Dow Theory Warnings Continue

Several months ago, I wrote back to back articles about the Dow Theory trend change. You can view them below.

http://www.investfortomorrow.com/newsletter/CurrentStreet$marts20141103.pdf

Simply put, this analysis holds that the Dow Jones Industrials and Transports should move in lock step to confirm each intermediate-term move in the stock market. When one index see a relative new high, so should the other. The opposite is true at lows. When one index diverges from the other, it is a possible sign of a trend change. When both indices closes below a previous significant low that is considered confirmed change of trend.

Let’s look at the two charts below for some real life, recent examples. At the far lower left of both charts you can see the Ebola October lows where both indices closed below previous significant lows. By early December, they both went right back to new highs where the party began to fizzle.

Since early December, the transports have seen a progression of peaks that were each lower than the previous one where the industrials saw a clear trend of higher highs through February. With one index lagging the other, this is called a non-confirmation or divergence and warns that all is not perfect healthy. Of course, if and when the lagging index rallies to confirm the leader, this Dow Theory warning completely goes away. Right now, we have a series of caution flags since late 2014 without much in the way of price weakness.

Beyond the Dow Theory non-confirmation discussed above, the more serious warning is the Dow Theory trend change. This occurs when both indices close below previous significant or above previous significant highs. On the left side of the chart in October, both indices saw Dow Theory trend changes to the downside that were immediately reversed. In other words, the October warning failed.Today, the transports are getting close and should breach the low points seen from December through February. The industrials have another 600 points to go, but don’t dismiss that as out of the question. I do believe, however, that if the industrials fall much more to signal a negative Dow Theory trend change, it will be short-lived like we saw in October.
Although the Dow Industrials and Transports are not and have not been perfectly in sync for many months, the broad stock market has been acting okay and lacking most of major signs that the bull market is ending. More than likely, any weakness this quarter will be of the ending nature, completing the divergence seen in the two major indices as the Dow Industrials prepare an assault on 20,000.
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Q2 Begins Where Q1 Left Off

I hope you all enjoyed April Fool’s Day. I know I definitely did and the emails, calls and texts continue rolling in. Even the media called for an interview about my new gig! :-)

The first quarter and the month of March rolled in like a bear and both rolled out like a bear, meaning that the bears had the upper hand at least in the short-term. During the middle of the quarter, the bulls were in firm control. The market certainly seems like it has transitioned into a trading range after February’s big surge. That’s not a bad thing.

When markets get overbought and sentiment is frothy, risk substantially increases. That can be worked off through a period of sideways movement in a range which frustrates both the bulls and bears, or it can be overcome by corrective action with a sharp pullback in prices. The former is what you most want to see during a healthy bull market.

While my intermediate and long-term views remain completely unchanged, the short-term is a bit murkier. The stock market doesn’t seem like it’s ready to explode higher by thousands of points just yet. That day is still coming, but I don’t think it’s right here. Rather, it looks like the trading range will continue and perhaps expand to the downside until we build up enough pessimism to launch another assault higher.

In the interim, it pays to watch sector leadership for future clues. There have been lots of good things happening, especially with the consumer as discretionary, retail and homebuilders have all led with biotech and healthcare. The latter two, which I remain long for full disclosure, went too far too fast and are now correcting sharply. On the laggard side, energy, which we also remain long in smaller size, has  been percolating nicely and seems poised to see a small breakout this month. Remember, every time oil has declined at least 50%, it rallied 50% from the low over the ensuing year. Something to continue to keep in the back of your mind.

In the very short-term, the government will release the March employment report tomorrow, Good Friday, when the markets are closed. Why they do this I have no idea. It makes little sense. The bond market and stock index futures market open for a brief period to disseminate the news and then close until Monday. The stock market remains closed. Rob Hanna from Quantifiableedges did some top notch research and found that when this release happens on Good Friday, Monday’s trading has outsized volatility. See his excellent work HERE

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Fox News Here I Come!

I am excited and thrilled to announce that I have signed a deal with Fox News to host my own TV show weekdays from 8 pm to 8:30 pm. As you already know, I have always enjoyed appearing on CNBC, Fox Business and Bloomberg, but the time is right to give this a go on my own, under my terms and my way. Apparently, there is a soon to be announced shake up at the network.

The content will be a spirited debate on areas of personal interest and expertise including a healthy dose of financial markets, economics, politics, the Fed, sports, wine and raising children. And when it gets too quiet and passive, religion will be discussed!

I look forward to sharing more details as they become available. For now, I will be reaching out to people on my email list as potential candidates to join the show as guests, regardless whether you share my opinions or have the wrong ones.

Have a great day!

 

 

 

 

 

 

 

 

 

 

 

Sloof Lipra

Goldilocks

The stock market continues its Goldilocks behavior of not too hot and not too cold. Two steps up and half or one step back. On Monday, markets were a little too warm early on and that should lead to a little cooling over the coming week or so. It should be just another small pullback in an ongoing uptrend in the context of major bull market. Until proven otherwise, any and all weakness is a buying opportunity.

On the sector front, I can certainly make the case that the three key sectors look okay over the intermediate-term, but want to digest right now. Banks continue their year long consolidation while the transports have done the same thing for five months. Semiconductors just recently peaked and seem poised to lead the next leg higher during the second quarter.

Meanwhile, the U.S. dollar has pulled back in an orderly fashion at the same as long-term bonds have quietly regained almost two thirds of the first quarter’s loss. Looking out beyond the short-term, all is reasonably well.

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Dow Jones Industrials Come Calling for Apple Today

After many years of speculation and a healthy 7 for 1 stock split to boot, the folks at Dow Jones finally added Apple into the venerable Dow Jones Industrial Average effective the close on March 18. This had to be one of the worst kept secrets on Wall Street for years. As I mentioned in my 2015 Fearless Forecast, I thought this would happen in 2015. There were no excuses left not to add the tech giant and bellwether. In two days, Apple will be in and AT&T will be tossed to the curb.

Does this really matter for the Dow?

Yes it does in a big way. Unlike the S&P 500 which is weighted by market capitalization or value of the company, the Dow is uniquely weighted by price with a divisor. In the simplest of terms that means that a $30 stock stock going up $1 has the exact same impact as a $200 stock going up by $1, which doesn’t make a whole lot of intuitive sense. Apple and Visa typically rise or fall several dollars each day, but lower priced stocks like AT&T almost never see that kind of price movement.

In short and without getting too technical, as of the last Dow Jones Industrial Average change in 2013, a $1 move in a component stock equals 6.42 Dow points. Now, imagine what the impact will be when Apple joins and AT&T leaves. You can expect more volatility in both directions. In a bull market, the more expensive stocks can juice the index to much higher highs. In reverse, the index can suffer mightily during a bear market.

Before the Apple bulls start popping champagne corks to celebrate, entree into the Dow may not be all candy and dancing elephants. History shows some perverse results with companies leaving the index far outperforming those joining the index. And who could forget Dow Jones adding Microsoft and Intel in late 1999, just as the Dotcom bubble was about to burst.

Since 1991, stocks added to the Dow had a median 12 month return of 12%, but an average return of 6%. Stocks removed from the Dow saw returns more than 25% better than those added and even better of late although my research had a few holes for the stocks leaving the index.

In short, Apple bulls would be best served to expect increased volatility and a period of intermediate-term underperformance from being added to the prestigious Dow Jones Industrial Average.

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Fed Trend Says UP, But They are Nuts to Raise Rates

Today ends the Federal Reserve Open Market Committee’s two day meeting where no action is expected to take place. Computer algorithms will be set to trade on any non-mention of the word “patience” or actual mention of the same word. Isn’t technology great?!?!

As you know, I have done a fair amount of research of Fed statement days and the trend for today is plus or minus -.50% in the S&P 500 until 2 pm and then a rally into the close. This has a 74% chance of occurring, in other words, it’s good data mining. Should stocks close higher today, there is another trend that calls for a down day tomorrow with 65% accuracy.

My own take is that Janet Yellen and the Fed are out of their minds to consider raising rate this year. The dollar soaring is a quasi right hike. Oil collapsing will create some headline deflation and cover to do nothing until it begins to recover and impacts future headline inflation. Growth in Europe is teetering on recession. China continues to downgrade their economy and Japan is, well, Japan.

Aside from trying to normalize monetary policy, which doesn’t have to be now, or provide some future ammunition to cut rates, there is absolutely no need to raise rates. And should the Fed need to cut rates in 2017 or 2018, they have already shown the creativity to make that happen with rates at 0%. Remember, it was Janet Yellen herself who indicated that short-term interest rates should have been -6% in the darkest days. That was essentially accomplished through a variety of outside the box tools including quantitative easing where the Fed bought treasury bonds and mortgage backed securities with created money.

I know my view of our economy and monetary policy has been anything but mainstream since I first forecast a $5 trillion Fed balance sheet on CNBC’s Squawk Box in 2010. This recovery is the epitome of a post-financial crisis recovery, which teases and tantalizes on the upside but never reaches escape velocity. There’s nothing permanently wrong or broken. Looking at history, it typically takes two recessions to return to normal or trend GDP growth. The Great Recession of 2007-2009 was the first and there is one more, probably mild, recession over the next few years.

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NASDAQ 5000. Bubble or is This Time Different?

Almost 15 years to the day after the NASDAQ last closed above 5000, the index finally breached that level again, albeit for only one close, so far. That means that if you invested in the NASDAQ in March 2000, it took you 15 years just to get back to break even, which doesn’t sound like such a great investment. Between then and now, the NASDAQ lost 78% to its October 2002 bottom and rallied 351% to its recent high. That’s a lot of volatility for sure!
While the close above 5000 was just another round number to the bulls, bears from all walks of life came out of the woodwork warning of the same demise that befell the index when the Dotcom bubble burst in 2000. Even Mark Cuban with similar arrogance and pomposity of Donald Trump shouted on all the major business channels about the new NASDAQ bubble. Cuban did later walk that back a bit, claiming he meant in the private markets not the publicly traded ones.
So, is this time really different? Or is the NASDAQ in a bubble that’s about to burst?
Longtime readers know how I feel about the market in general and the NASDAQ isn’t much different. First of all, with a 15 year return of 0%, how can anyone really get excited that it’s a bubble or excessive? Yes, I know we can start the study from October 2002 and end up with a wildly different result, but no one is arguing that the NASDAQ has gone parabolic. That’s just silly.
Looking at some routine fundamental data, analysts often use price to earnings ratio to compare stocks or indexes at different times in history. This number divides the price of a stock or index by the earnings and tells us how much it costs fort $1 of earnings. While this data is easy to obtain on most stocks it is very inconsistent on the NASDAQ going back. At the peak in 2000, I saw as low as 30 times earnings to as high as 200 times earnings. Today, the number 21, at least 50% away from the lowest estimates and worlds away from the insanely high ones.
Yale professor Robert Shiller’s unique cyclically adjusted (CAPE) ratio was an all time high 44 in 2000, but 25 today. Another measure of valuation is the price to book ratio which price divided  by the book value. In 2000, it stood at 5.1 while today it’s almost half at 2.6.
On a non-scientific sentiment front, individual investors were falling over themselves trying to buy the next great Dotcom company. Day traders became heroes and were featured in the Wall Street Journal, Bloomberg and CNBC. People were quitting jobs to day trade a few hours a day for multiples more money. I remember getting stock tips from my trainer at the gym. An old golf buddy’s wife came screaming on to the driving range that they were making millions and should retire to do this full time. My former doctor fired me as his advisor at the end of 1999 for not embracing the new paradigm. He said I didn’t get it anymore. There was a new kind of investing and I was being left behind.
Wall Street Internet analysts like Henry Blodgett and Mary Meeker became rock stars. Ryan Jacobs launched an Internet mutual fund and became a celebrity. Investors were told to ignore earnings and just focus on “eyeballs”. Not only did most of the technology initial public offerings (IPOs) not make money, many of them didn’t even have revenues!
Finally, the NASDAQ index melted up 278% from October 1998 to March 2000, the absolute epitome of a parabolic, bubble’esque advance. The best price move I can find of late saw the index jump 78% from November 2012 to March 2015.
As has been the case since early 2012, the bears have been completely misguided. They continue to believe in their conspiracy theories or manipulation by the global central banks or aliens landing at the NYSE and taking over. Bull markets form when it’s darkest with fear and despair abound. They continue to rise on optimism and eventually die on greed and exuberance. It’s very hard to make the case that death is imminent.
One day, the bears will be right and scream from the rooftops that they were just early. But we all know that they were just plain wrong for too long.
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Cash at “Alarmingly” Low Levels

As I mentioned in my 2015 Fearless Forecast, I view the bull market as being in the fourth quarter if this was a football game. While there is still a lot of game to be played, energy levels aren’t what they were in the first quarter and a few players have some injuries. And, the game could go overtime. It takes months and quarters and sometimes years for a bull market to peter out. The warning signs don’t all come at once, but usually over a long period of time. Today, the very early signs are low cash levels starting to appear. Investable cash is the Gatorade or fuel for bull markets to last. Of course, this can change since there is almost always several trillion dollars in money market funds.

My friend Jason Goepfert of Sentimentrader.com recently posted some good charts on his site regarding this topic. Cash available in margin accounts is at historically low levels. The same can be said about retail money market fund levels. The very volatile Rydex money market fund has seen assets dwindle as has pension fund cash levels. Finally, cash allocations by Wall Street strategists and individual members of the American Assoc. of Individual Investors have gone to almost 0%.

In a vacuum, the average person would or should be very concerned about the perceived lack of cash available to fuel the market higher. But the skeptical analysis may offer a slightly different take. With interest rates at historically low levels I believe that the average person is not using the cash equivalent like they used to. They have migrated away from CDs and money market funds for investments with at least a little yield. Now, you can push back that behavior like that is a sign of additional risk taking which is late stage bull market, but I don’t completely agree that it leads to the immediate end. When the Fed wrongly raises rates later this year and into 2016 we will know with better certainty if investors move back to more traditional cash equivalents.

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Is it Crash Helmet Time???

For the past three weeks, my message has been one of a little short-term concern against the backdrop of much higher prices to follow. That remains unchanged. Market sentiment had become frothy, meaning that too many people had become too confident in the stock market. We saw that in both the individual investor and newsletter writer sentiment surveys. Options traders were betting overwhelmingly on higher prices over the short-term. Corporate insiders were selling much more than they were buying. Traders using the Rydex mutual funds had become heavily invested on the “risk on” side. The short-term trading or ARMS index showed excessive buying pressure.

Combined together, we had stock market sentiment at potentially bull market killing levels. However, excessively bullish sentiment has never single handedly killed a bull market. There needs to be a poor monetary and/or valuation landscape as well, which we do not have today. So let’s not even begin the discussion about the bull market being over. I know I am beginning to play with fire as I have said that during every single pullback since 2012 began, but I continue to feel the same way today.

Anyway, the pullback is here. It looks and feels nasty. The bears are coming out of the woodwork calling for a bear market, a 20% decline, even the 10% correction. As always, I could be wrong, but I view this bout of weakness as yet another single digit pullback that can be bought and will lead to fresh all-time highs next quarter.

Yes, sentiment was really bad, but go back and reread my two pieces on Canaries in the Coal Mine. The big picture did not look unhealthy a few weeks ago and certainly does not today. The market was due for some cleansing and the job is getting done now. Stocks should begin to probe for a low shortly between current levels and 4% lower. Technical damage has been relatively mild so far and it’s time to make our shopping list.

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Sector Canaries Singing but Quietly

With the major stock market indices all in good shape beyond the short-term pullback, let’s take a look at the key sectors and two other important canaries.

The banks are first and they remain mired in a trading range for the past year. Before the last bear market, banks peaked a good nine months before the major indices did. In the Dotcom bear market, banks topped a full 18 months before the overall market did. As a bull, it would be very positive to see the banks exceed the level last seen at the end of 2014, roughly 5% higher.

 

Semiconductors are below and happily sitting at fresh 14 year highs. They are a vital sector because so much technology starts with a semi chip. As go the semis, so goes tech. And as goes tech, so goes the rest of the market. As I mentioned in my 2015 Fearless Forecast, I believe semis finally see all-time highs this year, exceeding the Dotcom bubble peak from 2000.

 

The transports are next and can be viewed both positively and negatively depending on your bias. They are entering their fourth month in a trading range with lower band much more defined than the upper. I downgraded them to neutral in early December (and sold them) when they stopped rallying as crude oil collapsed. That shouldn’t have happened in a strongly bullish scenario. While they still look a bit sloppy, given my more long-term positive outlook, I expect them to resolve the trading range to the upside in a big way by summer. For now, you would have to rate their divergence or inability to keep pace with the Dow Industrials above as a small negative.

 

 

My two favorite canaries are next. The first one is the cumulative New York Stock Exchange Advance/Decline line, which is just a fancy name for keeping track of the numbers of stocks going up and down on a daily basis and put on a chart. Using words like “always” and “never” are not prudent in this business, but the NYSE AD line is as close to a “never” as it gets. The stock market almost never tops out with this indicator at or near all-time highs as it is today. Before a bear market begins, we usually see this indicator peak 3-20 months before the major stock market indices, which signals that fewer and fewer stocks are participating in the rally.

 

 

Finally, you can see a chart of the PIMCO High Yield Fund, which for full disclosure we own in two strategies. I use this a proxy for the junk bond market along with the exchange traded fund JNK. Junk bonds are among the lowest credit quality in the fixed income space and are acutely sensitive to ripples in the financial system’s liquidity stream as well as the economy. They are the ultimate canary in the coal mine. As the economy very slowly and slightly begins to weaken, investors start to worry about these companies defaulting, long before the GDP numbers roll into recession. While high yields bonds may give too many early warnings, they typically don’t miss the big one.

 

 

Overall, the sector canaries are neutral to slightly positive, but the NYSE AD Line and high yield sector are strong. The likelihood of a bear market from here is very small.

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