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 Learning Center.

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 still exhibiting strength.

Below are the daily and weekly charts for the NASDAQ 100, 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 past channel.

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.

The 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.

The 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.

Personal 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.

The 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 2012. Overall, it was an excellent report.

The 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 yet stabilized."

Below is a summary of the Fed's Beige Book 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) trading at 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 were 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 gains.

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 world markets.

Below is the Ishares 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 PMI 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 PMI 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 PMI 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 PMI 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 shows 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 22nd shows 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 near 15. 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.

Industrials 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 is finding 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 be an 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 some 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 year SBV 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 Indicators.

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: http://www.briefing.com/investor/calendars/economic .

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 Spread
No recommended trade yet

SPY Bull Put Credit Spread
STO SPY '12 Mar16 131 put
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 Spread
No recommended trade yet

MNX Bull Put Credit Spread
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.