Monthly Archives: October 2018

Taking What XLF Gives You (or Not)

October 31, 2018Uncategorizedadmin

In this article on 10/30 I highlighted a hypothetical example trade in XLF, based on:

*An expected bounce in the overall market

*Extremely negative sentiment for XLF

*A positive divergence between XLF price action and the 3-day RSI

Guess what, folks…sometimes this stuff actually works!

The example trade was intended as nothing more than a short-term speculation hoping for a “pop” in XLF. Figure 1 displays the current status of the trade (assuming the trader was willing to risk $500 on the trade) as I type.

Figure 1 – XLF Dec 26 call option trade (Courtesy www.OptionsAnalysis.com)

The good news is that XLF moved higher yesterday and is up more than 2% today. The trade has already generated more than a 60% profit. The bad news is that everything could change very quickly if XLF turns back down.

So, a trader in this example has 3 basic choices:

1. Let it ride

2. Take a profit

3. Adjust the trade

Here is one thing you need to know and accept if you are going to trade options: There is no “correct” answer among the choices listed above. Each trader must make decisions about how they want to proceed based on their own individual outlook and priorities.

#1. Let it Ride: If you think things are looking good and you want to try riding it further then no action is necessary. Now would be a good time, however, to decide what exactly would cause you to act going forward, i.e., if XLF RSI hits 75, or if XLF price drops back below $26, etc., etc. (here again, there are no “correct” answers).

#2. Take a Profit: As this was intended as a speculative short-term trade hoping for a “pop”, there is nothing wrong with saying “Mission Accomplished” and cashing out. Just remember to avoid the human nature tendency to kick yourself if XLF keeps moving higher. You accomplished your goal – move on without emotion.

#3. Adjust the Trade: There are countless possibilities and again, no “correct” choice. But for the sake of example let me highlight one possibility. This one involves:

*Selling 4 Dec 26 calls @ $1.12

*Selling 2 Dec 27 calls @ $0.59

This leaves a trader with 3 long Dec 26 calls and 2 short Dec 27 calls. The sum total of all of this appears in Figure 2.

Figure 2 – Adjusted XLF position (Courtesy www.OptionsAnalysis.com)

This position has locked in a small profit and still enjoys the potential for unlimited profits if XLF continues to advance (albeit much less profit potential than with the original 7-lot position).

Summary

There are a lot of ways to “play the game”. The key is to:

*Spot opportunity

*Exploit opportunity (without assuming more risk than you can handle)

Jay Kaeppel

Disclaimer: The data presented herein were obtained from various third-party sources. While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information. The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

Serious Contrarian Speculation

October 30, 2018Uncategorizedadmin

When it comes to “investing” (roughly defined here as “putting money into investment vehicles with the intent of generating long-term growth of capital”), trend-following approaches tend to yield the best results (at least according to your esteemed author).

But when it comes to “trading” (roughly defined here as “speculating on shorter-term movements in the price of securities with the intent – if we’re being honest – of making as much money as possible as quickly as possible) anything goes.

When “trading”, it is OK to enter incredibly speculative positions (in fact some might argue that that is the whole point) in an effort to capture quick – and with any luck, sizeable – gains.

The key is to limit the amount of risk you expose yourself to in the process.

One Example

What follows is – as always – NOT a trade recommendation. It simply serves to illustrate the points I am trying to make.

Ticker XLF is presently beaten down, hated and loathed – not to mention unloved. In addition, in the last month it has broken down below its 200-day moving average. A quick glance at Figure 1 reveals a stock that most “investors” would have no trouble staying away from.Figure 1 – XLF trend appears to be breaking down (Courtesy AIQ TradingExpert)

But we are not talking today about “investing”. We are talking about “trading/speculating”. So, let’s consider the following:

*The stock market tends to perform well during the last few days of October/first few days of November.

*Sentiment for XLF has been in a range that often precedes advances (See Figure 2.Figure 2 – Sentiment has been very bearish for XLF (Courtesy Sentimentrader.com)

*The 3-day RSI for XLF is signaling a potential bullish divergence. See Figure 3

Figure 3 – Potential bullish divergence between XLF and it’s 3-day RSI (Courtesy AIQ TradingExpert)

XLF and 3-day RSI made a low on 10/11. Price made subsequent new lows on 10/15 and 10/24 while RSI made higher lows – thus forming a potential bullish divergence.

What to Do

If you are an “investor”, the thing to do is to stop reading and move on to the next thing on your “To Do” list.

If you are a trader/speculator the next thing to do is to assess:

*Is this a situation worth risking money on?

*And, if “Yes”, assessing how to play it without taking too much risk

One potential example play appears below. This play involves simply buying the Dec 26 call option on ticker XLF. The particulars appear in Figure 4 and the risk curves in Figure 5

Figure 4 – XLF Dec 26 call (Courtesy www.OptionsAnalysis.com)

Figure 5 – XLF Dec 26 call risk curves (Courtesy www.OptionsAnalysis.com)

As this is written, buying a one-lot costs $71. A trader with a $25K account who is willing to risk 2% (or $500) on a trade could buy up to 7 of the Dec 26 calls ($71 x 7 = $497).

In terms of trade management:

*If the trade does no show a profit with 30 days left until expiration it might be a good idea to exit and cut one’s loss.

*This is a short-term speculative play so in terms of profit, the trade should be looking to either, a) take a profit, or b) sell some at a profit and let the rest ride, at the first decent opportunity.

Summary

Remember, I am not “predicting” that XLF is about to rally nor am I “recommending” the trade displayed above. I am simply pointing out one example approach to Serious Contrarian Speculation

Jay Kaeppel

Election Cycle to the Rescue?

October 29, 2018Uncategorizedadmin

Well that didn’t go well. The month of October that is. With most of the major stock market averages drooping below significant long-term moving averages and with some of the moving averages starting to “roll over” – not to mention rising interest rates, a key election and the rest of the world’s stock markets plunging – there is suddenly a lot of “doubt” out there.

And if price action does not improve soon my view is that investors do need to consider playing some “defense” (i.e., reduce risk, even if it ultimately means buying back in higher). But the good news is that there is a chance that things will improve in the not too distant future.

The (Seasonal) Trend

For one thing, there are a lot of signs of an “oversold” market (see here for one example). Another “thing” hiding in plain sight from most investors is that we are about to hit one of the “sweet spots” in the 4-year election cycle. To wit:

*We will call the month of November in the mid-term election year through the month of April in the pre-election year a “bullish seasonal period.”

The Results

Figure 1 displays the growth of $1,000 invested in the Dow Jones Industrials Average ONLY during November of each mid-term election year through the end of April of the pre-election year (i.e., 6 months) starting on 12/31/1940.

Figure 1 – Growth of $1,000 invested in Dow Jones Industrials Average; November 1 of Mid-Term Year through April 30 of Pre-Election Year; 12/31/1940-10/26/2018

Figure 2 displays the returns seen by the Dow during the period in each election cycle.

Figure 2 –Dow Jones Industrials Average % price return; November 1 of Mid-Term Year through April 30 of Pre-Election Year; 12/31/1940-10/26/2018

*As you can see, the average 6-month return during this period is a resounding +15.0%.

*The largest gain was +25.6% during 1998-1999.

*The worst performance was a gain of +0.9% in 1946-1947.

Summary

So, does this mean that the worst is behind us and that stocks are destined to zoom higher in the months ahead? Not necessarily. As always, the one problem with seasonal trends is that you never know for sure if they are going to pan out as expected “this time around”.

Still, the consistency displayed in Figures 1 and 2 – combined with the heightened bearish sentiment currently surrounding the market – suggests that now may not be the exact moment to hit the panic button.

Jay Kaeppel

‘Dogs’ ‘Due’ for ‘Days’

October 23, 2018Uncategorizedadmin

While I am by and large an avowed “trend-follower” I also recognize that sometimes things get beaten down so much that they ultimately offer great potential long-term value. Or, as they say, “every dog has it’s day.” So, let’s consider some “dogs”.

For the record, and as always, I am not “recommending” these assets – I am simply highlighting what look like potential opportunities.

Dog #1: Soybeans (ticker SOYB)

As I wrote about in this article, soybeans are very cyclical in nature. According to that article there are two “bullish seasonal periods” for beans and one “bearish”:

*Long beans from close on the last trading day of January through the close on 2nd trading day of May

*Short beans from the close on 14^th trading day of June through the close on 2^nd trading day of October

*Long beans from the close on 2nd trading day of October through the close on 5th trading day of November

In Figure 1 (ticker SOYB – an ETF that tracks the price of soybean futures) has been beaten down quite a bit. This doesn’t mean price can’t go lower. However, given the cyclical nature of bean prices they probably won’t go down forever.Figure 1 – Weekly SOYB; prices beaten down (Courtesy AIQ TradingExpert)

Figure 2 is a daily chart of SOYB and displays the recent “bearish” seasonal period and the latest “bullish” period so far.

Figure 2 – Daily SOYB (Courtesy AIQ TradingExpert)

Dog #2: Uranium (ticker URA)

In this article and this article, I wrote about the prospects for uranium and ticker URA – an ETF that tracks the price of uranium. Since that time URA has basically continued to go nowhere. As you can see in Figure 3, it has been doing just that for some time. While there is no guarantee that the breakout out of the range indicated in Figure 2 will be to the upside, historically, elongated bases such as this often lead to just that. A trader can buy it at current levels and put a stop loss somewhere below the low for the base and take a reasonable amount of risk if they are willing to bet on an eventual upside breakout.

Figure 3 – Ticker URA with a long (really long) base (Courtesy AIQ TradingExpert)

Dog #3: Base Metals (Ticker DBB)

Under the category of – I called this one way, way too soon – in this article I wrote about the potential for ticker DBB to be an outperformer in the years ahead. As you can see in Figure 4, so far, not so good.

Figure 4 – Base Metals via ticker DBB (Courtesy AIQ TradingExpert)

Still, the argument for base metals is this:

*In Figure 3 is this article you can see that commodities as an asset class are due for a good move relative to stocks in the years ahead.

*In addition, the Fed is raising interest rates.

As discussed in the linked article, historically base metals have been the best performing commodity sector when interest rates are rising. Ticker DBB offers investors a play on a basket of base metals.

Summary

Will any of these “dog” ideas pan out? As always, only time will tell. But given the cyclical nature of commodities and the price and fundamental factors that may impact these going forward, they might at least be worth a look.

In the meantime, “Woof” (which – as far as I can tell – means “Have a nice day”).

Jay Kaeppel

A Look Ahead in Stocks, Bonds and Commodities

October 19, 2018Uncategorizedadmin

In the interest of full disclosure, the reality is that I am not great at “predicting” things. Especially when it involves the future. That being said, I am pretty good at:

*Identifying the trend “right now”

*Understanding that no trend lasts forever

*Being aware of when things are getting a bit “extended”

So, I am going to highlight a few “thoughts” regarding how one might best be served in the markets in the years ahead.

Where We Have Been

*After 17 years of sideways action (1965-1982) the stock market has overall been in a bullish trend since about 1982 – albeit with some major declines (1987, 2000-2002 and 2007-2009) when the market got significantly overvalued.

*Bond yields experienced a long-term decline starting in 1981 and bottomed out in recent years.

*Commodities have mostly been a “dog” for many years.

The way the majority of investors approach these goings on is to:

*Remain bullish on the stock market (“Because it just keeps going up”)

*Continue to hold bonds (“Because I have to earn a yield somewhere”)

*Avoid commodities (“Because they suck – and they’re scary”)

And as an avowed trend-follower I don’t necessarily disapprove. But as a market observer I can’t help but think that things will be “different” in the not too distant future.

Considerations Going Forward

Stocks

Figure 1 displays the Shiller P/E ratio. For the record, valuation measures are NOT good “timing” tools. They don’t tell you “When” the market will top or bottom out. But they do give a good indication of relative risk going forward (i.e., the higher the P/E the more the risk and vice versa).

Note:

*The magnitude of market declines following previous peaks in the P/E ratio

*That we are presently at (or near) the 2^nd highest reading in history

(click on any chart below to enlarge it)

Figure 1 – Shiller P/E Ratio (and market action after previous overvalued peaks) (Courtesy: www.multpl.com/shiller-pe/)

The bottom line on stocks: While the trend presently remains bullish, valuation levels remind us that the next bear market – whenever that may be – is quite likely to be “one of the painful kind”.

Bonds

Figure 2 displays the 60-year cycle in interest rates.Figure 2 – 60 -year cycle in interest rates (Courtesy: www.mcoscillator.com)

Given the historical nature of rates – and the Fed’s clear propensity for raising rates – it seems quite reasonable to expect higher interest rates in the years ahead.

Commodities

As you can see in Figure 3 – which compares the action of the Goldman Sachs Commodity Index to that of the S&P 500 Index) – commodities are presently quite undervalued relative to stocks. While there is no way to predict when this trend might change, the main point is that history strongly suggests that when it does change, commodities will vastly outperform stocks.Figure 3 – Commodities extremely undervalued relative to stocks (Courtesy: Double Line Funds)

The Bottom Line – and How to Prepare for the Years Ahead

*No need to panic in stocks. But keep an eye on the major averages. If they start to drop below their 200-day averages and those moving average start to “roll over” (see example in Figure 4), it will absolutely, positively be time to “play defense.”

Figure 4 – Major stock average rolling over prior to 2008 collapse (Courtesy AIQ TradingExpert)

*Avoid long-term bonds. If you hold a long-term bond with a duration of 15 years that tells you that if interest rates rise one full percentage point, then that bond will lose roughly 15% in value. If it is paying say 3.5% in yield, there is basically no way to make up that loss (except to wait about 4 years and hope rates don’t rise any more in the interim – which doesn’t sound like a great investment strategy).

*Short-term to intermediate-term bonds allow you to reinvest more frequently at higher rates as rates rise. Historical returns have been low recently so many investors avoid these. But remember, recent returns mean nothing going forward if rates rise in the years ahead.

*Consider floating rate bonds. Figure 5 displays ticker OOSYX performance in recent years versus 10-year t-note yields. While I am not specifically “recommending” this fund, it illustrates how floating rate bonds may afford bond investors the opportunity to make money in bonds even as rates rise.Figure 5 – Ticker OOSYX (floating rate fund) versus 10-year treasury yields)

*Figure 6 display 4 ETFs that hold varying “baskets” of commodities (DBC, RJI, DJP and GSG clockwise from upper left). When the trend in Figure 3 finally does reverse, these ETFs stand to perform exceptionally well.Figure 6 – Commodities performance relative to stock performance (GSCI versus SPX)

Finally, the truth is that I don’t know “when” any of this will play out. But the bottom line is that I can’t help but think that the investment landscape is going to change dramatically in the years ahead.

So:

a) Pay attention, and

b) Be prepared to adapt

Jay Kaeppel

Watch This Indicator

October 17, 2018Uncategorizedadmin

So, the big question on every investor’s mind is “What Comes Next?” Since this is not an advisory service (and given the fact that I am not too good at predicting the future anyway) I have avoided commenting on “the state of the markets” lately. That being said, I do have a few “thoughts”:

*The major averages (as of this exact moment) are still mostly above their longer-term moving averages (200-day, 10-month, 40-week, and so on and so forth). So, on a trend-following basis the trend is still “up”.

Figure 1 – The Major Index (Courtesy AIQ TradingExpert)

*We are in the most favorable 15 months of the 48-month election cycle (though off to a pretty awful start obviously) which beings Oct.1 of the mid-term year and ends Dec. 31^st of the pre-election year.

*Investors should be prepared for some volatility as bottoms following sharp drops usually take at least a little while to form and typically are choppy affairs. One day the market is up big and everyone breathes a sigh of relief and then the next day the market tanks. And so on and so forth.

An Indicator to Watch

At the outset let me state that there are no “magical” indicators. Still, there are some that typically are pretty useful. One that I follow I refer to as Nasdaq HiLoMA. It works as follows:

A = Nasdaq daily new highs

B = Nasdaq daily new lows

C = (A / (A+B)) * 100

D = 10-day moving average of C

C can range from 0% to 100%. D is simply a 10-day average of C.

Nasdaq HiLoMA = D

Interpretation: When Nasdaq HiLoMA drops below 20 the market is “oversold”.

Note that the sentence above says “the market is oversold” and NOT “BUY NOW AGGRESSIVELY WITH EVERY PENNY YOU HAVE.” This is an important distinction because – like most indicators – while this one may often give useful signals, it will occasionally give a completely false signal (i.e., the market will continue to decline significantly).

A couple of “finer points”:

*Look for the indicator to bottom out before considering it to be “bullish”.

*A rise back above 20 is often a sign that the decline is over (but, importantly, not always). Sometimes there may be another retest of recent lows and sometimes a bear market just re-exerts itself)

*If the 200-day moving average for the Dow or S&P 500 is currently trending lower be careful about using these signals. Signals are typically more useful if the 200-day moving average for these indexes is rising or at least drifting sideways rather than clearly trending lower (ala 2008).

Figures 2 through 8 displays the S&P 500 Index with the Nasdaq HiLoMA indicator. Click to enlarge any chart.

Figure 2 – SPX with Jay’s Nasdaq HiLoMA ending 2006 (Courtesy AIQ TradingExpert)

Figure 3 – SPX with Jay’s Nasdaq HiLoMA ending 2008 (Courtesy AIQ TradingExpert)

Figure 4 – SPX with Jay’s Nasdaq HiLoMA ending 2010 (Courtesy AIQ TradingExpert)

Figure 5 – SPX with Jay’s Nasdaq HiLoMA ending 2012 (Courtesy AIQ TradingExpert)

Figure 6 – SPX with Jay’s Nasdaq HiLoMA ending 2014 (Courtesy AIQ TradingExpert)

Figure 7 – SPX with Jay’s Nasdaq HiLoMA ending 2016 (Courtesy AIQ TradingExpert)

Figure 8 – SPX with Jay’s Nasdaq HiLoMA ending 2018 (Courtesy AIQ TradingExpert)

Summary

The stock market is in a favorable seasonal period and is oversold. As long as the former remains true, react accordingly (with proper risk controls in place of course).

Jay Kaeppel

A Seasonal Play in Crude Oil

October 16, 2018Uncategorizedadmin

A number of physical commodities have demonstrated some fairly persistent seasonal tendencies. That’s the Good News. The Bad News is that there is no way to know whether or not a given trend will work “this time around”. Makes life interesting I guess.

Anyway, one of those “fairly persistent seasonal trends” involves crude oil showing weakness late in the calendar year. To wit, consider Figure 1 (from Sentimentrader.com) which displays the annual seasonal trend for crude oil (the blue line is the annual seasonal trend, the red line is the action of crude oil so far this year).

Figure 1 – Crude Oil annual seasonality (Courtesy Sentimentrader.com)

If – and as I intimated, it is always a big “if” – this bearish seasonal trend exerts itself this year, then now would appear to be a good time to enter a bearish position in crude oil.

DISCLAIMER: For the record I am not “predicting” that crude oil will decline in the months ahead, nor am I “recommending” that anyone go out and play the short side of crude based solely on what I write there – including the “example” trade that appears below. JayOnTheMarkets.com is not an advisory service (it’s basically just the ramblings of a market-addled mind. I write about what I see – or think I see – and you take it from there – or not). The purpose of all of this is simply to highlight one potential way to take advantage of a particular seasonal trend.

Crude Oil Futures

The purest play would be simply to sell short crude oil futures and get point-for-point profit if crude oil declines in price. As you can see in Figure 2 crude oil futures recently hit a key resistance price and failed (at least so far) to break through.

Figure 2 – Crude Oil futures (Courtesy ProfitSource by HUBB)

While selling short crude oil futures is fine for well capitalized speculators, the reality remains that each $1 move in the price of crude oil results in a $1,000 change in contract value. So, if you sell short crude oil futures at $71.72 and instead of going down crude rallies back up to its previous high of $76.90, you lose over $5,000. Which is a little rich for the average investors’ blood.

Ticker USO

Ticker USO is an ETF that ostensibly tracks the price of crude oil. You can see its price action in Figure 3. It hit a resistance point and reversed recently.

Figure 3 – ETF ticker USO (Courtesy ProfitSource by HUBB)

Playing the Short Side

So, let’s say:

*We want to play the short side of crude oil

*We want as close to point-for-point movement as possible

*We don’t want the unlimited risk associated with selling short crude oil futures

What’s a trader to do? One possibility is to buy a deep-in-the-money put option on ticker USO. Figure 4 displays the particulars and Figure 5 displays the risk curves.

Figure 4 – USO put trade (Courtesy www.OptionsAnalysis.com)

Figure 5 – USO put trade risk curves (Courtesy www.OptionsAnalysis.com)

A few things to note:

*The maximum risk is $253 per 1-lot

*If USO drops from $15.13 to below $14.97 the put option gains value point-for-point for each lower tick in USO.

Let’s take a slightly closer look at this example trade. Figure 6 “zooms in” a bit – i.e., the lowest price on the chart is $13.20, which represents a 1-standard deviation move to the downside and the highest price is $16.40 which is above the recent high of $16.24. If USO takes out the recent resistance level the basis for the trade is sort of blown and it would likely be a good time to cut a loss.

*A move down to $13.20 would result in a profit of roughly +$176

*A move up to $16.40 would result in a profit of roughly -$97 to -$147, depending on how soon that price is hit.Figure 6 – USO example trade (Courtesy www.OptionsAnalysis.com)

Summary

Will crude oil decline in the months ahead? I have to go with my stock answer of “it beats me,”. But seasonality and a failed upside breakout offers some basis for considering playing the short side.

While an in-the-money put option on USO offers far less profit potential than a short position in crude oil futures, it also entails a fair smaller degree of risk.

The key factors are:

a) Do you think there is a chance crude oil will decline in the months ahead?

b) Are you willing to enter a speculative position which could result in a 100% loss (if USO is above $17.50 at expiration)?

c) Do you have $253 bucks?

Jay Kaeppel

The SPX/Gold Ratio

October 8, 2018Uncategorizedadmin

“Intermarket Analysis” was a phrase first popularized by the legendary investor and author John Murphy. Turns out he was on to something. To give you the idea, in this piece we will look at the interplay between the S&P 500 Index and the price of gold.

The correlation of monthly returns between SPX and Gold since 1975 is a measly 0.0132. To put if another way, there is no positive or negative correlation whatsoever between these two markets. The fundamentals that drive the prices of these two “assets” are completely different.

The SPX/Gold Ratio Indicator

A = monthly total return for SPX

B = monthly return for gold bullion

C = Growth of $1,000 invested in SPX

D = Growth of $1,000 invested in Gold

E = C / D (i.e., our SPX/Gold Ratio)

F = 21-month exponential moving average of E

Figure 1 displays the SPX/Gold Ratio and the 21-month EMA (Variables E and F above). In a nutshell, when the lines are rising it means stocks are outperforming and when the lines are falling it means gold is outperforming.

Figure 1 – SPX/Gold Ratio (blue) versus 21-month EMA (red); 12/31/1974-9/30-2018

Interpretation is simple:

*If the blue line is above the red line hold SPX (call this “Bullish”)

*If the blue line is below the red line hold Gold (call this “Bearish”)

*For my own purposes I use a 1-month lag (i.e., if the blue line crosses above the red line after the close of trading in January, buy SPX at the close of trading in February. If the blue line crosses below the red line at the end of March, buy Gold at the close of trading in April.)

Performance

Figure 2 displays the performance of buying and holding SPX when the indicator is bullish versus bearish.

Figure 2 – Growth of $1,000 invested in SPX when SGR is Bullish (blue) versus when SGR is Bearish (red); 12/31/1974-9/30/2018

As you can see, stock market is overall pretty good when the SGR is bullish.

Figure 3 displays the growth of $1,000 invested in gold bullion when the SGR is “Bearish” (i.e., favors gold).

Figure 3 – Growth of $1,000 invested in Gold when SGR is Bearish; 12/31/1974-9/30/2018

Figure 4 displays the growth of $1,000 invested in gold bullion when the SGR is “Bullish” (i.e., favors SPX).

Figure 4 – Growth of $1,000 invested in Gold when SGR is Bullish; 12/31/1974-9/30/2018

Results from 12/31/1974 through 9/30/2018

So clearly there appears to be an advantage to switching when the ratio changes from Bullish to Bearish and vice versa.

“System” Results

The rules are simple:

*When the SGR rises above the 21ema (wait one month) then buy SPX

*When the SGR falls below the 21ema (wait one month) then buy Gold

*For our benchmark, we will assume that money is split evenly between SPX and Gold on December 31^st of each year.

The results appear in Figure 5

Figure 5 – Growth of $1,000 invested using “System” (blue) versus “Buy/Hold/Rebalance” (red); 12/31/1974-9/3/2018

For the record:

Figure 6 – Performance Results; System versus Buy/Hold/Rebalance

The Good News regarding the System:

*It made a lot more money than buy-and-hold

*It was profitable over 12 months 84% of the time

*It outperformed buy-and-hold 74% of the time

The Bad News regarding the System:

*It was much more volatile than buy and hold (21% average 12-month standard deviation versus 14% for buy-and-hold)

*It had larger drawdowns than buy-and-hold (Worst 12-month return = -36%, worst Maximum Drawdown = -39%)

Summary

Our SPX/Gold Ratio System made 12 times as much money as buy-and-hold (and rebalance annually) over almost a 44-year period. Yet, it did so in a very volatile manner. The real question is “can an investor” stick with it through the large drawdowns long enough to enjoy the benefits?”

That’s a question each investor needs to answer for themselves.

Jay Kaeppel

Bond Bombshell

October 4, 2018Uncategorizedadmin

Just last week I wrote a piece title “The (Potential) Bullish Case for Bonds”. And as always, there’s nothing I enjoy more than when I publish something intimating a possible bullish move only to see the bottom drop out. But I digress.

Anyway, if you read the original article carefully (you did, right?) then you may recall that the gist of it was as follows:

*The long-term trend in interest rates is almost certainly higher and as a result bond “investors” (“investors” defined as people who buy and hold bonds or bond funds as long-term holdings) should eschew long-term bonds and stick to short-to-intermediates and/or floating rate bonds.

*In the short-term, a) the long-term bond was oversold and near potential support, b) trader sentiment was/still is about as overwhelmingly bearish as it can get, and c) we are entering a seasonally favorable time of year for long-term bonds.

*If long-term bonds took out recent support, then all bullish bets were off.

So, the real point was that if bonds could hold above support there appeared to be a chance for a decent “counter bearish sentiment” rally.

As of yesterday, all bullish bets are off.

As you can see in Figures 1 (TLT as of the close on 10/3) and Figure 2 (30-year treasury bond futures in the early morning hours of 10/4) the long-term bond plummeted through short-term support like a hot knife through butter (i.e., breaking down through support on 10/3 and following through to the downside overnight on 10/4).

(click to enlarge)Figure 1 – Ticker TLT breaking support on 10/3 (Courtesy ProfitSource by HUBB)

(click to enlarge)Figure 2 – 30-year treasury bond futures following through to downside on 10/4 (Courtesy ProfitSource by HUBB)

Sometimes price breaks down through support and then immediately reverses, forming a bear trap. And sometimes it breaks down through support and just keeps going. Figures 1 and 2 look like the latter.

To full appreciate the potential significance of this move consider Figure 3 which displays the yield (times 10 for some reason) for the 10-year treasury note.

(click to enlarge)Figure 3 – 10-year treasury note yields appear to be breaking out to the upside (Courtesy ProfitSource by HUBB)

Note that the 10-year yield has moved above the down trending trendline connecting previous peaks as well as a key resistance level. These are not good signs.

Summary

The trend in bonds is clearly “down.” As mentioned above (and in the original article) this has profound impacts for bond “investors” – most notably that holders of long-term bonds stand to get hurt badly if rates continue to rise.

On a shorter-term basis, with sentiment so overwhelmingly bearish do not be surprised to see a surprisingly strong counter rally once the current line runs its course. But that kind of thing is for aggressive traders only.

In the meantime, just remember that trying to catch a falling knife can be painful.

Jay Kaeppel

Bellwethers Looking a Bit Weathered

October 3, 2018Uncategorizedadmin

One of the benefits of being an avowed trend-follower is that it can allow you to avoid a lot of the “angst” that many investors suffer with each new twist and turn in the economic/financial/political/price of tea in China arena. Let’s face it, if you scan the internet, watch cable news or read the financial press you will always have at least – roughly – 10,000 “things” that you could be worried about that will kick the legs out from whatever bullish thing might be happening at the moment.

I have a friend (no, seriously) and his comment recently was “The next person that mentions the Hindenburg Omen gets punched in the face”. The bottom line: someone is always crying “Wolf”, and living in perpetual fear is – let’s be honest – kind of a crappy way to go through life. Which is why I typically advocate focusing on the major trends and not sweating all the small stuff along the way.

Yes, things can go wrong and yes it would be nice to have at least some sort of a heads up in advance. So, in an effort to not be completely ignorant of the goings on around me I do have a few “things” I follow in hopes of getting some “early warning” if trouble is brewing. I call them my 4 bellwethers.

The main thing I look for is “divergence” between the action for the major stock market indexes and the action of these bellwethers. Even the existence of divergences does NOT guarantee trouble. But more often than not, major market tops are presaged by some “signs of trouble”. So, let’s take a look.

The Major Indexes

Figure 1 displays the Dow, Nasdaq 100, S&P 500 and Russell 2000 indexes. As you can see, they are all in up trends, well above their respective 200-day moving averages and 3 of the 4 are at or near all-time highs. In other words, from a solely trend-following perspective, “Thing are swell, things are great.”

(click to enlarge)Figure 1 – Four major indexes all in bullish trends (Courtesy AIQ TradingExpert)

The Bellwethers

Figure 2 displays my 4 bellwethers – they are:

Ticker SMH: an ETF that tracks the semiconductor sector. The world runs on technology and technology runs on semiconductors.

Dow Transportation Index: Whether the Transports confirm or diverge from the Dow Industrials has long been used as a gauge of market health by investors.

Ticker ZIV: An ETF that is designed to track the inverse of the VIX Index. Long story, but bottom line, it should go up when the market goes up and vice versa. Any deviation from that standard can be a warning sign.

Ticker BID: Sotheby’s Holdings which run high-end auctions. Bottom line, if rich people are comfortable buying expensive stuff that is a good sign for the economy (and should be reflected in a rising trend in BID) and if rich people are NOT comfortable buying expensive stuff, well, vice versa.

(click to enlarge)Figure 2 – Jay’s Market Bellwether (Courtesy AIQ TradingExpert)

As you can see, the Bellwethers are mostly not confirming the major average at the moment. This is not a reason to panic or fell angst. It is simply something to keep an eye on. The longer these divergences continue the more troublesome, so let’s focus on a couple of key things to watch to decide if maybe you should go ahead and start feeling angst.

Dow Transports

As you can see in Figure 3, double-tops in the Dow Transports have in the past signaled trouble for the overall stock market.

(click to enlarge)Figure 3 – Dow Transport double tops often a sign of impending trouble (Courtesy AIQ TradingExpert)

The Good News and Bad News for the Transport Index is reflected in the daily chart shown in Figure 4. The Good News is that the Transports recently made a new all-time high. The Bad News is that price has subsequently fallen back below the important support/resistance level marked in Figure 4.

(click to enlarge)Figure 4 – Daily Dow Transports – up or down? (Courtesy AIQ TradingExpert)

Interpretation going forward is relatively simple:

Good = Dow Transports above 11,424

Bad = Dow Transports below 11,424

Ticker BID

As you can see in Figure 5, weakness in the overall market averages is often presaged well in advance by a major breakdown in the price of BID.

(click to enlarge)Figure 5 – Breakdowns in BID often an early warning sign (Courtesy AIQ TradingExpert)

As you can see in Figure 6, BID recently tanked 25% before rebounding slightly. Is this a “Look Out Below” warning sign for the stock market? Dunno, but gonna keep a close eye on BID to see if it rebounds…or falls further.

(click to enlarge)Figure 6 – Ticker BID – which way from here? (Courtesy AIQ TradingExpert)

Summary

The major market averages are (mostly) rallying to new highs while Jay’s 4 Market Bellwethers are, well, it’s too soon to say exactly what they are. But for the moment at least they are mostly not confirming the new highs in the major averages. Please try to remain calm. The proper response is Not fell angst and doubt, but rather to simply keep an eye on how things progress from here. If the Bellwethers start to move higher then “the crisis will have passed.” If not, then it will be very important to keep an eye open for – and to take seriously – signs of weakness in the major averages.

Jay Kaeppel