this point. Should the S&P however break to new heights in the next days and overcome resistance around 1225, many investors could feel "left behind" and push the market even higher. Many money managers are still behind their benchmarks and need to play catch-up in the last weeks of 2010. Combined with historically positive seasonality for the month of December, I'm actually more than long biased.