November 2014 – Adaptiv

Leader of the Pack [Weight of Evidence, Part 5…

November 20, 2014April 13, 2022

At 360 Investment Research, we like to dig deep into the market and take a look at what sectors are leading the US market upward. By analyzing sectors on a relative basis against the S&P 500, we can gain insight into what sectors are leading the charge. This, in turn, may provide clues on where we are in the market/economic cycle. The theoretical market/economic cycle is a model based on the work of Sam Stovall in his book, S&P’s Guide to Sector Rotation. The basic premise is that different sectors are stronger at different points in the economic cycle. StockCharts.com has done a great job elaborating on this rotational cycle. The chart below is courtesy of StockCharts.com. It does a good job of visualizing these relationships and the order in which each sector should outperform in the context of the overall market. Moving from left to right, we see that Cyclicals (or Consumer Discretionary) and Technology lead the market out of bottoms. Industrials, Basic Materials, and Energy lead during a Bull Market. And Staples, Healthcare, Utilities, and Finance are the safe havens during Bear Markets. It’s not as clear cut as what I just wrote or what is visualized below, but it is a really great guide to the likely relative performance characteristics of each sector as the market progresses.

Researching approximately how each sector is performing can be a good exercise in determining where we might be in the overall market cycle. Obviously, if we’re in a healthy Bull Market, we want to see Bull Market leaders like Technology, Industrials, Materials and Energy outperforming (or leading) the overall market. Conversely, we would be concerned about the overall prospects of the market and economy if we see that big money is moving into defensive sectors like Staples, Healthcare, and Utilities. So let’s dig in and see what sectors are leading the overall market.

One of the best ways of observing which sectors are doing the best and which sectors are lagging is through the use of Relative Rotation Graphs (RRG) [1]. RRG charts show us the relative strength and momentum for a group of stocks or ETFs. These stocks or ETFs are compared against a benchmark. In our case, we’re going to compare the aforementioned sectors using the overall market (the S&P 500) as our benchmark. That is to say, the performance of each of these sectors will be compared against the performance of the S&P 500. If a sector is outperforming the market, they are said to be the leaders. If a sector is underperforming the market, they are the laggards. On the RRG chart below, the following ETFs are being used as proxies for each sector:

XLY (Cyclicals or Consumer Discretionary)
XLK (Technology)
XLI (Industrials)
XLB (Materials)
XLE (Energy)
XLP (Staples)
XLV (Health Care)
XLU (Utilities)
XLF (Financials)

Of the ETFs above, those with strong relative strength and momentum in comparison to the S&P 500 appear in the green Leading quadrant. Those with relative momentum fading move into the yellow Weakening quadrant. If relative strength then fades, they move into the red Lagging quadrant. And when momentum starts to pick up again, they shift into the blue Improving quadrant. In the RRG below, the long tails represent the movement of each sector over the past 20 weeks in comparison to the S&P 500. So what do we see? We see that XLV, XLU, XLP, and XLF have moved from positions of weakness and laggards to positions of leadership. Health Care (XLV), Utilities (XLU), Staples (XLP), and Financials (XLF) – defensive sectors – are leading this market. On the other hand, Technology (XLK) is weakening while Energy (XLE), Materials (XLB), and Cyclicals (XLY) are lagging. Bluntly, defensive stocks are leading and those who we want to lead a Bull Market are lagging. Money is flowing into defensive sectors. This is not what a healthy and powerful Bull Market looks like. Does it mean that this the top of the Bull Market? No one knows that. But, enough money is flowing into defensive sectors that investors like you and me should take notice.

[1] Note: The terms “Relative Rotation Graph” and “RRG” are registered trademarks of RRG Research.

Bonds

Risk On or Risk Off? [Weight of Evidence, Part…

November 17, 2014April 13, 2022

The credit (aka bond) markets overshadow the equity markets in terms of dollar value. Yes, the equity markets get all the publicity and headlines. However, it is the waters of the credit market that run deep. By looking at the current state of the credit markets, we can learn about the relative health of a large portion of the financial industry. When the bond markets speak, we listen.

At 360 Investment Research, we examine investor demand for various grades of credit (Junk Bonds, High Yield Bonds, and Treasuries). Specifically, we compare these grades against each other as a ratio. See the first chart below. This is a ratio of High Yield Bonds versus Treasuries, represented here by ETFs HYG (High Yield) and TLT (Treasuries) in blue. This ratio tells us the credit market’s appetite for risk. When in a speculative mood, funds will flow out of Treasuries (less risk for lower yield) and into High Yield Bonds (more risk for higher yield). When more risk is being taken, the ratio rises. The opposite also applies. When the bond market is seeking safety, it flies to Treasuries and the ratio decreases. This is what we find right now – the ratio has been declining – the credit market has been seeking safety since January. All the while, stocks (the more speculative market) have been rising. The credit market is seeking safety while the stock market seeks more risk. This is unusual behavior. Normally, they are in agreement. When big money managers are increasing positions of risk within the stock market, the same takes place in the bond market with funds flowing into High Yield credit. So the fact that we have this divergence is a problem. Who’s right? I don’t know, but it will resolve itself one way or another. Either stocks are going to correct downward or the credit market is going to flow into High Yield.

Even though we don’t know what will happen this time around, when we look at the past, the credit market seems to be right more often than not. That leads us to our second chart, which shows proprietary moving averages of the same type of ratio comparing High Yield Bonds v. Treasuries (JNK:TLT). This is placed in the same chart as the S&P 500. Not only do we notice that when the moving averages cross (green below orange), it’s a good time to sell stocks. We also notice that these ratio moving averages can give early warning signs through divergence. More often than not, the credit market flees to Treasuries before equities sell off. In 2011, the bond market diverged from stocks for more than six months before there was some type of resolution (stocks sold off). We find ourselves in the same spot now. The bond and stock markets have diverged from each other for the past 11 months. Who’s right? We don’t know, but we’re going to find out sooner or later. Either stocks sell off or the bond market seeks High Yield. Get your popcorn ready.

Don’t forget to share the wealth with your friends using the social media icons below. Check back soon for part 5 of our 7 part series.

Equity

It’s Just US Against the World [Weight of Evidence,…

November 16, 2014April 13, 2022

At 360 Investment Research, we believe price is the manifestation of opinion and final arbiter of value. That is, price has the final say. It doesn’t matter if we think price should be lower or higher from a fundamental perspective. No matter the security (stocks, bonds, currencies, commodities, whatever), price determines value. Opinions don’t matter. Price matters. Period.

One of the exercises we go through is to look at equity indexes across the globe to see if we can find opportunities or confirm price action happening in the largest equities market in the world – the United States. If stocks in the US are making new highs, we like to see stocks making new highs elsewhere in the world. If the US market is doing well and so are some other countries, that bodes well for the global economy. However, if we see the rest of the world lagging behind, we find that to be a warning sign. We are currently in this situation now. When we look across the globe, all major indexes (except for Nikkei, S&P 500, and the DOW) are making new lows or lower highs. Not higher highs. Take a look at the chart summary below (click it to embiggen), which condenses charts of the most important stock indexes in the world (some are ETF proxies). It is quite telling. The Dow Jones, S&P 500, and the Nikkei (Japan) are the only indexes making new highs. We’d like to see more countries join the party by making new highs along with the US. Needless to say, we will be paying close attention to prices across the globe with a keen eye on the United States. You should be watching price action closely too.

Check back soon for part 4 in our 7 part series.

Equity

The Curious Case of Elevated Volatility [Weight of Evidence,…

November 13, 2014April 13, 2022

“Fear tends to manifest itself much quicker than greed, so volatile markets tend to be on the downside. In up markets, volatility tends to gradually decline.” ~ Philip Roth

The CBOE Volatility Index is often referred to as the FEAR Index. This forward looking index is calculated from option activity, and reflects the market’s expectation of 30-day volatility. We like to look for divergences between the VIX and the US Market. We look for odd behavior. Normally, as would be expected, when fear/volatility increase, stocks decrease in price – and vice versa. However, sometimes a change in market sentiment from greed to fear (and the opposite also applies) can tip its hand. When we see fear/volatility increase along with market prices, we take notice. This is odd behavior and could be a warning sign that market participants (big money managers) are changing their mood.

Below are two charts: one from 2007 and one from today (2014). Both show that while the US Market (in this case, the S&P 500) is making higher highs, the VIX is making higher lows. They are moving together. Odd behavior. In 2007, this was a clue that a change in trend was approaching. And as you can see, the same is taking place now. Does it mean that this is the top of the market for the foreseeable future? No. But, it means we’re going to keep close eye on the price action from here until this odd behavior resolves itself. Those who are looking for the bull market to continue want to see lower lows in the VIX and the market to hold onto these highs.

Stay curious, investor. Check back again tomorrow as we’ll have more to add. And if you find this information useful, make sure to share the wealth using the share buttons at the bottom of this article.

Equity

Headlines Sell [Weight of Evidence, Part 1 of 7]

November 12, 2014April 13, 2022

“This isn’t a stock market. This is a market of stocks.”

The quote above is a common phrase in Wall Street circles and it is absolutely true. You don’t have a stock market without the stocks. However, financial media will never present it that way. How many would read an article that says, “Individual Stocks Refuse to Participate in Broad Index Rally”? It is so much easier to click on headlines that read, “Market Rallies to All Time Highs” and, “S&P 500 at New Historic High”. After all, why let the facts get in the way of a good story? [thick sarcasm]

As curious investors, we need to know that the performance of stocks within an index is just as important as the performance of the index itself. And when the two don’t jive (this is called divergence), it is time to sit up and take notice. Now is one of those times. While the S&P 500 and DOW are making new historic highs (awesome!), the individual stocks within each index are not participating at the same pace (not awesome!). Less and less stocks are making new highs while the indexes themselves are at new highs. This is called a thinning (or stock pickers) market and could be a harbinger of a change in direction for the overall market. This is just a warning sign. Something to be aware of. We don’t need to take action… yet. We just need to be aware that things are not as they seem. This symptom can resolve itself with an increase in stock participation within this rally. If that happens, it means great things for the upward trajectory of the market. However, if this symptom does not resolve itself, any downturn in the market could be significant (a 10 to 30+% correction).

Now, on to the eye candy to show you what’s happening. The chart below is pretty simple. The line above is the percent of S&P 500 stocks that are above their 200 day moving average. Notice that a less and less percentage of stocks are above their 200 DMA. The line below is the S&P 500 itself. Price is at new highs. I’ve annotated (in 360 green) where past divergences have taken place. Notice the eventual reaction of the market. It doesn’t tell us when, but simply, that a resolution must take place. We’re taking notice as we weigh the evidence.

Silver Linings Playbook

November 1, 2014April 13, 2022

Since April, 2011, Silver has been getting crushed. When I say crushed, I mean it. Down over 65%, this precious/industrial commodity has been a wasteland for those hoping it would increase in price. We don’t fight price. Price is the manifestation of opinion and final arbiter of value. Price knows more than we do. We simply identify opportunities. And Silver, curious investor, may be approaching the best investment opportunity of the next decade. But let’s not get ahead of ourselves. There’s likely more downside to come. Between Thursday and Friday, Silver (represented here by SLV, the Silver ETF), continued its relentless downtrend – down another 7%.

We have some targets identified where a bottom in Silver seems logical. See the chart below (click it to embiggen). At first, it may seem a little confusing, but it’s really quite simple. Price moves to equilibrium. The orange annotations mark two measured moves (from the 2011-2013 broken descending triangle and from the 2013-2014 broken descending triangle). Those two measured moves end up within 10 cents of each other. We don’t get picky. The 13.50 – 14.00 range should provide stiff resistance to any further downside pressure. Assisting this logical turning point, is the downward trendline in green. And to help us in timing any potential bottom are some very accurate cycles (annotated in purple). Focus your eyes on only the cycles, you’ll notice they align with many minor and major turning points. Adding everything up, we are going to be looking for a major low in Silver sometime between now and February, 2015. Our price target is between 13.50 – 14.00. Once we reach that level, we’ll be looking for evidence of a change of direction. If/when that happens, I’ll let you know and share with you why this could a be major opportunity.

Month: November 2014

Leader of the Pack [Weight of Evidence, Part 5…

Risk On or Risk Off? [Weight of Evidence, Part…

It’s Just US Against the World [Weight of Evidence,…

The Curious Case of Elevated Volatility [Weight of Evidence,…

Headlines Sell [Weight of Evidence, Part 1 of 7]

Silver Linings Playbook