Yogi Berra? (Saut)

Tuesday, August 7th, 2012

by Jeffrey Saut, Chief Investment Strategist, Raymond James

“Yogi Berra”
August 6, 2012

“It’s hard to make predictions, especially about the future.”… Yogi Berra

To be sure, “It’s hard to make predictions, especially about the future,” and last week was no exception. I began the week, as stated in Monday’s missive, noting that there would be a trifecta of potentially market moving news events. The first was the two-day FOMC meeting where I thought the Fed would change its policy statement with a lean toward more accommodation. My reasoning was that the Fed would appear too political by waiting until the September meeting, just a few short weeks before the election. WRONG; and that was pointed out to me in spades on Thursday because while Wednesday’s “no change” policy announcement only produced a stutter step for the S&P 500 (SPX/1390.99), by Thursday the SPX swooned. Indeed, by mid-session the SPX had shed more than 20 points from Wednesday’s closing price (1375), and in the process tagged its intraday low of 1354. By the close, however, the index had recouped about half of those intraday losses, ending the sloppy session at 1365. Actually, Thursday’s late in the day recovery was yet another surprise to me because hereto my early week prediction was there would be no surprise from the European Central Bank meeting. But, a surprise it was with Mario Draghi unwilling to make good on his previous week’s market moving statement that, “Within our mandate, the ECB is willing to do whatever it takes to preserve the euro and, believe me, it will be enough.”

WRONG; and I had to suffer through that night’s, and early Friday morning’s, parade of pundits talking about how bad the employment number might be. Such musings should have had a dilatory effect on the preopening futures, but that wasn’t the case as a number of other rumors swirled down the canyon of Wall Street with positive implications. Still, everyone awaited the numba’! And as stated in Thursday’s verbal strategy comments, I had no idea as to what the number was going to be given the wide dispersion of previous reports; yet, my sense was it was going to be close to consensus. WRONG again because Friday’s number was much better than expected with nonfarm payrolls rising to 163,000 versus the median forecast of +100,000. Lost in the euphoria, however, was that the unemployment rate rose from 8.216% to 8.253%.

So it was three “strikes” and “out” for me and my predictions last week. About the only thing I got right was saying in Thursday morning’s verbal strategy comments that any pullback should be contained in the 1360 -1366 zone so often mentioned in these comments; and contained it was, with Thursday’s close of 1365. Given Friday’s surprise number, the SPX sprinted to its highest closing price since May 3rd and reinforced my more bullish stance of the past few weeks (as opposed to my previous trading range, but not bearish, stance). Friday’s Fling took the SPX up to the top of a parallel channel, as can be seen in the chart on page 3 from the astute Bespoke organization. If it can break out above that channel, last April’s reaction high of 1422 should be the next objective.

Regrettably, a strong earnings season has not been the driver of the upside breakout. Verily, of the 1,702 companies that have reported, the earnings beat ratio stands at 59.9%, well behind the S&P 500’s beat rate of 67.3% (376 companies have reported). Meanwhile, the revenue beat rate stands at only 48.2%. Yet by far the most troubling metric is the company’s forward earnings guidance, which is currently negative. Despite that forward guidance, the bottom up consensus earnings estimates for the SPX remain around $102 for this year and near $115 for 2013. If those estimates are anywhere near the mark, it means the SPX is trading at 13.6x this year’s estimates, and at 12x next year’s estimates, with concurrent earnings yields (earnings ÷ price) of 7.3% and 8.3%, respectively. Using the yield on the 10-year Treasury Note of 1.6% as your risk free rate of return produces what an analyst terms an equity risk premium of 6.7% basis next year’s estimates (earnings yield 8.5% – 1.6% risk free return = 6.9% equity risk premium, or ERP). Investopedia defines an ERP as:

“The excess return that an individual stock, or the overall stock market, provides over a risk-free rate [of return]. This excess return compensates investors for taking on the relatively higher risk of the equity market.”

QED, investors are being “compensated” by 6.7% (ERP) to own the SPX instead of the 10-year T’note.

While the aforementioned valuations are not as parsimonious as they were at last year’s October 4th undercut low (we were very bullish), they are still pretty inexpensive, offering the long-term investor a decent risk/reward ratio when combined with the SPX’s 1.9% dividend yield. Yet, I understand investors’ reluctance to commit capital since it seems like the trading of the “headline” < i>du jour is creating too much volatility. Interestingly, one vehicle that attempts to damp down some of that volatility is the PowerShares S&P 500 Low Volatility ETF (SPLV/$28.05), which consists of the 100 stocks in the S&P 500 with the lowest realized volatility over the trailing 12 months. This ETF currently yields 2.9%; as always, details should be checked before purchase.

Another strategy that has been working for the past few quarters has been to consider companies that have beaten quarterly earnings estimates, as well as revenue estimates, and guided forward estimates higher. Some names from the Raymond James research universe that have recently met these three criteria, are favorably rated by our fundamental analysts, and have “greened up” on indicators, like the SPX chart on page 3 shows, include: BioMed Realty Trust (BMR/$18.76/Outperform); Extra Space Storage (EXR/$33.45/Outperform); Kimco Realty (KIM/$19.94/Outperform); Power-One (PWER/$5.13/Outperform); Post Properties (PPS/$51.23/Strong Buy); and Wabtec (WAB/$78.38/Outperform).

The call for this week: As a sidebar, be sure to look at this month’s edition of < i>Gleanings for further insights from our economist, technical analyst, and my additional thoughts. As far as the stock market, last Friday’s rally extended the upside breakout by the SPX above the often mentioned 1360 – 1366 zone; and at this point, that breakout looks sustainable. The rally has also broken the index above the “neckline” of what a technical analyst would term a reverse head and shoulders bottoming pattern (read: bullishly). That said, the rally has left the SPX at the top of the parallel channel previously mentioned, as well as leaving every macro sector I follow pretty overbought in the short term. Also of note is that while the D-J industrials, the S&P 500, and the D-J Utilities bettered their June reaction highs, the S&P 400 MidCap, the S&P 600 SmallCap, the NASDAQ Composite, the Russell 2000, and the Value Line Arithmetic Index did not (read: potential non-confirmation). Still, the stock market’s internal energy continues to look strong, my proprietary indicators have been “green” on the S&P 500 for six weeks (see chart on page 3), the Dollar Index got crushed on Friday (lower dollar means the “risk trade” is back on), short interest on the NYSE is high, the equity markets survived a potential “flash crash” from the Knight Capital (KCG/$4.05/Market Perform) fallout, the recent investor sentiment figures were about as negative as they ever get, the public liquidated another $2.7 billion of domestic equity mutual funds last week (the highest weekly redemption of the year), the Spanish market rallied 7.41% on Friday, well y’all get the idea. Recently participants have been conditioned to sell each marginal breakout to a new reaction high because it has been followed by a pullback. I am not so sure this breakout plays that way. Indeed, I expect at least a test of the April highs (1422) over the next few weeks before a corrective phase begins.

P.S. – I will be in Boston all week spending time with portfolio managers, seeing accounts, and speaking at a conference. I will try and do my verbal strategy comments, but they are likely going to be abbreviated.

Click here to enlarge
 

Click here to enlarge

Tags: Chief Investment Strategist, ECB, Friday Morning, Futures, jeffrey saut, Mandate, Mario, Missive, Musings, Numba, oil, Policy Announcement, Pundits, Raymond James, S Market, Saut, Spades, Spx, Stutter Step, Trifecta, Wall Street, Yogi Berra
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Pivotal Point for Bonds…and Friday Rallies

Sunday, August 5th, 2012

The TLT ETF is one of the most watched in the market, since it’s the easiest way for institutions to quickly move in and out of U.S. Treasury bond exposure.   For many months during these rallies the fly in the ointment has been the U.S. dollar and Treasuries which constantly had a bid.  The TLT had not been below its 50 day moving average since early April which is just about the time the equity markets began weakening materially.  This instrument is now sitting on it for the second time in just over a week so it is at an important juncture.

As for the market as a whole you just have to tip your hat – I went back to review and 4 of the past 6 Fridays have seen monster moves up negating most/all of the moves down earlier in those weeks.  The Friday after the Euro summit, last Friday after Draghi’s comments, this Friday, and one other Friday that I don’t recall the reason for the big move.  Strangely each of the past 9 Mondays has seen markets close in the red.

However each time the market has been on a cusp like this of a breakout, the next few sessions have led to serious selloffs.  We’ll see if this time around it is for real.  This market is very similar to last summer/fall’s market in that the moves are violent and gaps are constant, but that market had a sideways to down bias whereas this one somehow has been going up with most of the gaps being to the upside instead of balanced between up and down (since June).  To put into perspective 15 of the past 22 sessions (68%) have been selloffs in the S&P 500 – but the 7 up sessions (4 of them on Fridays) have been so ferocious, the market is actually up 20 S&P points over those 22 sessions.  There is certainly little memory from day to day as each day’s headlines or rumors take everything with it.

Today the money is moving back into the pro cyclical areas which was another sign one would want for a sustained move.    The euro is also strong today and that inverse trade has been the key one for markets.

Copyright © Market Montage

Tags: Bias, Bonds, Breakout, Cusp, Draghi, ETF, Fly In The Ointment, Fridays, Gaps, Juncture, Last Friday, Moving Average, Pivotal Point, Rallies, S Market, Second Time, Selloffs, Trad, Treasuries, Treasury Bond, U S Treasury
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HFT Algo Goes Totally Berserk And Serves Knight Capital With The Bill

Thursday, August 2nd, 2012

We all know something went horribly wrong in various NYSE-traded stocks today between 9:30 am and 10:15 am. So wrong in fact that the NYSE had to step in and cancel numerous trades in 6 symbols. However it did not DK millions of other trades in 134 other symbols, the vast majority of which we assume traded errantly due to the market making of Knight Capital (as admitted by the company), which today saw its biggest drop ever since going public on volume about 60 times greater than its average. We also all know that one should buy low and sell high. At least that is what human traders are taught, and that is what they attempt. Because if one consistently does the opposite, one will simply run out of money. Well, the opposite is precisely what the berserk algo in Knight’s Market Making group may have done if Nanex, which has done a forensic analysis of one of the trades in question, is correct. In other words, instead of at least attempting to provide liquidity via limit trades, Knight’s algorithm acted as a market order… gone horribly wrong. As the third chart below shows what the algo did with furious repetition and steadfast consistency was to buy at the offer, and sell at the bid, in other words buy high and sell low. Over and over and over and over. As Nanex laconically notes, “In the case of EXC, that means losing about 15 cents on every pair of trades. Do that 40 times a second, 2400 times a minute, and you now have a system that’s very efficient at burning money.” Which also means that by not DK’ing several hundred million prints, the NYSE may have just thrown Knight under the bus, because the market maker is suddenly on the hook for tens if not hundreds of millions in inverse market making profits.

Here we will assume that readers are sufficiently familiar with market structure to know that market makers only participate in the market in order to collect liquidity rebates, i.e., to be the limit on the bid which is hit, or the offer which is lifted. What Knight did was effectively the opposite, and it also collected the opposite of a rebate: i.e., it paid someone else for no reason at all… well technically to withdraw liquidity. However liquidity that led to creation of losses not profits.

Naturally, when the entire logic of trading was perverted courtesy of Knight’s busted algo, everything went Bizarro Day, and stocks went higher, because they went higher, and the higher they went, the greater the incentive for the algo to keep pushing the stock higher. This explains not only the volume surge, but also the shocking price moves in some stocks such as China Cord Blood which exploded several hundred percent higher before someone had to finally step in. And what is most notable is that because there were neither fat finger trades, nor busted algos that took out the entire bid or offer stack in one trade, thus triggering circuit breakers, but a slow methodical bleed, there was no reason under the current SEC order cancellation methodology to bail out Knight and its berserk algorithm.

Simply said: today may be the single worst day in Knight’s market making history. And sadly, as the NYSE already noted minutes before the market close, the decision to not cancel any more trades is “not subject to appeal.”

From Nanex:

What really happened, or how to lose a ton of money, fast.

What follows should strike you as crazy. If it doesn’t, read it again, because it is.

The following 3 charts plot non-ISO trades (regular trade condition) reported from NYSE in the stock of Exelon Corporation (symbol EXC). By plotting and connecting only regular trades from NYSE we get a clearer picture of the nature (some might say horror) of this event.

1. EXC One second interval chart. Circles are trades, the blue coloring is the NYSE bid and ask which is mostly covered by gray lines that connect the trades.

2. Zoom of above chart showing about 27 seconds of data. Now the gray lines connecting trades are more clearly visible. NYSE’s bid/ask is the blue shaded area (the bid price is the bottom of the shading, and the ask is the top).

3. Zooming in to a 1 millisecond interval chart, we can see one second of data which shows 39 trades.

Note how the trade executions ping pong from bid to ask. As if someone is buying at the offer, then 10 ms later selling at the bid, and so forth. It turns out, the gray shading you see in the first chart of EXC is from this alternating between buying and selling. That’s right, almost all these trades alternate between buying at the offer and selling at the bid, which means losing the difference in price. In the case of EXC, that means losing about 15 cents on every pair of trades. Do that 40 times a second, 2400 times a minute, and you now have a system that’s very efficient at burning money.

Tags: Algorithm, Chart Below Shows, Consistency, Exc, Forensic Analysis, Hook, Human Traders, Hundred Million, liquidity, Market Structure, Money, Nyse, Prints, Profits, Rebates, Repetition, S Market, Stocks, Tens, Trades
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Recessions and Distorted Market Signals

Wednesday, June 13th, 2012

by Guy Lerner, The Technical Take

There is no question that the Federal Reserve’s market interventions have distorted market signals.  What used to be no longer applies.  The elephant in the room with the deep pockets has pushed bond yields down to historic lows, yet the desired effect – a growing economy — has been anything but that.  Despite the massive stimulus, the recovery is the weakest on record.  And now as the latest Fed incarnation of stimulus (i.e., Operation Twist) is about to end, the markets and economy are sputtering.  What will the Fed do next?  And this is the only thing that matters to a market hooked on the monetary morphine.

Figure 1 is a weekly chart of the SP500.  The red labeled bars are those times when the Economic Cycle Research Institute’s Leading Economic Indicator (ECRI) suggests that U.S. economy is in a recession.  The record of the indicator is not perfect in that it doesn’t always correlate with the National Bureau of Economic Research official recession calls, but the presence of a red labeled bar should alert one to look for other supporting factors that the economy may be sputtering.  (As an aside, the ECRI’s LEI is but one factor considered in my own Real Time Recession Indicator.)

Figure 1 SP500/ weekly

Now look at figure 1 and note the 2010 and 2011 time periods.  The ECRI’s LEI was suggesting that the economy was dipping into recession.  But rather than head lower in anticipation of a recession, the stock market bottomed and headed significantly higher.  So what gives?  Of course, thanks to QE2 (2010)and Operation Twist (2011), the Fed was able to avert the natural course of events and avoid the dreaded recession.  In other words, the ECRI’s LEI didn’t signal an oncoming recession; it signaled increasing liquidity and market intervention by the Federal Reserve.  What used to be no longer applies!  Fed intervention has distorted market signals.

Now comes 2012, which appears to be playing out like 2010 and 2011.  The market is selling off as another Fed program to stimulate the economy (and stock market) is ending.  The equity market is weak as the monetary morphine dissipates, and bond yields have hit new lows in anticipation of the economic weakness and a new round of bond purchases.  According to the ECRI’s LEI, the economy is weakening, and we should remember, this is just one tool to assess the health of the economy.  But if the Fed were going to intervene in the markets, now appears to be the time as economic growth is on the wane.

Of course the key questions remain: 1) Will doing more of the same avert the natural course of events — that is prevent another recessions?  and 2) How sustainable will the economic bounce be?  As I will show next time, the Fed appears to be losing the battle.

Copyright © The Technical Take

Tags: Bond Yields, Course Thanks, Deep Pockets, Desired Effect, Economic Cycle Research Institute, Ecri, Guy Lerner, Incarnation, Leading Economic Indicator, Market Intervention, Market Interventions, Morphine, National Bureau Of Economic Research, Qe2, Recession, Recessions, S Market, S&P500, Stimulus, Time Periods
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4 Reasons Europe is a Major Risk for the U.S. (Koesterich)

Monday, June 4th, 2012

Some investors have argued that events in Europe are having a disproportionate impact on US stocks. Their logic: the US is in the midst of a recovery, albeit a fairly anemic one, that is unlikely to be derailed by Europe’s travails.

It’s true that the US economy is doing much better than Europe’s, and especially southern Europe’s. But from my perspective, the trajectory of the US economy and the US stock market are very much tied to eurozone events. Here are four reasons why US investors should not underestimate the potential impact of events in Europe.

1.) Europe Makes Up a Significant Portion of US Exports. The US economy is much more consumption driven, and therefore more domestically focused, than other economies. That said, exports still count, and the United States still sends a significant portion of its exports to Europe. While exact data is spotty, in 2010 (the last year for which we have comprehensive data), Europe represented roughly 30% of foreign sales of companies in the S&P 500 index. Were a European recession to degenerate into a full-blown crisis, exports to European countries would plummet. At the margin, this would detract from US growth.

2.) A Rising Dollar Would Make US Exports Less Competitive. Since its 2012 peak, the euro has already depreciated roughly 8% against the dollar. To the extent fears of a European crisis continue to push the dollar higher, not just against the euro but against other currencies as well, US exports would become less attractive to other countries. To be sure, a stronger dollar is ultimately positive for US purchasing power and inflation, but in the near term, it would act as a further headwind for US exports.

3.) Recent US stock performance could negatively impact US consumer spending. As of Monday, US stocks were down 10% from their spring peak. Last Friday’s market drop can mostly be blamed on the United States’ own economic malaise. But the escalating crisis in Europe has also been a major catalyst for the recent US market correction, which has already erased roughly $1.5 trillion dollars from the US stock market since earlier this year. To the extent this drop hammers consumer confidence, it could have a modestly negative impact on consumer spending.

4.) The European banking system crisis could impact credit creation in the United States. While US banks are in a much stronger position than their European counterparts — US bank capital looks adequate and there is little risk of a run on banks here — banking stress in Europe is being felt in the United States thanks to the interconnectedness of the global financial system. On Friday, the Bank of America Merrill Lynch Global Financial Stress Index climbed to its highest level since the first days of 2012. At the very least, stress in the US financial system may harm the nascent recovery in US bank lending.

Looking forward, I believe a worsening eurozone crisis can still be avoided if European politicians get more aggressive in addressing their region’s, and particularly Spain’s, banking problems. However, until we see more clarity from European policy makers, equity investors may want to consider maintaining a defensive posture as Europe remains a major risk for US stocks as well as for the US and global economies.

Source: Bloomberg

Russ Koesterich, CFA is the iShares Global Chief Investment Strategist and a regular contributor to the iShares Blog.  You can find more of his posts here.

Tags: Consumer Spending, Cri, Disproportionate Impact, Economic Malaise, Europe 1, European Countries, Exact Data, Headwind, inflation, Last Friday, Midst, Purchasing Power, Recession, S Market, Southern Europe, Spring Peak, Stock Performance, Trajectory, Travails, Us Stock Market
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Going Defensive With Dividend Funds

Tuesday, May 29th, 2012

While market volatility now looks closer to fair value than it did in early May, I still believe that investors should remain defensive. Stocks remain very much exposed to a potential disorderly Greek exit (“Grexit”) from the euro and any accompanying contagion.

One defensive play I particularly like: dividend paying stock funds, including those consisting of equities in traditionally volatile emerging markets.

As I write in my new Market Update piece, dividend stocks generally have been less volatile than the broader market, which can make them a good defensive choice.

Since 1992, the beta (a measure of the tendency of securities to move with the market at large) of the Dow Jones Select Dividend Index to the S&P 500 has been around 0.8. That means that for every 1% the market moves this index typically moves around 80 basis points (see how I calculated the beta in the chart below).

In the case of the Morningstar Dividend Yield Focus Index, the beta has historically been even lower, at around 0.7.

This historical pattern has continued during the most recent downturn. As of Thursday’s market close, the S&P 500 was off approximately 6% from its May peak, while the Dow Jones Select Dividend Index and the Morningstar Dividend Yield Focus Index were down 3% and 2% respectively.

Even in emerging markets, typically a more volatile sector of the market, dividend stocks tend to cushion the downside. For instance, the Dow Jones Emerging Markets Select Dividend Index has a beta of roughly 0.80 to the broader MSCI Emerging Market Index.

Given the ongoing uncertainty surrounding Greece and the overall European Union, near-term market volatility is likely to remain high and I continue to advocate that investors have a high allocation to high dividend equity funds. In particular, I like the iShares High Dividend Equity Fund (NYSEARCA: HDV), given its low beta and quality screen, and the iShares Emerging Markets Dividend Index Fund (NYSEARCA: DVYE). Another potential solution focusing on US equities is the iShares Dow Jones Select Dividend Index Fund (NYSEARCA: DVY).

Russ Koesterich, CFA is the iShares Global Chief Investment Strategist and a regular contributor to the iShares Blog.  You can find more of his posts here.

Source: Bloomberg

The author is long HDV

Tags: Defensive Stocks, Dividend Funds, Dividend Paying Stock, Dividend Stocks, Dividend Yield, Dow Jones, Equity Fund, Equity Funds, ETF, ETFs, Focus Index, High Dividend, Index Fund, Ishares, Market Volatility, Morningstar, Msci Emerging Market, Msci Emerging Market Index, Quality Screen, S Market, Stock Funds, Volatile Sector
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Market Patterns: Does History Really Repeat Itself?

Friday, May 25th, 2012

May 24, 2012
Randy Frederick
Managing Director of Trading and Derivatives, Schwab Center for Financial Research

Key Points

• Sometimes understanding the past can help you with your forecasts.
• Pattern repetition can lead to potentially more reliable forecasting.
• Study and learn from history, but we recommend that you don’t base your trading strategies entirely on history.

Does history really tell us anything about today’s market? Trading has certainly changed from the day of brokers trading in the streets to today’s high-frequency traders. Indeed, the trading environment of yesteryear is as foreign to modern-day markets as a horse and buggy are to a Formula 1 race car.

And yet it often seems that the more things change, the more they stay the same. We often find that we rely heavily on past performance (or more specifically, past data) to forecast the future, because history has shown that past patterns often re-emerge, and quite frankly, history is all we have.
Technical patterns
As both an active trader and a market analyst, I spend quite a bit of my time looking for market patterns. Then I watch to see if things play out the same way this time. The belief that patterns repeat themselves is essentially the foundation on which technical analysis is based.

While I’m not strictly a technical trader, I think it’s unwise to ignore technical indicators. Because whether or not I believe technical analysis has merit, as long as market participants take action based on technical events, these events are worth watching.

Taking this into consideration, what makes a pattern noteworthy? The answer is repetition—or how many times it has occurred in the past with the same or a similar result.
Golden Cross and Death Cross
In the world of technical analysis, one of the most frequently discussed patterns is the Golden Cross—when a 50-day simple moving average (SMA) crosses up through a 200-day SMA. This is often seen by technical traders as a sign of a continuing bullish market.

The opposite of a Golden Cross is known as a Death Cross—when a 50-day SMA crosses down through a 200-day SMA. As you might imagine, this is most often seen by technical traders as a sign of a continuing bearish market.

But do they work? To find out, I looked at S&P 500® Index (SPX) data from 1950 to the most recent Golden Cross (January 31, 2012) to see what typically happens following these events.

Since 1950, there have been 31 Golden Crosses and 32 Death Crosses. The average return for a long position on the SPX going forward one year from each of these signals was 3.8% for the Death Cross and 10.2% for the Golden Cross. So interestingly, the Death Cross signal wasn’t actually bearish, just less bullish for the one-year period following the events observed.

Looking at more recent history, the results are pretty similar. Since 2003, there have been five Golden Crosses and five Death Crosses. The average return for a long position on the SPX going forward one year from each of these signals was 8.5% for the Death Cross and 9.2% for the Golden Cross. So again, the Death Cross wasn’t actually bearish, just slightly less bullish.

The chart below depicts all of the 50/200 SMA crossover points for the past four years.

• The yellow line is the 50-day SMA and the pink line is the 200-day SMA.
• Notice how the crossovers never signal the start of a bullish or bearish trend, but rather the continuation of a trend.

Crosses in Action

Source: StreetSmart Edge®.

Now, let’s say that since 2003 you had gone long only on the Golden Cross and short only on the Death Cross. Here’s what would have happened:

• For the five bullish signals since 2003, the average return on the SPX going forward from each Golden Cross until each Death Cross was 8.6% (so a long position would have gained 8.6%).
• For the five bearish signals since 2003, the average return on the SPX going forward from each Death Cross until each Golden Cross was 0.0% (so a short position would have essentially broken even).
• The most recent Death Cross was August 12, 2011 and while that is typically seen as a bearish signal, if you look at this period until the Golden Cross of January 31, 2012, the SPX actually gained 12.3%.
• Since the most recent Golden Cross (January 31, 2012), the SPX has gained about 5% (as of this writing), although it has only been a few months.

Cyclical patterns
Technical patterns aren’t the only events that re-emerge in the markets. Cyclical patterns can also occasionally provide insight into what the future holds. While investors should never base trading decisions strictly on cyclical patterns, the statistics associated with them are often interesting to discuss. Here are a few that I’ve found to be particularly noteworthy:

• Thirteen of the last 17 year-end rallies continued into January. Most recently, for example, SPX gained about 0.9% in December 2011 and about 4.3% in January.
• The fourth year of a bull market (e.g., 2012) is typically much stronger than the third (e.g., 2011). According to data compiled by Standard and Poor’s Equity Research, the average third-year bull-market return for the SPX is 3% vs. 13% for the fourth year. The SPX returned 0% in 2011 and was up about 10% this year as of this writing.
• Presidential election years have been positive 12 of the last 15 times. They have an average return of 6.6% (and that includes the 38% decline in 2008). If you exclude the 2008 election, the average return jumps to 9.8% and then election years would be positive 12 of the last 14 elections. The other two losing election years were 2000 (George W. Bush) and 1960 (John F. Kennedy).

The chart below shows the start (green vertical line) and finish (red vertical line) of each presidential election year since 1950.

• The three down years (1960, 2000 and 2008) are identified with a red box.

Stock Market Action in Presidential Election Years

Source: Schwab Center for Financial Research.
Seasonal patterns
Now, let’s take a look at the (sometimes) annual pattern often referred to as, “Sell in May and go away.” Like so many other patterns, this “rule” appears to have historical merit. It seems like the market often begins to wind down around Memorial Day and then does not pick back up until around Labor Day.

I looked at SPX performance from 1950 through 2011 for the 68 trading days preceding the Labor Day holiday (basically June, July, August and the first week of September). Here’s what I found:

• The SPX had an annual gain in 45 of those 62 years.
• But the period from Memorial Day to Labor Day (about 68 trading days) was only positive in 41 of those 62 years.
• During this 62-year period, the SPX increased from 16.66 to 1257.60, which was an average annual return of 7.22%. Note: To find out the annualized return we use the formula below.
• However, the average return for each yearly period between Memorial Day and Labor Day (68 trading days) was only about 1.1%.

So while 68 trading days represents about 27% of the approximately 250 trading days each year, the period between Memorial Day and Labor Day accounted for only about 15% of the total average annual returns. In other words, this tends to be a historically underperforming period of time.

Sometimes statistics can imply patterns that aren’t quite as repetitive as they appear, so below is a list of the 10 most bearish years for the Memorial Day to Labor Day period going back to 1950. While there is definitely a small bias toward negative action in more recent years, it is not as skewed as some might expect.

As shown in the chart below, sell in May and go away was a pretty good strategy for three of the last four years. But in 2009, the year the bear market ended and the SPX rose 23% overall, this strategy would have missed out on about an 8.5% gain during this period of time.

Summer Market Activity During the Last Four Years

Source: StreetSmart Edge®.
Volatility patterns
An area of the market that has garnered a lot of attention in the past few years is volatility. One of my favorite statistics in the area of volatility relates to the CBOE^® S&P 500 Volatility Index (VIX). According to my calculations, the VIX has closed above 40, exactly 167 times since it was created in 1993:

• 95% of the time, when the VIX closed above 40 on a given day, the market was higher exactly 12 months later. The average gain was more than 31%.
• Only 5% of the time, when the VIX closed above 40 on a given day, the market was lower exactly 12 months later. The average loss was less than 10%.

In 2011, the VIX closed above 40 on 11 days between August 8, 2011 and October 4, 2011. The average level of the SPX between August 8, 2011 and October 4, 2011 was about 1,170. So from a strictly historical perspective, there could be about a 95% likelihood that the SPX will be higher than Q3 2011 by Q3 2012, perhaps sharply higher.

Looking at this data a slightly different way, because historical spikes in the VIX were concentrated in just seven specific periods of time, it may make more sense to view the results if you simply went long the SPX¹ on the day of the very first spike above 40. If you did, the results would have been as follows:

1. From August 31, 1998, the 12-month return was 37%
2. From September 17, 2011, the 12-month return was -15%
3. From July 22, 2002, the 12-month return was 20%
4. From September 19, 2002, the 12-month return was 22%
5. From September 29, 2008, the 12-month return was -3%
6. From May 7, 2010, the 12-month return was 20%
7. From August 8, 2011 to the time of this writing, the return has been approximately 15

The chart below shows the seven periods above. The green lines represent gains over the next 12 months; the red lines represent losses. The pink line represents the inverse of the VIX and the black line shows the SPX. The red line at the bottom illustrates the equivalent level of 40 on the VIX. Since the VIX is mapped inversely, any time the VIX closed above 40, the pink line will be below the red horizontal line on this chart.
Seven VIX Spikes

Source: Schwab Center for Financial Research.
Bottom line
No strategy, statistic, research or historical pattern can consistently predict the future. But experienced traders study history anyway because they know that while, “History doesn’t always repeat itself, it often rhymes.”

For additional information or for assistance with other trading strategies, please contact a Schwab Trading Specialist at 800-435-9050.

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Tags: Death Cross, Derivatives, Formula 1 Race, Golden Cross, High Frequency, Horse And Buggy, Market Analyst, Market Participants, Market Patterns, Race Car, Repetition, S Market, Schwab, Sma, Taking This Into Consideration, Technical Indicators, Technical Trader, Technical Traders, Trading Strategies, Yesteryear
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Global Shipping: Any Port in a Storm? (PIMCO)

Monday, May 21st, 2012

by Sai S. Devabhaktuni, and Gregory Kennedy, PIMCO

May 2012

• With the exception of LNG tankers, all three major shipping categories have been suffering from a supply glut. This, combined with higher fuel costs, has led many shipping companies into financial distress.
• Although banks have worked with ship owners through this down cycle, they have also pulled back from financing the industry.
• Given the current low point in the cycle, we believe downside risks are likely minimized in the shipping industry for new lenders and investors. Vessel values are depressed by rates that are sometimes below owners’ operating costs and by an oversupplied market that suppresses secondary market values.​

In spite of the current woes in the shipping industry, including a significant erosion of value and a glut of new vessels, we see the potential for a brighter future on the distant horizon – especially as the order book of new vessels begins to shrink and emerging market growth provides a much-needed driver of demand.

As a result, select opportunities to buy the debt of operators or to buy portfolios of vessels at prices below their intrinsic value are now available to informed investors – and could offer attractive long-term returns. Capitalizing on this anticipated rebound, however, requires patience, dedicated long-term capital and a strong understanding of industry fundamentals and maritime restructuring dynamics. These waters demand careful navigation.

A brief history of the voyage to today’s market
The global shipping industry is in the midst of its worst cycle since the 1980s. A recent Bloomberg article highlighted that “the combined market value of the world’s 80 biggest publicly traded shipping companies plunged by $101.7 billion in the four years to March 23, 2012.” What caused so much value destruction? The combination of an excess supply of new vessels that were financed at the peak of the market and a global recession from which there has been an uneven recovery has led to persistently low charter rates and plummeting ship values. In its wake is nearly $500 billion of debt, the overwhelming majority of which is held by European banks.

Over 90% of world trade activity depends on the shipping industry’s global fleet of 58,000 ships, according to Clarksons and J.P. Morgan. The fleet includes tankers, dry bulk ships, container ships, chemical tankers, liquefied natural gas (LNG) tankers and other cargo ships across what is a highly fragmented industry. As the global economy expanded and international trade increased after the end of the Cold War, world seaborne trade increased by nearly 50% from 1990 to 2000, from about four billion tonnes to six billion tonnes annually, which helped the shipping industry recover from the vessel oversupply it faced in the 1980s (see Figure 1).

The global shipping industry has long cycles and was historically driven by demand and GDP growth in developed economies. But by 2003, demand from emerging economies like China began accelerating, which pushed global seaborne trade to over eight billion tonnes by 2008. China’s demand for coal and iron increased nearly 20% per year from 2004 to 2011, and the country is now a net importer rather than exporter of coal. This insatiable emerging market demand, combined with increased prosperity due in part to the credit bubble in developed markets, led to a vessel shortage, driving shipping rates to new highs (see Figure 2).

The shipping industry responded to these historically high shipping rates by ordering what turned out to be an excessive number of vessels. From 2003 to 2008, over $800 billion of new ships were ordered, with half of the orders placed in 2007–2008, when vessel prices were at their peak, according to Clarksons. During these boom years, bank lending was widely available for new ships, as banks offered financing of up to 80% loan-to-value (LTV) for new vessels (versus 50% to 60% today), leaving little margin for error in vessel values. Most of those vessels were scheduled for delivery in the years immediately following the financial crisis of 2008–2009, compounding the oversupply issue.

Rough seas follow the expansion
As a result of the order book overhang resulting from overly optimistic expectations of demand (i.e., volume) growth, shipping rates have faced persistent headwinds from net new vessel deliveries at about twice the rate of shipping demand growth during the recovery of the past few years (see Figure 3). With the exception of the under-fleeted LNG tanker market, all three major shipping categories (bulkers, tankers, containers) have been suffering from a supply glut. This, combined with higher fuel costs, has led many shipping companies into financial distress.

Because of new vessel deliveries over the past three to four years, the global fleet is fairly young, which means there are not as many older ships available that would typically make economic sense to scrap. And while delivery slippage of the order book and cancellations help to slow the supply of new vessels entering the market, there is an incentive for shipyards to maintain their order backlog.

Tags: Bloomberg, Distant Horizon, Downside Risks, Emerging Market, Excess Supply, Financial Distress, Fuel Costs, Global Recession, Global Shipping Industry, Gregory Kennedy, Intrinsic Value, Lng Tankers, Long Term Capital, Peak Of The Market, PIMCO, Port In A Storm, S Market, Secondary Market Values, Ship Owners, Shipping Companies, Supply Glut
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Do Emerging Markets Win, Place or Show in Your Portfolio?

Monday, May 7th, 2012

Do Emerging Markets Win, Place or Show in Your Portfolio?

By Frank Holmes, CEO and Chief Investment Officer, U.S. Global Investors

Since the stock market’s gate opened at the beginning of 2012, emerging countries were off to a fast start. Stocks in Brazil, Colombia and India galloped to the lead, increasing more than 10 percent within the first few weeks of the year.

By the time the end of April came around, Colombia had sprinted to the lead, followed closely by Thailand and the Philippines. All increased more than 20 percent in the first four months of 2012.

However, rather than focusing on the leaders of the pack, spectators seemed to have directed their attention toward the S&P 500 Index, as it galloped to its best first-quarter gain since 1998.

The recovery in U.S. stocks is significant and helps restore confidence in equities. We’re pleased to see markets improving, especially following a rough finish in 2011. Yet there lingers a persistent negativity toward emerging markets growth and commodities that prevents many investors from jockeying their portfolios into a position for growth. Rather, they remain spectators on the sidelines, with equity fund outflows continuing.

In contrast, Eastern Europe exploded on the upside and far outpaced not only the U.S. market, but also Europe. The chart below shows investment results across three different markets. Since the beginning of the year through April 30, the iShares S&P Europe 350 ETF has trailed, while the SPDR S&P 500 ETF has placed second. Among these three investments, the Eastern European Fund (EUROX) has kept the lead for most of the quarter and took first place as of April 30.

You can see above that EUROX and the European market were climbing steadily since the beginning of the year, but by April, began to fall because of the eurozone’s debt grief and concerns over China.

Over the past four months, Russian stocks, which are heavily weighted in energy companies, have underperformed many emerging markets, increasing only about 6 percent. HSBC Global Research believes that the low valuations seem to be “pricing in a lot of political risk” surrounding the protests against Russia’s newly elected presidential candidate. Investors need to see the opposition movements against Vladimir Putin as very different from the Middle East discontent, says HSBC. The firm says Russia’s protests are “largely liberal” without “religious dimension” which suggest future reforms to reduce the political discontent are more likely.

HSBC also thinks that the government will try to improve the investment climate. Putin suggested in a recent speech that he would like to increase Russia’s rating in the World Bank’s Ease of Doing Business report. Currently, Russia ranks 120th; Putin would like to set a goal of 20th place.

What may be hurting investor sentiment toward Russia in the short term is the political strain that has recently surfaced between Russia and the U.S. and NATO involving missile defense installations in Europe. This is precisely the reason we believe investors need to hold actively managed investments with experts who understand the political situation to skillfully maneuver around emerging Europe.

China, the Workhorse of the Global Economy

While China did not win, place or show among major markets during the first few months of the year, its H shares gained nearly as much as the S&P 500. Yet, the negativity that I’ve frequently discussed continues, even though the country is the Clydesdale of our global economy.
In the first quarter, China’s GDP growth was 8.1 percent, a likely trough for the year, according to a Merrill Lynch-Bank of America conference call recently. The firm listed several reasons that China will see an improved GDP over the next three quarters:

1. Although spring made an early appearance in many parts of North America, this past winter in China was the coldest in 27 years. This extremely chilly weather slowed down economic activity.
2. Credit growth has bottomed out and bank lending has been reaccelerating. BCA Research echoed this thought in its China Investment Strategy this week, saying there’s been a “sharp turnaround in bankers’ confidence in recent months, which is also being reflected in rising bank lending of late.”

1. Home developer price cuts and lower mortgage rates offered to first-time buyers have driven a significant recovery in home sales. In our recent webcast on China, Andy Rothman from CLSA made some excellent comments related to mortgages, agreeing with ML-BofA, saying that each month it was getting easier for new home buyers to get mortgages, and along with lower interest rates for mortgages, this was a clear sign of “the government’s process of easing up on the housing sector.”
2. With leadership transition close to conclusion, local infrastructure construction activity is poised to increase.
3. As shown below, crude steel, steel products and cement output has shown initial signs of recovery in the recent month.

While China’s Government Purchasing Managers’ Index (PMI) for April came in slightly below market consensus, the number remains above the three-month number for the fifth consecutive month since December 2011. We believe the government’s PMI is a far better indicator of overall manufacturing activity than the HSBC data because it takes into account domestic demand.

From the PMI’s inception in January 2005, the majority of the time the PMI is above the three-month average, Chinese and U.S. stocks, as well as copper and WTI crude oil, all see gains over the following three months. So far this year, each has proved true.

BCA Research says that the latest PMI substantiates that the “Chinese economy may be reaccelerating,” pointing to three trends: Monetary easing is working, external demand seems strong and may be accelerating, and the government has increased fiscal expenditures on social housing and infrastructure projects, which is supportive of ML-BofA’s view above.

The race in the stock market isn’t over until it’s over. While a top contender may ultimately win in the Run for the Roses, the assumed “long shot” might come from behind and race to first place. Rather than place all your money on the market you believe will win, place or show, we believe diversification among markets is the way to go.

Which countries are you betting on to top markets in 2012? Email us at editor@usfunds.com.

See Our Popular Periodic Table of Emerging Markets.

Expense ratios as stated in the most recent prospectus. Performance data quoted above is historical. Past performance is no guarantee of future results. Results reflect the reinvestment of dividends and other earnings.  Current performance may be higher or lower than the performance data quoted. The principal value and investment return of an investment will fluctuate so that your shares, when redeemed, may be worth more or less than their original cost. Performance does not include the effect of any direct fees described in the fund’s prospectus (e.g., short-term trading fees of 2.00%) which, if applicable, would lower your total returns. Performance quoted for periods of one year or less is cumulative and not annualized. Obtain performance data current to the most recent month-end at www.usfunds.com or 1-800-US-FUNDS.

For investment objective and risks regarding the SPDR S&P and the S&P Europe 350 ETFs, see the “Additional Disclosures” section at the bottom.

Tags: BRICs, Chart Below Shows, Chief Investment Officer, Eastern Europe, Emerging Markets, energy, Equity Fund, ETF, Eurox, Eurozone, Four Months, Frank Holmes, Investment Results, Ishares, Leaders Of The Pack, Negativity, Russian Stocks, S Market, Sidelines, Spdr, Spectators, U S Global Investors
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China Finally Breaks Above 200-Day Moving Average

Thursday, May 3rd, 2012

from Bespoke Investment Group

When an index or stock is above its 200-day moving average, it is considered to be in a longterm uptrend, and vice versa when trading below the 200-day.  China’s Shanghai Composite finally broke back above its 200-day today after trading below it for the past 228 trading days.  Going back to 1990, this was the third longest streak of its kind, and it clearly illustrates how weak China’s market has been over the past year.

China has had three prior streaks of 200 days or more below its 200-day.

And, this note, from Jon Najarian, OptionMonster:

Our @guyadami and @grassosteve love to trade stocks as they press support and resistance levels. The reason they do it is it just works, either buying on break above, or selling on break below.

Well, here’s a reason to NOT sell in May and go away; China’s Shanghai Composite broke back above its 200-day today after trading below it for the past 228 trading days.

According to our friends at Bespoke, this was the third longest streak of its kind since 1990. Bespoke says, “China has had three prior streaks of 200 days or more below its 200-day. Following the 278 day streak that ended in March 2009, China’s market took off, rallying 1.4% over the next week, 9.05% over the next month, and 25.66% over the next 3 months.”

Tags: Break, China Market, Day Trading, Investment Group, Jon Najarian, Love, Moving Average, Nbsp, Resistance Levels, S Market, Shanghai Composite, Stock, Stocks, Streaks, Uptrend
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