Tuesday, March 31, 2015

Trend is Your Friend

The Irrelevant Investor Blog hit on an interesting topic today and it's something that we've wanted to touch on.  We employ a slightly different method for long term moving averages (12-month vs their use of the 10-month) but the idea is the same.  We've referenced this trend on several occasions and offered that, from a tactical perspective, it's useful when attempting to be on the right side of a market trend.  When the S&P is above the 12-month simple moving average you want to explore opportunities from the long side and vice versa when the index has fallen below the measurement.

As of today's close, we'll have wrapped up the 39th consecutive month of closes above the 12-month moving average.  To put this in perspective, the current streak is the 3rd longest since 1960.  However the longest streak lasted 56-months during the 2003-2007 bull market.  So while we may feel extended, history suggests that there could be plenty of upside remaining.  What's to stop this current streak from eclipsing the 56-month record.  Trying to call a top and time frame of this current bull is an exercise in futility.  But we can use historical context to gain helpful perspective.  Naturally the longer we continue this streak the more likely we are to experience a correction.

For now the trend is your friend until the end.  That's when the fun begins!

Sunday, March 29, 2015

Week in Review (3/23 - 3/27)

This week signaled another test of the 50-day moving average and the lower trend line in the S&P 500.  The index finished the week down 4 out of 5 days en route to a 2.25% loss since last Friday's close.  In fact it hasn't had a two day win streak since the middle of February.

2015 started out with an incredibly choppy market and March has been no different.  The S&P started the year with a decline of 3% in January, followed by a 5% February rally and now it sits down 2% for March and flat for the year.  That's a lot of action and little to show for it.

We have the potential for double tops in the S&P 500 and Nasdaq on shorter time frame views while the NYSE has yet to breakout of a large 9 month consolidation.  The VIX rallied this week but hasn't yet reached levels seen at other recent short term bottoms.  This could put the odds of a bigger pullback into play.

Meanwhile, the previously leading small caps (IWM) had their biggest one day fall since the October bottom.  What's interesting about this chart, which plots the daily % return (ROC) in the bottom panel, is that the Russell 2k had this big drop while near 52 week highs.  During the run-up since 2013 of most the big down days have occurred closer to bottoms and after some significant weakness.

This type of back and forth action is symptomatic of an uncertain market.  You can take your pick of what to worry about: the Fed raising rates, oil, middle east, strong dollar, earnings estimates.

One of our priorities in these types of environments is to identify trends and see where money is flowing.  Right now we see that conglomerates took the brunt of the selling while basic materials held up best.  Healthcare, technology, and financials also sold off and if we drill down to individual industries, we see that biotech's had a huge reversal off highs but found some footing on Friday.   An easy way to find what was moving during the week is this color coded ETF heat map from Finviz

We touched on the dollar in a recent post and it continues to bear watching.  After hitting significant overbought levels (RSI) the dollar made a visit to the lower channel line and looks to be attempting to stabilize and hold this level while working off overbought conditions.  This could eventually set the stage for another move higher. 

Thursday, March 26, 2015

CFA Annual Dinner - Volatility, Risk and Permanent Loss of Capital

Last night, we had the pleasure of attending the CFA Society of Washington DC's annual dinner as guests of Ian Asvakovith and his great team at Piedmont Fund Services.  The event's keynote speaker was Cliff Asness, PhD, Managing and Founding Principal at AQR Capital Management.  We've read Cliff's analysis for a long time but this was our first opportunity to hear him in person.

His talk focused on his Top 10 Peeves in terms of commonly held investing beliefs.  The list was definitely thought provoking and grabbed our attention immediately as his first peeve was a topic we've often debated.  It centered on the relationship between volatility, risk and the permanent loss of capital and the widely held concept that the true definition of risk is the chance of losing money and never getting it back.  The peeve which he'd titled as "Volatility is for Misguided Geeks; Risk is Really the Chance of a Permanent Loss of Capital" bugged him for several reasons and one of them particularly resonates with us.  In his words:


"Think about a super-cheap security, with a low risk of permanent loss of capital to a long-term holder, that gets a lot cheaper after being purchased. I—and everyone else who has invested for a living for long enough—have experienced this fun event. If the fundamentals have not changed and you believe risk is just the chance of a permanent loss of capital, all that happened was your super-cheap security got superduper cheap, and if you just hold it long enough, you will be fine. Perhaps this is true. However, I do not think you are allowed to report “unchanged” to your clients in this situation. For one thing, even if you are right, someone else now has the opportunity to buy it at an even lower price than you did. In a very real sense, you lost money; you just expect to make it back, as can anyone who buys the same stock now without suffering your losses to date.

If you can hold the position, you may be correct (a chance that can approach a certainty in some instances if not ruined by those pesky “limits of arbitrage”). For example, when my firm lost money in 1999 by shorting tech stocks about a year too early (don’t worry; it turned out OK), we didn’t get to report to our clients,“We have not lost any of your money. It’s in a bank we call ‘short NASDAQ.’” Rather, we said something like, “Here are the losses, and here’s why it’s a great bet going forward.” This admission and reasoning is more in the spirit of “risk as volatility” than “risk as the chance of a permanent loss of capital,” and I argue it is more accurate. Putting it yet one more way, risk is the chance you are wrong. Saying that your risk control is to buy cheap stocks and hold them, as many who make the original criticism do, is another way of saying that your risk control is not being wrong. That’s nice work if you can get it. Trying not to be wrong is great and something we all strive for, but it’s not risk control. Risk control is limiting how bad it could be if you are wrong. In other words, it’s about how widely reality may differ from your forecast. That sounds a lot like the quants’ “volatility” to me."


We are in total agreement with him here and likewise agree that both sides can hold truths on this topic.  However for those (read: the buy-and-hold crowd) arguing that risk is only the likelihood of a permanent capital loss, they seem to be operating under the assumption that their initial forecast of outcomes will absolutely occur while discounting the scenarios of being wrong.  This type of mindset seems terrifying to us and particularly so if a group is operating in a fiduciary capacity and managing investor capital.  There are instances like his tech bubble example where managers had to wait years for their short thesis to be proven correct.  In the meantime, they had to face mounting losses and very likely some incredibly impatient clients.

We believe that one must always be assessing the chances of their thesis being wrong.  Actually, there's likely no better way to gain confidence in your positioning than constantly trying to poke holes in it.  Maybe that makes us seem like wimps but we'll also never be caught operating under the assumption that we're smarter than the market.  And we're fine with that.

Tuesday, March 24, 2015

Catching Up on the Week That Was

Forgive us for staying quiet on the blog over the weekend.  We had the opportunity to attend the Arnold Palmer Invitational in Orlando on Saturday and Sunday.  It's quite an event they put on at the Bay Hill Course and Sunday's closing holes were awesome to witness.

With that in mind, we wanted to circle back and touch on last week's action as there were some significant events.  For the week almost everything was positive with the Federal Reserve press conference working the market into a buying mood.  It seems investors were positioned for one thing and Yellen and company delivered the opposite, catching most off guard and forced to buy in a frenzy.


The Nasdaq, Russell 2k, and S&P Midcap all finished the week in new high ground.  The S&P 500, Dow, and NYSE continue to lag but are not far behind with new highs approaching.

One nice positive was the expansion of breadth during last week's move to the upside.  This came as a welcome sign as breadth has frequently shown negative divergence during several of the market's recent moves higher.  Below is a chart of all US 52-week highs minus lows (aka Net New Highs).  We got the highest reading since last summer. 

Moving on to this week, there remains a lot of talk about a biotech bubble.  Everyone loves to try to call the top but very few can actually do it.  Regardless, we'll let others argue that topic.  Yesterday started off with biotech's getting whacked hard and this is not a surprise for any sector that's experienced such a run.  Here, Ben Carlson takes an interesting look at the recent run in biotechs compared to the Nasdaq bubble of the late 90's.

But if we step back and look at a longer term weekly chart of the IBB, we can see a well defined channel has formed from late 2011.  However, we are currently closer to the upper channel line suggesting further/immediate upside could be limited.  Then again, there's always the potential for a parabolic move higher which would surely bring the bubble theory a bit more relevance.

For now the general market continues to grind higher as volatility remains low and supported by accommodative global monetary policy.  We don't think returns will be as easy to come by as prior years but there could still be plenty of upside left in this bull. 

Thursday, March 19, 2015

The Fed to the Rescue....Again

Janet Yellen and the Federal Reserve once again sang the type of tune the market had hoped to hear. The Fed's March commentary and press conference were yesterday and in the minutes leading up to their release, the S&P 500 was trading at 2,061 and down more than half a percent on the day.  Immediately upon their release, the index shot skyward and ultimately finished the day with a 1.3% gain.  Once the market had gotten its reassurance that Chair Yellen and Co. would continue to be incredibly deliberate and, yes, patient in their decision to raise rates, it was off to the races.  Stocks couldn't be bought fast enough for the rest of the afternoon.

The Fed appears to remain unconvinced of the sturdiness of the economy's footing and stated that they would like to see continued job growth along with a reasonable confidence that inflation will move back to its 2 percent objective.  Meanwhile the market had again prepared itself for the worst and priced in too much worry about what Ms. Yellen might say.  The reaction highlighted the accuracy at which the Fed Funds Futures market has displayed in predicting recent monetary policy.

This from Convergex:

Given that the Federal Reserve has as much trouble calling the pace of the U.S. economy as anyone else, it makes sense to look at the Fed Funds Futures market from the CME Group for another take on the trajectory of short term interest rates.  Here’s what prices there have to say after the Fed’s meeting and Chair Yellen’s press conference:

·The Federal Reserve will lift rates for the first time in September of this year, increasing Fed Funds by 25 basis points. 

·There is a reasonable chance of a second rate increase – also 25 basis points – at the October meeting, but more so in December.  And that’s it for 2015 – a forecast of 0.5% Fed Funds (44 basis points to be precise, indicating some uncertainty about the second move) versus the FOMC’s own 0.625%.

·In 2016, Fed Funds Futures currently price in a year-end rate of 1.25% (allowing for a little rounding – the actual number is 1.235%).  This would mean 3 rate bumps next year of 25 basis points apiece, plus a small chance for a fourth of the same magnitude.  The FOMC’s own median estimate is 1.625%. 

·In 2017, the spread between FOMC estimate and Fed Funds Futures really begins to grow.  The Fed’s dot plot currently shows a median observation of 3.125%. Fed Funds Futures register a 1.895% forecast.  To put this in context versus rates today, that is the difference between 12 rate increases of 25 basis points (Fed projections) and just 7 moves (Fed Funds Futures).

Why should you listen to the future market rather than the Fed?  The simple answer is that the marketplace has been able to predict where the FOMC was going with monetary policy long before the central bank updated its projections.  For example, Fed Funds futures for December 2015 predicted back in October 2014 that the Fed was unlikely to move more than twice in 2015, ending the year at 50 basis points.  The Fed’s dot plots from the September 17th meeting still showed an expected year end 2015 rate of 1.375%. The market was right; the Fed moved right to where Fed Funds Futures said they should be.  It just took 6 months to get there.

All this presents us with one clear message: given that the Fed Funds Futures market is forecasting a much slower climb for short term interest rates over the next two years than the central bank itself, there is ample room for more positive surprises like the one we had today.  Both U.S. stock and bond markets – and currencies for that matter – clearly priced in too much worry about the Federal Reserve lifting rates quickly in 2015. Now, we will likely have a period where asset prices will correct to the upside in both domestic fixed income and equities.  Will that be enough to pull some money back from the crowded trade of “Long euro equities, short euro currency”?  Perhaps, given how underweighted many hedge funds may be to U.S. stocks. Even if it isn’t, we’re likely to see a follow-on rally in U.S. large cap stocks through the end of the quarter.

Dave again - Convergex presents some interesting thoughts above.  While we hope their forecast of more upside for equities in the near-term proves accurate, we definitely get the feeling that looking further out, there will be more bouts of volatility in and around Fed events as the year progresses.

Given the topic, now's a fair time to share a chart from Bespoke that we first posted a few months back.  It signals that for all the volatility that recent Fed announcements have brought, history tells us that performance for equities has been incredibly strong in the months leading up to initial rate hikes.  Meanwhile the 2nd chart gives us a longer term sense of what rate hikes have meant for stocks over the last few decades.

Tuesday, March 17, 2015

Nasdaq Post-Streak Performance Update

The Nasdaq posted its 10th and final day of its consecutive day uptrend on February 24th.  The index closed that day at 4,968.12 and we posted commentary highlighting what history told us could be in store after such a surge.  As our previous post suggests, the index has been prone to initially pulling back after these uptrends.  The theme has been for the Nasdaq to fall over the first month or so before resuming higher as we look a quarter out.

We've now had 15 market days since that day and wanted to take a look at the early results:

Day 5 (March 3rd) - Nasdaq closed at 4,979.9 for a gain of 0.237%

Day 10 (March 10th) - Nasdaq closed at 4,859.79 for a loss of -2.181%

Day 15 (Today) - Nasdaq closed today at 4,937.43 for a loss of -0.618% since the last day of the streak.

Friday, March 13, 2015

Week In Review (3/9 - 3/13)

We finished the week with all indices finishing deeply in the red but a late day rally did help soothe some of the pain. What remains is a challenging and volatile market with wild swings back and forth based on a multitude of factors and excuses.  Investors are hearing daily chatter about the strength in the dollar, weakness in the Euro, oil prices, earnings and now Putin's health. The one common theme is they are all excuses and no one knows where the market is going.   A current snapshot of the S&P displays the type of uncertainty that leads to choppy markets. 

In an effort to see where money is flowing on a weekly basis we like to look at simple weekly performance metrics of certain sectors, industries, countries, and market caps.  A simple bar chart from Finviz presents an easy comparison.  We can gather a few facts from the two charts below.  Money continues to chase anything health care related while the utilities have stabilized after a few rough down weeks.  Basic materials were hit the hardest by a wide margin.  If we switch to weekly performance sorted by market cap, large caps have been sold more aggressively than their small cap peers.  What's learned from this quick exercise?  The strength of the dollar is continuing to dominate the macro landscape as bigger cap names that have multinational exposure are showing more weakness.  In the meantime money is hiding in smaller domestic ideas.  Dr. Steenbarger touched on this topic in an earlier blog post. 


We are still slightly oversold at current levels.  And considering how weak the markets reacted yesterday after Thursdays rally, some areas may need to be breached to the downside in order for a sustainable bounce to happen.

Our favorite reads from the week:

Today's fun fact is from   

Today is the worst Friday 13th for since -1.25% in April 2012. Worst Friday 13th ever was -6.12% in Oct 1989.

-Raymond James with comments on Thursday's strong bounce

-Some commentary on the US Dollar's rise and the impact on the stock market

-There's been some interesting debate recently on whether or not cash should be considered an asset class

-Fidelity's Jurrien Timmer on what could push stocks higher

Have a great weekend!

Thursday, March 12, 2015

An Updated Look at Sector Correlations and More

Identifying short term tops and bottoms is an incredibly difficult task and something that is unlikely to be done with any consistent certainty.  We choose to follow a specific set of indicators in an attempt to gain a sense of when the market might be putting in a top or bottom over various timeframes.  

For instance, in our Tuesday post, we highlighted the McClellan Oscillator, bollinger bands, stochastics and simple trend lines to show that while the market had moved lower rather swiftly, it had yet to start flashing the oversold extremes that we prefer to see.  

Another indicator we wanted to revisit is the rolling 20-day correlations of several key S&P 500 market sectors.  Simply told, the sectors within the index become highly correlated when the market gets really oversold because people just want to get out.  We've posted on the topic before and think it's really useful when trying to zero in on extreme readings.  As of yesterday, the indicator had yet to reach levels that have been typical of recent short term bottoms.  If you look at the data going back to 2013 in which the "buy the dip" strategy has ruled, we want to see correlations quite a bit higher than where they currently stand before declaring a market bottom.  As with any other indicator, there's absolutely zero chance this measure is infallible on its own but we like to see scenarios where it backs up/compliments the other gauges we follow.  While we're seeing a strong bounce in the market today, we'll be keeping an eye on sector correlations to see how they respond.

Another area we are focused on just like every other talking head is the dollar.  The chart below shows the rapid advance in the last 6 moths.  The USD is currently trading near its upper channel line.  This could act as resistance and bring about some weakness in the near term.  As part of our scenario analysis we've been scanning to see what effect a potentially weakening dollar would have on equity prices.  In fact, if you've yet to start investigating the matter, the Fat Pitch Blog just published his findings and they'd be a great place to start.  His stats show a very mixed bag.  We're going to keep digging.