TraderFeed

Quick Takes for a Bear Market Friday

2008-11-21T16:23:10Z

* Finding an Analogue - People have compared the current market to other bear markets, including 1987, 1974, and even the markets of the 1930s. I find it interesting that many of those comparisons implicitly equate the current year with the years in which past bear markets made ultimate lows. In many ways, the current market is acting like it did in 1973, which was the one year since the 1960s in which huge numbers of stocks making fresh 52-week lows did not lead to intermediate-term rallies going forward. We stair-stepped down in volatile fashion, and did not see an ultimate price low until late 1974. It's the inability of the market to find buyers and sustain rallies even amidst extreme weakness that is most troublesome about the current market.

* Do Bonuses Work? - Thanks to an alert reader for noticing this New York Times article on how incentives can actually lead to poorer performance. When we want something too much, our need interferes with our performance--something we see when traders too desperately need to make money.

* Lowry's Perspective - Excellent market overview from Trader's Narrative.

* Insider Buying - It hasn't been a good indicator of late, but interestingly it's been rising considerably as the market has weakened and now is at post-1987 crash levels, according to the excellent Sentimentrader service.

* Finding Market Themes - MarketSci follows up with a look at the relationship between SPX and the Consumer Discretionary shares.

* Extremity - Quantifiable Edges takes a look at how extreme this market really is.

Originally posted at: http://traderfeed.blogspot.com/

How Volatile Is This Stock Market?

2008-11-21T16:22:30Z

I went to the cash S&P 500 Index from 2003 through June of 2007 and calculated that the median weekly high-low price range was 2.09% (mean 2.32%).

I then looked at the *daily* high-low range for $SPX from July, 2007 to the present and found that the median was 2.63% (mean 3.58%).

The discrepancy between the mean and median for the recent daily time period indicates that we have had a number of outlier, high-volatility days that have skewed the average upward. This skew was less pronounced during the earlier period.

Bottom line: a single day's trading range in the S&P 500 Index is at least 30% larger than a week's trading range from 2003 to mid-2007. When we consider those outlier days, we're getting an average of 50% more volatility per day than we used to get in an entire week.

That has real implications for the sizing of positions and the need for tight risk management. As we saw late this afternoon, an hour in the present market can make all the difference in terms of entries and exits.

Originally posted at: http://traderfeed.blogspot.com/

Indicator Update for November 17th

2008-11-17T23:08:26Z

Last week's indicator review noted, "Unless and until we can pierce that level with some decisive breakouts among the indicators, I view this as a range market and expect further testing of market lows." We did indeed get that testing of lows on Thursday morning, followed by a vigorous afternoon rally, and then by a swoon on Friday. By the end of the week, the various S&P 500 sectors remained in a downtrend, with money flow negative on the week and a weak advance-decline line for NYSE common stocks.

The Cumulative Demand/Supply measure (top chart) remains moderately oversold, and we're coming off of expanded new 65-day lows (middle chart) among NYSE, NASDAQ, and ASE stocks on Thursday. Each selloff since October has resulted in fewer stocks making new 65-day lows, but we have also been unable to sustain periods in which new short-term highs have outnumbered new lows. This lack of buying interest is reflected in the Cumulative NYSE TICK line (bottom chart), which has been falling steadily through the week.

So that's the dilemma: while recent selloffs have not been as broad and sustained as in early October, neither are we yet getting indications of sustained buying interest. Until that occurs, it is premature to assume that a durable intermediate-term bottom is in place. The followthrough to Friday's weakness--whether we can hold Thursday's lows--will tell us a great deal about how much firepower the bears retain.

Originally posted at: http://traderfeed.blogspot.com/

Indicator Update for November 10th

2008-11-10T17:53:30Z

Last week's indicator review noted considerable strength among the indicators, overbought readings, and resistance around the 1000 area of the S&P 500 Index. After some continued strength early in the week that briefly took us above that 1000 region, very strong selling hit the market for two consecutive days before a bounce on Friday left us pretty much in the middle of the wide range defined by the October lows and the recent price highs. As I noted in that earlier review, until I observe signs of breakout or breakdown among the indicators, I continue to view this action as part of a bottoming process that started with a momentum low around October 10th.

We continue to see signs of buying interest in the Cumulative Adjusted NYSE TICK line and a downward trend in the number of stocks making fresh 20-day lows. Overall, however, the majority of stocks within the major S&P 500 sectors are in short-term downtrends. We have come off very overbought levels in the Cumulative Demand/Supply Index (bottom chart) and finished on Friday at relatively neutral levels. While we've seen a reduction in the number of issues making new 65-day lows (top chart), we have not yet seen a meaningful expansion of 65-day highs, given the sharp market decline of the past few months.

The advance-decline lines specific to the S&P 500 large cap stocks and the S&P 600 small caps are off their late October lows, but also off their recent highs after the strong two-day selloff. That 1000 region of the S&P 500 Index remains important resistance; we saw plenty of sellers enter the market when we hit that mark. Unless and until we can pierce that level with some decisive breakouts among the indicators, I view this as a range market and expect further testing of market lows.

Originally posted at: http://traderfeed.blogspot.com/

Cross-Talk: Stabilizing Debt Markets as a Priority for the New Obama Administration

2008-11-07T16:23:16Z

A recent New York Times analysis includes economic stimulus, aid to the auto industry, and economic assistance to homeowners at the top of likely priorities to start the Obama presidency, followed by a regulatory crackdown on Wall St. Indeed, the President-Elect has suggested that the tax relief promised during the campaign will be the first bill that he introduces when he comes to office.

In his latest post, which I heartily recommend reading, Jeff Miller proposes a very different priority for the new administration: stabilize trading in debt securities. That requires a process of price discovery that will enable banks to objectively assess their vulnerability--and that of others--so that they can once again function as trusted participants in financial markets.

"Counterparty risk" is a top-of-the-mind concern for many banks and hedge funds. Concerns over preservation of capital have led them to withdraw from many credit markets. When hedge funds and investment banks are mentioned in normal political discourse, however, the focus is usually on how to punish them and hold them accountable for their greed--not on how to restore their proper functions to the marketplace.

There is no question that laws and regulations must be enforced and that proper regulation and oversight of markets must be ensured. The priority is not to "bail out" banks, but to ensure that markets function normally so that lending can proceed and reinvigorate housing, business, and the general economy.

While it's nice that interbank lending rates have declined from their historic peaks, it is far from clear that financial institutions have the trust and confidence to use the cash from the government to resume their normal lending functions. Banks are not lending when borrowers can obtain funds from the Fed cheaper than they can in the normal market; banks are also not lending when vulnerable businesses, consumers, and homeowners look to become more vulnerable. But if banks and other financial institutions additionally won't do business with each other, then we have markets in dislocation and unable to facilitate an economic rebound.

Thus far, if press reports are accurate, Jeff Miller's suggested priority for the new administration does not appear to be on the radar. Hopefully, his efforts and those of others will correct this situation.

Originally posted at: http://traderfeed.blogspot.com/

Indicator Update for November 3rd

2008-11-03T20:35:09Z

Last week's indicator update noted that "While I'm making note of the divergences with respect to the number of new lows from two weeks ago, enough stocks continue to behave in weak ways to make me want to see confirmation of fresh buying interest before taking intermediate-term long positions in stocks." We did, indeed, get that confirmation of buying interest this past week, as strength in the Cumulative TICK line and a positive turn in money flow led to a breakout move in stocks that was sustained into week's end on solid buying interest.

On Friday, we saw the first occasion in which stocks making fresh 20-day highs notably outnumbered those making new lows (data updated each AM before market opening via Twitter). We're not yet to the point where we're seeing stocks making significant numbers of new 65-day highs (top chart), but we've clearly pulled the majority of shares off their recent lows.

Meanwhile, for the first time since the decline began, we're getting overbought readings from the Cumulative Demand/Supply Index (bottom chart). Indeed, we're at levels similar to the August top in markets. It's not unusual to get topping out action following a sharp spike in the Cumulative DSI, with prices drifting higher, but the overbought level--combined with the significant resistance around the 1000 level in the S&P 500 Index--suggest that future near-term gains may be more constrained than they were this past week. Note, however, that this is a short-term overbought indication; the majority of sectors that I follow are not overbought on an intermediate-term basis.

Thus far, I'm viewing the current market action as part of a larger bottoming pattern that began with the momentum flush out in mid October. It is not at all unusual to see such bottoming occur over a period of weeks if not months following significant declines; this was the case in 1982, 1987, 1990, 1994, 1998, and 2002. If that is the case, we should have trouble vaulting and staying above that 1000 level in the S&P 500 Index. I will be watching the Cumulative TICK and sector strength carefully to handicap the odds of an upside breakout versus a move back into the heart of the recent, wide trading range.

Originally posted at: http://traderfeed.blogspot.com/

Two Perspectives on Recent Stock Market Activity

2008-10-31T15:05:37Z

I recently posted on the topic of record volatility in the stock market. Volume and volatility tend to be highly correlated; it takes the participation of large institutions to move markets. As we can see from the top chart, depicting the S&P 500 ETF (SPY; blue line) and the 20-day moving average of volume in SPY (pink line), volume has also greatly expanded with the recent decline and bounce back.

Meanwhile, we continue to see a bid underneath this market, as the Cumulative NYSE TICK line moves to new highs. For an explanation of the recent divergences between the TICK line and price during the market bottoming, check out this post.

Originally posted at: http://traderfeed.blogspot.com/

Historic Stock Market Volatility and the Concentration of Ownership in Stocks

2008-10-31T15:04:38Z

Here's an update from an early October post; it helps illustrate how the recent stock market's volatility has been qualitatively and quantitatively unlike anything we've seen in years. Indeed, this is the highest level of 20-day average true range for the S&P 500 Index since my data began in 1962. That means that we've seen higher volatility than during the 1987 market crash and higher volatility during the major declines of 1970 and 1974.

The recent bout of extreme short-covering in Volkswagen stock is an illustration of the volatility that can result from a concentration of shares in institutional hands. According to recent estimates, institutions account for over three-quarters of all stock market ownership. By contrast, individuals owned 94% of stocks in 1950 and 63% of stocks in 1980. With the recent liquidations forced upon hedge funds, mutual funds, pension funds, insurers, and other financial institutions, we've seen historic levels of volatility as a function of historic levels of concentration of ownership among institutions.

Originally posted at: http://traderfeed.blogspot.com/

What the Cumulative Adjusted NYSE TICK Line Is Telling Us

2008-10-27T16:15:51Z

In the chart above, we have a plot of the Cumulative Adjusted NYSE TICK Line (blue line) plotted against the ES futures (pink line). Recall that this line simply adds together the one-minute readings of the adjusted NYSE TICK, much like an advance/decline line (see this post for calculation of the adjusted TICK). As we plunged to intraday lows on October 10th, we made a low in the cumulative TICK line; as we've now moved back to those lows, the line has held at much higher levels in a dramatic divergence. What gives?

The TICK is a measure of stocks trading on upticks versus downticks. It begins its calculations with the start of trading in NY and ends when the NYSE closes. As a result, the TICK does not account for action that occurs overnight, between the U.S. market close and the next day's open.
If we take a look at the S&P 500 Index (SPY) from the start of September, we find that the market lost almost 42 SPY points (approximately 420 ES points). From the start of September up to that October 10th inflection point at which the number of stocks making new lows hit its highest level (see chart), SPY lost 3.29 points between the NY close and the next day's open and lost 34.8 points between the NY open and close. From October 10th forward, SPY has lost 8.46 points during overnight trade and, during the day session, has actually gained 4.8 points.

The cumulative TICK is capturing the fact that buying pressure has been exceeding selling pressure during the day trading sessions from October 10th to the present. Indeed, during that time, the S&P 500 Index--if we look at day session only-- has risen in value. This is a clear shift in regime and suggests that weakness in equity markets from October 10th forward has shifted to the European and Asian markets. That weakness prompts the U.S. market to open lower, but has not led to further net selling initiated in the U.S.

This morning, as of my writing, we're seeing a potential repeat of this same pattern. Markets were very weak in Asia, opened quite weak in Europe, and are trading lower in preopening trading in the U.S. stock index futures. We made new bear market lows overnight in the ES futures but, as I write, are trading about 1.5% above those lows. Should we build value during the regular trading day above these lows, I will be leaning to the long side in my short-term trading, entertaining the hypothesis that, in this change of regime, the day markets in the U.S. have already seen their price lows, even as markets overall (due to overseas/overnight influence) have been weak.

What prompted this little investigation was a simple observation that a growing share of my intraday trading profits was coming from the long side, despite the overall weak market. That makes sense, given that many of my trades attempt to capture swings in the NYSE TICK (i.e., try to follow short-term buying/selling sentiment). I will continue to follow these swings in early action today, with a particular eye toward whether we sustain a positively or negatively sloped cumulative TICK line on the day. That will tell us whether U.S. traders during the day session are using overseas/overnight selling for bargain hunting, or whether they are succumbing to the global market weakness.

P.S. - On a related note, a very recent article just happens to look at overnight stock index futures action as a questionable gauge of day session strength and weakness. The posts below will provide some background on short-term trading and NYSE TICK. I'll send out a Twitter "tweet" during the AM to update how the day's cumulative TICK is behaving. For new visitors to TraderFeed, the Twitter feature provides a blog within a blog containing links to important market themes, news, and indicators. The last five Twitter posts appear on the blog under "Twitter Trader"; the entire list of posts (and automatic, free subscription to the Twitter feed) can be found here.

RELATED POSTS:

Cumulative TICK and Short-Term Sentiment

Trading With the TICK

Trading Breakouts With TICK

Originally posted at: http://traderfeed.blogspot.com/

Indicator Update for October 26th

2008-10-27T16:14:52Z

Last week's indicator review concluded, "What this means is that we could see more broad, range-bound, whippy action as markets seek an intermediate-term bottom. Unless I see breakout strength in such indicators as money flow, NYSE TICK, and new highs/lows, my leaning will be to fade sharp market rallies, but also to fade tests of recent lows that are accompanied by non-confirmations in these indicators." We certainly did see the volatile, whippy action during the week and a seeking of a bottom by week's end. Did we see the non-confirmations that would lead us to believe, however, that we are near a bottom? The evidence, we shall see, is quite mixed on that score.

We continue to be oversold in the Cumulative Demand/Supply Index (bottom chart), which, if you recall, is a cumulative line of a daily index that compares the number of stocks closing above their volatility envelopes and those closing below. When we see persistently low Cumulative DSI numbers, it means that stocks are persistently closing closer to their lower envelopes than their top ones. That is a clear sign of broad market weakness, since the Cumulative DSI assesses all stocks traded on the NYSE, NASDAQ, and ASE. (I update the Demand/Supply numbers each weekday AM via the Twitter app, so that you can track emerging strength and weakness).

This indication of broad weakness is supported by the advance-decline line for NYSE common stocks, which has been making fresh bear market lows through the past week, as well as by the persistently weak money flows for the Dow industrial stocks. As I noted during the week, 38 of the 40 stocks I follow in my basket of highly weighted S&P 500 stocks across eight sectors are trading in downtrends based upon my Technical Strength measure. This is not what I'd look for in a market in which selling is drying up.

To be sure, the number of stocks making new lows vs. highs (top chart) were lower this past week than two weeks previous. Still, this number is quite elevated. For example, Decision Point reports that 228 of the 500 S&P large cap stocks made fresh 52-week lows on Friday. Among the 600 S&P small cap issues, 250 made fresh annual lows; among NASDAQ 100 stocks, fully 59 made new 52-week lows. While I'm making note of the divergences with respect to the number of new lows from two weeks ago, enough stocks continue to behave in weak ways to make me want to see confirmation of fresh buying interest before taking intermediate-term long positions in stocks.

I recently noted the weakness in the corporate bond market, particularly in the high-yield sector. This is important, because the current crisis is first and foremost a credit market event that has spilled over into the broad economy and affected stocks. As long as the credit markets continue to make new lows, it will be difficult to sustain a bull move in stocks. I am watching several market themes--corporate fixed income weakness, Treasury strength, U.S. dollar and yen strength, and commodity weakness--as a way of assessing likely moves in stocks. We'll need to see a reversal in those themes to begin any kind of bottoming in stocks.

Originally posted at: http://traderfeed.blogspot.com/

Five Trading Behaviors I'm Seeing Among Traders Making Money Now

2008-10-24T16:18:17Z

As I'm writing this, the ES futures are lock limit down and my email count is off the charts. Lots of fear, not much greed: fear, not only for one's trading, but for retirement savings and the economy. Most of people's money is tied up in some combination of stocks, bonds, and residential real estate. That means that many, many people are worth 25+% less than they had been just a year or so ago.

It is difficult to insulate those fears and concerns from one's trading. And yet, I do hear from traders who are making money in these markets. There *is* volatility, and there can be opportunity. Here are ten factors that stand out among the traders I talk with who are making money in the current environment:

1) Patience - The ones who are afraid of missing moves, who chase moves as a result, are getting hurt. The ones who wait for clear signals and good reward-to-risk opportunities can take advantage of the volatility. The successful traders aren't afraid of missing a move; they know, in this volatile environment, other opportunities will arise.

2) Position Sizing - Trading smaller when markets are moving more means that one or two losing trades won't knock you out for the day or the week. The successful traders tell me they're making plenty of money with smaller size simply because we're moving triple digits in the Dow just about every day.

3) Resilience - When you're wrong in these markets, you can really be wrong. My first trade yesterday lost over 20 S&P points; I wound up the day solidly in the green. By managing risk, you also manage emotions and can stay in the game. The successful traders are in there, making trades. They get off the canvas when they're wrong and they play defense, even as they look for opportunity.

4) Minimizing Distractions - One thing I noticed is that the successful traders in this environment have taken active measures to protect their personal finances. The less successful ones have been distracted by losses they're incurring outside of trading. It is difficult to focus on trading if you're worried about unemployment or loss of savings; addressing personal security helps maximize focus during trading.

5) Self-Maintenance - It's easy to get run down following markets through the day, every day, and then tracking them overnight and overseas. One troubled trader told me he was living, eating, and breathing trading. That is a risk factor for burnout, lessened concentration, and bad decision making. The successful traders aren't afraid to step away from the screens; once again, they know opportunity is not going to go away.

I'm finding that execution is the better part of success in these times. If you have a good idea, but the timing of your entry is wrong or your position is too large, you're likely to get stopped out at the worst conceivable time. By waiting for markets to put in a seeming high or low, waiting for a bounce or pullback that can't make a new price extreme, and *then* getting into a position, you can minimize the heat you take on trades. That, I'm finding, is half the battle.

Originally posted at: http://traderfeed.blogspot.com/

Coping With Challenging Markets By Hedging Your Bets: Financial and Personal

2008-10-22T15:27:38Z

Dear Readers,

It really has been an amazing time; I've traded the equity markets since late 1977, and I've never seen market and economic conditions like these. It's not just the ferocity of the decline: it's also the extended high volatility and the way that so many of the major asset classes: commodities, bonds, and stocks have been hit hard--and simultaneously. Add that to the decline in housing and more general concerns over recession and you have bearish sentiment that feels qualitatively different than at prior market drops. Polls show that the vast majority of Americans feel dissatisfied, convinced that the country is headed down the wrong path. Confidence in Congress and the White House is at all-time lows. Consumer confidence has tanked.

Traditional logic says that such pervasive bearishness should lead to favorable market returns going forward. After all, who's left to sell when everyone is bearish? In normal times, that logic holds. Although I'm currently working with a scenario of stock market bottoming and an eventual intermediate-term rally, I'm not sure the traditional logic makes for sound investment policy. At some point, qualitative differences yield quantitative ones: when negativity is pervasive, it affects future decision-making, with self-fulfilling effects for the economy. That's what we saw at important secular market bottoms in the 1930s/1940s and in the 1970s/early 1980s. Undervalued markets stayed undervalued for an extended time; bottoming took years.

That doesn't mean that civilization as we know it is over, that we will replay the Great Depression, etc. It does mean, as my friend Henry Carstens observed, that we're moving from a leveraged world to a deleveraged one, as credit is unwound throughout the financial system, from banks to homeowners and consumers. It's a bit like getting off amphetamines: there's quite an initial crash. Leverage has pumped up home sales, profits, real estate development, and consumer spending--and now deleverage is winding those down. Valuations from a leveraged world are transitioning to deleveraged valuations. In my personal financial planning, I'm assuming that such a transition will not occur in weeks or months. I am prepared for the possibility of subnormal stock market returns for years to come (just as market returns were subnormal following the massive declines of 1928 and 1974), and I am prepared for the scarcity of credit to keep corporate and municipal bond yields high for an extended period.

In times of stress, we tend to anchor our thinking in the most salient pieces of information; behavioral scientists refer to this as the availability bias. When volatile markets rise, we hear talk of "the worst is behind us"; when they fall, we hear of repeats of the 1930s. Worse still, financial planning--even among supposed professional financial planners--becomes simplistic: either hold on and wait for the turnaround or bail out of everything and rescue what capital you can. Little wonder that so many investors are frozen, not knowing whether to stay the course or jump ship.

Prudent investment planning, however, suggests that neither extreme is necessary. The important consideration is identifying which assets (stocks, bonds, etc.) are likely to outperform the general markets during any period of extended weakness and ground investment in those. Then, hedge your bets. If you think that some companies that offer value to consumers--or that offer necessities--will outperform those that do not, you can be long the attractive names and short the unattractive ones. Or you can be long the attractive names and short the broad stock market. You hedge your bet by reducing your exposure to overall market risk. Your investment becomes a relative value play, rather than an outright directional one. I almost never hear financial planners talk about that, and I almost never hear of such strategies from the general investment public.

Recently, in my investment accounts, I've been long some high-grade, insured municipal bonds and short stocks. My bonds have declined in value; my short position in stocks has helped compensate for that. Meanwhile, I collect the "carry": I make more in yield from the bonds than I pay out financing my short stock position. That's a kind of hedge (albeit not a perfect one). I'm looking for relative value, not just absolute market movement.

In difficult markets, there are always areas of relative opportunity. You might be long the U.S. and short some vulnerable emerging markets; you might be long gold and short base industrial metals. Getting away from availability biases and thinking multidimensionally is an excellent coping strategy for difficult markets.

That having been said, one antidote for abnormal markets is to ground ourselves in normal, daily life and the things we can control and enjoy. I've cut back on business travel and will be taking some extra family time in weeks ahead. I'll be getting back to editing my new trading psychology book and writing my free e-book. When you're hedged and can sleep with your portfolio, it frees you up to enjoy what's most important in life. And, psychologically, those important activities--whether they be family, writing, or other personal pursuits--are the best hedges of all, the most valuable sources of diversification.

Thanks as always for your interest and support--

Brett

Originally posted at: http://traderfeed.blogspot.com/

A Macro View: Economic Weakness Themes Continue to Dominate

2008-10-22T15:26:55Z

With economic growth waning in China and other emerging markets (top chart), demand for commodities has plunged (second chart), weighing on raw materials stocks (third chart). Meanwhile, in a world where USD and JPY are carry currencies amidst risk aversion, the U.S. dollar (bottom chart) continues to make new highs against a basket of world currencies. Those looking for a turnaround in stocks will want to also see an unwinding of these economic weakness themes, which we're not seeing yet.

Originally posted at: http://traderfeed.blogspot.com/

Cross-Talk: Deleveraging the Consumer and the New Realities of a Pay-As-You-Go World

2008-10-22T15:25:45Z

Margie and I were flipping through channels and happened to stop on financial guru Suze Orman making the case that we're now living in a pay-as-you-go society. Her point was that credit of all sorts--from credit cards to student, mortgage, and car loans--was going to be more difficult to come by and thus more expensive. In a world of constrained lending, we go from a credit card mentality to a debit card mind set. We pay out of money that we already have, not out of money that we can borrow.

At a broader level, this means that the deleveraging we've been seeing at banks is filtering down to the public. As Mish observes, this greatly affects consumer outlooks: it's no longer about keeping up with the Joneses. Rather, frugality becomes the operative priority. When employment, housing values, stock values, and bond values are contracting, the incentive is huge to hang on to what you've got. You certainly don't dig a hole for yourself by going into debt. Pay-as-you-go is the prudent alternative.

There have been many comparisons of the current market/economic period with the 1930s and the Great Depression. Most of those comparisons, understandably, focus on how bad market and economic conditions could get. A better comparison, however, would be the ways in which financial crises affect societal attitudes for an entire generation. From the Roaring 20s to the Depression 30s, we saw a dramatic shift in attitudes about saving, investment, and risk. My grandfather, who lost his fortune in the that crisis, never went back to investing in stocks and bonds. He became a frugal saver, who kept many different bank accounts lest there be problems at any one institution.

That is the way of psychological trauma: a single set of painful, powerful emotional events can reshape perception and action. As the deleveraging of the consumer unfolds, I believe we'll see a similar reshaping of views: fiscal prudence will become a mantra for households--and eventually will be expected of government. Not all of that will be for the worst. In the interim, however, that deleveraging--and the accompanying shift in attitudes--will create winners and losers on Wall St. Companies that produce necessities and that create unique value will prosper over those that connote luxury; firms that are well-capitalized and generate significant free cash flow will have the advantage over those that depend upon borrowing--their own, and that of consumers.

I was looking yesterday at companies in my basket of stocks that were making fresh 10-day closing highs. They included MRK, PFE, T, VZ, MO, and JNJ. All make products that, rightly or wrongly, are perceived as necessities--or at least affordable (and indispensable) luxuries. At the end of this month, we'll spend a little extra to get our kids the cell phones they want. We may very well, however, scale back our plans to buy them cars or travel abroad. As the recession unfolds, the companies that make the things you'll buy in a pay-as-you-go world may be the best place to look for market outperformers.

Originally posted at: http://traderfeed.blogspot.com/

Indicator Update for October 20th

2008-10-20T18:55:39Z

Last week's indicator review concluded, "I will need to see evidence of a drying up of selling pressure before concluding that the worst is over for stocks. Thus far, every indicator tells us that weakness has been expanding, not drying up." This past week, we saw a dramatic move higher in stocks, followed by an almost equally dramatic move downward, as volatility continued at extreme levels. So how have indicators fared?

Money flow has continued weak and the advance-decline figures suggest that no broad-based price strength is yet evident. The cumulative Demand-Supply Index (top chart), which cumulates the daily index of stocks closing above vs. below their volatility envelopes, remains at oversold levels, albeit off its recent lows. Similarly, we see weakness in the number of stocks registering fresh 65-day highs vs. lows (bottom chart), but these numbers are also well off their lows. For example, we had 107 new 20-day highs on Friday against 383 new lows. At the market's momentum low to date, we registered over 6500 new 20-day lows across the NYSE, NASDAQ, and ASE. Also well off its momentum lows is the cumulative NYSE TICK.

Thus far, I am working with the following assumptions:

1) The market made a momentum low for the recent bear move, and we are now in the process of bottoming;

2) Significant market declines (1974, 1981-2, 1987, 1990, 1998, 2002-3) have taken weeks to months to form bottoms, and the current bottoming process could be similar;

3) Given the current volatility, any market rise from such bottoming could be quite sharp;

4) While such bottoming may bring a meaningful intermediate-term low, it is not at all clear to me that we've seen the ultimate lows for this secular bear market.

What this means is that we could see more broad, range-bound, whippy action as markets seek an intermediate-term bottom. Unless I see breakout strength in such indicators as money flow, NYSE TICK, and new highs/lows, my leaning will be to fade sharp market rallies, but also to fade tests of recent lows that are accompanied by non-confirmations in these indicators.

Originally posted at: http://traderfeed.blogspot.com/

Corporate Bonds: Year-to-Date Price Performance Along the Yield Curve

2008-10-20T18:54:48Z

Above we see year-to-date price performance for four corporate bond funds in the Vanguard family: short-term investment grade (VFSTX); intermediate-term investment grade (VFICX); long-term investment grade (VWESX); and high yield (VWEHX).

What we see is that, as the yield curve has steepened, longer-term bonds have dramatically underperformed shorter-term ones.

Even more dramatic is the way that high-yield bonds have underperformed investment grade offerings. The bonds in VWEHX are roughly the same in maturity as those in VFICX, yet it has been almost twice as weak in price performance.

The bottom line is that reaching for yield--either by going further out on the curve or by compromising bond quality--has hurt investors. Conversely, short-, intermediate-, and long-term Vanguard funds for Treasuries have all seen price gains on the year. Safety has ruled the roost for 2008; this remains an excellent market sentiment indicator.

Originally posted at: http://traderfeed.blogspot.com/

Recession or Depression? It Might Depend On Where You Live

2008-10-20T18:54:02Z

In a recent post, I found that the banking crisis was far from uniform within the U.S.. Many small communities continue to boast strong banking institutions, even as larger cities that experienced residential and commercial real estate booms host banks with lesser safety ratings.

As a follow-up to that theme, I went to the Bauer Financial site and looked up the number of "troubled" banks as a function of their state locations. Bauer awards up to five stars for bank safety, based on CAMELS criteria (capital adequacy, asset quality, management quality, earnings, liquidity, and sensitivity to market risk). They recommend banks with four and five stars; those with two stars and below pose safety concerns.

What we see in the chart above is that the number of troubled banks, broken down by the number of stars, is much higher in the states that experienced real estate booms (Florida, California, and Georgia) than in states that experienced less exponential growth (New York, Kansas, Wisconsin).

Out of 313 banks in Florida, 37 had ratings of two stars or less. The ratio was 28 out of 312 banks in California and 65 out of 358 in Georgia. Across the three states, about 13% of banks qualified as troubled as of June 30, 2008. (One can only surmise the proportions would be higher today).

Conversely, in New York, there were only 7 out of 198 banks with two or fewer stars. That ratio was 11 out of 353 for Kansas and 7 out of 293 for Wisconsin. Across these three states, only about 3% of banks qualified as troubled.

The financial health of banks is intimately tied to the financial well-being of communities. Banks that cannot lend due to capital constraints cannot fuel an economic rebound. Banks also reflect the health of the communities around them. Home owners, real estate developers, and businesses that cannot pay off loans will also be constrained in their ability to spur an economic comeback.

In many areas of the country, the current economic crisis may look and feel like an unpleasant recession. In other areas, it could feel much worse, with depressed housing and business growth for some time to come. The regions with the greatest credit booms are feeling the brunt of credit contraction; how bad the economy gets could depend very much on where you live.

Originally posted at: http://traderfeed.blogspot.com/

A Look At Fundamental Valuation: How Low Could We Go?

2008-10-20T18:53:16Z

An interesting recent article asks the question, "How much is this market worth?" It turns out that, over the last 30 years, the S&P 500 Index has averaged about 2.4 times the combined book values of the component stocks. At the market peak in 2000, we traded at almost 5 times book value. In 1982, we actually dipped below book value.

Periods of overvaluation and undervaluation can persist for a considerable time. We were over 3 times book value from 1997 through 2002. We were below 1.2 times book value for much of the late 1970s through 1982.

At an estimated book value of 615, we're trading around 1.5 times book value, not quite the level noted by Ned Davis as "undervalued". Should the current market and economic weakness prove as troublesome as the late 1980s--a conclusion surely implied by those who call this the worst economic period since the Great Depression--a move below book value would certainly be in order before we could say stocks are a screaming bargain. That could be a meaningful decline, given that book values themselves can move lower as assets held by companies (real estate, receivables, etc.) are valued downward.

Back in the Great Depression, as Jason Zwieg notes, stocks sold for less than their cash and marketable securities. Should the ratio of stock price to cash and marketable securities in the current market return to the level of 10 that we saw in the late 1970s and early 1980s, he notes, that would take us to about 600 on the S&P 500 Index--back toward estimated book value. If we overshoot to the ratio of the market low in 1982, however, the S&P 500 Index would be closer to 400.

Interestingly, this fits with the recent analysis of market valuation based on Tobin's Q. Based upon the replacement cost for assets of the S&P 500 companies, the index should be trading around 910--roughly where it stands now. At historic market lows since 1920, however, indexes have tended to trade closer to somewhat above half their replacement cost.

If we look at this market from a trading vantage point, it is hard to escape the sense that we're tremendously oversold and due for a rally. In the short-to-intermediate term, that would not be surprising. If, however, we focus on fundamental valuations and historical norms, we're not at all at historically highly undervalued levels. There is a disconnect right now between how severe we say the economic problems are and how we think markets will move from here: most investors I talk with say the problems are quite severe *and* they say, with more than a little hope, that they think the worst of the market decline is behind us.

If this is indeed the worst economic crisis since the Depression, we will likely see book value in the major averages before we make a long-term bottom. That is not an extreme prediction of doom; it represents a level of valuation we've seen within the last 30 years. I don't see average investors and investment advisors thinking through or planning for this possibility--and that could lead to sorry retirements for a number of baby boomers.

Originally posted at: http://traderfeed.blogspot.com/

Will We Know When We've Made A Low?

2008-10-17T15:53:32Z

At some point, this stock market is going to overshoot to the downside, just as it overshot to the upside, and there will be tremendous money to be made. Of course, everyone wants to catch the bottom, so that creates violent rallies when it seems as though we've made a low and equally violent reversals when those hopes are dashed.

A look at some recent large market declines--1970, 1974, 1987, and 2002/2003 (charts above)--suggests that market bottoms following major drops tend to be complex affairs. Sometimes, as in 1970 and 1987, you get a washout selloff that marks intraday lows for the bear move, followed by retests that hold above that intraday low. Other times, as in 1974 and 2002/2003, you get the classic pattern of a momentum low (the point at which the number of stocks making fresh annual new lows hits a peak) followed by subsequent price lows on lower momentum (and fewer new lows).

Note how, in the charts above, there tend to be substantial rallies and sizable selloffs even after price lows have been made. This volatile choppiness makes it difficult for traders and investors to hold positions with conviction.

It is this tendency toward complex bottoms that means that investors can find good points for entry even after ultimate lows have been made. Indeed, traders who were too eager to catch market bottoms in early May, 1970; September, 1974; early October, 1987; and July, 2002 found themselves facing significant further declines. We really only know when we've made a low when we're able to assess subsequent buying interest after price and momentum lows have been made. That often means missing exact price lows, but it also avoids the discomfort of catching those proverbial falling knives.

Originally posted at: http://traderfeed.blogspot.com/

A Midweek Look at Stock Market Indicators

2008-10-16T16:10:26Z

* Dollars Continue to Flow Out of the Market - The top chart shows money flow for the 30 Dow Industrial stocks; note how the four-day moving average (pink line) plunged to lows when we made our recent market low and has stayed below the zero line after briefly spiking positive. This indicator has been the single most important factor keeping me out of stocks on an investment basis, and it continues to suggest that institutional investors and traders are transacting more volume on downticks than upticks--not something we'd expect to see if they were finding value at lower prices and accumulating stocks.

* Divergences Brewing? - As we test the recent market lows, note that the Cumulative NYSE TICK (bottom chart; blue line) is still well off its lows. I noted that we made bear market lows on Wednesday in a couple of sectors, including homebuilders ($HGX) and semiconductors (SMH) and near lows in materials stocks (XLB). Banks ($BKX), however, are well off their lows and only 646 stocks made new 20-day lows on Wednesday, much lower than the 5000+ new lows at the recent market lows. I'm watching closely to see how indicators hold up on any further test of lows and might even nibble at the long side if we see sectors holding up well. Still, that will be a trade rather than an investment as long as money flows (see above) stay negative.

* Broad Weakness - As readers know, I maintain a basket of 40 stocks that are divided evenly across 8 S&P 500 sectors. These are among the most highly weighted $SPX stocks, so they provide a good snapshot of the large cap market. As of the Wednesday close, 39 of the stocks were trading in downtrends by my Technical Strength measure (a quantified measure of trending) and only one stock (WFC) was neutral. According to Decision Point, less than 2% of NYSE issues are trading above their 20-day moving averages and only 1% of S&P 500 issues.

* Nice Historical Perspective - "There have only been two other times in the last forty years that the 200-day average has remained negative for six months - August of 1973 and February of 2002. In both cases, the market continued to trend steadily lower until the 200-day average rallied convincingly back above the zero line, signaling a real end to the selling pressure and a long-term bottom. There's little reason to think this time will be any different." - Rennie Yang, Market Tells.

* Catching Trends - This recent post was particularly relevant to trading Wednesday's market.

* Twitter Note - Several readers have asked me to include real time trading comments and observations about markets in my Twitter posts. Thus far, the Twitter feature of the blog has been used to update readers in the AM about upcoming economic reports, market indicators, and links to articles on market-moving themes. My extensive travels and work with traders make real-time market commentary difficult, but when possible I will try to include observations of particular note. Thanks as always for the interest.

Originally posted at: http://traderfeed.blogspot.com/