Archive for February, 2014

Resistance Turning to Support?

Friday, February 28th, 2014


Our chart is getting interesting! You can see that after a couple of days of the market trading between the two support/resistance lines, we broke out and closed above the former all-time high yesterday. The index added to the move today, which brings us to the Rule of Three.

For long-timer readers of the blog, you are familiar with Mark’s Rule of Three – its states that when either support or resistance is broken, the price much remain above or below the broken resistance or support level for either three days or three percentage points to change resistance into support or vice versa. Today is day two of closing above the former resistance line.

We executed several purchase trades today as part of our rebalance effort – we focused on the issues that were not overbought as those are set to pull back a bit and we will buy those at that time.

You might ask yourself how we tell if a company we want to own is at a point where the price is statistically likely to fall. Lets look at the chart below and I can give you a better idea of what I am talking about:


This is our standard company view chart of Illinois Tool Works (ITW). ITW is a manufacturer of a range of industrial products & equipment. Its segments are: Industrial Packaging; Power Systems & Electronics; Transportation; Construction Products; Food Equipment; Polymers & Fluids; & Decorative Surfaces. It is one of my favorite companies based upon its diverse group of businesses, shareholder friendly policies, and key operating ratios like a Return on Equity in excess of 16%, Return on Invested Capital in excess of 21%, Free Cash Flow Yield in excess of corporate bond yields, and an annualized Book Value Growth Rate in excess of 22%.

From the graph above, you can see that I’ve added two purple circles to two short-term momentum indicators I follow. These two have readings that say the price has moved up to levels that are not sustainable and that either the price has to come down or it has to move sideways until some time passes and investor enthusiasm returns.

As far as investor enthusiasm goes, I’ve drawn two downward sloping blue lines. The one on the index itself shows you this company is having trouble moving back to its previous high – and in fact it is making a series of lower price highs. The one further down is a graph of the money flowing into or out of this company’s stock. In this case, since the line is downward sloping, money is flowing out of the stock. Both downward sloping lines show you that investor enthusiasm is waning here in the near-term at the same time that the momentum indicators show the company is set to fall back in price.

As a buyer, this is what you want to see – the likelihood that we will be able to pick up shares of this high-quality industrial with strong operating ratios at a price lower than currently trading.

If you are already an owner of these shares (like some of our client portfolios that already own shares in this company) – and given the operating ratios you are likely a long-term investor in this company – you can deal with a short-term pullback in price from an all-time high as it is a quality company and will ultimately move higher again. It also gives you a chance to add to your position if you want to increase your allocation to a quality industrial with shareholder friendly operating policies.

We go through this process for every company we purchase. Each one goes through our formal Equity Review, we calculate how much potential upside to price there is, what the various key ratios say about the company, how it compares to other companies in its industry and economic sector, and how it has performed over time. Below is the Equity Review I performed on ITW today, just so you get a feel for our methodology:

Double Click on Any Image to See a Larger Version


This is page one, and the highlights of this page include: our Investment Thesis for owning this company; our estimate of near-term upside potential of a 26.50% return (from today’s price, higher if we buy it lower in a few days); those key ratios I mentioned; and other pieces of data that go into the decision process.


This is page two of our analysis, and it focuses on what independent third parties think about the company along with some detailed momentum data. Additionally, in the yellow box in the center, you get our proprietary Earnings Growth Rank and Financial Strength Rank. These two ranking methods are based upon the research from my Masters’ Thesis from the mid-80’s and have served us very well over the years in helping to point to strong companies with an opportunity of providing above market returns.

Both of these ranks are based upon a comparative analysis of several key ratios that rank a database of 6,000 companies from 1 (lowest) to 100 (highest) on a bell curve. From my perspective, when you have both ranks above 80, you have a company that has strongly positive financial/operating characteristics – it is operating well above the level of most other companies and it is doing it in a fiscally prudent and responsible manner.


This is page three of the analysis, and it gives you the comparative operating ratios for ITW, its industry, and its economic sector. You can see that from a valuation standpoint, at a quick glance, the pink indicates it is a bit expensive at the moment (another reason we’d like to buy it a bit lower in price) but that from an operating perspective (see the Financial Strength, Profitability, and Management Effectiveness sections) the green shows it is going gangbusters. For me, this confirms the results of the two ranks detailed above and adds to my confidence level in this company.


This is page four and it provides a 10-year visual history of the stock price, tangible book value, and free cash flow. For me, it helps me keep in perspective how the company has done over time.

There are additional pages to the analysis, but you are likely getting tired of reading this post so I’d like to close it with this thought: buying a company at the right time and price is just as important as selling it at the right time and price.

No one will ever get it right 100% of the time, but I believe our analytical methodology that combines the fundamental analysis required to ensure (to the greatest extent possible) we own the right companies along with the technical analysis to ensure (to the greatest extent possible) we buy and sell them at the right times is key to our clients wealth management objectives. No need to try to be a hero in investing and take undue risks – sound analysis and decision making is the key to long-term success.

Have a great weekend, stay warm and dry with the expected snow we have forecast, and feel free to subscribe to the blog so that you don’t miss any of our updates.

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Resistance Vs Support

Tuesday, February 25th, 2014


Just a quick note today to point out something interesting.

I’ve posted the graph above the past couple of days, so by now you are familiar with it – in particular the fact that it is a two hour graph and that each bar represents the price range for a two hour period.

If you look at the four final bars on the right side of the graph, that represents today’s eight trading hours.

The interesting thing I wanted you to see is that all of today’s action took place between the two resistance lines I drew on this graph, the blue and the purple. This shows you have the blue line (which was formerly resistance – possible could be again in the future) has started to act as support.

If the blue truly acts as support, then the market should be able (solely from a technical analysis perspective) to make a move above the purple resistance line, and possibly close above it. That would be a strong technical sign that the market is ready to move higher.

From a fundamental standpoint, things are a cloudier:

(1) The housing recovery numbers reported this morning are being interpreted as negative for the continuation of the recovery;

(2) Oil above $100 per barrel is the psychological level where consumers start to modify spending behavior much as if a new tax has been levied upon them;

(3) Valuations are high, whether its based upon Price to Earnings, Price to Sales, or Price to Book, all these traditional gauges of valuation are at the top end of their ranges;

(4) Consumer Confidence reading dropped below last month even though the expectation was for an increase;

(5) The various Manufacturing Surveys from the Federal Reserve Banks (NY, Philadelphia, Richmond, and Dallas) all came in weaker than anticipated; and

(6) The developments in the Ukraine are being largely ignored by the stock market, even in the face of Russian armored personnel carriers being deployed on Ukrainian soil in the area of the Crimea.

The Hundred Years War, the Crimean War and WW1 all started with similar (though not exactly the same) issues in the volatile area of the world. A standoff between Russia and Europe over Crimea would ultimately be pretty ugly for stocks given that valuations are at currently lofty levels. Most investors are not mentally prepared for something like this, so a war-induced selloff would probably be swift and ugly – like an episode of the Walking Dead.

So, it appears that we have a standoff between the technicals and the fundamentals, between support and resistance, between Russia and the West. Which will come out on top?

Last year, the fundamentals did not matter and bad news as well as good news was considered good for the stock market.

This year? So far, with the market marginally negative for the year, it doesn’t look like we are in for a repeat of 2013. However, we have ten months to go in 2014, so there a lot of time left for some catalyst to justify the current valuations and for the market to shrug off the negative fundamentals detailed above.

What happens if we look at technicals beyond support and resistance? Those say we are overvalued and should move lower in the near-term. But there will be plenty of time to look at that stuff in the next blog post.

For now, we will continue to execute the strategy I detailed for you last post as we employ our traditional risk management techniques.

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Resistance Held – All Time High Fails

Monday, February 24th, 2014


Last week I posted this chart showing the two levels of resistance that the market was facing.

There was lots of new this morning that the market was at an all-time – lots of talk about good times while ignoring the crappy economic reports that seem to abound. The pump and dump crowd was everywhere on TV today talking about how the market would simply run higher from here.

As the day wore on, very likely those same folks started selling and drove the market back below the resistance level that has stymied it all year.

The graph above is a two-hour chart – meaning that each of the bars you see represents the market’s price range for that two hour period. The final four bars on the chart show you the eight hours in today’s trading day.

Since we did move higher on the day into record territory, I executed some purchases for companies that were under-performing on the day.

On a positive note, a market will often have days like today where it flirts with breaking resistance then falls back only to take another swing at it, maybe fail again, then eventually close above resistance. We will have to see if that is how this market plays out.

The one thing I do want to show you, however, is the Year-To-Date performance of the Gold Miners Index compared to the S&P 500 Index:


The gold miners are up 26% so far in 2014 while the S&P 500 Index is down 0.4%. Gold is a contrary indicator for the stock market, and the miners are a higher beta play on gold. As long as gold is out-performing, the rule of thumb in investing is that stocks will under-perform. It is not a 100% perfect correlation, but it does have historical precedent.

Our strategy was outlined in the previous post, but we will (mostly) be waiting for a confirmation that the market has enough strength to break resistance or that it pulls back a few percentage points and execute the reinvestment part of our trade. We’ve put some cash to work in under-performing stocks as those tend to out-perform if we pull back as well as play catch-up if we break the resistance – but we have plenty of other purchases entered into the system that are ready to execute when the market shows us it is ready. This is a short-term situation that will be resolved one direction or the other within a few days.

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Friday, February 21st, 2014

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We have seen a major move higher in the market after the pullback earlier in the month, so I thought it would be interesting to look at the technical picture to see if that gives us any guidance to positively impact our strategy.

The graph above covers a two month time frame – it is a different view than we normally look at here on the blog but I wanted to point out some things that are easier to see at this level of granularity.

Since this is a new view, let me give you an overview of what you are seeing. The top section represents the seven day Relative Strength Index (an important near-term indicator that demonstrates price momentum). The middle section is the S&P 500 Index for the past two months. And the bottom section is the Stochastics (also an important near-term indicator).

In the middle section, you see that I have drawn two horizontal lines that represent two levels of resistance. The red line is placed at the all-time closing high for the S&P 500, and you can see we have bumped up against it several times since year-end, but we have not closed above it. The blue line is another layer of resistance where the market seems to want to trade around. We have bumped up against it and traded through it up to the red line a few times, but there has been no sustainable advance above it which makes it another level of resistance. (Greg Schnell gets the credit for pointing out the double layer of resistance in his blog).

As I look at this graph I see a stock market that is tired and potentially making a near-term top much like it did in late January before the 5%+ drop into early February. A classic sign of a market top is when the index cannot move to new highs after several failed attempts. We always like to keep on top of signs like this as it gives us an opportunity to book profits on positions that have moved higher or to sell something that should be replaced with a company that has more favorable investment characteristics.

But, we can use that sign alone – I like to look at other indicators like the ones I’ve included with this graph.

As I look at the RSI, I see we are right at the upper line that indicates when a market has gotten overvalued. If the index pushes higher up to the red resistance line, the RSI will likely form one of the “hills” above the line that are filled in – that flashes a warning that the index is likely to pull back because momentum has gotten too aggressive and buyers will likely take a breather.

As I look at the Stochastics (which is another representation of the momentum in the market), I see that we are headed toward the upper indicator line on it as well. In this case, once the indicator moves above the upper line, it tells us that buying momentum will soon top out. You can see that after a couple of days above the upper indicator line during February, both times saw the market fall a couple percentage points.

January and February are portfolio rebalancing points for us. From a strategy standpoint, we have used the recent moves to the market top to sell holdings that had gotten overweight in client accounts due to the big moves in the market last year. We have also used it as an opportunity to sell certain holdings whose fundamentals have started to deteriorate (maybe they missed their earnings expectations or some other issue). We then use the drop in early February to reinvest that money in either underweight holdings or new positions that had appealing fundamentals or valuation. We used the move higher in recent days to continue repositioning holdings and we now have a bit of cash on hand to reinvest.

The reinvestment will happen in the next couple of days when the market shows us some clarity. Based upon what it tells us: (1) if we move up to the red resistance line and cannot make a sustained advance above it, then subsequently fall back a few percentage points, we will execute our reinvestment when the indicators tell us the move down has lost selling momentum; or (2) if we are able to break through the red resistance line and sustain that move, that line will then become support and it will be our tell to reinvest for the next leg higher in the market.

This is a simple risk management strategy and it has proven time and again to add positive return over the index. In a market like the current one – unlike last year’s buying and holding of the index being the big winner – it takes proper risk management, stock selection, and timing of purchases and sales to manage portfolios properly.

I have written here many times: invest what you see not what you believe. In the current market, we are investing according to what we see and will implement the reinvestment strategy as detailed above based upon how the market handles its resistance.

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Ugly Day

Monday, February 3rd, 2014

Click on graph for Full Screen View

Lot’s of really ugly bon mots about the sell-off today:

· worst February start since 1982 for the Dow
· worst monthly start since 1972 for the NASDAQ
· S&P closed the furthest below its 100-day in over a year
· worst February start of the entire market since 1933

I thought that given all of the news about the market and the > 2% drop today, we ought to take a look at the graph and see what it is saying.

I’ve annotated the graph above with some red circles – these circles show you what investor sentiment is saying. Both of these show readings below their lower indicators and say that we are due for a bounce higher.

I’ve also put some green arrows on the graph showing how the market, during all of 2013, would bounce higher off the 100-day moving average (the green dashed line), but today we broke decisively below it.

I also added two purple boxes to show you the last time that the market was trading below the 200-day moving average (the bold green line). It has been well over a year since we last traded below the 200-day MA.

All of this says to me that we will likely get an oversold bounce higher tomorrow or the next day, but I think we are due for a trip to the 200-day moving average.

But the real question is: are we going to see a change in the trend from a bullish up-tend to a bearish down-trend? Let’s look at my Trend Change chart below:


We have looked at this graph in the past here on the blog, but not in a long time. The essence of the graph is the relationship of the S&P 500 Index monthly price graph compared to its 10-month moving average with the 7-month Relative Strength Index used as a timing key.

What I like to look for as a change in the market’s character is a situation where the RSI has been either above or below the top and bottom indicators, then change direction – this reflects an extreme change in investor sentiment. And, we then look for a move of the index to cross over the 10-month moving average.

I have circled several instances on the Trend Change graph showing you how a change in trend can be a significant event for the index. Right now, the S&P 500 is at 1,741, falling today by about 40 points. However the 10-month moving average is at 1717, or about 24 points below today’s close. You can also see that the RSI has fallen below the top indicator line and is heading lower.

Is it time to panic? No – the big change in trend that took the market down to crash levels happened due to major financial crises. Do we have one of those ahead?

Check out the Kansas City Federal Reserve Financial Stress Index:


We’ve reviewed this index published by the Fed and you can see that it is not flashing a warning sign that we have some systemic issue that would cause a crash.

Let’s take a look at the Fed’s National Financial Conditions Index that also measures risk:


Again, this index is not showing any sort of systemic issue that would cause a market crash.

Another worry that can cause a market crash (or at least a > 20% correction) is a Recession. Let’s look at the Recession Probabilities Index:


There is nothing about this index that says we are nearing a recession.

Given that the three primary indices I follow to give me a feel for whether we are nearing a correction of crash proportions are stating all is quiet, my conclusion is that the current correction is a normal pullback to or a bit below the 200-day moving average.

For people who are under-invested, this can be a real gift as it gives them a chance to get into the market. For everyone else, the key is to hang-on, don’t do something stupid, and ride out the dip. The biggest concern I have is whether we will move back higher once we bottom or will we move sideways to allow the various measures of valuation we follow to catch up with prices.

One way or another, prices and valuation realign – it just depends on how you take your medicine – fast and painful drop in prices or a slow grind sideways while earnings grow and P/E’s fall – different strokes for different folks.

However, it might not be the time for a realignment and we could simply have a repeat of the two moves below the 200-day moving average in the purple boxes on the graph at the top. We will only know by watching the indicators and seeing what they tell us – and as always, we will keep you informed here on the blog.

If you have not subscribed for notices of new posts, please do so at the top. We will keep you up-to-date on what is happening.

Thanks for reading!

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Keep an eye on the blog as we will keep an eye on the trend change chart