Archive for November, 2012

Every Breadth You Take

Monday, November 19th, 2012

Indices and Breadth Charts

More Breadth Charts

Some significant technical damage has been done to the markets since the peak in September. Most of the major averages are down 7 to 10%, with companies that are perceived to be in the worst position to deal with the fiscal cliff (eg, high dividend paying companies) showing the greatest damage. You can see the four primary US indices on the left side of the first graphic above (S&P 500, Dow Industrials, NASDAQ, and Russell 2000).

But I thought I’d share with you some of the breadth indicators that I follow that give me a clue as to the internal workings of the stock market and whether the selling pressure is about to change directions.

To give you a feel for what you are looking at, the four graphs on the right side of the top graphic plus the eight graphs on the bottom graphic are all classified as breadth indicators.

Breadth indicators measure the level of participation of individual companies in market moves. Over the years that I’ve used them, I’ve become comfortable with certain levels as indicating that either selling or buying moves have, at least in the near term, run their course. I have drawn blue horizontal lines on these graphs to show you where those levels are, and if you review these twelve breadth indicators, you will see that we are near or have surpassed the levels that indicate selling pressure has run its course – at least in the near-term.

You may be familiar with the names of some of these indicators:

> the Advance/Decline Line measures the difference between the number of stocks advancing in price and the number of stocks declining in price

> the Hi-Lo Index measures the difference between the number of stocks making new highs and the number of stocks making new lows

> the % of S&P 500 companies trading above the 50 and 200 day moving average

> the Volatility Index is an index based upon Options and is an indicator of fear among traders – the greater the fear, the more Puts that are bought to protect against market drops

> the Bullish Percent Index shows how many companies have a bullish chart pattern on a point and figure chart

> the McClellan Oscillator is a short-term view of buying and selling pressure

> the Summation Index is an intermediate-term view of buying and selling pressure

> the Force Index is a trend indicator that gives a short-term view of buying and selling movements of investors

> the TRIN is also known as the Arms Index is a trading index that measures the number of shares traded in the market instead of the dollars

> the Put/Call Ratio demonstrates the sentiment in the market as to whether buyers are bullish or bearish based upon whether they are playing the options market in a bullish or bearish manner

> the TICK indicator measures on a cumulative basis whether the last trade in the market was a buy or sell

Each of these measures shows a different aspect of what is happening within the market and gives us an insight into what investors are doing.

As we have discussed previously on the blog, the stock market is influenced by actual earnings, the perception of future earnings, and how much investors are willing to pay for those future earnings (aka, sentiment).

These breadth indicators demonstrate in an objectively calculated manner something as subjective as sentiment – and it is in this conversion of the subjective to the objective that they hold their real value for an investment decision. You want to make sure that you are buying when sentiment seems too negative and selling when sentiment seems too positive – as demonstrated by the relationship of these indicators to the horizontal blue lines on the graphs.

Will they ever all show exactly the same thing? It would be rare, but we did see it in March 2009 when I wrote to you that we had begun to move from a heavy cash position to a fully invested position. If you remember back to that time, we were dealing with a stock market crash that took over 50% from the value of the S&P 500 – more for other indices. Since then, the S&P 500 has more than doubled.

As with every investment decision, we have to use these indicators in conjunction with other information. We started raising cash in client accounts in September when these indicators showed the market was nearing a top. That proved to be a good decision as we sold many holdings much higher than today’s prices.

However, at this time, even though the indicators show selling pressure has abated, the prospect for our economy to go over the fiscal cliff is still fairly high. Congress is on Thanksgiving break and the President is on an international trip, so no negotiations are taking place, and when they return they will have roughly one month to come to a compromise position that will not harm our economy, which will be a big job.

Since the price of the market is based upon future earnings and how much investors are willing to pay for those earnings, it is likely that if we go over the fiscal cliff earnings will be down (for at least a quarter or two) and the sentiment that drives investors pay more or less for those earnings will be squarely in the “less” camp.

So, we are taking a cautious stance until we see positive movement on this issue. We are, however, not selling anything at this point given that the indicators show the market should move higher in the near-term. Until we know the outcome of the fiscal cliff, caution is the best plan.

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Don’t Panic

Wednesday, November 7th, 2012

Index Summary

Investors are selling the market broadly this morning and I’ve had several phone calls/email mails/drop-by visits from clients and others who want to know if they should just sell everything.

Its too early to know what exactly will happen with the fiscal cliff and other important issues during the coming lame duck session of government before the new and returning players are sworn in a few weeks from now.

However I can tell you that the one important rule to remember in investing is: DON’T PANIC. Selling into a market retreat like this is a bad decision.

Another important rule that I follow is: DON’T INVEST YOUR POLITICS. In the coming four years, there will be winners and there will be losers as government policy is shaped to reward certain industries and punish others – it happens with every administration, R or D, so the coming four years will be no different.

I am working on a strategy piece that will spell out what I think will be those winners and losers over the next four years based upon where government policy will likely head. I’ll get that published on the blog in a day or two, so my best advice to anyone is not to make wholesale investment changes the rest of this week. Things will be volatile as people who do not follow the second rule above will tend to then not follow the first rule above.

I’ll be back to you with thoughts on how portfolios need to be positioned, but until then, please let things play out until the beginning of next week at which point the post-election reaction swings will hopefully have played out and we can see where opportunities exist based upon thoughtful analysis.

Until then, DON’T PANIC.

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Federal Spending V Revenues – Log Scale

Tuesday, November 6th, 2012

Federal Spending V Revenues - Log Scale

Yesterday, I posted the above graph in a nominal scale and someone asked what it would look like in Log Scale to take out the time skew of more recent changes being in larger dollars. The above graph plots the same information on a Log Scale and you can see the impact of WW1, the Great Depression, and WW2 much clearer.

Very interesting. Many thanks to Doug for the suggestion!


Federal Revenues Vs. Spending

Monday, November 5th, 2012

Federal Spending V Revenues
Click on the graph for a larger view

I’ve been collecting data and put the graph above together with some historical annotations to give you a feel for how our government has balanced its revenue and spending since 1902.

You can see that we did really well as a country until Nixon took the US off the gold standard and we began to print as much money as we needed. The big exception was during WW2 when we ran significant deficits in order to win the war.

The whole concept of deficit spending is ingrained in popular economics (popular with politicians and university economics professors) through the work of John Maynard Keynes. Unfortunately, and this is from the view of someone with a couple of accounting degrees and not an economics degree, I see that the governments around the world have taken Keynes basic theory of short-term government spending (on things like infrastructure that generate economic momentum) and translated that into long-term deficit spending on preferred projects (whether its entitlements or defense).

There are some popular misconceptions about things that have happened along the way (the Bush tax cuts really did stimulate revenues – the misconception that everyone quotes is the revenues relationship to GDP which shrank, but that was because spending was growing faster than revenue collections).

Probably the most important thing to note is that during the period of March 1991 to March 2001, the US did not have any sort of economic recession. That allowed economic growth to positively impact tax revenue collections, and that combined with fiscally prudent budgets during the Clinton years, a working relationship between Congress and the President (the good old days), the Peace Dividend from the end of the Cold War, and Welfare Reform all acted to keep spending in check as revenues grew.

As you look at the graph, you can see that there is currently a significant gap between spending and revenues. Whomever is elected President tomorrow will have a difficult job bringing those two closer together. From a historical perspective, some bad decisions in the past 65 years by politicians that have gotten us where we are today. The changes it will take to fix our situation will not be fun.

When we wake up Wednesday morning, 1/2 the country will be happy and 1/2 the country will be upset. So I’d like to give everyone a bit of perspective through the words of Eric Idle at this past Summer Olympics: “Always Look On The Bright Side of Life.”

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For those of you purists that want a taste of the original version from Monty Python’s “Life of Brian,” you can find it here: This links you to Eric Idle in Life of Brian If you’ve never seen the movie, and you are easily offended, please do not click on the link – it is typically offensive in that Monty Python sort of way.


That Didn’t Take Long

Friday, November 2nd, 2012

Apple Breaks 200-day Moving Average

My blog post earlier today discussed whether Apple might drop below its 200-day moving average. While I was at a lunch appointment, it pushed decisively through the 200-day line. The intermediate trend trumped the short-term oversold levels – at least today.

The 50-week moving average stands at a price of $555, so we are about 5% above that level which will need to hold.

Interesting time for this company.


Apple – Time To Buy Or To Sell?

Friday, November 2nd, 2012


I thought we should take a look at the technical picture of Apple stock today.

I have drawn two blue circles on the chart above to show you the two times in the past year where Apple has tested the 200-day moving average. You can see that the first time in December of last year proved to be a good entry point for those people that had not yet gotten into the stock.

The next circle represents the current level for Apple – but the question is this: Will this prove to be an equally good time to buy Apple (or add to shares you already own) or will the current difficulties with the new iPhone prove too much for the bulls and the stock sinks below the 200-day moving average into bear territory?

Unfortunately, the chart is giving us mixed answers.

If you look at the two blue arrows, these short-term sensitive indicators say that the current level of the stock price is oversold and that we should see a bounce higher. That doesn’t mean it would be a sustainable advance, just that too many sellers have overwhelmed the stock and that an imbalance exists where buyers should materialize.

If you look at the two brown boxes I’ve drawn, these two more intermediate indicators say that the current trend is down and they don’t really show a change of that intermediate trend.

My best reading says that this time, the 200-day moving average will not hold and we will likely see further downside in the stock price.

So the question we need to ask given this assessment is: should I be a seller on this short-term development in the stock or wait it out and buy when it looks to have bottomed?

Apple - 5-year Chart

To get a better perspective, I like to look at the 5-year chart. From here, you can see that the last time Apple dropped below the 50- and 200-week moving averages was during the 2008-9 crash, and buying then proved to be a golden opportunity to get into this technology/consumer product company.

You can see that from a longer-term perspective, we have not yet reached the point at today’s prices where we are crossing the 50-week moving average. There were two previous times in 2011 that we touched the 50-week moving average and those proved to be good buying opportunities.

Given this history, I think waiting to see what happens to Apple relative to its 50-week moving average is the best plan. The current problems with the iPhone are fixable and its customer base is very tied-in and find it difficult to switch. When you have several gigabytes of music in iTunes, its tough to switch to another phone – the thought of figuring out how to transfer/import that into another device is daunting.

Steve Jobs was a genius and has his customer base locked-in, to a certain extent, and that will keep people buying the iPhone in spite of its problems. Apple has a history of fixing problems and moving on (anyone remember the whole antenna issue with iPhone 4?). The safe money bet is that they do it again but the stock price relative to its 50-week moving average seems to be key to exposing consumer/investor sentiment relative to this company.

Will we see them return to the innovative company it was in 1984 when they introduced the Macintosh or will they cede the technology/consumer products mantle to Samsung? I will be watching and will keep you in the loop.

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