divergence – Adaptiv

Tag: divergence

One Important Divergence Bulls Need To See

May 1, 2017April 13, 2022

Last time we checked, new all-time-highs are not a characteristic of bear markets. While all bear markets start from all-time-highs, not all-time-highs start a bear market. With many U.S. Indices recording new highs last week, we see uptrends still intact. And new all-time-highs have a tendency to make traders and investors nervous. In the end, we don’t need emotions involved in our investment decisions. We need to use hard data and the weight-of-evidence to guide us. And since we’re students of the markets and use intermarket relationships as part of our approach, we can look across sectors, industry groups, regions, and asset classes to get a top-down, big-picture view of market health. As part of that exercise, we want to see what areas are not making all-time-highs. Simply, as all-time-highs in U.S. markets are recorded, are there any important areas not currently joining the uptrend party? This is called divergence. Once such divergence market bulls need to keep an eye on is the Transportation sector. Take a look.

For many logical reasons, the Transportation sector is a bell-weather sector. This means it gives important clues about overall market health. This is due to its economic importance. If there is no demand to transport goods and commodities, it is logical that overall demand for those goods and commodities is to be desired. Many reading this will identify this relationship in regards to Dow Theory. For brevity’s sake, we’re not going to get into the nitty gritty of Dow Theory. We’ll save that for another post as it’s an important tenet of technical analysis. For now, we’ll observe the relationship in the chart above. Right away, we notice the Transportation industry giving important clues to market health in late 2014 through 2015. As U.S. markets were making new highs (using the S&P 500 as our proxy here), the Transportation sector was not. It was diverging. Making lower highs and lower lows. By very definition, this was not an uptrend. Rather, it was a downtrend. A downtrend that signaled caution for the overall market, which ended up selling off hard in July 2015. It came as no surprise when the S&P 500 bottomed exactly when Transports did the same. Together, they recorded higher highs and higher lows, the most significant new high coming in early November 2016. Since then, U.S. equities have been ripping. However, with last week’s new high across many U.S. indices, the Transportation sector recorded a divergence as it did not follow suit with new weekly highs. This is an important divergence bulls will want to see resolved to the upside. A breakdown here (below $160 using IYT, an ETF for the Dow Jones Transportation Average), would be problematic for broad market health. Conversely, if bulls are going to see this market continue to rip higher, we need the Transportation sector to participate. A new closing high above 170.74 would clear this divergence and indicate ongoing health for the overall market. Keep your eye on this one.

As always, you can get real-time updates and commentary about this development and many more opportunities here: @360Research

AND, you’ve got FREE access to an investing tool we’ve created, The Ultimate ETF Cheat Sheet. It’s an easy-to-use resource guide.

Disclaimer: Nothing in this article should be construed as investment advice or a solicitation to buy or sell a security. You invest based on your own decisions. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in this blog. Please see our Disclosure page for full disclaimer.

Equity

Internal Weakness Means Caution Is Warranted

March 31, 2015April 13, 2022

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 aren’t confirming each other, it is time to sit up and take notice. For the past six months, if not longer, we’ve been witness to that scenario. While the S&P 500 (a major U.S. Stock barometer) has been gaining ground since July 2014, the individual stocks within this index are not participating at the same pace. 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. 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).

Let’s take a look at 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 near new highs, but fading. 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. As you can see, the current divergence has been in place for a significant amount of time when compared to similar occurrences in the past eight years. We’re taking notice as we weigh the evidence. Do we think a major correction is upon us? Maybe. We don’t trade on maybe, but caution is warranted. We trade on price and we’ll be watching it closely to see what our next move should be.

Disclaimer: Nothing in this article should be construed as investment advice or a solicitation to buy or sell a security.

Equity

Unique Index Provides Insight Into The Current State Of…

January 15, 2015April 13, 2022

It’s important to take a look at price, markets, and trends from different angles. Any edge we can gain in identifying opportunities is valuable. Today, we’re writing about an index that you might not be aware of, but that is very helpful in gaining insight into the current condition of the U.S. stock market: the Value Line Geometric Index (XVG). This index tracks the median move of stocks within the index using the assumption that each stock has an equal amount (for example, $1,000) invested in them. The daily average move of this index is calculated geometrically (rather than arithmetically). I don’t want to bore you with the details, but if you need more info, you can read more about the methodology here, page 4. More simply put, this index eliminates an illusion created by weighted index components. Weighted stocks within an index can pull it higher even as the majority of the stocks within the index are not following along. For example, in a weighted index like the S&P 500, it’s possible for the top 100 weighted stocks to carry the index higher while the remaining 400 stocks lose value. As an investor, it might be helpful to identify when this is happening.

We previously released research that provided a similar approach by looking at the percent of S&P 500 stocks that were above their 200 day moving average. In the same way, by looking at the Value Line Geometric Index alongside the S&P 500, we gain valuable insight into what is currently taking place in the market. Looking at the chart below, the Value Line Geometric Index is in the upper panel and the S&P 500 in the lower. Notice that the equal weighted Value Line index is struggling to break its previous highs from 1998 and 2007 while the S&P 500 has continued higher (divergence). This condition has been persistent since March, 2014. This means the market is thin: money is flowing into large cap stocks and leaving the rest behind. This is a stock picker’s market and can be a hallmark of market tops. It should be noted when looking at the chart below that this condition can persist for quite a while before there is an overall resolution to the market (aka a correction in price). In the past, a noticeable divergence developed between the equally weighted index and the weighted S&P 500 before the S&P 500 corrected in price. This doesn’t mean the S&P will correct in price right now or at all. But, it does mean that it is getting harder to find U.S. stocks that are trending up. And as long as this condition is in place, we’ll be watching the price of the S&P 500 closely. You should be too.

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Equity

Want to Make Great Investment Decisions? Just Look Left.…

December 2, 2014April 13, 2022

Using a weight-of-evidence approach is valuable for making quality decisions on desired or current investment positions. As technicians, we have a wide variety of tools at our disposal to anticipate potential rough spots, corrections, or buying opportunities. But that is all they are – tools of warning or anticipation. They give us an edge in identifying when and where to take on risk with limited downside. Finding asymmetric risk/reward opportunities is the epitome of what we do at 360 Investment Research. We don’t care about being right. We only care about being on the right side of the trade.

Over the past 5 posts, we’ve identified some warning signs for the overall U.S. equity markets. All of the posts carry weight as we analyze our long exposure to U.S. stocks. But none is more important than what we write about today – price. Price is the most important evidence. It carries the most weight. We can have all the common and proprietary indicators in the world and they mean nothing without the confirmation of price. Below is a diagram so you can visualize what we’re saying.

As you can see, we like to look for evidence to support our investment decisions. The best piece of evidence is price. What is it doing? What’s its direction? If price is making higher highs and higher lows, the trend is up. If price is making lower highs and lower lows, the trend is down. By analyzing price itself, we can determine the general trend and the potential change thereof. Using the diagram above, which shows the current status of the market, we can see that price moving to the right side of the scale would cause it to tip dramatically to the right into a new and potentially strong downtrend. In the same light, if the evidence on the right shifted to the left side of the scale, the swiftness of the uptrend would increase. So at this point in time, we are watching price like a hawk. How do we do this in reality? Simple. Just look left. When we analyze price using charts, we find the current price and look left. See the daily price chart of the S&P 500 below. Notice that price has been steadily making higher highs and higher lows. It is a beautiful staircase upwards, hallmarking an uptrending market. The exceptions are back in early February (SPX made a lower low and tested the trendline from the 2007 top) and back in mid-October (SPX made a lower low and tested previous highs/lows near 1825). Each time, the market recovered by subsequently making new higher highs without recording a lower high. When we consider this most important piece of evidence, the scale is easily tipped towards an uptrending market. All the other evidence only provides perspective in the event price changes and makes lower lows and lower highs. All the other evidence indicates caution is warranted. But, that doesn’t mean we need to short or be out of the market. Right now, price is telling us to remain long this market. As for the future, we’ll let price dictate what we should do next.

Look for our series finale on game planning and risk management soon.

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.

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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.

AAPL of your eye?

June 26, 2014April 13, 2022

Recently, a few friends have asked about buying Apple stock. The reasoning, as far as I can gather, is because the stock is now “cheap.” While it is good to buy things at cheap prices, I would argue that Apple is not “cheap”, but perceived by the retail investor as “cheap” because of the recent 7-for-1 stock split, which brought the share price from above $600 to below $100. A deal, right? I can now get Apple stock for less than $100! Awesome! Freeze! – not so fast. What is really happening here? Let me try an analogy:

One Benjamin for Five Jacksons
As nice as it is to have a $100 bill in your wallet, it’s difficult to use on a daily basis because many stores will not accept them. Therefore, it’s usually best to take that $100 to a bank and exchange it for five $20 bills.
A stock split is a corporate action that increases the number of shares by dividing each share, which in turn diminishes its price. The stock’s market capitalization (the overall value of the equity) remains the same much like the value of the $100 bill is not altered by swapping it for five $20 bills. Five $20 bills still equals $100.

So… Apple has not become “cheap” and is the same in value, but in a different denomination. Why would Apple do this? THIS is the question you, the curious investor, should ask. And the answer should make you think twice about buying Apple right now. So why did Apple do this? Simple. To make the stock appear “cheap” so that more investment dollars will flow in from retail investors like you and me. On it’s face, this not a unique practice and is done by many companies each year. However, be aware that this practice does not make a stock “cheap”, rather affordable. And when you consider that Apple is also well on its way to completing a massive stock buyback program ($130 Billion worth!), it is apparent that Apple is working hard to keep the value of its stock near all-time highs. This buyback program directly affects the price of the stock as they remove shares from the market. This, along with the current price picture for Apple, tells me that the risk is way too high to own Apple stock right here, right now. Take a look at the monthly chart below (which accounts for the split). We are bumping up against resistance from the all-time highs back in November 2012 with a major divergence in momentum. It took a huge buyback program, and now a stock split, to get it here. You can buy Apple stock right here… but you’ll probably be able to get it truly cheaper in the not too distant future.