Archive for April, 2013

One Bad Apple

Thursday, April 18th, 2013


One of the big stories this week is the move lower by Apple. There is a lot of speculation that their sales of Mac computers have slowed significantly along with PC sales. This speculation is coming from two primary sources – Cirrus Logic, who provides components to Apple, reported slow sales this week and an online tech news source reports that Apple has stopped ordering components leading to the belief that they severely overestimated potential Mac demand (source: Doug Kass’ blog).

If you look at the chart above which shows Apple from the March 2009 low to today, you can see that it has retraced almost 50% of its move. From a technical standpoint, that is generally considered a good buy point. The 50% retracement level is considered a fairly strong support level and can generally be bought – if the fundamentals are still intact.

However, if Apple earnings are significantly impacted by the issues above, then we may be in for more downside and the $385 we see at the 50% retracement level might simply not hold.

If, on the other hand Apple earnings are not as bad as people speculate, then we could easily see a bounce back to the $458 level that was previous support.

Right now, its trading at a P/E of 9.7, well below the market P/E of 14.3, Microsoft’s P/E of 15.8, and IBM’s of 14.4. It has dropped to a new 5-year P/E low, falling out of its previous range of 14.6 to 20.1.

It is trading at a 6.1 Enterprise Value to EBITDA ratio (very close to the key “5” level I’ve written about here on the blog previously).

If Peter Lynch were looking at this company, he would be thrilled to see that it is trading at a P/E to Growth (PEG) ratio of 0.52 and has no debt.

Unfortunately, until Apple reports, all we have is speculation that earnings estimates are overly optimistic. Right now, this stock is trading on speculation (albeit speculation based upon some solid reporting) and will continue to move with any further news until they report actual results and forecast the year.


One of the big speculations that is going on outside of earnings is on what Apple will do with their cash. Many value investors are betting they announce a dividend increase so that stock yields in excess of 3.5%, potentially even 4%. They are also speculating that there might be a stock buy back that will increase the earnings per share and help drive the stock price back up.

Again, this is all speculation until we hear from the company. However, if we get a 4% dividend from Apple, you will see people jumping into this stock with abandon as value managers and dividend income investors grab up shares to augment their portfolios.

So, at this point, we are all just waiting to see what they have to say. We will probably pick up some shares if it falls to the $385 level because odds are we will get some sort of dividend increase, and since we are already at a 2.5% yield it wouldn’t take a big increase to get us above 3% and that will begin to draw some people into the stock.

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The Importance of 200

Wednesday, April 17th, 2013


Something I follow but don’t write much about on the blog is the importance of watching the price of an index or a stock compared to the 200-day moving average and the 200-week moving average.

If you look at the chart above of the S&P 500 Index over the past 20 years, you can see how the 200-day moving average (the red line) acts as support for the market during an uptrend and as resistance during a downtrend.

[as always, you can double click all the charts for a better view]

What is less discussed on investment TV and other blogs is the usage of the 200-day moving average in helping to determine whether a market or a company is over-valued or under-valued.

To do this, I like to watch the price of the S&P 500 Index as it moves within a +10% to -10% band around the 200-day moving average. I’ve shortened the time frame in the chart below to 10-years so you can more readily see the price movements:


Whenever the S&P 500 Index moves to a level that is 10% above or below the 200-day moving average, the market sets up for a move in the opposite direction – unless you have a situation like the 2008 stock market crash where the market itself became so severely undervalued that moves greater than 10% beyond the average to the downside are offset in the correction back to more normalized valuations.

If you look at where we are today, you can see that the market itself is telling us that from a technical valuation standpoint it is time to pull back toward the 200-day moving average.

The question I get via email fairly often when I explain my reading of graphs here on the blog is why it matters. The answer is that the price movement as illustrated by the graphs as well as the various indicators I follow give me a feel for the psychology of the market. Investor psychology equates to how excited they are to pay more or less for the earnings of companies, which gives you expanding or contracting P/E multiples – and lets you know whether investors are paying too much or too little for earnings because they have gotten too excited or too negative. For me, the visual interaction of the price movement on the graph with its past helps me to spot situations where investors have gotten too excited or too negative, making the analysis of how aggressive or conservative to be much easier.

As I look at this chart, I see a market that is in a sustained uptrend off the March 2009 post-crash lows – it is one that gets a little too much excitement and pushes ahead of itself from time to time (as shown by the touching of the top band meaning it has moved 10% away from the 200-day moving average) and needs to have a healthy pullback, maybe even to the 200-day moving average, so that it can then make the next step forward. You can see that happened twice in 2012 and there is every reason to believe it will happen in 2013.

But, I like to double check what the chart is telling me, so I like to also look at where we are compared to the 200-week moving average, just to see if it is confirming what the 200-day moving average is saying.


The chart above gives you a 20-year view of the 200-week moving average of the S&P 500 Index. On this chart, what I like to watch is a +25% to -25% band around the 200-week moving average to give me a feel for whether the market psychology has gotten too optimistic or too pessimistic.

In looking at the chart, you can see that it is confirming what the 200-day moving average chart was saying – we are at the point where it will be healthy to have a move down in price for the market.

What we do not want to see is a change in the uptrend to a downtrend when we get the move down in prices. To give me a feel for that, below is the chart I’ve shared with you at various points in the past:


I’ve circled points on the chart that tell me when a trend has changed – you can see that the top section of the graph moves above its upper indicator or below its lower indicator lines shortly before the trend in the market changes – as depicted by a move in the price line below the moving average. What I see here is that we have not had a change in the trend (we may still yet depending upon whether the market actually pulls back in price in a significant manner) because the price chart in the pink circle on the top right side does not show the price falling below the moving average line (10 month moving average in this case).

Ideally, what we would want to see is the market pull back to the 1450 to 1460 range on the S&P 500 – that would set the market up for a strong move higher in its next leg – it would shake out the new entrants that do not have a long-term investment horizon and it would help prevent an even larger move lower to the -10% band on the 200-day moving average (like we experienced in 2011).

Will we get the move to 1450? Its possible, but we’d need to get the fear level up much higher than we currently see it. Right now, unless the fear level increases, we will most likely experience a 3% to 5% correction off the highs (3% correction takes us to 1,545 and a 5% correction takes us to 1,513). To measure fear, I watch a number of charts that you can find in my post on Risk Management but just to tell you where we are on the VIX we have seen a 50% upward move on that indicator, but it is still well below levels that say there is rampant fear among investors.

So what should you take out of this post?
>The market got a bit ahead of itself by moving to 10% above the 200-day moving average;
>that investors can get too excited and act irrational, paying too much for equity investments;
>that it is healthy for an up-trending stock market to pull back toward the 200-day moving average as that sets it up for another leg higher based upon better/more realistic valuations;
>that there is not enough fear in the market yet to show we will get a move all the way back to the 200-day or 10-month moving average at 1450 to1460 on the S&P 500 index, but fear has increased to make at least a move to 1545 or 1513 quite possible; and
>that we are seeing no change in the overall uptrend at this time but that we are watching it closely to make sure.

Pull backs are natural, part of the process of investing, and ultimately profitable for investors who have cash on-hand because they can buy shares of companies at better valuations than others paid in the recent past. This is the situation we are currently in, having ample cash on hand, and it is one I feel good about as my eye in on beating the market over the long-term not just sporadically in the near-term.

My last piece of advice: invest what you see, not what you believe. Believing what you hear on investment TV and wanting to be fully invested when you see the market saying that it needs to correct is just not the best plan. Raising cash, letting it correct, then putting that cash to work is always the best, most profitable plan for the long-term, one where you have less chance of getting hurt than chasing prices at the top of the market.

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Japan’s Bond Market Gets KO’d (or was it QE’d ?)

Friday, April 5th, 2013


This graph (courtesy of Bloomberg) is a little busy, but what it is showing you is the volatility in today’s bond market in Japan. Investors are getting frightened by the sheer magnitude of the money printing Japan has authorized, and the Yen fell 5% today against the dollar. A 5% currency move is something that you just don’t see for a widely held currency like the Yen (its saved for Argentinian pesos and the like).

Given the potential impact that this volatility could have on the markets – remember, we are printing money just like Japan, albeit not as fast (yet) – I thought it would be instructive for everyone to learn a bit more about the impact of quantitative easing if taken too far.

So, here is a short video that gives a very easy to understand explanation – one I hope everyone in Washington DC has a chance to watch.

In summary – you can’t continue to spend more than you earn – even if you are the world’s third largest economy (and maybe not even the first largest).

Use this link to watch it on YouTube

And for those of you who emailed me after the rap video from last week kidding me that I’d not post an opera video on the blog – yes, you know who you are :) – here you go:

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Risk Management

Wednesday, April 3rd, 2013

Market Indicators

One of the key parts of investing is risk management. Sometimes the hardest decision looks like the wrong one until it is proven right. For me, the hardest decision has been to raise cash for the past four months or so in the face of a rising stock market.

However, given that the market has been moving higher on low volume, the fact that the internal mechanics of the market have been deteriorating over this time frame, and that there is speculation about whether the Fed will continue its bond buying activity that has pushed the market higher – I feel we need to be prudent by having higher than normal levels of cash so that we can reinvest it when the market corrects.

It is tough to watch the market move higher on a near-term basis and not be fully invested, but by following proven risk management strategies, you always win in the long-term. The current market is much like what we saw with NASDAQ in 1999 and 2000 – albeit to SIGNIFICANTLY smaller extent.

The market continues to move higher as new entrants put money into it several years into its bull market run, at a time when earnings growth has diminished – but the new entrants’ money expands P/E multiples to move the index higher.

This is what happened to the NASDAQ on a much bigger scale, but it is also happening to the S&P 500 right now – and it is wise to learn from the past in order to be successful in the future.

As the market has been moving higher (or more accurately sideways with a slight upward tilt for the past few weeks) on low volume – there just are not that many institutional investors participating in the move, but instead its retail investors who missed much of the move off the March 2009 lows – I wanted to show you the market indicators that I follow that have me wary of the validity of these new highs.

But, to put things in perspective, even though we are positioned very conservatively at the moment with respect to the stock market, our fully diversified equity accounts have averaged 17.82% net of all fees since March 2009 compared to the comparative blended index of 16.90%. I am OK being under weight equity exposure in the short-term so that we can protect those gains for the long-term – especially in light of the current readings on the indicators I follow which are shown above (you can double click the graphic to see a larger version).

I use these sorts of indicators – and many others – as a risk management tool. It is a difficult decision to raise cash as the market goes higher, but when the indicators flash a warning it pays to heed their signal – even if you look dumb (or as I prefer to think of it, conservative) in the near-term.

The upper left hand corner chart above is the Bullish Percent Index (the red line) overlayed with the S&P 500 Index (the green line). The BPI is a breadth indicator that tells us the number of stocks with a bullish chart pattern – as a contra-indicator, this one basically says that when things are overly bullish there is too much excitement in the market and it is due for a rest.

When you look at this chart, you see that moves above the upper blue boundary line are relatively short lived, and always result in a market that pulls back several percent – last year about this time the market topped out and pulled back 10%. A move below the bottom blue line is always a good time to buy into the market as it precedes a several percentage move higher.

The HiLo indicator is just below the BPI. You can see that it is also above its upper indicator. This indicator measure the number of new highs net of new lows. Again, this contra-indicator shows us when there is too much excitement in the market. Moves above the upper boundary line precede pullbacks in the market, so it is saying that caution is warranted.

The chart below the HiLo Indicator is the number of stocks in the S&P 500 that are trading above their 50 day moving average. You can see that this one is already in correction mode with a move below the upper blue line – and that generally precedes a pullback in the market.

The chart below it is shows us the number of stocks trading above their 200 day moving average. This is a more intermediate term chart and can have readings above the upper boundary for a considerable time. However, once the chart above it moves below, we start to watch for this one to correct as well.

The Volatility Index chart at the top of the next column shows us how much fear or complacency is in the market – right now, we have extremely complacent readings.

The Advance Decline graphs below it are significant to the extent that the blue line is trending below the red line which tells us that the market is weakening and that we have fewer stocks advancing in price than we did on average over the past 30 days.

The final two charts are price oscillators that differ primarily in their timeframes. It is easier to spot short-term changes on the top one and easier to spot trend changes on the bottom one. The bottom one to me is saying that the price trend has rolled over but it needs to be confirmed by a move below the upper blue boundary line.

S&P 500 Index with Bolinger Bands

The graph above includes two green lines that acts as bands around the S&P 500 Index over the past year, and you can see the big pullbacks from April to June 2012 and September to November 2012. Both of these corrections were in the 10% range, so I believe there is every reason to assume that we can have a similar type of pull back – the issue is as always the timing of it.

The green bands I mentioned earlier are called bollinger bands and they represent a measure of volatility – when the bands get too narrow, the market has become too complacent and we should expect some event that will increase volatility and send the index either higher or lower depending upon investor sentiment.

Sentiment Indicators

I’ve included the chart above from Barrons so you get a feel for current sentiment readings. Sentiment is a contra-indicator (meaning that high/bullish readings are signs of a market top and low.bearish readings are signs of a market bottom).

Looking at the readings here, they are at the high-end of the range, indicating to me we are nearing a correction, but not so high that it would mean any correction would be extended in duration – much like the two 10% corrections from 2012 we experienced.

10-year Treasury Note Yield

One of the primary determinants of sentiment is interest rates, and the key rate to watch is the yield on the 10-Year Treasury Note. As you can see on the chart above, we have been in an upwardly trending pattern for the past four months. At the current level of 1.88%, we are still experiencing very low interest rates in our economy, rates that are stimulative (or should be in normal economic circumstances).

If I were to pick one issue that could lead to a correction larger than the normal ones of 10% we saw in 2012, I’d pick a continuation of this trend that showed an increase in the 10-Year Treasury yield to 2.50%. Will that happen?

There are some economists that are forecasting such a move – but they have been forecasting an increase for the past couple of years so you have to ask: is there something different today than 2011 and 2012 that would make that forecast become a reality.

Goldman Sachs seems to believe that what we will see is a move by the Federal Reserve to stop buying Treasury Notes as part of their Quantitative Easing activity (their current method of stimulating the economy by buying bonds as a way to get newly printed cash into the economy). The economists at Goldman believe that the Fed will continue to purchase mortgage backed securities in an effort to keep the monetary stimulus in place, but will simply no longer purchase treasury notes as part of their activities.

If that is the case, we then have a supply/demand imbalance (the US Treasury has more supply – they need to issue the bonds to fund the deficit – so they will have to stimulate demand by offering higher yields). Given some of the interviews of Federal Reserve Governors I’ve been watching, there seems to be some support for Goldman’s view.

Obviously, we will not know anything about the Fed’s plans until they tell us. However, long before there is a public announcement, the markets will react based upon speculation about their plans – that is just the nature of the investment process.

One index I like to watch that is closely tied to interest rates is the mortgage index.

Mortgage Index with S&P 500

I have overlayed this index with a green line that represents the S&P 500. If you look closely, you can see that the general trend of the two prices move together, with movements in the mortgage index generally preceding movements in the S&P 500 index.

Mortgage Index - Past 3 Months

What I really want you to see is the past three months movement on the graph above, so I have shortened the time frame to make it easier to see what is happening right now.

You can see that we have had a significant drop in the mortgage index (the red line) without yet having a drop in the S&P 500 (the green line). This is just another sign of caution as mortgage investors seem to be anticipating higher rates – but we do not yet know if that will translate into equity investors anticipating the same thing. If it does, then we will see a pullback – if not, our sideways pattern of the past few weeks will continue

So, for now, based upon the indicators that I follow, the higher than average sentiment indicators, and the upward trend in treasury yields, caution is the word.

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