Monday, December 07, 2015

Trading Notes: Week of December 7th

Friday, December 11th

*  We got a bounce in yesterday's trade, only to fall back late in the day and move back to recent lows in overnight activity.  I will be watching downside follow through closely in early trade today, especially with respect to breadth, which--while negative--has improved over the past two trading sessions.  Yesterday we saw 93 stocks make fresh three-month new highs and 342 new lows across all exchanges.  My cycle measures are quite close to levels that have been typical of intermediate-term market lows.  That has me careful about pounding the downside here.

*  While trader attention has been quite focused on central banks in Europe and the U.S., we continue to see unusual weakness in emerging markets and oil.  It's a disconcertingly disinflationary trade and I find it difficult to envision a longer-term picture of higher U.S. rates, higher U.S. dollar, and higher U.S. stocks if that dynamic continues.  Note the toll taken on the high-yield bond market.  At least so far, the China weakness dynamic seems to be trumping the central bank stimulus dynamic.

*  Note that the VIX closed near 20 yesterday for the second consecutive day.  The median VIX from January through July was about 14.  The median VIX since the start of August has been 17.  I am open to the idea that 2016 could be a higher volatility year than 2015 given the above disinflationary dynamic and its potential impact on global markets. 

Thursday, December 10th

*  We saw weakness overnight, then morning strength in stocks, followed by significant selling pressure and new price lows for the latest move lower.  Interestingly, however, we saw fewer stocks register new lows on the day.  For example, across all exchanges we had 385 new three-month lows compared with 601 the day previous.  Meanwhile, we're short-term oversold per the breadth chart below, with fewer than 20% of SPX stocks trading above their three- and five-day moving averages.  We've bounced overnight from the afternoon lows yesterday and I'll be watching breadth closely on any further weakness.  Should we get to intermediate-term oversold levels and hold above the price lows from mid-November, I would start looking for an end of year rally in stocks.

*  We once again saw very different price action yesterday during hours in Asia, Europe, and the U.S.  Assuming that price moves in one time zone will necessarily continue into next ones has not been a great bet for short-term traders.  I find the current environment to be much better to trade within each time zone, buying oversold levels and selling overbought levels.  The chart below tracks short-term rate-of-change where each period represents 500 price changes in the ES futures.  This normalizes for overnight trading, but still takes into account movement overnight.

Wednesday, December 9th

*  We continue to work off the overbought condition per yesterday's post, but my intermediate-term cycle measures are not yet in oversold territory that has corresponded with recent market lows.  Meanwhile, breadth continues to deteriorate.  Across all exchanges yesterday, we had 21 stocks make fresh annual highs and 252 register 52-week lows.  This is more new lows than we saw at the mid-November market bottom.  In all, this looks like a weakening market, not a strengthening one.

*  No doubt contributing to the weakness is the unusual weakness in the high-yield bond market.  See the weekly chart of JNK below.  With energy prices continuing to fall, there are increased risks of bond defaults among oil producers.  It is difficult to square that dynamic with a bull market thesis.

*  Given the commodity weakness and heightened prospects for bond defaults, it's not surprising that much of the weakness among stocks this past month has come from raw materials shares per the graphic below from FinViz.  Even with central bank ease around the world, deflationary pressures globally have not abated.

Tuesday, December 8th

*  I'm watching volume carefully as the year winds down.  It would not surprise me to see traders pack it in early this year, given low liquidity and the challenges of P/L.  Tracking volume intraday has been very helpful in gauging how far market moves can extend.

*  We continue to work off an overbought condition (see below), with only modest losses in large caps but greater weakness among smaller caps.  That weakness has contributed to overall weak readings with respect to the number of stocks making new highs vs. lows.  For example, we had 194 stocks across all exchanges make fresh 3-month highs yesterday against 546 new lows.  That number of new lows was the weakest reading since early October.

*  If I had to choose a surprise for stocks in 2016, it would be that interest rate sensitive issues catch a bid, shrugging off any hike from the Fed and focusing instead on the (modest) path of rate increases going forward.  It is increasingly clear that this will be an abnormal hiking cycle.

Monday, December 7th

*  Here's what I see among talented traders who can't seem to make their trading their career.

*  We've moved quickly from oversold to overbought on my short-term measure, which is a 50-period rate of change measure, where each period is defined as 50,000 ES contracts traded.  (See below).  It's not unusual to see some upside follow through after such a thrust, so I'm flexible in trading today's session. 

*  One way I like to stay flexible is by going with statistics that I've gathered that find that the majority of trading days either put in their highs or lows for the day during the first hour of trade.  By watching early flows, including uptick/downtick values, I can get a sense for whether we've made a likely high or low for the day and trade the remainder of the session accordingly.  

*  The weakness in oil prices in the wake of the OPEC meeting has implications for energy shares, commodity currencies, and economic strength/weakness of various countries.  Ultimately it is difficult to reconcile commodity weakness with growth perspectives leading the Fed to likely hike this month.  Some interesting views have popped up lately regarding the possibilities of 2016 recession.  If that scenario is to hold, we should see little follow through to Friday's rally in stocks.