DSCN2568
Posts

Respect The Trends In These “Widowmaker” Trades

“Bull-markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.” -Sir John Templeton

There are a couple of trends out there in the markets right now that are becoming so-called “widowmakers.” Specifically, I’m referring to oil and long bonds.

Oil has been crashing while long bonds have been soaring. Oil is way oversold and long bonds are way overbought. They should both probably retrace a bit of their recent moves simply because they’re both so overextended right now.

However…

See the massive inflows into the oil ETF in the chart above? That is not the sort of “pessimism” that forms a major bottom.

Conversely, in bonds…

Investors have been drastically underweight and heavily short bonds for over a year now. This is why I’ve been writing for some time that bonds may be more likely than stocks to see a “blow off” sort of move.

Now traders are clearly trying to anticipate a trend change in both of these asset classes. They are getting heavily long oil and they remain heavily short long bonds. Now, to be clear, I think they may revert a bit if only to work off their overextendedness (if that’s even a word).

But the big problem with these trades is that the trend is plain as day and traders shouldn’t forget, “the trend is your friend!” Oil is nowhere close to breaking out of its downtrend and long bonds are nowhere close to breaking down out of their uptrend.

Trying to anticipate these trend changes must have been inordinately painful for these traders over the past few months. And the odds are neither of these trends will actually change until we see some real despair in oil and some true euphoria in long bonds, as witnessed in ETF flows or some other similar indicator. At least, that’s what I imagine the brilliant Sir John would have told us.

Follow me on Twitter: @jessefelder

Standard
8fb59899747e9f3c15532e11278a5362
Posts

Does This Pattern Ring A Bell (At The Top)?

Let me preface this post by saying this is really more of a curiosity than anything actionable but I found it rather interesting. My last post focused on the possibility of 2015 being another 1999. This post looks at one indicator that may suggest 2015 rhymes better with 2000.

There has been a fair amount of talk recently about the fact that we have seen a couple of powerful short bursts of buying power that have resulted in the stock market surging 3% in only 2 days time. It happened coming out of the mid-December lows and again over the past couple days (and coming out of the October lows, too):

sc-2As @ukarlewitz points out (guys’s a must follow on Twitter), this is not a very common occurrence during bull markets:

And as I responded, it happened at the peak of the internet bubble in March/April of 2000:

sc-3It’s pretty remarkable how closely these patterns fit, actually. They start will a selloff which evolves into a scary powerful rally to new highs. Then another selloff quickly followed by a matching 3% rally in 2 days.

In 2000, stocks were unable to make a new high on the second attempt. It will be very interesting to see if stocks can manage the feat this time or if history will rhyme and this will end up being a signal that volatility is staging a comeback after another long absence.

Standard
MB_MILTON_BRADLEY_4620_EASY_MONEY_REAL_ESTATE_TRANSACTION_BOARD_GAME_BOX_LID
Posts

Easy Game

A few weeks ago social media was buzzing with a New York magazine story about a teenager who made $72 million trading stocks during his lunch break at high school. It turned out that was just a farce.

Even before that Business Insider ran a profile of 18-year-old Julian Marchese who is planning to launch a hedge fund from his dorm room at NYU.

Today, the Telegraph bring us the story of 17-year-old Brandon Fleisher who has doubled his parents $50k by picking stocks over the past year. He’s now making recommendations through his new website.

Maybe this game’s just too easy…

Related: Why Dollar-Cost-Average When You Can Just Go “All In”?

Standard
record player for dad
Posts

Greatest Hits 2014

Here are the most popular TFR posts of 2014:

  1. Why Mr. Market Is Still Wrong About Apple
  2. This Is Probably The Second Worst Time In History To Own Stocks
  3. For Everyone Who Thinks Tom DeMark’s 1929 Analog Is A Joke…
  4. How To Time The Market Like Warren Buffett
  5. ATTN: DUMB MONEY – The Smart Money Is Selling To You (Yet Again)
  6. Don’t Believe The Hype Of Rising Interest Rates
  7. The New Wolves Of Wall Street
  8. Seeing The Forest For The Trees
  9. The Creative Destruction Of Wall Street
  10. The Problem With Index Funds

So we were bullish on Apple (up 70%) and bullish on bonds (up 20%) and bearish on stocks (up 15%). Well, two out of three ain’t bad.

Thanks for reading. I wish you a very profitable new year!

Standard
think_different_hi_rez-1280x960
Posts

It Pays To “Think Different” About Apple’s Stock Price

About 10 months ago I wrote that I thought Apple was worth $114 to $128 per share (split adjusted). That day the stock closed at $72. Today it closed at $116, 60% higher. So this morning I sold it. Here’s why:

Fundamentally, the company has gone from being very undervalued to fairly valued in a very short period of time. (Note: Carl Icahn, who is a lot smarter than I am, says the company is worth $200 per share. I just don’t know how much of this is salesmanship/optimism and how much is cautious analysis.)

I know, I know, Apple is firing on all cylinders and will probably continue to do so. iPhone 6 is selling like hotcakes even before we get into the holiday shopping season. New products are in the pipeline and Apple Pay will probably be huge for the company.

But how much of this optimism is already baked in to the current valuation? At 5 or 6x cash flow, almost none of this was priced in. At nearly twice that valuation today I’m not so sure. Ultimately, at the current price I no longer have a margin of safety. Should the company stumble, and I’m not saying they will, there’s no reason the stock couldn’t go back to the $80-95 level (where I’d probably buy it back).

Screen Shot 2014-11-21 at 12.18.53 PMAnd this is where fundamentals and sentiment get blurred. Clearly, investors don’t quite love the stock as much as they did during the summer of 2012 (will any stock be that loved ever again?) but they no longer think Samsung is going to eat the company’s lunch. So I wouldn’t say sentiment is super-frothy but a 60% run in 10 months tend to inspire at least a little euphoria and StockTwits sentiment has reflected that for some time. 90% of the messages on the site tagged with Apple’s ticker are bullish. That’s a pretty crowded trade.

As for the long-term trend, clearly it’s still bullish. But there are some signs that it may be getting exhausted. DeMark Sequential sell signals are now triggering on multiple time frames. A daily 13 sell signal registered at today’s open while another 9 sell setup triggered a couple of days ago. All this means is we are seeing a cluster of trend exhaustion signals currently:

sc-6

 

The weekly sell signal won’t trigger until the Monday after Thanksgiving but this time frame gives us a good look at the action over the past couple of years. The stock famously peaked in the summer of 2012 before losing roughly half its value into the spring of 2013. The stock has since rallied back and broken out above that prior high (taking the major indexes with it). A simple 1.618 Fibonacci extension projects a target of roughly $122.

sc-8

 

Interestingly, that 2012 peak was accompanied by a completed monthly DeMark 9 sell setup. Last month the stock triggered a monthly 13 sell signal off of that same setup. The risk level for this monthly signal sits at roughly $121. Coincidentally, that’s also the risk level for the daily signal. So according to DeMark Sequential analysis on multiple time frames, the stock could continue to run to $121-122 to test these risk levels and complete the 1.618 Fibonacci extension on the weekly chart.

sc-9

 

From where I sit, however, the stock has pretty much reached fair value, sentiment has shifted positively once more with investors nurturing great expectations for the holiday season and the parabolic move over the past few weeks has triggered a flurry of sell signals. So I’m not saying this is the top. I’m just saying I’ve had my fun and the risk/reward equation no longer appeals to me.

Standard
steam_roller3
Posts

Overcrowded Trade Du Jour: Short Volatility

Periods of low volatility are to investors what a sweet lullaby sung by whispering nanny is to an overtired baby. It relaxes them, gets them to put their worries aside and believe that everything is going to be okay. Great for babies. Not so great for investors.

Because Mr. Market is a sadistic nanny, usually lulling investors into a sense of calm and security right at the worst time.

The few years that led up to the financial crisis were the last great period of low volatility investors witnessed. Clearly, the overwhelming sense of calm in the market (lack of fear), even through the first half of 2007, was unrealistic. You may remember that all of the gains earned during those years were quickly given back and then some during the financial crisis.

sc-2

But investors were simply doing what they do best: projecting the results of the recent past way out into the future. They were lulled into believing that volatility was no longer cyclical and that the goldilocks economy meant that it was smooth sailing as far as the eye could see.

Alas, we learned shortly thereafter that volatility AND the economy AND the credit markets were, in fact, still subject to cycles.

“Ignoring cycles and extrapolating trends is one of the most dangerous things an investor can do.” -Howard Marks

I bring this up today because volatility has once again witnessed a period of sustained depression and investors have once again been lulled into a sense of extreme complacency (if that’s even a thing).

ETFs that track the inverse performance of the VIX have become hugely popular this year. They have now attracted nearly $2 billion in assets, $800 million of that coming just in the month of September. In effect, these are bets that the current period of low volatility will last for the foreseeable future – that’s the only way they will make any money.

Screen-Shot-2014-10-23-at-17.17.451

Chart via FT.com

The problem is that the VIX currently stands at about 15. It’s lowest point in the past few decades is around 10. From the beginning of the year to early July when the VIX neared that 10-ish level these ETFs saw about a 35% gain (on about a 35% decline in the underlying index). Nice! Right?

Wrong. During the brief, not-even-10% correction we witnessed last month these ETFs declined nearly 50%!! Imagine what would happen if we actually saw a 20% decline… or more. These funds would be obliterated.

sc-3

I was recently listening to Tony Robbins on the Tim Ferris podcast and he shared an insight about one thing the world’s greatest investors have in common: they look for fantastic risk/reward setups. They look to risk a penny to make 25 cents. To me this looks just the opposite. It’s like risking 50 cents to make pennies. Good luck with that.

Further reading:

“Now that everyone’s a volatility seller…” – FT Alphaville

“Record short VIX notes sounding alarm to Deutsche Bank” – Bloomberg

Standard
doggator
Posts

Wagging The Dog

Regular readers know I like to try to combine fundamentals with technicals and sentiment to form a holistic investment/trading thesis. Right now I believe that these three factors are lined up on the bears’ side in the case of small cap stocks, which have led the broader indices of late – the proverbial tail wagging dog.

First, to say valuations are stretched in the case of small cap stocks doesn’t quite tell the whole story. In fact, they may have never been more stretched than they are today. (I’d love to see a CAPE ratio for the Russell 2000 if anyone’s got that data.)

The trailing price-to-earnings ratio currently looks fairly absurd:

Screen Shot 2014-10-25 at 11.55.37 AM

Chart via WSJ.com

I would assume that the astronomical level of the p/e is due to the fact that a large number of companies have losses rather than earnings. But even if you look at price-to-revenues the stocks look extremely overvalued. WSJ reports:

As of Sept. 30, for example, stocks in the Russell 2000 traded at 1.5 times their revenue of the previous 12 months, a measure known as the price/sales ratio. That is just a hair below the highest valuation seen going back to 1994, the earliest year for which data is available. Such levels were last seen during the stock bubble of the late 1990s, according to Russell Indexes.

The index would have to fall another 15% just to return to the average price/sales ratio of the past 20 years.

A price/sales ratio of 1.5 times in the Russell 2000 doesn’t happen often, says Lori Calvasina, a U.S. equity strategist at Credit Suisse Group CSGN.VX +0.08% who specializes in small and midcap stocks. “But whenever we’ve been there, the Russell 2000 has literally never been up 12 months later, and the average decline is about 16%,” she says.

So it’s hard to make the case that small caps aren’t currently overpriced and technically, they look vulnerable on a couple of time frames.

Back when the ETF broke out above the 82.5 level at the end of 2012 I called this chart the most bullish chart I could find. I’ve been watching ever since, adding the 1.618 Fibonacci extension which has proved to be significant resistance since early spring:

sc-2

What’s most glaring about this chart is the recent selloff has seen the uptrend line that dates back to the 2009 low break. The ETF is now testing the underside of the trend line along with its 20-week moving average. So this correction is more than the typical brief pullbacks we’ve seen over the past two years.

Comparing it to the 2010 and 2011 corrections, then might give us a bit better idea of what to expect from this selloff. Notice both of those pullbacks saw the ETF make lower lows with divergences in RSI, volume and MACD histograms. Should the current selloff follow this pattern we should see a lower low made over the next few weeks.

The daily chart confirms this view. RSI (at the top of the chart) is showing another divergence/non-confirmation with the latest high made on Thursday. The index has failed to overcome its 61.8% retracement along with the other major indexes. Finally, volatility looks to have broken out and the pullback is just a test of the breakout level, suggesting we could see another surge in volatility soon. Unlike the other indexes, this relative high for the Russell comes in the context of a clear pattern of lower highs and lower lows, the definition of a downtrend:

sc-4

All of this makes a retest of last week’s lows very likely, in my opinion. It may be putting the cart before the horse, but I believe the big question after this next pullback will be whether this all amounts to a larger topping pattern for index.

Last month the index closed more than 1% below its 10-month moving average which amounts to a long-term sell signal for trend followers. Should it be unable to regain that level by at least 1% over the next few months, the most bullish time of year for the markets, I think it will be safe to assume the Russell will be faced with a new bear market lasting anywhere from roughly twelve to twenty-four months.

In fact, should the complex head and shoulders pattern in the chart above play out it would see the index decline to around the 950 area, a 21% decline which meets the definition of a bear market. But as I said, let’s see what happens over the next couple of weeks first.

Finally, sentiment toward the sector has surged. StockTwits traders are absolutely rip-snorting bullish on the Russell 2000 futures contract right now – even more bullish than they were a month ago when the major indexes were hitting all-time highs:

Screen Shot 2014-10-25 at 11.59.05 AM

Chart via StockTwits

The bottom line is these stocks are overvalued, overbought and over-owned right now. What’s more, they have led the broader indexes over the past couple of months and I believe they could very well represent a significant “canary in the coal mine” investors should pay close attention to.

See also: “The Dominant Risk For Wall Street” May Be Manifesting In Small Caps and What Does “Reduce Risk” Mean To You?

Disclosure: I currently own inverse Russell 2000 ETFs (what amount to short positions) for myself and for clients.

Standard