Category Archives: Technical Analysis

February 16th, 2012

Parallel trendlines for positioning targets

There are those who follow Bob Prechter, one of the strong proponents of the Elliott Wave principles have their ways of identifying price level targets.  And then there’s the crowd who hide out at Slope of Hope, the place where perma-bears can always find a reason for an impending correction or “much welcomed” bear market crash through targets derived by their overly precise application of arcane Fibonacci mathematics.  But I’ve always found a rather simple approach to projecting out potential targets by applying a resistance trendline parallel to the corresponding supporting trendline and thereby creating a channel.

Take for example XHB, the homebuilders ETF.First, you should note how reversal and consolidation patterns easily morph from one form to another without a general market tailwind.  Until last summer’s meltdown due to the domestic budget and European sovereign debt crises, it looked as if XHB would break out the upside of a symmetrical triangle.  Since last summer’s 30% decline, it now appears that pattern has morphed into an ascending triangle and, with cooperation of a more constructive general market backdrop and expectations for finally an improved housing market, that upside breakout might now be at hand.

If break out does materialize, the next question is what might be a reasonable target for the move higher?  Consider a parallel line as on benchmark:

Parallel lines are simplistic and anything but elegant but they usually work.  They definite position a target for one’s expectations.  They won’t let your dreams run wildly out of control and add a time dimension to a price expectations.

Reality never really works so perfectly but, if the market and XHB dramatically diverges from this trajectory then we can make mid-course adjustments when and to the degree necessary.

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February 9th, 2012

Will the Market Soon Cross into All-time New-High Territory?

There’s no question about it, I’m definitely in the minority.  First I wrote a piece entitled “KISS in Market Timing Too” in which I compared my approach to a complex algorithm developed by Ciovacco Capital Management called the Bull Market Sustainability Index (BMSI).

I followed that up with a piece yesterday entitled Market Momentum Turning, But Will It Accelerate? in which I see each of the four moving averages that I use in my Market Momentum Meter market timing tool having turned up and soon approaching a perfect bullish alignment (50-dma>100-dma>200-dma>300-dma).

Now I see something written by Ray Barros in Green Faucet entitled “S&P Nearing A Top?” in which he lists the following six indicators that have convinced him that the market is just one step like the failure of Greece debt negotiations away from collapsing into a bear market. Those six technical indicators are:

  • Price – Structure: The 12-Month Swing and 13-week swing show we are in a sell zone. Figure 3 shows that since the Dec 2, 2011 that the up move has been on declining volume and range. In this context this is bearish.
  • Time: Kress Cycles suggest we are in a window when a top is likely.
  • Momentum: Figure 4 shows that this up move has been on declining momentum.
  • Sentiment: The sentiment indicators I use suggest the S&P is skewed to the upside.
  • Normalised Volume: We saw a sell setup with ‘below normal range’ and ‘normal volume’.
  • PoMo: For me, this indicator generated a sell signal today.

He even includes charts depicting each of the above as supporting evidence like the one below:

However, I looked at those charts and what struck me was that: 1) they were so complicated and there was so much to digest that I couldn’t possibly make heads or tails of them and 2) I wondered what those signals might indicate if we hadn’t been in a secular bear market for the past 11 years.

The answer to his question of whether the market is approaching a top is definitely yes!  I have little doubt that the market will approach the previous all-time high of 1576 sometime this year or next.  The correct question to ask is will the market soon scale to new heights and cross into all-time new-high territory?”  Since my Market Momentum Meter is turning bullish at these loft levels, I hope the answer is yes and I think the answer will be yes.

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February 4th, 2012

FAST: Two Views from the Heart and the Mind

I’m always intrigued by those who go to lengthy extremes when comparing the Fundamental and Technical approaches to analyzing stocks.  For me it’s rather simple; I consider the Fundamental approach as the one using the heart while the Technical approach uses the head.  Fundamentalists point to their belief and their feelings about such factors as future earning results, growth rates and valuation multiples.  Technicians point to actual historical trading results and project those results into the future assuming all conditions remaining constant.

A  perfect example was a recent post by Chuck Carnevale entitled “Fastenal (FAST): A Vivid Case of Overvaluation. Carnevale’s case is that

“From 1994 to 2008 the Fastenal Company grew earnings from $.6 a share in 1994 to $.95 a share by 2008, resulting in a 23.7% compound annual growth rate. The normal PE line depicts a trimmed (the highest PE and the lowest PE trimmed) average PE ratio of 36.3, this simply indicates that the market has often priced this company at a peg ratio in excess of one. On the other hand, it is clear from the picture that the stock price often moved above and below the normal PE, and in many cases traded at its orange earnings justified valuation line…

 

…since calendar year 2010, Fastenal Company has grown earnings at the average rate of 33.9% per annum. This accelerated earnings growth should be considered as coming off of the low base which was created by the recession of 2008. Furthermore, we believe this accelerated earnings growth greatly attributes to the company’s current abnormally high PE ratio of 37.8. In other words, the market is valuing this company very optimistically..

 

…assuming that the estimates from the various analysts are within reason correct, then we would argue that this high-quality company, with no debt on its balance sheet, and a great record of earnings growth, is nevertheless very expensive today. We believe this is also apparent in the context of the fact that there are numerous other companies with similar operating histories, and dividend yields that are trading at PE ratios one-half to one-third of what is currently being awarded to Fastenal Company. “

Carnevale includes a number of tables and charts depicting the relationship between the earnings and sales growth with the stocks price history from 1994 to 2017 … yes 2017 to make his case.

As an individual investor, I like to keep things simple.  Why pay good money for expensive services to give me all sorts of information about individual companies and their stocks without talking about market conditions or the rotation of the big money into various industry groups?  It would be better to make my own decision using basic and readily available charts like this one on FAST:

An unequivocal ascending channel since 1994 with parallel trendlines and, yes, FAST is approaching the upper trendline.  If the stock continues to rise at its current rate then, after another 16% move higher, it will touch the upper boundary at around 56.  A slower ascent will allow a slightly higher touch point.  My conclusion is that one can get another 16% gain before the “overvaluation” becomes an issue.

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February 1st, 2012

KISS in Market Timing Too

KISS is an acronym for the design principle articulated by Kelly Johnson, Keep it simple, Stupid!  Variations include “keep it short and simple”, “keep it simple sir”, “keep it simple or be stupid”, “keep it simple and straightforward” or “keep it simple and sincere.”  The KISS principle states that most systems work best if they are kept simple rather than made complex, therefore simplicity should be a key goal in design and unnecessary complexity should be avoided.

Other forms of this maxim are “everything should be made as simple as possible, but no simpler” (Albert Einstein), and “”Simplicity is the ultimate sophistication” (Leonardo da Vinci).  The principle is true whether applied to the design of an airplane, conceiving the theory of relativity or developing a market timing tool.

The following statement was made in a post today entitled “Golden Crosses Can Lead To Golden Losses“:

“While both CCM [that's Ciovacco Capital Management] market models have jumped back into bull market territory, the Bull Market Sustainability Index (BMSI) is approaching levels that are typically associated with market corrections.”

Stick a statement like that in front of me and I had to find out more about the BMSI to see how it compares with my MMM (Market Momentum Meter) which members know that it is serves as the barometer of my market timing approach and is previewed here.

About the only similarity between my MMM and the BMSI is that both are depicted on a scale that runs from Red to Green.  While my is a simple 5 traffic light approach, the BMSI looks like this:

But the similarity ends there.  Where the MMM uses 4 moving averages and the underlying S&P 500 Index, the BMSI is constructed with 30 different indexes as follows:

Complexity doesn’t mean precision and precision doesn’t mean accuracy.  It sort of reminds me of Cramer inferring in his “are you diversified?” segment that investors are safe and can generate high returns over the long run by merely diversifying their portfolio.  Aggregating a large and diverse number of indicators doesn’t necessarily give a better market timing signal than do a combination of four moving averages.

I’ve back-tested the MMM back to 1963 and am convinced that it performs well.  It got me out of the market in 2007, signaled reentry back into the market in 2009 and kept me safe through the fears brought on by last summer and winter’s worst European sovereign debt and US debt downgrades and budget debates.  It’s just issued a new signal indicating ….. sorry, that’s for members only.

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January 27th, 2012

VTR and REITs: Awaiting Resolution of “Great Convergence”

As discussed in the previous post, the market is at a crucial juncture, something I have labelled “The Great Convergence”.  The confluence of risk and opportunity is seldom as obvious as it is today.  Many of the risks still hang over our heads (need I mention Europe sovereign debt, U.S. election season, renewed U.S. budget debates, housing market still on its back, another round of debate about healthcare, etc.) yet each, through the prospect of their ultimate resolution, presents impetus offers another reason to be bullish.

The Convergence is evident as the apex of the huge symmetrical triangle that has formed over the past 4-5 years in chart of the S&P 500 Index since 2007.

One sector that safe for waiting for more certainty are the REITs.  With the Fed announcing that they foresee low interest rates through 2014, the yields available in REITs still looks competitively attractive, even though the stocks continue to appreciate without any significant correction.  One stock that seems to fit that description is VTR (Ventas Inc).  With a dividend yield of 3.9%, VTR appears to be a stock in which one can sit and wait until the direction out of the Great Convergence is clear.

Rather than mimicking the chart of the S&P 500, VTR recently broke above a significant 5-quarter resistance trendline.  That may be considered a consolidation cup-and-handle after the long run from the reversal pattern at the bottom of the Financial Crisis Crash.  If it turns out to actually be a consolidation, then the next move could take the stock up to around 100 using the charting rule-of-thumb that a consolidation is at the mid-point of the move (the move after the consolidation should approximately equal the move before):

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January 25th, 2012

“The Great Convergence”

In last week’s Recap Report recently sent to subscribers, I wrote and included the following chart:

“….. at the risk of being labelled melodramatic …. I see “The Great Convergence” coming to a head and finally getting resolved with the 18-month struggle between bulls and bears with (I hope it’s not just wishful thinking but an actuality) the bulls finally gaining the upper hand and finally being able to break into new higher ground.”

After today’s close and after closing higher for 20 of the last 23 trading days, the market is now up 10.01% since December 19.  Even more important is to note that today’s close was at 1326.06, almost exactly the level many chartists have touted as the breakout point that confirms an exit from this summer’s bear market and the continuation of last year’s bull market run off the lows.

It should also be noted that it’s almost exactly where the descending trendline connecting the 2007 and 2011 peaks is today.  However, rather than thinking in terms of points (e.g., 1325 or 1326) we need to think of a zone.  Every single trader doesn’t simultaneously decide to buy or sell which in turn causes a reversal at a single point.  Furthermore, the Index is composed of 500 different stocks in every economic sector and each of these stocks will have their own underlying market dynamics.  Market psychology does change when the market hits various levels but a change of psychology happens over time.

What the above chart indicates is a change in market psychology that’s been on-going since the bottom of the Financial Crisis Crash (see “Revisiting Housing and Banking With a New Ending” of a few days ago).  The ascending trendline since the bottom (higher lows) and the descending trendline from the pre-crash peak (lower highs) results in this “Great Convergence”.  The best momentum indicator (in my book) of moving averages across multiple time horizons are turning constructive adding to the conviction that a clear-cut signal to put, as they say in Wall Street, “risk back on”.

I believe there needs to be a 4-6% consolidation of this 10%, 23-day run and we’re going to look at it as a buying opportunity.  But if the market continues to zoom ahead another 2-3% without that correction, then it’s “damn the torpedoes, full speed ahead.”

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January 24th, 2012

The Outlook for FXI and Chinese Stocks

From the EconomicTimes of India:

“China’s economy is showing signs of slowing, with foreign investment falling for the second straight month in December and home prices dropping in most cities, the government said Wednesday.

The latest indicators came a day after data showed the economy expanded 9.2 per cent last year, narrowing from 10.4 per cent in 2010, as global turbulence and efforts to tame high inflation put the brakes on growth.”

From USAToday:

“China’s gross domestic product grew at its slowest pace in more than two years in the fourth quarter, and the worst may be yet to come, as weak exports and government tightening ripple through the world’s second-largest economy.

In the final three months of 2011, China’s GDP — the total value of goods and services — increased 8.9% from a year earlier. That was a fourth-consecutive quarter of slowing growth and the slowest expansion since the second quarter of 2009, when the economy grew 8.2%, the Chinese government said Tuesday.

For all of 2011, China’s economy expanded 9.2%, compared with 10.4% the year before.”

And finally, from The Guardian in the U.K.

“China’s economy is also “unstable, unco-ordinated and ultimately unsustainable”, a verdict delivered not by some capitalist running dog on a Canary Wharf trading floor, but by none other than premier Wen Jiabao. Nevertheless, any appraisal of China’s prospects must begin by admitting that the Middle Kingdom is the most astonishing development success story in the world today, and that its three decades of 9%-plus growth have been achieved in the face of widespread scepticism from foreign observers.”<

When we look at a chart of FXI, the ETF of Chinese stocks, we see a classic inverted head-and-shoulder or ascending triangle or any of a number of bottom reversals:

From the above chart it appears that the Chinese market would rebound in sync with the US market ….  should that come to pass.  The extent of that rebound, however, is bound by different constraints than the US market when viewed from a longer-term term perspective:

This short-term inverted head-and-shoulder may signal the beginning of a Chinese market recovery but a complete reversal of its long-term downtrend would also require a cross above a long-term descending trendline stretching back to the heydays of 2007 followed by a cross above the top boundary of what now looks potentially like a multi-year ascending triangle at 46-47.

The near-term inverted head-and-shoulders supports a move to 47 but moves above that need more umph and momentum to overcome their local economic and international trade challenges.

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January 19th, 2012

Revisiting Housing and Banking With a New Ending

There was much conversation today about how the housing and banking industry was leading the market higher ….. which reminded me of a post I made close to a year ago on May 11, 2011 entitled “Homebuilders and Financials: The Economy’s and Market’s Missing Wheel“.  The S&P 500 closed at 1342.08 that day, 2.06% above today’s close of 1314.50.  I concluded that piece by saying

“If you believe that these two sectors will be able to successfully cross their resistance hurdles and begin advancing to levels last seen in 2008 then you should be “all-in” believing the market will continue heading towards the all-time high. If not, stay on the sidelines because rather than riding a car to the top it would be like riding a three-wheeler powered by the rest of the economy including: healthcare, retail, tech & internet, commodities, industrials and consumer non-durables.”

Because of the new more constructive view of housing and banking with the hopes of continued advances for stocks in those groups, I repeat that blog, including those charts, below:

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Two Industry Groups stand in the way of further market advances: financials and homebuilders.

Home building industry spokespeople go on CNBC regularly each time of the housing statistics are announced, like monthly sales, financing and refinancing, starts, or permits issued. And the spokespeople each time differentiate between the sales of new homes and resales, especially those that are in foreclosure or underwater; they also attempt to differentiate between national statistics which include negative information from extremely skewed markets like Las Vegas, Phoenix and Florida and the rest of the national housing market.

Discussed less frequently are conditions and prospects for banking, insurance, asset managers and the rest of the financial industry group. Since the bottom in 2009, I have believed the sector was a key to launching a true bull market:

  • On 3/20/09 in Financial Stocks are Laggards I wrote: “It’s often said that financial stocks are the Industry Group that leads the market out of the average Bear Market. In this case, however, the financials not only lead us into the Bear Market but they were the principal cause.
  • On 5/18/09 in XLF (Financial Sector ETF): What Now? I wrote: “XLF seems to be making what looks like the beginning of an inverse head-and-shoulder, a stock pattern that looks similar to the S&P 500 Index pattern….There’s only a one-in-four chance that XLF will be able to cross the resistance at the 13.00 neckline allowing it to move up to 17.00. It’s almost certain that 12-18 months from now XLF will be double what it is today [closed at 12.29 on that day], we just can’t say when.
  • On 6/7/2009 in XLF (Financial Sector ETF) = Market Health I wrote: “…the key to solidifying the market’s turn, to a true change in momentum from bear to bull is financial stocks starting to move up…..The financial sector is tied up with economic health, exchange value of the $US, interest rates and the health of the financial system itself. I’ll rest easier when I see the XLF successfully and with conviction cross above it’s neckline. “
  • On 9/16/10 in Housing and Finance: Two Superimposed Crises and Bear MarketsI wrote: “[The] graph clearly depicts what I see as two coincidental and superimposed Crises the country has faced. We often see them merged into one continuous stream of bad news but, in reality, there was a Financial Crisis (impacting business) that was preceded by Housing Bubble and Bust (impacting consumers).” and inserted the following graph, now updated to last night’s close (click on image to enlarge):

A year later, while the rest of the economy has regained its footing enabling the market to push higher (up nearly 20% since then), those two industry groups are still stuck below significant resistance and unable to breakthrough and push significantly higher:

  • Homebuilders
  • Financials

If you believe that these two sectors will be able to successfully cross their resistance hurdles and begin advancing to levels last seen in 2008 then you should be “all-in” believing the market will continue heading towards the all-time high. If not, stay on the sidelines because rather than riding a car to the top it would be like riding a three-wheeler powered by the rest of the economy including: healthcare, retail, tech & internet, commodities, industrials and consumer non-durables.

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If those groups start advancing this time, the rest of the market may not be much far behind.

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January 18th, 2012

The Challenge of Assembling a Watchlist

Since the market looks like it’s firming (my opinion and, yes, I’m aware that many believe the market is actually topping out and will soon be making its final leg down to new lows), now’s a good time to begin assembling your watchlist of stocks that may be ripe for the picking as soon as a bull market begins unequivocally.  I’ve assembled four such Watchlists for members of Instant Alerts, each based on one of the following four scans:

  • 5-yr Highs(scan run on December 23): a truly momentum-based scan that produced a list of 51 stocks that crossed into all-time new-high territory .  The premise is that a stock that has made “all-time new highs” has a low risk of reversing course and is likely to continue making new highs.
  • Relative Strength (scan run on December 30): another momentum-based scan that produced 22 stocks that had a the top 10% relative strength vs. the S&P over the past year plus were in the top 10% in shares traded over the previous five days.
  • “Stocks on the Move (scan run on January 7): a scan that produced 53 stocks based on a combination of both fundamental and technical indicators as follows:
    • Price > $15
    • Price % change today > top 25%
    • Relative Strength Indicator (RSI) > top 50%
    • “Moneystream” Surge for past week > top 50%
    • EPS % change for past 4 qtrs > top 50%
    • Volume Surge today > top 50%
  • Momentum (scan run on January 13): another stab at a combined fundamental and technical scan that produced 128 stocks
    • Earnings Growth Rate over 5-years – top 25%
    • Sales Growth Rate over 5-years – top 50%
    • P/E Ratio – top 50%
    • Price > $10
    • Volume ($) for the day – top 50%
    • Relative Strength vs. S&P 500 past year – top 50%

You would expect that the same names would appear on multiple lists because the criteria overlapped to some extent. Interestingly, that didn’t happen.  While 254 stocks appeared on all these lists, there were 237 unique stocks …. only 17 names appeared multiple times.  In other words, each scan produced pretty much different names.

To see how this list compared to stocks that have performed well, I produced another scan: stocks whose four moving averages (50-, 100-, 200- and 300-dma’s) were in a perfectly bullish alignment from the fastest on top to the slowest at the bottom.  Out of 5100 stocks,  436 met this criteria.

You would expect that many if not all the stocks in the previous scans would be on this broader list of stocks with favorable price momentum but this wasn’t the case:

  • Only 89 of the 237 stocks in the previous scans, or 37% had bullish price trends as indicated by their moving averages.
  • Fully 80%, or 347, of the 436 stocks with bullish price trends weren’t caught in the previous technical/fundamental scans.

There actually was little correlation or overlap between the different scans.  It’s actually very difficult to narrow the field down:

The conclusions I draw from these statistics are that:

  • scans are a good place to begin but there’s no substitute for good judgmental chart reading and
  • good market timing always trumps stock selection.

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January 13th, 2012

Cement, Concrete and Aggregate Group: EXP

As subscribers know, my searches for suitable stocks to buy follow a strict process: evaluate the market through the guidance provided by the proprietary Market Momentum Meter, drill down to find the Industry Groups and, finally, zero in on those stocks with the best chart patterns.

I can’t tell you the Meter’s specific reading because that’s available exclusively to members but I can share with you that there appears to a glimmer of hope, a prospect of a slightly more positive tone after nearly a year of frustrating horizontal action.  So it’s appropriate to begin looking for some of the most promising Industry Groups.

I use IBD’s Industry Groups rankings three ways:

  1. The top ranked Industry Groups are those with the stocks currently showing the best relative strength performance.
  2. The Industry Groups that have advanced the most over the past four months (granted, an arbitrary time horizon) to offer a preview of which might soon become the top performers in the near future.
  3. The Industry Groups that have advanced the most above the 20-week moving average of their ranks.

The Industry Group ranked highest by IBD last Friday were 9 stocks comprising the Cement, Concrete and Aggregate Industry Group.  Another fact that makes this group so enticing is that, as the graph below depicts, Friday’s highest rank put it 112 places higher than its 20 week moving average …. the greatest span of any of the 197 Groups.  Plus, its rise in rank over the past 4 months was greater than any other Group.  In short, this Industry Group performed better than any other when measured by these three conditions:

One typical stock in the Group is EXP (Eagle Materials), a manufacturer and distributor of gypsum wallboard and cement in northern Nevada, California, the greater Chicago area, the Rocky Mountain region and Texas:

If I were a fundamental investor, I could probably come up with any number of stories, rationales and explanations for why stocks in the group should be bought.  Could it be because infrastructure spending will finally be evidenced?  Is it because the construction drought might finally be ending?  But I’m actually a Stock Chartist who looks at the pattern of price movements and sees that for the past four years, this stock as well as several others in the Group, has been stuck for the past four years. Whether one sees a double bottom or a horizontal trading range, it’s clear that the stock is now bumping up against a resistance trendline (or you may call it a “neckline”).

After such an outstanding climb, the odds are in favor of some profit taking now.  But this is a stock and industry group that probably should be watched and bought on the dips (unless the market surprise us by losing the little momentum it’s trying to build by turning and collapsing …. then all bets are off).

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