Sunday, March 4, 2012
We've decided to hold off on the top bear call
spreads until the unemployment number comes out this Friday.
Even though we've been seeing toppy/choppy behavior from the S&P 500 and Russell 2000 volume and
advance/decline indicators telling us that the market is ready to pull
back, we've been concerned that Friday's job report could be strong; and if it is, this could be the
next catalyst that solidly pushes the Dow over 13,000 and drags the
other indexes higher. So, we would rather be careful this month and wait
for Friday's jobs report. What is most compelling (and
concerning) when thinking about opening top bear call spreads is initial
unemployment claims, shown below. We can see that it's been trending
lower over the last 6 months, and because the 4 week
moving average is now near 350k the economy could easily add 300k jobs, which
could drive the indexes higher.
Let's look at the charts. Below are the daily and weekly charts of the Dow and
we can see that it continues to trend higher and it has broken over 12,800, a key
resistance level. The
A/D Line and
On Balance Volume indicators continue to show strength. The next test is if the Dow
can solidly close above 13,000. When the Dow eventually pulls back
to take a breather, there is a high probability that it will find support at 12,500
just below the 50 day SMA (simple moving average) and the 78% Fibonacci level. If this level
fails during a pull back,
there is a very high probability that it'll find support at its 200 day SMA
and major psychological level of 12,000. For more on
the indicators used in this chart please visit the
Below are the daily and weekly charts of the SPY, an ETF that tracks the S&P
500 index. The SPY is now solidly above 135 representing the
July high. The next test is if the SPY can close above
138, representing the 78% Fibonacci level. The indicators such as
Commodity Channel Index, Accumulation/Distribution and On Balance Volume are
Below are the daily and weekly charts for the
showing both the MNX and QQQ. We show the QQQ chart, an ETF that tracks the
NASDAQ 100, because it allows us to see additional indicators. The MNX broke
out above 243 and continues to rally. Time will tell how long and how far
this rally will go. When the MNX eventually
pulls back to take a breather, it'll most likely find support at its Nov
high and 50 day SMA near 243. If during the next pull back the 243 level fails,
then there is a very high probability that it'll find support near its 200
day SMA and bottom of the Oct/Nov channel at 232.
Below is the Russell 2000 index where we show the IWM,
an ETF that tracks at 1/10th the value of the Russell
2000 index, RUT. The IWM successfully broke above 78,
representing the Jan, Mar and June low, and has been
trading sideways since early February; it's also
possibly starting to roll over and this will motivate
many traders to start taking profits. As the IWM pulls back, there is a high probability that
it will find support at 78 near its 50 day SMA, and near
the Oct high and June low. If the 78 level fails, there
is a very high probability that the IWM will find
support at 76 near it's 200 day SMA and the top of its
Macro-Level, Fundamental View of US Economy's Underlying Health
Below are a selection of macroeconomic indicators to
give us a big-picture, fundamental view of the health of
the US economy. If/when the US economy begins to weaken
per deteriorating market breadth, macroeconomic indicators and estimated
corporate earnings, this information will help us: 1)
reduce our downside exposure by opening fewer bull put
spreads, and being ultra-careful when we do open some;
2) trigger us to possibly open a
long term hedge to protect some/all of our bull put
spreads; 3) alert us to possibly start opening bearish
directional, speculative trades; and 4) tell us when
it's time to move to the sidelines.
Initial Unemployment Claims, a weekly report declined from
353,000 to 351,000 new claims and this was an excellent reading. It's best,
however, to monitor the 4 week moving average (orange line)
because it filters out weekly fluctuations; we can see that the 4 week
average also has been declining where it's now at 354k, which is also an excellent
reading. When initial unemployment claims drop below
400k it's classified to be in the "recovery zone" and the economy will usually
add 200k jobs or more monthly. The 2nd chart is the 4 week average going back to
1994 showing how this indicator behaves during good times and bad. Note that
when the economy is expanding at a GDP growth rate of approx. 4% new claims are usually near 325k per month, and
when new claims drop below 300k the economy is overheating and inflation usually
becomes a problem. Overall, it was an
excellent report and this most likely represents a turning point for the US economy.
The 2nd estimate of Q411
Gross Domestic Product
was revised up to 3.0% from 2.8% in the preliminary
estimate. The data shows that the US
economy continues to expand. Overall, it was a good report.
ISM Index that measures manufacturing/business activity across the entire US
decreased from 54.1 in Dec to 52.4 in Jan, telling us that the
business activity pulled back a little, but it continues to expand. Any reading over 50 represents expanding economic activity.
Overall, it was a good report.
Chicago PMI increased
from 60.2 to 64, which was a strong reading and tells us that
the Mid-West region continues to expand at a healthy rate. This was the fourth
consecutive month that this index has held above 60. Any reading over 50 tells us
that manufacturing is in expansion mode. Overall, it was an excellent report.
The headline number for
Durable Goods showed that it decreased month-over-month by
4.0%, which was a very large drop. The briefing.com analyst noted that a
drop-off was expected because many corporations pulled in capital spending into
2011 to take advantage of tax credits that expired at the end of 2011.
Briefing.com does not believe this is the beginning of weakness and predicts
that durable goods will bounce back in short order. Overall, the results looked
bad on the surface, but a pull back in January was expected due to expiring tax
credits in 2011, and analysts believe that durable orders will bounce back and
continue to demonstrate strength.
Personal Consumption was a decent indicator leading up to the Oct 2008
crash, so it's something that we now monitor each month. As long as
year-over-year personal consumption growth continues to stay above 1%, which it
currently is, it's one data point that tells us that the US economy continues to
expand. Overall, it was a good report.
spending increased 0.2% in Jan after holding steady in December. The
spending data was not too far off expectations. Personal income rose 0.3% in Jan
down from 0.5% in Dec, also close to expectations. Overall, the report was
pretty good for both personal spending and income.
sales of autos and light trucks
rocketed to their highest level since Feb 2008, jumping from
14.18 mln SAAR vehicles in January to 15.10 mln SAAR.
(SAAR = seasonally adjusted annual rates)
For the first two months of 2012, sales have averaged 14.6 mln SAAR,
which is well above industry expectations of 13.7 mln vehicles being sold in
Overall, it was an excellent report.
S&P/Case-Shiller Home Price Index, using data through
Dec 2011, shows
that housing prices hit new lows. “In terms of prices, the housing market
ended 2011 on a very disappointing note,” says David M. Blitzer, Chairman of the
Index Committee at S&P Indices. “With this month’s report we saw all three
composite hit new record lows. While we thought we saw some signs of
stabilization in the middle of 2011, it appears that neither the economy nor
consumer confidence was strong enough to move the market in a positive direction
as the year ended. After a prior three years of accelerated decline, the past
two years has been a story of a housing market that is bottoming out but has not
Below is a summary of the Fed's
Report released on Feb 29, 2012:
Reports from the twelve Federal Reserve Districts suggest that overall
economic activity continued to increase at a modest to moderate pace in January
and early February. Activity expanded at a moderate pace in the Cleveland,
Chicago, Kansas City, Dallas, and San Francisco Districts. St. Louis noted a
modest pace of growth and Minneapolis characterized the pace of growth as firm.
Economic activity rose at a somewhat faster pace in the Philadelphia and Atlanta
Districts, while the New York District noted a somewhat slower pace of
expansion. The Boston and Richmond Districts, in turn, noted that economic
activity expanded or improved in most sectors. Manufacturing continued to expand
at a steady pace across the nation, with many Districts reporting increases in
new orders, shipments, or production and several Districts indicating gains in
capital spending, especially in auto-related industries. Activity in
nonfinancial services industries remained stable or increased. Reports of
consumer spending were generally positive except for sales of seasonal items,
and the sales outlook for the near future was mostly optimistic. Tourism
remained strong in some reporting Districts, but declined in the Minneapolis and
Kansas City Districts because of reduced snowfall. Residential real estate
market conditions improved somewhat in most Districts, with several reports of
increased home sales and some reports of increased construction. Commercial real
estate markets also showed positive results in some Districts. Banking
conditions generally improved across the Districts. Hiring increased slightly
across several Districts, and contacts in a variety of industries faced
difficulties finding skilled workers. Wage pressures were generally contained,
and prices of final goods remained stable, although contacts in some Districts
anticipate passing rising input prices through to consumer prices.
Earnings, and projected S&P 500 Price Target Based on Earnings:
(no change to this text or charts since Feb 26th) Fourth
quarter earning's season has come to a close and below are the
results. Overall, the results were mediocre. The 1st chart shows that 60.4%
of the S&P 500 companies
beat earnings estimates, lower than average. The 2nd chart shows that 56.7%
of these companies beat on revenue estimates, which was also weaker than normal. The 3rd chart shows the
earnings beat rate by sector, where the results bode well for the US
economy because materials, industrials and consumer discretionary
led the beat rate, and these sectors are viewed as leading indicators
for the broad economy. The 4th chart shows the
net % of analyst's upside earnings revisions and we can see via the
red line that more analysts are lowering their earnings projections
than raising them, which is not good - so analysts are still
pessimistic. The 5th chart shows that more companies are lowering guidance
than raising guidance, the
first time since Q209, also not good. The 6th chart projects that the S&P 500
companies are on track to grow earnings year-over-year (YoY) by 6.2%,
but note how the YoY projection has been coming down. The 7th
chart projects that the S&P 500 companies will earn about $97 of aggregate earnings
in 2011, and the 8th chart projects $108 of aggregate
earnings in 2012, so these projection are positive, but maybe
too high. (On Feb 23rd, one analyst predicted $103 of earnings) Based on the S&P 500 Index (SPX)
1360, it's trading at 14x 2011 earnings, and 12.6x estimated 2012 earnings, which is
still relatively cheap. Traditionally, the S&P 500 index trades at a
price/earnings ratio of 15 to 16.
Seasonality: The best time to get into stocks is usually October
where the market tends to do well through April, and then many investors
will follow the adage "sell in May and go away".
Sentiment: About 70% of the money managers and Chief Investment
Officers that were interviewed late last week on the financial news stations
bullish about US stocks, they believe the
US economy will grow 2% to 2.5% in
2012, they predict that earning will grow by 5% to 8% in 2012, and they recommend to
add exposure to US equities on pullbacks. Thirty percent of the money
managers interviewed are more defensive and recommend to focus on US large
cap, global, dividend paying companies, along with utilities, healthcare and
consumer staples. Most analysts and money managers, however, regardless of
being long-term bullish or bearish, believe the market is short-term
overbought and that the market is ready to pull back to consolidate its
Volatility: Below is the VIX (fear gauge) and we can see that it
has deflated down to the old support level of 15.5. The VIX is telling us that more cash will most likely move back
into stocks over the short to intermediate term. The 2nd chart is the
weekly chart of the VIX going back to 2007, providing perspective of how
the VIX shot up in Aug 2011, and we can see that Aug, Sep, Oct
2011 represented a severe "flair up".
Where is the US market in the current super cycle?: The chart below tells us if the
US economy and stock market are in a long-term bull or bear market -
sometimes called a super cycle. This
system does a good job of getting us "long" in the market and keeping us
long in the market during a
super cycle bull market; conversely, it does a good job of getting us into cash and/or
into bearish trades, and keeping us out and/or in bearish trades during a super cycle bear market.
We use the NASDAQ Composite because it's a good proxy for the entire US
equities market. We use the weekly chart along with the 17/43 week exponential
moving averages (EMA) and the 75 week EMA. When the 17 week EMA (blue line) is
above the 43 week EMA (thin black line) the US economy is most likely expanding
and the stock market is trending UP. During pullbacks, while in a super cycle bull market,
as long as the 17 EMA doesn't cross below the 43 EMA, and as long as the COMPQ
index doesn't carve down too far below the 75 week EMA, the UP trend will remain
intact and we should stay long the market. Alternatively, once the 17 week EMA crosses below the 43 week EMA the US economy is
most likely contracting and/or is ready to contract and it's a good time to
start moving out of long stocks and to increase your allocation to cash or to longer term
bearish strategies. Note how the 17/43 EMA got us long in March 1995 and kept us
long in the super cycle bull market through Sep 2000; it got us out in Sep 2000
and kept us out (or short) through May 2003; it got us long May 2003 and kept us long in the super cycle bull market through Jan
2008; it got us out Jan 2008 and kept us out (or short) through Jul 2009; it
got us back in and kept us long until Jul 2009; and told us to get out (or go
short) in Sep 2011. Since we focus on a sideways, non-directional strategy we
can make money in both bull and bear super cycles, but we need to be very
careful during the transitional periods.
What we see today from the 17/43 EMA on the COMPQ: The 17 week EMA is
above the 43 week EMA, and we now can make the call that US equities are in
an intermediate to long-term bull market. Nothing will go UP in a straight line,
so pull backs and periods of choppy trading are expected, especially through the
summer; however, when drawing a longer-term trend line it most likely will point
"UP and to the Right" for at least the next 6 months, and most likely through
all of 2012.
Performance of the credit markets, which have had a good track record of
predicting the future direction of the stock market:
Below is the interest rate on the 10 year US treasury note and we can see
that the interest rate is trading just above its 50 day SMA (thin black line) near
2.0%, and it will be artificially held down due to certain Fed policies.
Regardless of the Fed's action, some analysts project that the interest rate on the
10 year note will start to trend up, as shown in the 2nd chart, which
usually translates to a higher stock market, which is good, but it also
pushes up home
mortgage rates, which is bad.
Below is the interest rate spread between US treasuries and high yield
corporate bonds (aka junk bonds), which tends to offer prescient insight
into the future direction of equities. (both charts are the same...the 2nd
chart goes back 1996) Per the Aug '11 crash, note how this interest rate
spread started to trend higher in May '11. Prior to the Oct '08 crash, note
how this indicator started to climb in Aug '07. Regarding the current chart
shown below, it's still moderately elevated, but it continues to deflate. Overall, it's
telling us that market risk is decreasing, which translates into more cash
moving into equities.
Performance of world markets, which ultimately affect US markets:
Below is the Ishares MSCI Europe Financials ETF (EUFN)
- We can see that the European financials are rallying and this ETF is
breaking above the 200 day SMA, so this is sending a positive signal to
Below is the
MSCI European Union ETF (EZU) that holds approx. 300 stocks in myriad
industries, across 10 EU countries. Like the chart above, it's been rallying
and attempting to break above the 200 day SMA and the Oct high near 32.
Below is the EWI representing a large basket of Italian companies where it has broken over
its 50 day SMA, but it seems that it's going to hit resistance at the Oct high
and 200 day SMA near 14. The 2nd chart shows
data for Italy, as of March 1st, where it came in at 47, telling us that manufacturing in
Italy continues to contract, but at a slower rate. Overall, there is a
reasonable chance that this country will
go into a recession.
Below is a German ETF and it has successfully broken above its 200 day SMA and
Oct high. The 2nd chart shows
data for Germany, as of Feb 22, where it came in at 53, telling us that manufacturing
in Germany has rebounded and there is a low probability that this country
will go into a recession.
Below is an ETF that tracks a basket of companies in France, and it's
now testing its 200 day SMA. The 2nd chart shows
data for France, as of Feb 22nd, where it came in just above 50, telling us
that manufacturing in France is expanding just slightly, and this country
might avoid a recession.
Below is an ETF that tracks major Spanish companies where
it's holding above its 50 day SMA, but it looks weaker than the other
European ETFs and it might be breaking down. The 2nd chart shows
data for Spain, as of March 1, where it came in at 45, telling us that manufacturing in
Spain continues to contract and there is a reasonable chance that this country will
go into a recession.
Below is the EEM, and ETF that represents emerging markets around the globe,
and it has successfully broken over its 200 day SMA. This chart is looking strong, telling us that
investors believe that emerging economies might start to lead again, and/or be
pulled up by a growing US economy.
Brazilian stocks are looking strong as they've already broken out over
the 200 day
SMA, and it's now trying to break over the June/July lows. The 2nd chart
PMI data for Brazil, as of Feb 22, where it came in at 52, telling us
that manufacturing in Brazil has rebounded and there is a low
probability that this economy will head into a recession.
Below is the FXI ETF that represents a basket of Chinese stocks. We can see
that it broke out to the upside and is now consolidating above its 200 day
SMA, but below 40.9, a past support level. The PMI data that came in on Feb
continued weakness, so this could be an early indicator that the Chinese
economy will start to slow sometime in the future.
Performance of certain US sectors, which provides insight into the
future direction of US markets (i.e. sector rotation analysis):
The XLF, representing US financial companies, broke up through its 200 day
SMA and is now testing the bottom of its previous channel in June and July
In the last few months a lot of money has moved back into
financials, and this will help pull the rest of the US market higher.
successfully broke above 35
representing the June low, and it's nearing the July
highs near 38, but it is flattening out. Most likely this ETF will pull back
to its 50 day SMA near 36 to take pause and consolidate.
Transports are rolling over
because of surging oil prices, which is one indicator that this rally is
ready to take pause and/or get hit with a correction. However, so far the IYT
support at the 50 day SMA, so currently this is a signal to investors that
this rally is not yet over.
Copper is testing its 200 day SMA
and the 52 level representing the Aug low.
If this index stalls at its 200 day SMA and starts to roll over, this will
indication that the rally is ready to stall.
Freeport-McMoRan, the world's
largest miner of copper, gold, molybdenum and cobalt is pulling back and is
testing its upward sloping trend line and 200 day SMA, which is not a good sign for the current rally. Many traders watch FCX, and they'll start to take profits on their long positions if FCX starts
to look weak. However, if the FCX holds above its upward sloping trend line near
43 and then tries to rally gain, this will be an "all clear" signal to
of the bulls.
Broad-market breadth indicators that provide insight into the general
strength of the market - sometimes called the "internals" of the market.
Percent of S&P 500 Stocks Above Their Respective 50
day SMA - When a stock is above its 50 day SMA it's
classified as "healthy", and right now 78% of the S&P
500 stocks are above their respective 50 day SMAs. It's
also rolling over as shown by the red 12 day SMA of this breadth indicator along
with the MACD. It tells us that the
"internals" of the market is still bullish, but sooner
or later this rally is going to run out of steam.
Below is the Bullish Percent Index on the S&P 500 Index. For more info on
this broad-based breadth indicator please go
here. Overall, the chart is still trending UP and the 12 day SMA (red line)
of this chart is trending higher, telling us that the market is still in a
confirmed UP trend...at least for a few more days. Note how the RSI shows
that this indicator is very overbought and the MACD is starting to roll over
a little....but right now it's still bullish.
Cumulative Advance Decline Line on the NASDAQ Composite
- The cumulative number of advancing stocks less the number of declining stocks provides
broad insight into the strength of a developing trend or
prevailing trend, and provides insightful prediction
into the timing of a trend reversal. This indicator is
classified as a market-wide breadth indicator. We
monitor the 12 day SMA (red line) on the A/D Line
looking for a positive slope (bullish) or negative slope
(bearish), we monitor the blue MACD histogram, and look
at the intermediate-term of the trend via the red MACD
line crossing above or below the zero line.
Conclusion from the Cumulative A/D Line: The 12 day SMA
on the NAAD is
starting to roll over telling us that fewer stocks
are participating in the UP trend; many bulls will view
this as a cue to take some profits over the next week.
Volume Flow Indicators - Below are the 1.5 year charts using 1
day volume bars on the
S&P 500 and the Russell 2000 indexes. The 1.5 year chart provides 2 to
5 weeks of predictive visibility. We
look at volume flow because it's one of the few ways to predict the strength
of a developing trend, gauge the strength of an existing trend, and predict
the timing of a trend reversal.
Conclusion for the Volume Flow Indicators: The primary 1.5
Oscillator for the SPX index is telling us to stay long, but
it's weakening so we need to monitor it. The primary SBV oscillator for the Russell 2000
small cap index is telling us to get out of our long RUT positions and that the "risk on" rally could soon
turn to "risk off", at least for the short-term as the market pauses to
digests its recent gains. For
more on how to read these volume-based indicators please visit
Primer on Trend and Trend Reversal Analysis using Volume Based
Below is the economic calendar for the next 2 weeks:
The Week of Mar 5th: The big one this week is the employment report
on Friday the 9th, and the market could move a lot in response to this
release. For more information on this economic calendar please go to:
The Week of Mar 12th: Retail sales on Tues the 13th is the release
this week that could move the markets.
We recommend the following trades as of March 4th, 2012:
RUT Bear Call Credit Spread
No recommended trade yet
RUT Bull Put Credit Spread
STO RUT '12 Mar16 750 put
BTO RUT '12 Mar16 740 put - for a credit of 55 to 85 cents.
If this spread starts to fill for more
than 85 cents credit, suspend any further fills on it and click-DOWN a
strike to keep your credit between 55 and 85 cents. We will hold onto
all existing spreads if we're forced to click down.
SPY Bear Call Credit
No recommended trade yet
SPY Bull Put Credit Spread
STO SPY '12 Mar16
BTO SPY '12 Mar16 129 put -
for a credit of 10 to 16 cents.
If this spread starts to fill for more
than 16 cents credit, suspend any further fills on it and click-DOWN a
strike to keep your credit between 10 and 16 cents. We will hold onto
all existing spreads if we're forced to click down.
MNX Bear Call Credit
No recommended trade yet
MNX Bull Put
No recommended trade yet - we have our eye on the MNX Mar 232.5/237.5
bull put spread; we will notify everyone via email as soon as we
recommended a specific trade.
Note: If you're an auto-trade subscriber using either Iron Condor 1 or
Iron Condor 2 services, no action is required. We will be opening
another bull put spread sometime this week.