by ilene - July 27th, 2016 1:18 am
Courtesy of Cullen Roche, Pragmatic Capitalism
If you’ve read my paper Understanding Modern Portfolio Construction you know that I like to think of all financial instruments as if they’re bonds. This is helpful for multiple reasons:
- It helps provide a realistic timeframe for holding certain instruments.
- It helps put the various risks of those instruments in the right perspective.
The thing about bonds is that they pay a specific coupon. So, a 10 year T-Bond paying 2.5% will pay you 2.5% for the next 10 years. If you have a 10 year time horizon then you can virtually guarantee that you’ll get 2.5% per year plus your principal upon maturity. That creates a really clean linear relationship between the time of issuance and maturity. In other words, if you buy the bond today and wake up in 10 years it will look like the bond exposed you to zero permanent loss risk over that time period. I apply the same sort of thinking to the stock market in my paper by calculating a 25 year duration. The stock market, is a lot like a super long maturity bond paying 8-10% per year.¹
Of course, that’s not how bonds (or most other financial instruments) work. They do expose you to the risk of permanent loss in the short-term. And the big problem with low yielding bonds is that they expose you to a lot of potential interest rate risk which creates a lot of short-term risk. If you’re uncertain about your time horizon or you’re worried about generating a positive real return then holding that 10 year bond for 10 years might feel really uncomfortable. This is why I say that the current low yield environment has turned every bond investor into a trader. You’d have to be nuts to buy a long maturity bond and actually hold it to maturity when the risk of a negative real return looks high.
What I most like about thinking of everything like a bond is applying the concept of price compression. You might remember a post I wrote back in 2014 describing the price compression in Biotech stocks. Biotech stocks are akin to a super…
by phil - July 26th, 2016 9:25 am
That's our shorting line on the S&P 500 Futures (/ES) and the significant line below that is the S&Ps 15% line on our Big Chart at 2,127.50 so that's the range we'll be looking for if we're going to have the beginnings of a proper correction. Anything less than that is just a blip as we consolidate for (and I hate to say it) a move higher.
Of couse, we don't need to go all the way back to 2,127.50 to make money. Last Thursday, we laid out our shorting lines from our Live Member Chat Room, right in the morning post and they were (and still are):
18,500 is lined up with 2,165 on /ES, 4,650 on /NQ and 1,205 on /TF, we want to see them all below to play a short.
Then on Friday, I noted we made a profit of $500 per contact at 2,155 so of course we did it again when the levels broke again yesterday. Learning to make money in the markets is a lot like learning to be a great stage performer – you learn your part, do it well and then learn to consistently repeat your performance over and over again. Much like most rock bands – no one in the audience is interested in your new stuff – just play the hits please!
S&P Futures expire in September and sentiment has them trailing the actual index, which finished at 2,168.50, 6.50 above the Futures levels, so keep that 6.5-point difference in mind when we're looking at the S&P chart and talking about the headline levels vs. the Futures.
As you can see from the hourly S&P chart, yesterday's 13-point dip hardly registers in the bigger picture and we're still costing along the upper end of the 50-hour moving average at the top end of the bullish range. It's going to take more than a blip like that to scare off the dip buyers – who have been rewarded by the Fed(s) for their aggressive behavior pretty much since 2009!
There's not much to do but watch and wait ahead of our Fed's announcement on Wednesday afternoon and the BOJ on Friday morning and we can expect to drift along near the highs at least until we year from our own Central Bank tomorrow.
by phil - July 25th, 2016 8:01 am
Unlike the wicked witch, who uttered that phrase during the previous Global Depression, liquidity has been good for the markets so far as the World is swimming in it and, even this week, more is expected from the Bank of Japan on Friday. The entire G20 got together this weekend and promised to use "all policy tools" to lift global growth:
"While the weekend's signals from the G20 meeting in China were welcome, investors were bracing for a hectic week that includes a U.S. Federal Reserve meeting, European bank stress tests and what could be another super-sized slug of stimulus from Japan. 'The Bank of Japan is really the one that is front and centre this time with the all talk around 'helicopter money," said TD's Richard Kelly, "if they disappoint, which I think is probably more likely, then we are likely to see risk assets coming off.'"
I've been calling for CASH!!! all summer and so far, so wrong on that one as we make fresh record highs pretty much every day since the Brexit but now Goldman Sachs (GS) has decided to agree with me, putting out their own 5-point warning to clients:
- Valuations are already at historical extremes. The S&P 500 trades at a forward P/E of 17.6x, ranking in the 89th percentile since 1976. At 18.4x, the median constituent ranks in the 99th percentile. Most other metrics such as P/B, EV/EBITDA, and EV/Sales paint a similar picture. These valuations are only justifiable because of the historically low interest rate environment.
- Zero profit growth is not consistent with high stock valuations. Sluggish global growth and low inflation along with negative interest rate policies in Europe and Asia have led to record low US bond yields. Consistent with this backdrop, 2Q results will show the seventh consecutive quarter of declining year/year operating EPS (-3%, but +1% ex-Energy). Despite near-record margins, adjusted S&P 500 EPS have been flat for three straight years.
- Many Financials will have lower profits if low interest rates persist. Historically low yields squeeze the net interest income of banks and make liabilities harder to meet for insurance companies. Our Bank equity research team this week cut their EPS forecasts by 5%-7%. The fall in Treasury yields explains most
by ilene - July 23rd, 2016 7:49 pm
Courtesy of Dana Lyons
The S&P Mid-Cap Index is trading in the tightest 8-day range in over 20 years; is a big move imminent?
Yesterday, we wrote about the Dow Jones Industrial Average’s rare streak of 7 consecutive all-time highs since its long-awaited breakout. However, scanning the broad equity landscape, it appears that consolidation has been more the norm since the market’s last big up day on July 12. This consolidation is demonstrated by the S&P 400 Mid-Cap Index as clearly as any space. Specifically, the 7-day range in the index spans less than 1 percent for just the 8th time ever. And, at precisely 1.00%, the 8-day range is the narrowest in more than 20 years. In fact, all of the historically tighter ranges occurred in the low-volatility early to mid-1990′s period.
So what are the implications of this tight range? Well, it is generally thought that exceptionally tight ranges lead to out-sized moves once the range is broken. The notion is that the action is akin to a coiled spring that, when released, expends its considerable pent-up energy. And, generally, we have found that to be the case with breakouts from similar ranges. However, it also depends on the type of environment we are in as well.
From 1992-1995, for example, the daily average true range in the S&P 400 averaged about 0.65%, an exceptionally low level. Thus, we should not be surprised to see that most of the historically tight trading ranges took place during that period. We also should not be surprised to see that the tight ranges of that era did not always lead to out-sized moves.
On the other hand the average true range during past 4 years has averaged around 1.30%, or about double that of the early-1990′s period. Therefore, when we see an unusually tight range like we are seeing now, it is not unreasonable to expect a sizable move once the tight range is broken.
Additionally, in an environment like the present, a tight range or consolidation is often representative of a continuation pattern.
by ilene - July 22nd, 2016 4:30 pm
Courtesy of Lance Roberts of Real Investment Advice.com
While the markets have indeed broken out to new highs, as I addressed earlier this week, it has done so without a significant improvement in the fundamentals. However, the breakout, such as it is, should not be dismissed or ignored. The technical underpinnings have improved enough to warrant an increase in equity related exposure given a proper entry point in the days or weeks ahead. Such an entry point would require a relaxation of the extreme short-term overbought conditions that currently exist. But a violation of critical support would negate the breakout and return the market back to a more bearish posture.
The potential for such a pullback is extremely high. As Tom McClellan noted recently, the “14-day Choppiness Index,” which tracks the path of a short-term trend, suggests Wall Street’s “uptrend is getting tired.” As McClellan notes, the very linear path for the index implies that the trend is likely to come to an end soon, while more volatile, or choppy, action suggests the opposite. A low reading in McClellan’s index signals a fairly straight-line, or linear, move. And presently, his choppiness index is at its lowest level in two decades.
“The reading on Monday was the lowest since Feb. 12, 1996 (yes I scrolled all the way back that far to find a lower one). And in case you are interested, that 1996 instance marked a price top which was not exceeded until 3 months afterward. Linear trends either upward or downward are very exhausting, requiring a lot of energy from either the bulls or the bears to keep everyone in formation and marching together. The market tends toward entropy, so excursions like this toward extreme organization cannot last for very long.”
Furthermore, with volatility levels at extremely low levels the probability of a further advance, without a pullback first, is extremely limited. My friend, Salil Mehta made a great comment on this recently noting that at current levels of volatility there is only about a 20% probability of further declines.
“At 11 [in the VIX] you are really close to the floor. chances are higher that you won’t go lower on VIX and will
by phil - July 22nd, 2016 7:26 am
What a week.
Congratulations if you caught our call to short the Dow at 18,500 yesterday morning, that was good for a profit of $500 on each contract as we tested 18,400 in the afternoon – not bad for a day's work! Our other winning short index calls were:
- 2,165 on the S&P Futures (/ES), which fell to 2,155 – up $500 per contract
- 4,650 on the Nasdaq (/NQ), which fell to 4,630 – up $400 per contract
- 1,205 on the Russell (/TF), which fell to 1,198 – up $700 per contact
As you can see from the Dow chart above, we took a few losses poking short on the Dow during the week but it's all worth it when you catch a big winner on the way down. This morning, of course, we're moving back up on no volume – which is why we end up shorting in the first place.
Per our 5% Rule™, the week's fall from 18,550 to 18,400 is 150 points so a weak bounce is 30 points to 18,430 and a strong bounce is 60 points to 18,460 and 18,475 is the 50% line, which is where we'd poke short again with very tight stops and then, once the strong bounce line fails – we'd look for shorting opportunities at the strong bounce lines on all our indexes again.
Despite successfully playing for a bounce on oil and gasoline in yesterday's Live Member Chat Room, we are generally expecting a repeat of last Fall's fall and that is going to be bad news for the broad market as there is already a severe disconnect between Energy Sector stocks and the price of the energy they sell.
Like much of the S&P, a combination of financial engineering (and note that Business Insider is now a lot more critical of Microsoft's (MSFT) earnings than I was on Wednesday) and completely irrational exuberance has led to unrealistic valuations that even the loosest of Fed models won't be able to sustain. With Exxon (XOM) and Chevron (CVX) both heavy Dow…