Weighing the Week Ahead: Technical Danger Signals?

After a week of modestly strong data, what is next? This week has some second-level data, with the big news next week.  Expect plenty of action from technical analysts, who will wonder:

Do the charts suggest a new level of danger?

Last Week Recap

The housing news was OK.  Much attention was focused on the Senate version of the ObamaCare repeal.  That discussion will also carry over into the week ahead.

 

The Story in One Chart

I always start my personal review of the week with a chart of the price action.  The chart shows some swings, but the overall scale is very small.  Basically, nothing is happening to the overall averages.

Note to Readers

I am doing only a brief indicator update and a few thoughts on my weekend away.  Mrs. OldProf is already scolding me.

The News

Each week I break down events into good and bad. For our purposes, “good” has two components.  The news must be market friendly and better than expectations.  I avoid using my personal preferences in evaluating news – and you should, too!

The economic news last week was pretty good.  Home sales data beat expectations and initial claims continued at a very low level.  The only soft news came from the “newbie” PMI indexes.  Until further proven, I am paying little attention to these.

 

The Week Ahead

We would all like to know the direction of the market in advance. Good luck with that! Second best is planning what to look for and how to react.

The Calendar

It is a calendar with some interesting news, mostly setting things up for the big data in the following week.  I will be especially interested in personal spending and Michigan sentiment.

Fed speakers are out in force.  Expect more color on the reduction of the Fed balance sheet.

Briefing.com has a good U.S. economic calendar for the week. Here are the main U.S. releases.

Next Week’s Theme

The story has not changed much in the last few weeks.  We have covered most of the main themes in the last few installments:

  • Low volatility
  • Bonds versus stocks
  • Sector rotation
  • Various threats to growth

I expect plenty of articles on “newly discovered” recession indicators, the yield curve, the Hindenburg Omen, and other similar threats.

 

Quant Corner

We follow some regular featured sources and the best other quant news from the week.

Risk Analysis

I have a rule for my investment clients.  Think first about your risk.  Only then should you consider possible rewards.  I monitor many quantitative reports and highlight the best methods in this weekly update.

The Indicator Snapshot

 

The Featured Sources:

 

Bob Dieli:  Business cycle analysis via the “C Score.

RecessionAlert: Strong quantitative indicators for both economic and market analysis.

Georg Vrba: Business cycle indicator and market timing tools.

Brian Gilmartin:  All things earnings, for the overall market as well as many individual companies.

Doug Short: Regular updating of an array of indicators.  Great charts and analysis.

 

 

Final Thoughts

 

Last week I noted that I was not much concerned about the unwinding of the Fed balance sheet.  I explained more fully this week.  If you missed it, please take a look.  I’ll have more on this subject in the week ahead.

This will include some discussion of the ACA repeal legislation.

 

Stock Exchange: Are Traders Joining the Yield Chase?

Our Stock Exchange is all about trading. Each week we do the following:

  • Discuss an important issue for traders;
  • Highlight several technical trading methods – including current ideas;
  • Feature advice from top traders and writers; and,
  • Provide a few (minority) reactions from fundamental analysts.

We also have some fun. We welcome comments, links, and ideas to help us improve this resource for traders.

Review

Our last Stock Exchange we asked whether you can analyze the market using psychology. If you missed last week’s edition, check it out.

This Week— A tough stretch focuses attention on yield

This important topic has already attracted expert attention, as we see in today’s Trading Tips.

Trading Tips

  • Dr. Brett Steenbarger, who is a strong advocate of having method in your trading, has a typically insightful post on the need for flexibility. He always has a finger on the pulse of the trading community, and sees a lot of frustration. Many systems have hit a dry spell. Brett asks:

    Are you trading what you subjectively prefer, or are you trading what is objectively present in the market?

A great question.

  • Options trading may seem like the answer if you need some excitement. Steve Burns (See it Market) highlights ten pitfalls to avoid. If you are not an experienced options trader, you will definitely benefit (perhaps a lot) from spending a few minutes with this post. Here is my favorite pitfall:

    When used correctly options can be tools for managing risk by limiting capital at risk exposure and capturing huge trends, used incorrectly they can blow up your account.

[Jeff]I started in the investment world with Chicago market makers, who risked their own money along with that of some backers. Some of them scored big. Many others blew out. Some got a second or a third chance. Steve’s questions are definitely important.

I’ll have more in this week’s conclusions.

 

Expert Picks from the Models

This week’s choices are decidedly more conservative.

Athena: I have another choice this week – two in a row since my vacation. I am looking at the hotels sector, and my pick is:
Host Hotels & Resorts, Inc. (HST). This stock has made a nice move since November. It delivers consistent payments for its owners. Though the stock had a very slight dip this week, I expect the uptrend to resume.

Jeff: The security is a REIT, so it is not like a regular equity investment. People are reaching for the apparent yield of over 4%, but the P/E ratio is high for a pick like this.

A: You are telling me that current buyers are unwise.

J: Not necessarily. It depends upon their investment objective and the level of risk they are willing to take on. This is a “reach for yield.”

A: I am not troubled by that. I am interested in the stock price. I will make a quick profit and then sell.

J: You mean the REIT price.

A: Yes. My method is different from yours – and it is quite effective, as you know.

Oscar:
This week I like long-term bonds. Usually I trade a basket of names for each sector. The extra liquidity in this case means that using the 20+ Year Treasury Bond ETF (TLT) works well. Here is what I see.

 


 

The intersection of the 50-day moving average with the 200-day moving average tells me this sector is getting over the hit it took in early November. The recovery is for real, and we could be on a trend back up to the $135 level. If the next 4 weeks look anything like the last 8, I’ll be sitting pretty.

 

J: A further big move in bonds might mean that money is getting pulled from stocks. Don’t you have positions there as well? This was a very good week for biotech. I think we discussed that sector a few weeks ago.

 

O: Yes.

 

J: Do you think the move is based upon the President’s plans for drug pricing. It is much less stringent than expected.

 

O: I guess I missed that. The U.S. Open was pretty exciting. But biotech has done well. The only thing that would have made our 5/25 Biotech investments better would be if we had made them on 5/30. In any case, I won’t complain about a ~10% pop in one of my three holdings.

 


 

J: Do you expect the move to continue.

 

O: The charts will tell me. There are almost always attractive new sectors.

J: Did you analyze the sectors requested by your fans?

O: Yes. This week’s list includes everything that has been requested.

J: TLT is still not on the list. It was a “sell” a few weeks ago.

O: The rankings in the sell range do not imply a recommendation to “short” the group. They simply have very low ratings when other choices are much stronger. Bonds have improved dramatically, and have moved near the top of the list.

J: Some readers do not like the rankings based upon your requests. Why not just post your own ratings?

O: I’m working on that.

 

 

 

Holmes: My choice this week is HD Supply Holdings, Inc. (HDS). What a tempting chart!

 

 

Looking at the one-year chart, the shares which were trading above $36 last August had quite a fall to touch just about 30-31 in early September. However, its recovery was quick in November. Since then, for another eight months in a row, the shares have been consistently maintaining the highs even reaching close to 42. Early this June, the shares plunged to a low again though not to such lows as seen last September. I expect a nice rebound – perhaps not to the old highs, but good enough for a trade.

J: I checked this out with our go-to site for stock valuation – F.A.S.T Graphs.


While the earnings history is short, it looks good until the big 2018 decline. One of the firms gave it a “sell” rating.

H: That kind of over-reaction by analysts is typical of my choices. I will not be holding this stock in 2018. I need only a rebound.

Felix: Nothing new from me this week. That is not surprising given the lack of significant sector momentum.

J: I understand. Do you have your updated ratings?

F: Of course. My fans have made some new requests, which I added to the list. Keep those emails coming!

J: I don’t see RoadRunner here this week. He is leading in the YTD race in our group, barely ahead of Holmes.

F: RoadRunner has been checking his charts, but has nothing for us this week.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Conclusion

Getting active at the wrong time can be a fatal mistake. Brett Steenbarger effectively uses examples from poker. The strategy is similar and the odds calculated more readily. While we see the dramatic hands on TV, they omit scores of deals where the champions are just sitting there.

When there is an overall market move to bonds and bond substitutes, it has a dramatic effect on trading systems emphasizing stocks.

How do our own models deal with quiet times?

  1. Reducing size, or exiting altogether. That is the current RoadRunner approach.
  2. Switching to more conservative choices. That is the current Oscar plan.
  3. Not pressing for new choices. Felix and Athena have taken this approach.

What about Holmes? The dip-buying style nearly always finds candidates. Holmes is not bothered by quiet market times, but will exit completely if things turn dangerous.

Traders need to accept one or more of these methods – or perhaps switch methods with the times. What do you do?

Here is a summary of the cast of our characters. Find your own favorite!

Stock Exchange Character Guide

Character

Universe

Style

Average Holding Period

Exit Method

Risk Control

Felix

NewArc Stocks

Momentum

66 weeks

Price target

Macro and stops

Oscar

“Empirical” Sectors

Momentum

Six weeks

Rotation

Stops

Athena

NewArc Stocks

Momentum

One month

Price target

Stops

Holmes

NewArc Stocks

Dip-buying Mean reversion

Six weeks

Price target

Macro and stops

RoadRunner

NewArc Stocks

Stocks at bottom of rising range

Four weeks

Time

Time

Jeff

Everything

Value

Long term

Risk signals

Recession risk, financial stress, Macro

 

 

Background on the Stock Exchange

Each week Felix and Oscar host a poker game for some of their friends. Since they are all traders they love to discuss their best current ideas before the game starts. They like to call this their “Stock Exchange.” (Check it out for more background). Their methods are excellent, as you know if you have been following the series. Since the time frames and risk profiles differ, so do the stock ideas. You get to be a fly on the wall from my report. I am usually the only human present, and the only one using any fundamental analysis.

The result? Several expert ideas each week from traders, and a brief comment on the fundamentals from the human investor. The models are named to make it easy to remember their trading personalities.

Getting Updates

We have a (free) service for subscribers of our Felix/Oscar update list. You can suggest three favorite stocks and sectors. Sign up with email to “etf at newarc dot com”. We keep a running list of all securities our readers recommend. The “favorite fifteen” are top ranking positions according to each respective model. Within that list, green is a “buy,” yellow a “hold,” and red a “sell.” Suggestions and comments are welcome. Please remember that these are responses to reader requests, not necessarily stocks and sectors that we own. Sign up now to vote your favorite stock or sector onto the list!

 

Fed Balance Sheet Unwind? No Reason to Worry!

In the wake of the Fed decision to begin reducing its balance sheet, speculation abounds. Pundits of all stripes are speculating about what this will do to interest rates, the economy, and the stock market.

The answer is easy. Nothing.

Those commenting often make two types of mistakes – omitting important data and using pop economics instead of real analysis. Let’s consider each in turn.

Data

If we put aside the political debate and merely asked about the impact of reduced demand in a market, what would be our approach? We would take the rate of the change and compare it to the daily volume. If it was very small, we would expect little effect. In a Federal court where I was an expert witness the Fidelity Investments team opined that 1% would be small. While no one really knows, that seems reasonable. Let’s do the math.

The Fed plans to halt replacement of maturing Treasury securities at some point in 2018. We do not know the exact plan, so I’ll make a more aggressive assumption. Suppose that the Fed begins immediately—no replacement of maturing securities. Let’s do the math.

Amount of Treasury holdings expiring in the next five years: $1.4 trillion.

Dividing by five years: $280 billion per year.

Dividing by 250 (or so): $1.12 billion per day.

Total daily volume in the cash Treasury market: $500 billion or so, or about 0.2%.

And this does not count trading in futures markets, where a buyer can hold until delivery if desired.

This is a very deep and liquid market. The error made by many is to compare the size of the Fed balance sheet with net new issuance by the Treasury. Why is this comparison relevant?

Analysis

The net new issuance comparison makes a common, pop econ mistake. It treats a large and complex market as if it consisted of two parties. This may be easier to understand, but so was the concept of “flat earth.” It leads people, like a top TV bond commentator, to ask, “If the Fed and other central banks quit buying new bonds, who will step in?”

In the last few years we have also witnessed assorted experts asking, “who will buy our bonds?” And then shortly thereafter, shamelessly discussing a shortage of long-term bonds. These are great stories to attract viewers and readers, but a simplistic view of the market. It ignores the millions of participants making up the deep market. This cannot be represented as two parties. A beginning economics class is all you really need. Think about supply and demand in terms of distributions of many players. Consider these simple graphs from a helpful source.

If you look at the chart on the right, you might view the Fed absence from the market as an external shift in demand. This does not affect the plans of other participants, but it does mean less demand at each price, so a shift from D2 to D1. We should expect a lower quantity and price (higher yield), but not a hugely dysfunctional market. During the QE period, I sought estimates from many macro economists about the total effect of QE. Some Fed economists also made a similar estimate – about 1% in the ten-year note.

Over a period of several years, we might expect a gradual adjustment in the ten-year note by 1% — or perhaps less, since some of the balance sheet will be maintained. It is small enough that other factors will be the main drivers.

Conclusions

We can now see why past scary predictions did not come to pass. If every TV pundit was required to pass a two-part test:

  1. State the size of the bond market;
  2. Draw and explain one of the charts above…..

…CNBC would have a lot of air time to fill!