Sunday, February 26, 2012

Market Analysis 2/24/2012

Macro Analysis
 All the major averages ended up the week on a slightly positive note save the Dow Transports.  The Dow Industrials flirted with the 13,000 mark which the media hyped all week but has no technical significance.  Momentum is slowing as we reach the more important 1370 resistance level on the S&P 500.  Commodities with the exception of oil had another lackluster week and Treasuries continue to maintain their strength in the face of stronger yet moderate economic growth. 
Stocks – much was made by CNBC on Friday that the S&P 500 closed above its June 2008 level.  Yet when I look at the chart I find this fact hardly significant (double click on chart for larger image):

What’s important about the chart above is that the S&P pierced the blue dashed resistance line from the high set in October 2007. 

The yellow horizontal line on the first chart above is a significant resistance area and we’re hugging that resistance line.  However, there are no indications we’re setting up for a correction. 

As I highlighted in last week’s commentary breadth indictors are very strong.  And the daily chart above of the New York Stock Exchange High/Low Index for the exact same period as the S&P chart supports that fact.  This is a cumulative total of New Highs versus New lows on the New York Stock Exchange.  As you can clearly see, we are considerably higher at Friday’s close than we were at the all time S&P high in October 2007.  The bottom panel is a ratio of cumulative new highs to NYSE total volume.  Even here, with a seeming divergence highlighted by the purple dashed line, we have still broken a downtrend that started in April 2011.
No matter which way you try to manipulate these charts to suit your opinion on which way stocks are going, you can’t help to come away with a bullish bias to this market.
Here’s one more indicator that I’m especially excited about.  This is a daily chart of the CBOE Equity Only Put/Call Ratio.  It simply can be defined as the ratio of put options to call options for all equities (stocks) for which options are offered on the Chicago Board Options Exchange.  This is an excellent indication of sentiment in the market.  When utilizing the raw data any number less than 1.00 but even more so less than .80 means bullishness is more pervasive in the market while numbers over 1.00 means bearishness is the prevailing sentiment.  It can used as a contrarian indication meaning that as bullishness becomes rampant it’s time to sell and when the reading is bearish it’s time to buy.  But notice the momentum oscillator in the top panel called PPO (Percentage Price Oscillator).  I’ve drawn horizontal green and red lines that correlate to the S&P chart in the lower panel.  The green horizontal lines are meant to highlight that when the PPO dropped into negative territory (six times in the past year), in five of those instances stocks moving higher; four of those times almost immediately.  Conversely, the red lines highlight that when PPO surged above the 10.0 level we had at least two solid sell signals.
Now, no indicator is 100% accurate in predicting the market and the indicator below proves that fact.  But when I see an upward trending market like we have now and this indicator dipping below 0, I believe that, in conjunction with the other breadth indicators I’ve posted in the past two weeks, that this is predictive of higher prices in the short to intermediate term. 
I believe we are consolidating after the run up we’ve had since December 19th and we will be breaking through the 1370 level in the S&P very soon (maybe as early as this coming Wednesday).  I’ll have more on why Wednesday may be important in my Analysis.
Treasuries & Commodities –   I’m grouping these two asset classes together this week as I’ve been beating this subject to death on my blog for some time.  The bottom line is that commodities other than oil are going nowhere!  I can put up numerous charts to support this fact but I’ve put up so many on my blog I’ll just refer you there: .
Treasuries are giving up the ghost but only with a fight to the death.  The “fear trade” is still very much with us and of course, as highlighted in last week’s commentary, the FED is very active in the bond market, “jawboning” the short end of the yield curve while actively buying the “belly” of the curve (7 to 10 year paper).
Below is a chart of TLT (iShares Barclays 20+ Year Bond ETF) which is a proxy for the long end of the yield curve (Treasuries with maturities 20 to 30 years).  As you can see, the ETF broke to the downside of the consolidation triangle.  Momentum as seen in the upper panel has been declining since mid September.  Lower Treasury prices equate to higher interest rates and I’ve been forecasting a back up on the 10 year note to the 2.4% – 2.5% level barring any easing of the “fear trade”.  But take notice of the black arrows on the momentum indicator (RSI – Relative Strength Index).  Even though momentum is waning the indicator has found solid support at the 40 level four times since November.  And in the last few trading days RSI is showing signs of strength. 

Now stocks and treasuries can coexist in the current market conditions we find ourselves in (stocks relatively flat to marginally higher).  However, a break of the RSI above the blue dashed line will be a negative for stocks.  Conversely, a breakdown below 40 on the RSI will be a positive for stocks. 
Gold – had a good week, breaking out of resistance.  Here’s an updated version of the chart I posted earlier in the week on my blog:

Gold is setting up for an interesting week.  I’ll have more on this in my analysis.
The Dollar - The dollar acted like a wet noodle this week.  Below is a one year daily chart and we broke down below the 61.8% Fibonacci retracement level on Friday.  Any continuation lower will serve to confirm the breakdown and if we break down below the purple dashed support line we’ll be on our way back to the 76 - 75 level very quickly.

For all the pundit predictions of an imminent Dollar rally the FOREX market refuses to acquiesce and we’re seeing significant strength in the Euro.  I’ve given up pinpointing when the big sell off in the Euro is going to occur and I’m staying away from the trade.  The Euro, Yen and Dollar are in the “least ugly” beauty pageant.  With the Bank of Japan announcing this week that they are finally going to get serious in fighting their two decade battle with deflation by printing trillions of Yen, the Euro comes out the winner with the least cratered face J. 

The big event this week is going to be on Wednesday when the European Central Bank’s  second LTRO (long term repo operation) takes place.  Anyone who has read my commentaries or blog knows that my bullish thesis has rested on the results of the first LTRO offered on December 21st, 2011 when European banks took advantage of the liquidity offered by the ECB to the tune of 489 billion Euros. 

Many are stating that the second offering may see combined demand by European banks reach 1 trillion Euros!  But, in fact, no one really knows how much liquidity the banks are going tap this time around.  There are a number of variables that the banks need to consider before borrowing from this source of liquidity.  I will not address those variables here but if anyone is interested Simon Nixon has written some excellent pieces this week in the Wall Street Journal that can give you some insight into what the banks may be considering.

In any case, this will be a significant market mover for the same reasons as the first LTRO.  The difference this time will be the size of the “take”.  The money the banks as a group decide to access will determine market direction.  Predictions on “the street” seem to delineate the 500 billion Euro marker as a determinant of market direction.  In other words, if the European banks as a group access less than 500 billion Euros this will be seen as an insufficient amount that is needed to further insulate the banking sector from exposure to sovereign default.  If however, the amount borrowed is over 500 billion than this will be seen as “market friendly” and stocks will rally.

Of course, such a rigid parameter is speculative at best.  I’d say that the market will be disappointed if the amount borrowed is less than 500 billion and there would be negative reverberations if it was, say, 200 billion.  On the upside, any amount over 500 billion would be positive for the market but not anything that would suddenly move stocks higher.  If however, the banks borrowed 1 trillion Euros this would be a big mover and stocks would lurch forward right away.

I believe Gold has pierced resistance in anticipation of a higher than 500 billion LTRO.  Gold is also being buoyed by rising tensions caused be the Iranian situation.  If however, a poorer than expected LTRO takes place, deflationary expectations will negatively impact the precious metal in the short to intermediate term.  An escalation of tensions in the Gulf of Hormuz might mute any downside for Gold if those tensions should occur simultaneously with Wednesday’s LTRO.

In any case, when we wake up on this side of the Atlantic on Wednesday morning we’ll know the results.  Of course, if you can’t wait until you wake up start checking Bloomberg or CNBC at 2:30AM!  J 

I want to address rising oil prices.  I have to admit I haven’t been following the fundamentals behind its rise but I’ll take a stab on where I see this going.  Rising oil prices would have a negative impact on economic growth but I don’t believe as much as many others think.  That’s because rising oil prices harbor the seed of demand destruction, where at a given point, rising prices curtail demand.  Now, if there was an Iranian instigated crisis a sudden spike would roil markets and the shock would create a hiccup in global economic growth.  But will such a crisis take place?  My answer to that is probably not. 

First of all, the U.S. has prepared to keep the Strait of Hormuz open.  So if the Iranians close it, there will be some shooting which will cause oil, gold and the Dollar to spike.  But the Strait would almost immediately be opened again and things would quiet down almost immediately.

Secondly, it’s clear that the Israelis do not have the necessary political support to launch an attack against Iranian nuclear facilities and its been well documented that such an attack would have formidable logistical challenges in terms of distances involved and Israeli Air Force access to air space.

Thirdly, there is considerable unrest brewing in Iran itself and inflation is getting out of control.  While this could be the catalyst for an unexpected act of aggression out of the Iranian leadership, it more likely could be the reason for a de-escalation of the crisis or even a change in the government.

I don’t want anyone to think that I’m minimizing the possibility of a crisis and $5.00+ gas at the pump because anything can happen.  I just believe the odds are decidedly in favor of such a crisis not happening. 

Other than that, when I look at other commodity prices I still see that disinflationary to deflationary forces are prevailing.  Agricultural commodities are flat, copper is flat, nickel is flat, zinc is flat, aluminum is flat.  About the only commodities that are rising is the livestock complex and oil.  And I would submit to you that while the price of oil may continue to rise from here there is considerable supply coming on line in this country which will serve to blunt that rise and there is another industry that is growing by leaps and bounds that will insulate us in the long term from higher oil prices: the natural gas industry!

If you’re going to play the LTRO be positioned by close of business on Tuesday.
That’s it for now.  Have a great week!