October 10th, 2012

Assessing Market Opportunities and Risks

It’s been some time since I last posted because, well, because there wasn’t much new or much positive to write about.  As a matter of fact, the last time I wrote about the market was on August 29 in “Every Trading Range Is Not a Reversal Top“; the market is a mere 1.56% above the level at that close.

I pretty much fully invested now; I like most of the stocks I own since I’ve been cleaning house as this bull run has progressed.  There are a ton of stocks that look like they, along with the over-all market are struggling to clear an intermediate sort of resistance level (the market Index may actually be stuck in the claws of a tiny “buyers’ remorse” correction after having barely crossed above that resistance at 1420-1425.

One must always evaluate the market in two ways : what are the upside opportunities and what sort of downside reversal risks are there.  When I step back today from the market’s day-to-day noise, I see upside potential to the 1567 all-time high level.  However, I also see what I hope will be only short-term obstacles.

My longer-term optimism comes from the fact that the market has steadily crawled up the lower boundary of an ascending channel emanating from last year’s low connecting with this year’s March low.  The parallel upper boundary of the channel conforms nicely.

Furthermore, this spring’s correction can be interpreted as a flag pattern.  Traditional chart reading rules of thumb suggest that the consolidation pattern will be approximately midway between the trough of the channel and the peak.  If that turned out to be true, then the peak should be somewhere in the 1600 area (1410/1125*1280), or not far from the all-time high.

The fly in that ointment is volume which just doesn’t seem to be cooperating so far.  Since 2011, the 50-dma of daily volume of the S&P 500 stocks has been trending lower (with the exception of last summer’s correction).  Even more ominous is the divergence that’s emerged between the Index levels and the on-balance-volume.  For those who need a refresher, OBV is Joseph Granville’s indicator in which volumes on up days are added and volumes on down days are subtracted from a rolling total.  A declining OBV indicates that volume on days when the market closes lower tend to exceed the volume on days when the market rises.  A divergence indicates that a rising market isn’t supported by adequate volume.

There’s sufficient cash on the sidelines waiting to be put to work and fixed income with it’s low rates isn’t the place to put it anymore.  ZeroHedge had an interesting piece this morning entitled “Are Businesses Quietly Preparing For A Financial Apocalypse?” about all the cash sitting on corporate balance sheets.  If the uncertainty coming from Presidential Election, Fiscal Cliff and continuing Eurozone saga then a good chunk of that money, both investor and corporate, could come into the stock market and make up for the volume drought.

While prices haven’t indicated a reversal process emerging yet, there sure are a lot of risks out there, both fundamentally and technically.

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May 9th, 2012

Buffett and Precious Metals

It’s been some time since last discussing precious metals so I thought I’d revisit those charts to see if something new might be revealing itself.  What struck me was the near perfect patterns in both the charts that stretch back almost a year to the early days of the European sovereign debt crisis began in August 2011.  The only problem is that one can interpret the emerging patterns as either consolidation (flags) or as reversal (right triangles or head-and-shoulders) depending on whether you’re a gold bug or Warren Buffett.  On CNBC this past Monday, Buffett stated that

When we took over Berkshire, it was selling at $15 a share and gold was selling at $20 an ounce. Gold is now $1600 and Berkshire is $120,000. Or you can take a broader example. If you buy an ounce of gold today and you hold it at hundred years, you can go to it every day and you could coo to it and fondle it and a hundred years from now, you’ll have one ounce of gold and it won’t have done anything for you in between. You buy 100 acres of farm land and it will produce for you every year. You can buy more farmland, and all kinds of things, and you still have 100 acres of farmland at the end of 100 years. You could you buy the Dow Jones Industrial Average for 66 at the start of 1900.” Gold was then $20. At the end of the century, it was 11,400, and you would also have gotten dividends for a hundred years. So a decent productive asset will kill an unproductive asset.

As is usually true with statistics, there are several interpretations depending on what you’re trying to prove.  Forbes points out in that same article that Berkshire would have outperformed gold over the 20 years since Buffett started Berkshire Hathaway but the reverse was true over the last 10 years as gold far outshined Berkshire stock.

What do the charts say?  Again, it depends on the frame of mind of the observer:

Both charts contain familiar features:

  • descending channels;
  • potential necklines;
  • a zone that could indicate whether the controlling pattern is a consolidation or reversal;
  • lack of clarity as to whether price will cross below the potential neckline

I’m not an economist but it would seem to me that with all the uncertainty surrounding the future of the Euro money would continue to boost the prices of precious metals.  Instead, Euro Zone investors have been dumping money in what they assume to be the world’s last safe haven, the $US … even when they earn near next to nothing.

But with another round of our own debates on our deficits, federal budgets and taxation coming at the beginning of the year after the Presidential election, so analysts say it’s going to be like falling off a cliff.  If anything happens to interest rates here it’s going to have to be that they go higher and bond prices are going to decline.  Foreign investors are going to begin seeing increased risk in US bonds and will jump ship quicker than they climbed on board.

With all that upcoming uncertainty in the $US, I can’t imaging that the emerging pattern in precious metals isn’t a consolidation and, with all due respect to Warren Buffet, there won’t be another run higher beginning towards the end of the summer.  For all those conspiracy afficionados out there, perhaps Buffett wants us all to sell our gold so that he can scope it up at this price and lower.  After he’s bought all he wants and these prices , he could even come back in August and say that everyone should own some gold and thereby start pushing the price higher.  He’s a nice guy but he didn’t get to be the richest man by being a sweetheart.

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December 19th, 2011

Shorting Treasuries: Conventional Wisdom Gone Awry

One of the perplexing aspects of the monetary and fiscal issues  around the world (especially here in the US) has been the absence of inflation and the strength of the $US.  In “Short TLT Rather Than Be Long TBT” (January 2010), I quoted from the NY Times:

“Liquidating investments that pay almost nothing in order to shift to long-term bonds that pay substantially more may not make sense right now, said Robert F. Auwaerter, the head of fixed-income investing at the Vanguard Group….interest rates — at both the short and the long ends of the yield curve — are likely to rise this year if the economy keeps expanding…..When bond yields rise, their prices fall. The effect is magnified for longer-term securities, so a 30-year Treasury bond would fall in value much more sharply than, say, a six-month Treasury bill.”

That was the conventional wisdom and has continued to be for some time.  To take advantage of what seemed patently obvious, one could play the rise in Treasury bond yields by either buying TBT, the ultrashort ETF or shorting TLT, the ultralong ETF.

But this was just another case of conventional wisdom goes awry.  The turmoil in Europe has caused money there to seek out a safe haven and,  as incredible as it is, that safe haven has been the $US and US Treasuries.  Rather than seeing yields rise as prices decline, rates continued to decline to historic lows.  Holding TBT in the expectation of rising rates has been an unmitigated disaster for all those holding TBT:

20-yr Treas Yields vs. TBT 2010-2011

Not only have yields declined rather than rising this year causing TBT to also decline but TBT has declined further on a relative basis (some of the difference is compensated by dividend distributions).  Holding TBT in the hopes of increases in yields due either to inflation or fears brought on by the budget disputes has resulted in a nearly a 50% loss.  If interest rates reverse and return from the current 2.5% to above 4.0%, the levels it was at the beginning of the year then TBT could be expected to nearly double.

It could be a long wait but perhaps at this point one that might be worthwhile.

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January 16th, 2010

Short TLT Rather Than Be Long TBT

There’s been a lot of focus of interest rates recently as they finally start edging higher because of the magnitude of the Federal deficit. For example, the NYTimes, in an article entitled “For ‘Safe’ Investors, This May Be a Challenging Year”, pointed out that

“There are many indications that this herculean intervention has been working. In the bond market, though short-term interest rates are still hovering near zero, longer-term rates have been on an upward trajectory since late November….”

but

“Liquidating investments that pay almost nothing in order to shift to long-term bonds that pay substantially more may not make sense right now, said Robert F. Auwaerter, the head of fixed-income investing at the Vanguard Group….interest rates — at both the short and the long ends of the yield curve — are likely to rise this year if the economy keeps expanding…..When bond yields rise, their prices fall. The effect is magnified for longer-term securities, so a 30-year Treasury bond would fall in value much more sharply than, say, a six-month Treasury bill.”

While fixed income investors may be enticed to switch from the ultra-safe but low yielding money market accounts to higher-risk, higher yield long-term bonds, we stock and ETF investors have another possible trade.

Many recommend the purchase of TBT, the Proshares Ultrashort 20+ Year Treasury ETF (in full disclosure, I’ve owned TBT since August after writing about it last August in “Life Insurance Stocks: GNW, HIG, LNC, AZ, PFG and Others). This ETF purports to be a mirror image of the trend of 20+year Treasury bonds. As long-term interest rates edge higher, long-term treasury bonds should, theoretically, decline in price. Being an “ultrashort” ETF means that the price of the ETF should increase in value at twice the rate at which the average price of 20+year bonds decrease in value.

The reciprocal of the TBT is TLT, the iShares Barclays 20+ Year Treasury Bond Fund. This ETF mimics the long-term interest rates. When interest rates decline, TLT increases in value; when rates increase, TLT should follow bond prices and decline.

Investors who want a quick and easy way of playing an expected increase in interest rates would be either to buy the TBT or short the TLT (or buy calls or puts, respectively). So I thought I’d check out how these two ETF’s have performed over the past year and a half, since Labor Day, 2008:

I created an index for the values of each of TLT, TBT and 20+year interest rates with August, 25, 2008 set to 1.00. The scale for TLT (the “long” ETF for 20+year bonds in red) is on the left while the scale for TBT (in blue) and interest rates (in green) is inverted on the right-hand side of the graph.

I was shocked. While interest rates and TLT work very closely together (by the way, cumulative dividends paid on each of the ETFs were added back in order to show a true total return for the period), TBT has been falling far behind. Interest rates on 20+year Federal debt today is about at the same level it was on 8/25/ 2008 and TLT (after cumulative dividends are added back) are at the same level as they were on 8/25/2008. On the other hand, TBT (after its only dividend of 9/24/08 was added back) is 25% less than it was on 8/25/2008.

While TBT and TLT correctly work (in opposite directions from one another), the volatility of TBT falls behind that of TLT. This may reverse in the future and TBT may catch up with TLT but someone looking at interest rates rising over the next 6-9 months or more could have better results shorting TLT than buying TBT, even if the latter is supposed to be twice as volatile as the underlying security.

October 29th, 2009

Managing Portfolios Today With Three Indicators

I don’t know how many of you are full-time traders, how many self-manage your portfolios on a part-time basis or how many visit here only periodically to get a different take on the market, something that you can take back to your financial advisers just to let them know you’re looking over their shoulder.

But I spend most of my day with my Fidelity trading platform (Active Trader) running on one screen and my charts or whatever else I might be working on, reading or playing (I’m a mediocre chess player) on another screen. Furthermore, as the day progresses, I have either Bloomberg or CNBC running muted over my desk so I can see how the market is doing and watch for any major news headlines. Periodically during the day, I calculate how closely my portfolio tracks, percentage wise, the S&P in the hope that it does better than the benchmark index (either gaining a greater percentage or losing less of a percentage).

The reason I tell you this is that I find that my portfolio rarely ever moving opposite the benchmark. They usually move in tandem, it’s only a matter of degree. So managing my portfolio is rather simple. It’s essentially a cash, or risk, management decision: how much do I want to have at risk given what I see happening in the market and only secondly in what types of assets it should be invested. In short, the portfolio management decision is essentially a market timing decision. I spend most of the time trying to figure out whether the direction of the market’s trend has changed (the answer I share with you).

As an aside, I went to an MTA (Market Technicians Assoc.) meeting last night and heard an excellent presentation by Frank Teixeira, of Wellington Funds and the manager of John Hancock’s new Technical Opportunities Fund that I’d like to share with you. One of his points that obviously resonated with me, is that more and more institutional investors are disappointed with Index funds or the notion that “there’s always a bull market somewhere” and it’s only a matter of finding it. They’re disappointed in “buy-and-hold” since the strategy since 1999, a long ten years, has led to returns only marginally above break even. Given the two market crashes since 2000, the objective now is managing risk and the tactic is to consider cash a safe default investment.

He also said that the world of investment alternatives has greatly expanded with the introduction of all sorts of etf’s and adr’s. There’s no way one person can become familiar with all industries, all commodities, all interest rate trends, all currencies around the world. But the worldwide search for investments can be narrowed by using technical analysis (studying trends) and looking at charts. Human behavior, as represented in price trends (charts), is the same around the world for all assets.

Having said that, the key to where the market will be next March can be found, I believe, in essentially three areas: 1) the foreign exchange value of the $US, 2) monetary policy as reflected in interest rates and 3) the US economy as reflected in the S&P 500 index. [The only thing that has a significant impact on our portfolios but we have no way of predicting or monitoring is what Congress does with income taxes.] Here are the relevant charts:

  • $US: If this were a stock chart you wouldn’t consider anything in the price action to indicate that a bottom has been reached and that a reversal pattern is being formed. If this were a stock, the only safe assumption would be that, at best, the downward trend remains in tact and, at worst, it will remain at current levels for a while (a couple of months) before turning back above 78.
  • 20+ Year Long-term Treasury Rates: When interest rates increase, bond prices fall and vice versa. If this were the a stock’s chart, I would sell or short it. Moving averages indicate that longer-term trends have turned down (how could they not have from the historically low current rates) and there’s higher interest rate (lower bond prices) since the chart depicts a possible head and shoulder pattern. [A caveat is warranted here. Treasury Bond ETFs are relatively new so there’s no history of how the ETF will perform over a wider range of interest rates.]
  • S&P 500: This is what we’re all interested in. If the neckline of the inverted head-and-shoulder that everyone now believes was the bottom is the mid-point of the move from bottom to top (a standard technical charting conventional rule), then the full extent of the bull market run could be to 1328. But the full move can be divided into two, separated by a period of consolidation. We could no be seeing the beginnings of that consolidation (given that volume supporting further upside is waning as indicated by OBV diverging from price).

Bottom line? We are in or very near a consolidation. It’s best to reduce exposure to risk by increasing cash relative to investments (I’m currently at 10% and plan to increase to 25% at the next opportunity). Looking at the above exchange and interest rate trends, I will look for investments that take advantage of those trends. But until the market indicates otherwise, the correction should be short with another leg up possible sometime in 2010. As Teixeira said, this first phase of the recovery has seen “a rising tide lifting all boats”; the next phase will see much more divergence among stocks, between the leaders, the average and the laggards.

November 17th, 2008

The Parking Lots Called SHY, TLT, IEF and AGG

I feel the tension in the air. Everyone is looking for an answer to the question of when all this anxiety and pain are going to end. You listen to one talking head and he/she asks “where will all the money that’s standing on the sidelines be put to work?” Another one says, “there are potentially several million of unemployed workers if this slowdown can’t be stopped in industries as varied as auto manufacturing, retail, newspapers, real estate, basic materials, etc.” A third says “it’s going to be 2-3 years before we see any daylight.”

Is there anything we can learn from history? At the risk of appearing to beat a dead horse, here’s one view (the 2003 bottom):

Let’s compare that with what we’re suffering through today:

The only thing I can say with complete confidence is that a bull market won’t be returning in 2009; perhaps it will be 2010.

The remaining question (for those of us who are primarily in money market funds) is what to do with the money over the forseeable future. There’s nothing to indicate buying significantly marked-down large caps is yet safe. Selling short after an average 50% crash in the stock prices seems like a risky strategy. Putting money into tax-free state bonds or ETFs doesn’t look safe either given the revenue shortfalls that have begun to appear on state, municipal, school, highway authority and other budgets (take a look at the Nuveen tax-free ETFs like NXP).

Perhaps the only safe securities are government bonds (or ETFs like SHY, TLT, IEF and AGG). They’re currently yielding 4.2-4.9% in dividends (actually, interest less management fees) which is better than money market rates. Not great but a fairly safe lot to park in.