Monday, March 07, 2016

Trading Notes For The Week Of March 7, 2016

Friday, March 11th

*  Thursday's ECB meeting brought stock buying and euro selling--and then a sharp reversal of both during the day before a rally late in the day and overnight brought us back toward the highs.  As the one-hour oscillator of upticks/downticks for all listed stocks shows below, the selling was quite broad during yesterday's selloff and the buying has been broad on the reversal.  New highs vs. lows for listed stocks deteriorated yesterday, so I will be watching breadth going forward to see if participation expands or contracts on upside moves.

*  We've turned down on the cumulative number of buy vs. sell signals given by the Wilder Parabolic-SAR system.  That tracks all NYSE shares on an end-of-day basis (raw data from Stock Charts).  Note that, during vigorous upward cycle phases, such as we had in October of last year, the cumulative SAR measure will peak ahead of price.  So far, during the deterioration in the measure, price has held up well.  I lean toward buying weakness that remains above yesterday's lows.

*  I noticed some underperformance of small cap shares yesterday.  One day does not make a trend, but during the vigorous rise from the February lows, small caps were outperformers.  I will be watching that relative performance going forward, as it could offer clues as to the eventual turning of the cycle.

Thursday, March 10th

*  Wednesday saw rangebound markets, as selling greeted early strength, but stocks by and large held against their prior day's lows.  We closed with under 50% of SPX stocks under their 3 and 5-day moving averages.  Going into the ECB announcement, we need to see the lows of the last two days hold up in order to continue the vigorous uptrend from the February lows.

*  Here is a chart of the number of NYSE stocks giving buy signals versus sell signals with respect to their Bollinger Bands--a very useful measure of broad market strength vs. weakness.  Note the upthrust from the February lows, followed by a pullback in buy signals, but not at a point where we're getting net sell signals.  It is common for thrusts higher in the Bollinger measure to be followed by further price strength; market rises become vulnerable when we begin seeing net sell signals. Note how thrusts lower in the measure have represented good buying opportunities as a whole.

I recently wrote on the topic of a powerful measure of stock market sentiment.  Interestingly, that measure shows a net reduction of SPY shares outstanding over the past 5, 10, and 20 trading sessions.  That configuration has tended to lead to price gains over the next 5-20 trading sessions.

Wednesday, March 9th

*  Monday's post talked about a normal correction from stretched levels and we got that yesterday, as about 19% of SPX stocks closed above their 3-day moving averages and 26% above their 5-day averages.  In an uptrend, we expect short-term oversold levels to occur at successively higher price lows.  We're seeing a bounce in overnight trade and my base case is that yesterday's lows hold as we set up a test of the recent highs.  Of course, market response to tomorrow's ECB announcement could have a lot to do with whether that base case plays out or not.

*  Yesterday, stocks across all exchanges making fresh monthly highs dropped from 1720 to 719; new lows rose from 80 to 88.  In general, I only become concerned about the reversals of cycle uptrends when new lows expand meaningfully.  The past week we've had the lowest number of new monthly lows in years.  The absence of weakness ends up being as strong a predictor as the presence of strength.  Markets generally turn because one or more sectors are rolling over, creating the expansion of new lows.

*  Here's a look at the performance of major stock market sectors from the Finviz site.  Note how the sectors that led performance on the downside (utilities) are now lagging and how those most hurt in the downturn (raw materials) are now leading performers.  If the uptrend is to continue, we would want to see broad participation of the sectors; a rally with strong sector rotation is what often leads to a more prolonged correction.


Tuesday, March 8th

*  After a sizable run higher, we're beginning to see signs of distribution.  While the number of stocks across all exchanges hitting fresh monthly highs was impressive yesterday (1720), that number was below the levels seen the prior day (2082) and the day before that (1868).  Small cap and midcap stocks continue to outperform.  NASDAQ shares have been relatively weak; commodity-related shares have been relatively strong.  Consumer staples shares (XLP) hit a new high yesterday, part of a theme that I believe will emerge in this world of growing negative interest rates:  the appeal of stable, high quality stocks that offer relatively safe and attractive yields.  Such stocks are richly valued already, but could see bubble-like performance should central banks continue down the negative rate path.

*  Commodities have staged a significant rally; DBC is now above its December 31st close (see below).  The U.S. dollar (UUP) is down on the year.  With ECB coming up on Thursday, might we be pricing in significant reflation, and might the central banks in Japan and Europe be embarking on stimulus measures above and beyond negative interest rates and bond-buying?  That would be a most significant macro development.

*  The recent selling around the 2000 level in ES notwithstanding, I continue to be impressed by the vigor of the rally off the February lows.  Note below how we've gone from an overbought situation to an even more overbought one, with stocks moving steadily higher.  (Chart tracks SPX stocks making new highs versus lows over 5, 20, and 100-day lookback periods).  If indeed we're getting reflation from central banks, the implications for stocks would not be short-term and could continue to power shares higher.

Monday, March 7th

If our trading does not provide these four psychological benefits, we're apt to underperform and lose our ability to perform in the zone.  We can best manage our positions if we're managing ourselves well.

*  We saw some broad selling late on Friday and so far have not been able to bounce in overnight trading.  Friday closed with over 80% of SPX stocks closing above their 5, 10, 20, and 50-day moving averages, but a waning percentage closing above their 3-day averages.  (Data from Index Indicators).  I would not be surprised to see a normal correction of the recent strength; that should terminate above the late February lows to sustain the current uptrend.  I would also not be surprised to see subdued risk-taking ahead of this week's ECB meeting.

*  The intermediate-term cycle measures that I track continue to be stretched to the upside.  Note how we've rallied in the face of an "overbought" cycle.  That momentum suggests that we're not yet at a point where we would expect the uptrend to meaningfully reverse.  

*  One measure I track is the volatility of market breadth.  Specifically, I track the volatility of the daily readings of SPX 500 stocks making fresh new highs and lows on a 5, 20, and 100-day basis.  We recently hit a meaningfully low level in that measure.  Since 2010, when we've been in the lowest quartile of readings for breadth volatility (as at present), the next five days in SPX have averaged a gain of only .01%.  When we've been in the highest quartile, the next five days in SPX have averaged a gain of +.44%.  It's one more measure that makes me open to the possibility of some short-term correction of the recent market strength.