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Markets, Posts, Trading

Two Key Fibonacci Levels I’m Watching Right Now

There are two charts I’ve been watching for weeks now that I thought I would share today. Both represent critical Fibonacci levels in important indexes. For that reason they matter greatly to the broader stock market.

First is the Russell 2000 which represents small cap stocks. These little guys have just torn it up over the past few years – so much so that they are now trading at a valuation that is 26% above their late 90′s peak! A while back I labeled the breakout above $85 “the most bullish chart I’m watching right now.” Since then the index has soared nearly 40%. But now it’s running into the 1.618 Fibonacci extension within the context of a broken rising wedge (bearish) and diverging money flow and MACD (bearish):

iwm

This next chart shows the weekly performance of the Financial Sector ETF. It hasn’t performed nearly as well as the small caps over the past few years as it still has a long way to go to recover the losses it suffered during the financial crisis. it’s now running into the 61.8% Fibonacci retracement of that decline also within the context of a broken rising wedge (bearish) and divergences in RSI and MACD (bearish).

xlf

Small caps have led the broader rally over the past few years and finance now makes up a very large part of our economy so both of these charts are key “tells” in my book.

For more fun with Fibonacci see “Nature by Numbers.”

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Featured, Investing, Markets, Posts, Trading

For Everyone Who Thinks Tom DeMark’s 1929 Analog Is A Joke…

If you can keep your head when all about you
Are losing theirs and blaming it on you,
If you can trust yourself when all men doubt you,
But make allowance for their doubting too;

 

Tom DeMark has been absolutely lambasted since he first proposed his 1929 analog a few months ago. It suggests stocks might be following a similar pattern today as they did back then, ultimately headed for a crash. Even many market watchers I deeply respect have turned the study into a joke on social media.

To these folks I’d just like to point them in the direction of Paul Tudor Jones II, one of the most successful hedge fund managers in history. Anyone who has read the original “Market Wizards” should be familiar with his story. It begins, “October 1987 was a devastating month for most investors as the world stock markets witnessed a collapse that rivaled 1929. That same month, the Tudor Futures Fund, managed by Paul Tudor Jones, registered an incredible 62 percent return.”

How did he do it? How did he manage to profit so handily from an event nobody saw coming? Jones answers, “our analog model to 1929 had the collapse perfectly nailed. [Paul Jones' analog model, developed by his research director, Peter Borish, super-imposed the 1980s market over the 1920s market. The two markets demonstrated a remarkable degree of correlation. This model was a key tool in Jones' stock index trading during 1987.]” The 1929 analog was the “key” that helped him predict and prepare for the crash.

Screen Shot 2014-03-13 at 7.31.03 AMphoto via “Trader” (chart title reads “The Dow in the Eighties and Twenties”)

The documentary, “Trader,” also verifies this account. It was filmed in the months leading up to the 1987 crash. There are many scenes in the film in which Jones and Borish discuss the analog and how it provides the foundation for their daily trading. “At times like this, what gives these two confidence is a theory that says the stock market moves in cycles, in patterns, and Paul and Peter subscribe to the Elliott Wave Theory which says to them what happened 49 years ago, in the late 1920s, is happening again now.” Sadly, Mr. Jones has removed the film from circulation. His reason for doing so is anyone’s guess but witnessing the ridicule that DeMark has suffered recently I can’t blame him.

Jones and DeMark are two of the men I respect most in this business. I believe that one of the main reasons behind their success is their ability to, ‘keep their heads and have faith in their own convictions when all about them are losing theirs and doubting them.’ To me, this latest 1929 analog is still valid until the Dow Industrials make a new high. Until then, I’ll take the ridicule as a contrarian sign that Tom is onto something.

UPDATE: After I shared this post with Tom via email he shared this response with me:

[blockquote2]In regard to the 1929 comparison it was taken entirely out of context and was merely a talking point. It originated from an interview with a business week reporter in early October. At that time, she was asking about the market and I forecast it would likely bottom October 7 or 8—interview was October 7 i believe—and it would rally 12.6% and a likely market top would appear. She asked if it would be a major market top and I replied anecdotally among the charts we were following at the time was a comparison between 1929 and the current market and I sent the chart to her. It showed the rally from the August 1929 low to the September 3, 1929 peak was also 12.6%. She asked if I expected the same outcome and my one sentence response which she quoted in the article and appeared beneath the gold chart– “I’m (the analog) not afraid I’m going to be wrong,” DeMark says. “I’m just saying it’s something to consider.”  See link http://www.businessweek.com/articles/2013-10-14/hedge-fund-chart-guru-tom-demark-sees-dark-days-ahead [/blockquote2]

[blockquote2]Subsequent to the article we received various congrats as the both DJIA and SPX rallied 12.6-12.7% into their respective december 31 and Janaury 14 highs. Then the market declined and unexpectedly we received interview requests from virtually around the world. The casual comparison between the two periods surprisingly had taken on a life of its own. Late Novenber and December tv interviews served to fuel the fire of this analog. Finally when I appeared on CNBC at the february bottom the topic of conversation, just as it had been throughout the decline and in interviews, was the comparison and I was very clear it was unlikely to occur and assigned 10% likelihood and this was also mentioned on Glenn Beck interview about the same time.[/blockquote2]

[blockquote2]Now you have the background of how a casual remark erupted into something more than intended. Agree with your assessment that DJIA has not yet cancelled the comparison. In fact the following report by Goldman Sachs seems to agree with you as they conducted their own research of comparable market periods and the one with the strongest correlation was actually identical to what we off-handedly referenced in an interview early last Ocotber—see below for Goldman update.[/blockquote2]

[blockquote2]BY the way, the gold forecast made in same interview and numerous times on tv late last year forecasting December 31, 2013 as the low in advance and which has been very accurate has been given little or no notice whatsoever. Strange.[/blockquote2]Here’s an excerpt from the Goldman note:

[blockquote2]Recently, Tom DeMark brought up 1929 as a possible analog for today’s market.  In discussing sentiment, I also showed how the idea of that analog was mocked in the media.  In light of the fact that the Dow Industrial did not make a new high in tandem with SPX, I feel it is appropriate to make my contribution to the discussion.[/blockquote2]

[blockquote2]Using a historical software product, I asked for the historical best match for the last 2.5 year (~500 days) of action in the Dow. Combing the Dow’s entire history, the best match was 1929 (Chart 6). The charts match up right in October of that year. The program uses a term “correlation” to judge the quality of the match. The correlation for the match is 97.5%.  I have been using this software since 1997, and a match of that quality over a period of 500 days is relatively rare.[/blockquote2]

[blockquote2]Bottom Line: My opinion is that it might be a good idea to protect yourself from a further decline in SPX.[/blockquote2]

To put the 97.5% correlation into context, in the “Trader” documentary, Peter Borish says that the 1987 correlation with the 1929 chart was roughly 92%.

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Charts, Investing, Markets, Trading

The Bear Case For The Banks

A few of the things that concern me are: Portfolio managers are very overweight the sector, analysts love the stocks heaping loads of “buy” ratings and zero “sell” ratings on the stocks and earnings expectations have gone through the roof just as the fundamentals look most challenging. Continue reading

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Charts, Investing, Markets, Trading

Bulls’ Logical Fallacies May Be A Great Contrarian Indicator

Twitter comes public tomorrow. I’ve been using the site since 2007 and it’s changed my life. But I’m not buying the stock. It’s just too hard for me to value. I say it’s changed my life, though, because it’s revolutionized the way I collect, assimilate and interact with news and information related to the markets. It’s become invaluable to me as a resource.

red-herring

Even in terms of anecdotal evidence I find it fascinating and informative. Over the past few days and maybe weeks I’ve found a lot of bullish tweeps (twitter peeps), rather than argue valid points against bearish perspectives, resort to red herrings and ad hominem attacks. (Ironically, in offering stock to the public Twitter has also released a “red herring” of its own).

The common response from bulls online recently to a bearish data point is to ask, “what are your returns this year? Have you missed the rally?” I never studied debate but I know that this is a classic logical fallacy. In order to avoid the real issue you use a red herring to draw attention away from it.

It’s also a way to ridicule the bears which brings me to another logical fallacy: the ad hominem attack. This is merely another way to avoid the real issue at hand by directing attention to the individual who brings it up. Doug Kass, one of the few bearish (and unusually insightful) voices on Twitter, has suffered all kinds of haters and trolls on the site recently. Nearly all of them ignore the trades or ideas he shares and attack him personally, mostly just finding new and creative ways to call him a loser.

Spend anytime on Twitter or StockTwits and you’ll find many more examples of both of these fallacies in the bull/bear debate. They stem from bulls unwillingness to even consider the possibility that stocks may be unattractive at current levels. This closed-mindedness is merely a way for them to avoid “cognitive dissonance” (having to reconcile their position with evidence to the contrary).

All in all, it seems to me both reactions are simply desperate attempts to hold onto an illogical/unsustainable position and potentially serve as terrific contrarian indicators. The psychology of market tops and bottoms are absolutely fascinating to me and these kinds of debates on Twitter only make it more so.

Chart of the Day:

A couple of weeks ago I wrote that investors should pay attention to the MoMo‘s for signs of a stock market top. Today, the major indexes moved higher but these stocks were red across the board. Heads up.

momos

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Charts, Investing, Markets, Trading

Leverage Works Both Ways

A couple of weeks ago I took note of the following tweet:

It looks as if traders in Rydex Funds have recently become more bullish on stocks than they have ever been. The charts shows that money that has been poured into leveraged “bull” funds now outweighs the money in “bear” funds by a ratio of 8-to-1. In the past, 4-to-1 has been pretty extreme and we’re now double that level.

Not only is this a pretty good contrarian indicator it also raises questions regarding systemic risk to the stock market. If Rydex traders are this bullish it’s probably safe to assume that traders in leveraged ETFs are similarly bullish. Just a few months ago the Fed warned about the risks that these kinds of funds pose to the broader stock market and even went so far as to compare them to the “portfolio insurance” strategies that have been blamed for the crash of 1987.

Ultimately, the large amounts of cash committed to leveraged bullish funds have acted like financial steroids, powering the indexes higher than they would have been able to climb without these performance-enhancing funds. Should the market reverse trend it could fall victim to its own success as the unwinding of these trades magnify the downside in a bear market. Add a record amount of margin debt to the equation and you could be looking at the raw fuel for a pretty brutal selloff.

Chart of the Day:

Speaking of the 1987 crash, it’s interesting to note that a 13-year cycle (and 6.5 year cycle) lines right up with that stock market peak, the 2000 peak and today.

cycles

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Charts, Markets, Technology, Trading

Watch The MoMo’s For Signs Of A Top

Momentum has been the name of the game for traders this year. There are countless stocks that have risen manyfold since the beginning of 2013 and internet stocks have led the pack. This is why the king of floor traders, Art Cashin, said last week that the current environment feels a lot like the internet bubble to him.

But momentum is a fickle friend. Should the euphoria in these stocks begin to wane traders could jump ship just as quickly as they hopped on. Here are a few to pay attention to:

nflxNetflix announced earnings yesterday and CEO Reed Hastings had this to say:

In calendar year 2003 we were the highest performing stock on Nasdaq. We had solid results compounded by momentum-investor-fueled euphoria. Some of the euphoria today feels like 2003.

Props to Reed for having the balls to say what I’m sure plenty of other execs are thinking. After surging 10% on earnings Netflix has seen a pretty brutal reversal and is now down half as much as it gained earlier in the day.

fbFacebook has seen its stock price more than double over the past 3 months despite the fact that all reports suggest its flagship site is waning in popularity.

lnkdLinkedIn has been a favorite of internet investors for quite a while and for good reason; it’s probably got the most solid business plan. The stock price took a good hit a couple of weeks ago and though it has recovered nicely since it hasn’t been able to follow the indexes to new highs.pPandora has had a terrific year by any standard but looks to be forming a broadening top pattern.zZillow has now formed a clear head and shoulders top with implications for both the momo internet stocks and possibly the real estate sector.tslaTesla is perhaps the most beloved of all as it’s been the best performer of this group. Like Zillow, it has also formed a head and shoulders top pattern. Should investors lose faith here it could sour the mood toward momentum stocks in general.

UPDATE:

Add these two to the list, as well (HT, Toddo):

yelpYelp has tripled over the past few months.

pclnTraders like to say, ‘don’t short the Shat,’ but nothing goes up in a straight line forever – not even Priceline.com

 

 

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