Monday, December 31, 2007

December 2007 Rewind - Santa's Folly

Apparently Rudolf got lost this year as the vaunted "Santa Claus Rally" became "Santa's Folly." Indeed, with the S&P 500, Dow Jones Industrials and NASDAQ 100 cash indices falling -0.86%, -0.80%, and -0.20%, respectively, the equity markets put in their poorest December performance since 2002.

Although there were more positive days on balance throughout the month, the markets could never quite get over their collective disappointment with the Federal Reserve's mere quarter-point rate cut on the eleventh, and fears stoked by former Chairman Greenspan's subsequent stagflation warnings. Apart from that, the typical positive holiday seasonality and pervasive sovereign fund acquisition news were simply overcome by a barrage of further subprime writedowns, mixed retail sales reports, geopolitical events, heated inflation readings, and tepid home sales news.

Interestingly, Large-Cap and Growth stocks continued to outperform this month even as the Small-Cap and Value stocks overwhelmed the indices into the red. On this New Year's Eve with all the volatility of the second half fresh on our minds, it is easy to forget that the major indices still managed to close ahead on the year, as follows:

2007 Index & ETF Returns (excluding & including dividends):
  • SPY (S&P 500) +3.5%/ +5.2%
  • DIA (Dow Jones Industrials) +6.4%/ +8.8%
  • QQQQ (NASDAQ 100) +18.7%/ +19.0%

And now we have a full 250 trading days ahead of us to celebrate in 2008. Cheers!

The Style Box below was calculated using the following PowerShares™ ETFs: Small-Growth (PWT), Small-Value (PWY), Mid-Growth (PWJ), Mid-Value (PWP), Large-Growth (PWB), and Large-Value (PWV).

The Standard & Poors 500, Dow Jones Industrial Average and NASDAQ 100 may be traded through ETF proxies, including the SPY or IVV, DIA and QQQQ, respectively.

Sentiment: Negative
Volatility: Moderately High (VIX 18-25)
Direction: Lower

12.31.07 - The only thing...

... to be enthusiastic about today's market action is the relative strength we are seeing in the Financial Sector (XLF). Maybe that will lead the overall market somewhere more positive by day's end.

Interesting barbell forming in the 2008 Market Opinion poll on the right. We traders certainly do have our opinions, don't we? Have you voted yet? Better yet, take a minute to post a comment with your prognostications!

Trade Idea Result: Lastly, if you were in one of the India Country ETFs (IFN/INP) for a possible bounce trade on a geopolitical over-reaction rational, it might be time to take profits on that trade, which is now up just over +4% since I posted the idea a few days ago.

12.27.07 - India Fund Opportunity?

3:32PM CST UPDATE: Throw away at the close. No big surprise and possibly the first tradable "on-sale" pricing of the new year. Worst December in five years? Have fun and be safe tonight -- Let's HAVE A HAPPY NEW YEAR!


Friday, December 28, 2007

12.28.07 - Nuetral Day... far... Tick and A-D lines essentially flat -- constructive, I suppose, but looks like we could be slipping here. Europe is holding up relatively better. The TNX (ten-year note) is getting pounded. Boy those new homes numbers were bad; really killed what could have been a nice bounce day going into New Year's Eve. Meanwhile the Chicago PMI came in strong, go figure.

12:00PM CST UPDATE: Yup, the market has deteriorated and now is around S1. Volume is extremely low. May hold around here. As a side note, I noticed that the Sentiment signal triggered long yesterday. I'll be thinking about taking that at the close or on evidence of a reversal, which is nowhere to be be seen as of now.

3:00PM CST UPDATE: Sort of a go nowhere day after all. Speaking of which, looks like Monday is a full-trading day after all. See you then.

Thursday, December 27, 2007

Grading 2007 Risk/Reward across Sectors & Styles

Even the casual investor couldn't have missed this year's financial news focus on "Increased Volatility" and "Split Markets." Exchange Traded Funds ("ETFs") provide us with an easy tool to take a deeper look into these headlines across both Sectors & Styles alike.

In this regard, the table below catalogues total returns and historic volatility across 14 Select Spider-Sectors and six PowerShares-Style category ETFs, as ranked by their respective Sharpe ratios:

As a brief reminder, William Sharpe's ratio is one of the simplest measures of the historic risk/reward characteristics of a security's return series, as follows: (Total Return - Risk Free Rate)/ Standard Deviation of Returns. Yes, there are fancier, better measures than this out there these days, but the table above tells our two stories quite nicely on its own; thank you very much!

Looking across the select ETF categories, the two headline saws become most apparent. First, volatility increased dramatically in almost every ETF category, in some cases nearly doubling between the first and second halves of the trading year.

Second and equally dramatic was the much ballyhooed split-nature of returns. Not surprisingly, Energy (XLE) and Metals (XME) led the pack here, with Financials (XLF) and Homebuilders (XHB) bringing up the proverbial caboose. Similarly, Large- & Mid-Cap Growth ETFs (PWB/PWJ) ranked the leader board throughout the year, with the Small- & Mid-Cap Value ETFs (PWY/PWP) generally taking it on the chin. In case the increased volatility wasn't a strong enough "tell" for you, split returns like these are not characteristic of a healthy bull market!

The scatter plot chart below takes our analysis up a notch, showing a slight inverse linear (albeit dispersive) relationship between positive total returns and relatively lower historic volatility:

Note: Volatility is presented highest to lowest.

The Metals & Miners (XME) complex located in the upper-left hand quadrant above was a bit of an outlier last year, posting both strong returns and relatively higher volatility.

As you develop your investment allocation plans for 2008, perhaps you will consider the persistence of these risk-reward characteristics through time, as well as the possible linear relationship between the two elements of Mr. Sharpe's equation.

12.27.07 - India Fund Opportunity?

I just heard Bob Pisani on CNBC "predict" the creation of several hundred new ETFs for 2008, including an India fund. I guess he has never heard of the NYSE's IFN, or Barclay's INP.

These are both down big-time today on the neighboring Pakistan/Bhutto news. They seem to have bottomed for the day and could be good buys as they still rank highly on most relative strength screens.

Back in the USA, the building negative economic news has finally come home to roost, at least for the day. Note the divergence between the slope of the Cumulative Tick and the actual prints... I "predict" that next Tuesday will be the first day of the New Year!

3:15PM CST UPDATE: Too much for the markets to digest to hold it together, albeit on light volume. Only one and a half trading days left in the year... doesn't look good! Watch India overnight and in the morning to consider nibbling around the edges. It could take a while for that news-cycle to play out in terms of geopolitical risk identification.

PM UPDATE II: For the record, this post was put up nearly a full day before CNBC thought to comment on the very same thing. Interesting how news and commentary filters out these days.


Wednesday, December 26, 2007

12.26.07 - Leaders Weakness

The so-called "leaders" (Financials - XLF, Transports - IYT and Semi-Conductors - SMH) are all showing more relative weakness than the major averages belie. Overall a flat, low-volume market. What did I expect the day after Christmas? Speaking of which, hope yours was terrific!

Nothing to show today so far... oh how I hate sideways markets -- you just know they are going to break one way or the other. Technically overbought, but now we have year-end to consider. Have you voted in the right hand side-bar poll yet? Didn't think so... come on gang!

12:15PM CST Update: Little break-out to the upside about 45-minutes ago. Cumulative Tick has turned positive and "leaders" making a come back, but still down.

Trade Idea Result: I should also update the Market Sentiment long signal noted last week on the 19th. It closed-out two days thereafter for a hypothetical +2.0% gain. Had you continued to hold through today, you obviously would have done better yet.

12.19.07 - Bad News Saturation?

Monday, December 24, 2007

12.24.07 - "The Only Gift Worth Possessing"

Markets are up nicely on MER news and holiday cheer. Some short-term overbought signals starting to trigger. I'd consider hedging, but don't fight the tape -- especially this week. In answer to a Wall Street Journal article today... enjoy your time with friends and family! - Jeff

Happy Holidays!


Saturday, December 22, 2007

2008 Market Prediction Poll

It won't be long before the primaries take over the news cycle. Why wait to vote? Make your prediction of the S&P500's 2008 performance on the right-hand sidebar now!

Post your prediction as a comment below to win a prize this time next year!

Friday, December 21, 2007

12.21.07 - Flatlined

First, yes, I retitled and final edited the article below to make it "cuter" for republication. Strong consumer spending has us up nicely on the day, but now the market is essentially flat and financials are pulling back slightly. Yes, this could keep going through the end of the year, but do keep an eye on it and consider a stop loss at yesterday's close.

PM UPDATE: Enjoy your weekend!


Thursday, December 20, 2007

Stagflation: A Christmas Carol Warning

Former Federal Reserve Chairman Alan Greenspan sounded a lot like Jacob Marley's Ghost from The Christmas Carol last weekend, warning how we are seeing “the early symptoms” of stagflation.

That’s right, the only word whose first letter strikes more fear into the heart of investors than the dreaded “R” word. Mr. Greenspan was behind the curve with his chain rattling on this one though; Mr. Bernanke’s Federal Reserve has been essentially saying the very same thing since mid-summer with its statements stressing concerns over higher inflation and slower growth ahead.

Most investors understand that growth is good and inflation is bad. For the newly initiated; however, this article explores at a very high level how this intuition is pedantically grounded in valuation theory, and why stagflation is truly an asset killer to be feared on the level of Scrooge's ghosts!

First, however, a couple definitions:

  • Inflation – Consumers experience inflation as rapid price increases relative to their purchasing power. This can be caused by several means. In the example du jour, strong demand for an oligopolistically controlled productive resource, read energy, pervades corporate cost of goods sold. However, for that cost increase to spread, note that firms must be able to pass it along to willing consumers.

    For these reason, most argue that true inflation must ultimately be supported by an expectation of more to come along with the injection of liquidity into the monetary system.

  • Growth – Expansion of corporate free cash flow, defined here as cash flow available for payment of debt, dividends and reinvestment. On an aggregate level, such growth is thought to be bounded by a nation’s gross domestic product.
The following sections discuss the effect of stagflation on several major asset classes, including Bonds, Equities, Commodities and Real Estate.


In many ways, bond pricing is the easiest to get one’s arms around, so let’s start there. The simplest model for bond pricing looks likes so:

     Bond Price = Coupon Payment/ (1+ Required Rate of Return)

Because coupon payments are fixed, the higher the required rate of return, the larger the denominator and therefore the lower the price. Bond investors require compensation for inflation expected over the life of the bond. Therefore, as this expectation rises, so does the required yield and price drops.

As for growth impact, required yield also factors in firms’ ability to repay their debt. Slowing growth may increase the perception of repayment risk, further increasing the required yield and thus reducing price.


The basic model for stock valuation is fairly similar to bonds, except that it cues off of sustainable dividend potential and considers future growth, as follows:

     Stock Price = Dividend/ (Required Rate of Return - Growth Rate)

Or, put another way in terms of dividend yield:

     Dividend/ Stock Price = Required Rate of Return - Growth Rate

Focusing on the right side of the equation, note that whether rates are stated in real or nominal terms, the spread remains the same. Inflation cancels out! On an asset class level; however, we have to consider a different dynamic. For this perspective we need to look back to bonds and the idea that investors have a perennial choice among the two classes. The much debated “Fed” model for aggregate equity market pricing takes this choice into account, as follows:

     Market Price = Aggregate Dividend/ (10-Year Treasury +
         Equity Risk Premium)

Above we learned that bond prices quickly factor in inflation expectations. As bond yields rise relative to stock yields, demand for stocks as an asset class declines and, as the theory goes, so does price. Presto, inflation plays a role and a destructive one at that!

Several economists feel this has more to do with a growth effect whereby potential dividends are pressured during inflationary spikes as the costs of production rise faster than they can be passed along. Either way, the result is the same. Speaking of which, and back to the original stock pricing model, we see that growth is deducted from the denominator. The smaller the growth rate, the larger the denominator, and, once again, price declines!


Commodities are thought to be tied more directly to Economics 101 - Supply & Demand pricing. It is much easier in this arena for producers to timely pass along cost increases. Take a look at food these days. Up to 40% of the retail cost of food is comprised of energy related components. Is it any surprise that prices at the grocery store have risen so quickly?

In this way, so long as they don’t rise so quickly as to squelch demand, commodities are thought to be largely insulated from inflation. The good news here is that everyday investors now have unprecedented access to this asset class through new ETFs such as iShares GSCI Commodity-Indexed Trust (GSG) and Deutsche Bank Commodities (DBC). Be advised; however, that gold no longer falls as strongly into this category as it once did. Nonetheless, it is still regarded as a good crisis hedge.

Real Estate

As my great grandmother said many times, "They aren’t making any more land!" Due to its intrinsic value, like commodities, residential real estate is also thought to be fairly well insulated from inflation. By the same token, as we have been recently reminded, demand may be squelched if borrowing rates to obtain and hold the asset rise too quickly.

Commercial real estate falls into a bucket somewhere between residential real estate and equities, albeit with a much greater emphasis on its ability to generate operating cash flow.

*     *     *     *
In his recent remarks, Mr. Greenspan pointed to rising import prices and declining productivity as offending tell tail signs of the “S” word. In fact, both CPI and PPI were recently reported to show extremely high year-over-year changes. At the same time, this week’s Philadelphia Federal Reserve and Conference Board leading economic indicator appear to reaffirm growth concerns.

On the other hand, a recent productivity report showed good strength, consumer spending remains high, and current market worries have yet to express themselves in measured GDP. Also, at this point in the cycle real estate trends are deflationary and jobs, although weakening, remain at historic levels.

Over time, markets tend to self-correct. A low, yet stabilized dollar may soon make our goods and services look relatively attractive to the rest of the world, keeping employment and earnings high. Witness all the sovereign fund investments reported of late.

A long enough period of stagflation almost always precedes recession. You can almost feel the tension in the Federal Reserve's statements as it rides the tightrope of its dual mandate to restrain inflation while supporting jobs. As we head into 2008 and in the spirit of the holiday, let’s hope for Mr. Bernanke's sake that Mr. Greenspan’s warning, like Marley's to Scrooge, is cautionary at best. The last ghost of Federal-Reserve-Chairmans-Past we want this economy visited by, is Mr. Volcker's.

Nothing ever changes, Hilarious!

Thank you Brian for the link below! I'd bet alot of investors wish they had the last two months of their equity back!

This whole sub-prime mess reminds me so much of the S&L debacle I was involved in cleaning up 16 short years ago. Nothing changes much... If anything, I'm surprised the real estate cycle lasted as long as it did.

On the more serious side, if you are interested in an introduction to tape reading, Brian's daily blog is a super place to start.


12.20.07 - Can't Catch a Bid

All the comments from yesterday still hold. The day isn't over, but this market can't seem to catch a bid and this range is becoming dull.

Still, somewhat higher highs and lows have occurred over last several days. Maybe well see a mid-day recovery ala the recent pattern. Hope springs eternal this season!

12:53PM CST UPDATE: Promise I didn't know that pop was going to happen, nor had I seen any evidence of it right up to my post. No, I can't take credit for that one. What is it they say about rather being lucky than smart? Take it easy, Tick and A-D still negative.

1:42PM CST UPDATE: Hey, what do you know, back up to the five-day moving average on the SPY. Watch the rising VWAP as potential pull-back support/ trailing stop level. Still lots of "technical" resistance potential around here, but we've tested this often enough, maybe, just maybe it will break this go around. One thing is certain, tomorrow's expiration day will be quite a trip.


Wednesday, December 19, 2007

12.19.07 - Bad News Saturation?

Today's action gives me the feeling that the bears sense that all the bad news that's out there has more or less come out and it may be time to cover for now.

This morning was looking very constructive IN SPITE of more "bad news" until the longs decided to play whack a mole with their best positions to take money off the table. If we can hold this dip here and reinstill some confidence in this constituency to let profits run, maybe we'll see some more upside progress.

Overall, slope of Tick and A-D are flat, which at this point is good.

PM UPDATE: Another good intra-day call. If only I could do that every day... Stellar Nike and Oracle earnings after the bell. A slew of additional "go-long" signals have triggered, including the revised Sentiment model. I'd just like to see some more conviction and follow through here... it's a bit of a worry.

Tuesday, December 18, 2007

12.18.07 - Sell the News?

A heavy sell program hit the tape about half an hour ago (see the large dashed green spike). This time it was met with some buying and the Cumulative Tick and A-D slopes appear to have flattened.

This could indicate an important level of support, but trend is still down so wait for more confirming strength and a reversal out of bonds before considering buying in for a bounce trade.

1:10PM CST UPDATE: Did you catch it? Important break through the VWAP and now test of the pivot. I'd like to see bond rates rise a tad indicating potential rotation "into risk."

1:23PM CST UPDATE: We are getting that rotation along with more volume than we've seen in a few days. Shorts are covering and money is going to work. Bullish Hammer. Each upward thrust typically will be associated by a leveling, or shallow pull-back in time, which is usually buyable. Speaking of which, please don't forget to trail stops!

1:55PM CST UPDATE: Bounced down off of R1 (dotted blue line). Look for support back at the pivot (dotted yellow line) else consider exiting if you are just a scalper. I don't think it's done yet, though -- but -- as always, respect price.


Monday, December 17, 2007

12.17.07 - No Respite

Persistent negative Cumulative Tick and A-D lines. Large-cap Tech is being especially hard hit: selling the winners over growth concerns? Certainly Financials are holding up relatively better: a rotation in anticipation of a sector bounce? The markets are technically oversold, but... there are too many buts!

Friday, December 14, 2007

12.14.07 - Pivot Resistance

The SPY is finding resistance at its daily pivot line (yellow dotted line). Relatively constructive considering the inflation confirmation though.

"Looks like" the market "wants" to be finding a bottom around here going into the end of the year, but we are so news driven and volatile it's hard to be confident in that assessment. Maybe the shorts will start covering next week going into expiration day to lock in gains.

Cumulative Tick and A-D Line slopes are flat to negative. Not much green on the screen in any investment category today.

WEEKEND UPDATE: I don't necessarily give a lot of weight to the last hour sell-off on accord of the day-of-week, Friday. Note how much volume has dropped off in-spite of the downward-vol and how we are almost back at the -62% retracement off the highs. In spite of the extreme negative reaction to the Fed announcement, the lows from that day have not seen a major violation and now we are in the final weeks of the month, December no less, not to mention leading into option expiration week. Is it possible that a bit of the selling we have been seeing has been tax motivated?

I'm no huge bull here, but I wonder just how much is and how many more shoes are going to fall off the "millipede" (to quote the "Oracle") at this point going into mid-January? Sentiment is SO negative. Goldman reports next week... smartest guys in the room?

Thursday, December 13, 2007

12.13.07 - Mixed News Day

So Lehman beats and retail sales look good, but wholesale inflation runs hot largely due to energy costs. Energy is a tough nut: it both drives inflation and yet can moderate economic growth of its own accord. That has got to put the Fed in a tough spot since it's not the type of inflation it can easily fight: market forces driving energy consumption are now at a global level. I'd therefore think the first-order concern would be the growth impact here, but hey, I'm no economist.

Price-wise we are retesting yesterday's lows, but without yesterday's strong trend action. Asia and Europe sure didn't get us off to a very good start. Speaking of which, overnight performance of the foreign markets is the very first thing I look at every day. A good practice.

Cumulative Tick isn't looking very good, I'd look for the slope to change and a break of the VWAP before I'd consider a long bet. We are essentially within the next level of retracement "support" in the SPY $146.50-$147.50 range.

1:20 PM UPDATE: Transports pulling hard starting about an hour ago. Money is either coming out of long-term bonds or a premium (edit: discount) is being paid... If the former, where is it going? Short-end? Would have expected a bigger equities pop otherwise. [OK -- Bit slow on the uptake on this one, it's an inflation repricing.]


Wednesday, December 12, 2007

Thank You!

With Christmas fast approaching and Hanukkah underway, I just wanted to say "Thank You" for all of your kind and supportive emails and comments over the course of the first three months of my journey into the "blogosphere."

That said, I would like to encourage posting/ commenting directly to the site going forward to better exchange ideas and share insights. However, I only ask that you establish a Google identity to avoid SPAM postings to this site. Otherwise, I promise I will post anything relating even remotely to the posted article, (constructive) criticisms included. That's what it's all about.

Sincerely, Jeff

Fed-Day VIX Option Trade Result

Last week Wednesday I pondered a long $VIX.X option trade to capture noise around the Federal Reserve announcement. I naturally thought I would report on that trade idea result today.

Excluding costs, if the hypothetical trade had been put on this Monday afternoon and taken off at yesterday's close after the announcement, it would have generated about +13.7% (corrected). Not too shabby.

Nice Move

12.12.07 - Slow Bleed...

Cumulative Tick and Advance-Decline line slopes are negative. The financial sector is being sold off/ shorted, pushing down the S&P500. Took some off at the open myself... guess I wasn't the only one. Back to looking to SPY $149 for support -- respect the trend though.

Tuesday, December 11, 2007

12.11.07 - Yippie-Yeah - 25bps All Around!

How do you spell that? Took off some of those hedges. Remember that the market typically takes an hour or more to "decide" what it all means. And you were wondering where all this mythical volatility was hiding?

P.S. - I will be looking for support just under/around SPY $149. Just exchanging IMs with J.W. speculating whether the Fed was able to respond to much of the negative news out just this week versus Mr. Market's always current expectations.

P.S.S. - Looks like I had a limited imagination yesterday because that statement isn't making anyone happy. Note the limited Window cut too.

P.M. UPDATE I - Well, more of a move than certainly I had expected and a one way trade at that, which is somewhat unusual. This is still a very tricky environment, although today did "feel" (both intuitively and quantitatively) like an overreaction to me. Yes, I also "felt" alot better about my hedges by the end of the day as compared to yesterday!

P.M. UPDATE II - What's this on CNBC after the bell about 4:55pm CST... a "secret" Fed source says that they are still considering "other means" of addressing the liquidity problem? Hmmmm. It is true that very few banks have been using the Window... Well, tomorrow is another day - as always - we will see.


Monday, December 10, 2007

12.10.07 - Bit of a Dull Day... spite of the early grind higher. It is difficult to imagine a bad result tomorrow:

50 Bps - Hallelujah and off to the races (but watch out for a hangover next day -- wow things are that bad + already short-term overbought). Dollar down, oil up.

25 Bps - Economy must be doing alright after all, and hey, it is the Holidays.

Zero... hmmmn, not going to happen. Famous last words? Maybe we'll get more at the Window. I'm still mostly hedged (and hating it). Good luck tomorrow, play the noise if you must and are quick on the draw. Volatility is the only certainty for the day.

Sunday, December 9, 2007

Market Sentiment System Revisited - Part I

Last month I posted a two-part article building on the always excellent work of Dr. Brett Steenbarger of TraderFeed fame. The article presented an outline for an intermediate-term Market Sentiment-based swing trading system incorporating the observations of Dr. Steenbarger. As background, links to the article follow:

Part 1Market Sentiment Oscillator

Part 2Sentiment Trading System

With the closing of the open trade referenced in Part 2, I thought I would post the results of that hypothetical trade and revisit the original system to see how it might be improved.

First, November's trade opened on the 5th when the ten-day oscillator first fell below 0.995, and closed on the 30th when the 2-day RSI exceeded 90 for a total of 18 open trading days. This was about seven days longer than the average trade, as previously tested back through January 2003 (about 1,240 trading days).

Using the S&P500 (SPY) as the trading vehicle, the maximum drawdown of this trade would have been -6.1%, the worst of the entire test period. This comes as no surprise, as the test period represented a remarkable bull recovery right up until the recent stall. Nevertheless, due to the strength of the end-of-month bounce, by exit day the trade was down by only -0.7%.

This is the general nature of the trade: buying on extreme weakness in measured sentiment, and selling into price strength. However, as I wrote, "this simple system can generate long holds during very rocky times...." This trade was certainly no exception!

Second, the lesson to resolve was clearly how to avoid getting in too early. In this regard, I decided to take a closer day-by-day look at the ten-day oscillator in conjunction with the absolute value of its underlying indicator, as follows (the x-axes indicate days prior to exit):

As shown above, like many technical indicators, the best time to take the trade signal is when a divergence between the oscillator and its underlying value is observed, suggesting a change in momentum. Had the hypothetical trader waited for such a divergence to occur on or around the mid-point of the trade window, as indicated by the originally specified system, a significantly better result of +2.1% to +4.9% may have been achievable (see end-of-day bars -10 and -7, respectively).

Visually reviewing prior open trade periods, I made similar divergence improvement observations. This inspired the following rule modifications:

Buy – Buy the SPY at the close when (1) the oscillator has fallen below 0.996 during one the prior three days, and (2) the two-day RSI of the SPY is below 50. These rules are somewhat looser than before, but two additional criteria are added to pinpoint a potential divergence point, including: (3) the oscillator must be higher than its lowest close within the last three days; and, (4) the underlying indicator must be lower than its highest close within the last three days. In other words, the oscillator must have potentially bottomed, and the underlying indicator must have potentially topped.

Sell – Sell after the earliest of the following: the oscillator reaches 1.01, the 2-day RSI of the SPY exceeds 90, or twenty days has passed. This is the same as before.

During the test period, this modified system would have generated a 53% gain before trading costs with 28 wins out of 31 signals (90% wins/ average +1.7% gain), and was invested 21% of the time for an average hold period of eight days with a maximum drawdown of -4.3%.

These results demonstrate the desirable attributes of a lower drawdown, a higher win rate, a shorter average trade duration, and less total market exposure as compared to the system's first iteration. Indeed, the most recent November trade would have recorded a +2.3% gain. Even better absolute results may be garnered by waiving the higher oscillator criteria (rule #3) and just waiting for a confirmed capitulation of the underlying absolute indicator (total gains of 65%). These results challenge the total gains of the SPY over the same period (+79%) with substantially less market exposure.

This analysis is still "Level 2" at best, and more work is required before I would consider the system tradable per se, including a parameter sensitivity test. In a later article, I will also take a look at how the system might be used, if at all, intraday.


Friday, December 7, 2007

Financial Services Downgrades Losing Impact

Financial Services continued to be downgraded heavily this week -- yesterday's slew of Merrill downgrades being just the latest. Talk about being late to the game and calling the kettle black!

Below is the six month chart of the Ultrashort Financials Proshares (SKF)(moves -2X). Notice the head and shoulders formation, and more importantly, the lack of downgrade impact as the ETF has backed off of its highs. At its peak, SKF was up nearly 70% this year -- now it's closer to 30%! Could we have seen a bottom in this sector Mr. Paulson? What say you Mr. Bernanke? Hmmn?

P.S. - I will post the long promised Market Sentiment System revisit over the weekend. Yes, that VWAP study is yet to come. My guess is that it only works during the strongest of persistent-trend volatility days. Why? By the time you have observed the reversal and take the next bar, the edge is likely gone. That's not to say I assume it will be an absolute bust. Let's wait for the numbers to tell the story.

P.S.S. - What, you are thinking about going (double) long! Try UYG. Sometimes I just find it easier to turn things upside down! Be careful, still tricky out there.


NASDAQ100 Up 7% in 10 Days: What Happens Next?

As of the time of this post, the NASDAQ 100 (QQQQ) has rallied more than 7% during the past ten days. Quite a "V" bottom, and a rather rare one at that. In fact, this last occurred in April of 2003. I ran a quick scan of the last ten years to see what happens over the subsequent five trading days when such fast moves of equal magnitude occur.

Of the 66 instances, 38 were negative (58%) for a total loss of 62% (average loss of -0.93% per instance). The chart below shows the equity curve of the hypothetical trade back through December 1997 (about 2,500 trading days):

In spite of the average loss over the period in its entirety, you can see how the trade was actually positive on balance during the heavy upward momentum "bubble" period through the Spring of 2000 before it devolved into a pattern of sharp-bounce breakdowns during the bear market period that ensued.

This month is typically bullish and has brought relatively good news. The Federal Reserve's decision next week will certainly dominate trading for the rest of the month. While many of the major indices are back at prior highs (save the subject of this study), volatility has increased significantly since this past summer, not unlike the 2000 transition period.

At the end of the day, how you view this study thus likely depends on which type of environment you believe we are in.

UPDATE: For a good second interpretation of the recent surge, read this TraderFeed article on new highs. I always advocate looking at multiple indicators to get a true read on the market. Price is just one, and as you can see above, in this instance its interpretation is indeterminate.

Thursday, December 6, 2007

Daily View - Look out above!

Technically an exceptionally strong day thus far. Clearly lots of hope riding on non-farm jobs tomorrow. Also, it looks like rate cut expectations and Washington's rate freeze are supporting a rotation into Financials in-spite of industry downgrades.

Nonetheless, it's nice to have broken that recent high with broad participation and great Tick strength. Transports are not doing quite as well, however, nor are interest rates confirming a trend-wise rotation into risk. Furthermore, whereas yesterday we were in a virtual "no man's land," we are once again headed into possible resistance above (see prior downtrend line, high-level Oscillator cross, 50-Day MA, and 62% retracement).

Fulfillment of the Market's hopes could easily pierce this (though it is a bit of a long list). Consider hedging as/if we hit that target area (say SPY $150.25 to $150.75), but I wouldn't try to pick a top just yet.


Wednesday, December 5, 2007

12.05.07 - Nice Move

Nice move and our fund took a small leveraged position at last night's close on the weakness, so all the better. We are back at the 50% retracement though; consider a loose trailing stop with an eye towards that rising VWAP.

1:30PM CST UPDATE: So did you trail a stop? I realize I looked neutral to bearish yesterday. My intraday comments are often based on discretionary/personal technical observation -- by day's end we had a quantitative buy signal. The day isn't over yet.

2:50PM CST UPDATE: Nice bounce back up off of R2, but now we are back at that area of concern. Yes, we got it twice. May be we'll be "in the clear" until Fed day (CNBC talking head speak), but you know there will be volatility ahead of the real jobs report and actual decision/event day. I still tend to think that if the VIX continues to collapse, there will be a decent short-term trade there on the $VIX options contract.


Tuesday, December 4, 2007

12.04.07 - No Motivation to Buy

Always tempting to fade the gap, and it looks like that was the morning trade, but I'm just not feeling any motivation to buy.

Cumulative Tick is flat lined, Semi's and Transports are pulling, but Financials are going nowhere fast and the five-day moving averages are again headed flat to southward.

The S&P500 may look more attractive around the twenty-day moving average in anticipation of a long Fed trade in a week or so, though a volatility/VIX option play may be more in order.

For today, keep an eye on that daily S&P VWAP to see it holds and whether the TNX keeps rising and/or the Financials decide to join the party, indicating a possible move back into equities after this as yet mild pullback.


Monday, December 3, 2007

November 2007 Rewind – The Write-Down Elevator Ride

Mortgage bank subprime write-down news and reoccurring recession fears predominated the trading environment this November, together pushing the major U.S. equity indices into their largest monthly decline and second “official” 10% correction of the year.

Over $80B in cumulative subprime write-downs have now been announced, with wide-ranging predictions of another $100B to $300B yet to come. Meanwhile, the White House revised its 2008 Gross Domestic Product growth estimate downward from 3.1% to 2.7%. November also found oil on the verge of breaking the psychological $100 per barrel mark, stoking consumer spending fears that were all too well confirmed by sentiment readings at multi-year lows.

In a more positive vein, the broad stock market declines and weak dollar proved too tempting for a number of sovereign wealth and private equity funds to pass up. Most notably, the Abu Dhabi Investment Authority took substantial, albeit non-controlling stakes in Citigroup (C)($7.5B) and Advanced Micro Devices (AMD)($0.7B), while Citadel made a 20% investment in E*Trade Financial (ETFC)($2.6B).

Together with an all out promise from Messrs. Bernanke and Kohn of further Federal Reserve rate cuts ahead this December, a put was effectively placed under the market, supporting a significant bounce going into the final days of the month. In fact, the magnitude of the S&P 500's final four-day rally had not been seen in over four years time. What is it that they say about the largest bounces occurring in _ _ _ _ markets? Grrrr!

By the end of the month the S&P 500 and Dow Jones Industrial Average were down 4.4% and 4.0%, respectively. In contrast, and unlike last month, the technology heavy NASDAQ 100 showed relative weakness, down 6.7%. While that effect was likely an attempt to fund margin calls and rotate into oversold financials, recession fears had an especially strong impact on Small-Cap stocks, which were down 6% to 7%. Meanwhile, the ten-year note ended the month below 4%, its lowest level since 2005.

In spite of this traditionally bullish season, I am concerned that should we see another test of the recent lows, whether it be this month or early next year, a more substantial breakdown may ensue. Let’s hope for the bulls that this volatility elevator slows and climbs more steadily upward this month. Happy Holidays to you all.

The Style Box below was calculated using the following PowerShares™ ETFs: Small-Growth (PWT), Small-Value (PWY), Mid-Growth (PWJ), Mid-Value (PWP), Large-Growth (PWB), and Large-Value (PWV).

The Standard & Poors 500, Dow Jones Industrial Average and NASDAQ 100 may be traded through ETF proxies, including the SPY or IVV, DIA and QQQQ, respectively.

Sentiment: Negative
Volatility: High (VIX 17-31)
Direction: Lower

Rising 5-Day MA Providing Support

Still catching up from last week's trip (back late last night) and need to get November's "Rewind" out, not to mention my fund reports.

The rising 5-Day Moving Average of the SPY appears to providing support. Although the cumulative TICK is positive, it seems weak and there is very little trend strength either way. Nonetheless, we are seeing a pattern of higher lows and highs here, which is constructive. We will see.

We are just under the 50% retracement on the first trading day of the month. Getting more short set-ups than longs at this point... Oil has got to be helping to sustain the gains here. Also, have you looked at the ten-year note lately? It's well under 4%! Although small-caps have been taking it on the chin, this has got to help at some point, although I suppose LIBOR is more relevant in this regard. As a last heads up, I believe the Sentiment trade from (too) early last month finally closed out Friday.

Apologies for the random walk, more when I have caught up.