StockCharts Blogs - ChartWatchers

JURY DUTY, CRYSTAL BALLS AND BLACKJACK

(THIS WEEK'S DECISION POINT ARTICLE WAS WRITTEN BY GUEST WRITER ERIN SWENLIN HEIM)

As many of you are aware, I've been doing my duty as a citizen of this great country by serving on a jury.  It has been interesting, to say the least.  The trial is still not over, but I hope to be back full time sometime next week.

After my fellow jurors found out I was a stock market analyst, I began getting questions like, “What is the market going to do?”, “Can you tell me what stock I should buy?”, “What is up with Greece?”, etc.

For those of you who have had the pleasure, you know that jurors have a LOT of time on their hands.  It seems you ‘hurry up and wait’ constantly, so I was able to answer questions (except the one on Greece, because I have NO idea what the answer is there).

I began explaining my job as best I could without getting too technical.  First and foremost I told them that 1) I cannot predict anything, I have no crystal ball because if I did, I’d be rich and likely not here sitting on this jury; and 2) I am not a registered investment advisor, so don’t take anything I say as investment advice.

I told them that my job is to get as much information about market conditions and trends as I can so I can evaluate whether I want to take action or not.  Then I write about it on our website.  I explained that you didn’t want to ‘bet’ against the trend or conditions that tell you to expect a certain outcome. You have to determine what is happening in all three time frames, short-term, intermediate-term and long-term and let each time frame help guide you along.  All three time frames may say something different, but ultimately, the long-term trend affects the outlook for the long-term and the intermediate-term; and they both affect the outlook for the short-term. Additionally, I consider our technical indicators.  They give me more insight into what the condition of the market is whether overbought or oversold. 

I equated it to black jack (not that investing is the same as gambling, although for the uninformed investor I suppose it is).  You will generally do better than the ‘house’ or the market if you know the best way to play your hand given the condition of the dealer’s hand and the card trend (how many small or high cards have already been played).  You won’t always win, but you have a better chance. 

So, what is the trend and condition of the market right now? Looking at the chart below, the top part of the chart shows that the S&P 500 has been trending up since the market low in October.  The three bottom panes of the chart show us that right now in all three time frames, the market is overbought.  The majority of stocks are currently trading above their 20-, 50- and 200-EMAs.

How should we play this hand?  I like my odds.  It appears I have a good hand because the trend is with me.  However, the condition of the market is overbought and could work against me.  It is time to probably play conservatively.  I don’t think I want to ‘double-down’ on my bet and "invest more" money, I’ll count on the trend and that the dealer will not beat my hand;  I should see a return on the bet I already have on the table.

Unfortunately like blackjack, there is some ‘luck’ involved.  In the market, I equate luck to those outside influences on the market that I don’t have control over and can't usually predict.  Things that can throw the market an unexpected curve ball.  An example: news headlines from Europe and Greece.  Right now, certain news from Greece and Europe can cause the market to shoot up or tumble lower on just one headline!  A stray economic report or utterance by Mr. Bernake and all my prudent investments can greatly suffer or profit without any basis in technical analysis.

Bottom Line:  I told my jury friends to keep it simple, don’t get bogged down in the chatter and noise.  Get educated on technical analysis, learn as much about current market conditions and trends as possible so your investment decisions are based on analysis not chance.  Don’t let the “house” take advantage of you!

 

HOUSING RECOVERY?

The market rally on Wednesday was driven in part by a surge in housing stocks, which was triggered by a favorable housing report. Since the fundamentals of the housing market are not too thrilling, regardless of short-term gains, my curiosity was piqued and I pulled up some charts.

The daily chart of the Dow Jones US Home Construction Index, which is one of a set of 100 Dow Jones US sector indexes we track, shows that Wednesday's rally was a small extension of a +78% up move that began after the Index hit rock bottom in October 2011. This is good but how does this rally present in a larger perspective?

I would normally zoom back to a weekly bar chart, but in this case the monthly bar chart is much more helpful, and the current rally looks rather insignificant compared with what has gone before. First, between 2000 and 2005 there was a parabolic advance of about 1,000%, perfectly depicting the frenzy of the housing bubble. Then between 2005 and 2008 we can see all the air coming out of the bubble. Since the bottom in 2008, the Index has entered what is called a basing pattern, and it typically becomes a "long base" because it can go on for many years.

Bottom Line: The purpose of the base pattern is to work out the excesses of the parabolic rise and collapse that preceeded it, a process that normally takes many years to complete. The range annotated on the chart probably represents the range of movement for the Home Construction Index for the next decade or more. There is money to be made playing the range, but I don't expect the top of range to be significantly exceeded any time soon.

A TIMELY BOUNCE FOR GOLD

After reaching an all-time high in August, gold has corrected about -18%, but a recent bounce prompts us to take a closer look to see if the correction could be over. The most encouraging technical evidence is on the weekly chart.

Note how the recent low occurred just above the long-term rising trend line. From the beginning of the correction I thought that this trend line was a logical downside target. Whether or not the bounce off this line is the beginning of a new up leg destined to take out the August highs, has yet to be determined.

The fact that the support has held is very positive, but the weekly PMO (Price Momentum Oscillator) configuration is still negative -- falling below its EMA, and still somewhat overbought.

Shorter-term the daily PMO below is oversold and has bottomed, but the price line has encountered resistance at the 200-EMA.

Our Trend Model for gold is currently neutral (in cash or fully hedged), and a new buy signal will not be generated until the daily 20-EMA crosses up through the 50-EMA. That will probably take a few weeks if prices continue to rise.

Bottom Line: The correction has been of sufficient depth and duration that the bounce off long-term support presents a short-term buying opportunity for those anxious to exploit the next leg up, assuming that there will be one; however, not enough tumblers have fallen into place to justify anything but very tight stops.

 

LONG-BOND YIELD: HOW LOW CAN IT GO?

The 30-year bond yield has dropped below three percent many times this year, dropping as low as 2.694% in October. It has been trending up since then, but today it looks as if the October low could be retested.

On the daily bar chart below we can see that the rising bottoms line has been penetrated at the time this intraday snapshot was taken. This is not a decisive break, but it is a logical one, since the triangle formation is a continuation pattern, and a continuation of the larger down trend should be expected.

To determine if the October low has historical credibility as long-term support, let's look at monthly chart going back to 1943. As we can see, the long-term support is just above 2%. Hoisington Investment Management Company in their Third Quarter 2011, Quarterly Review and Outlook stated, "In view of the United States extreme over-indebtedness, we believe that 2% is a an attainable level for the long treasury bond yield."  Technically speaking, 2% looks attainable and likely.

Why would anyone want to commit their money for 30 years at 2% to 3%? Because U.S. treasuries are considered to be safer than other options, which is amazing given that we are borrowing 42 cents of every dollar we spend. Doesn't sound safe to me. I guess it speaks more to the sorry state of the global economy.

DOLLAR STARTING DOUBLE TOP?

The US Dollar Index appears to be setting up for a medium-term double top. This week it broke down through a short-term rising trend line drawn from the October low after reaching a level equal to the October top. The PMO made a lower top, creating a negative divergence.

The 20-EMA crossed up through the 50-EMA in early September, generating a Trend Model BUY signal. The 50-EMA crossed up through the 200-EMA signaling that The Dollar Index is now in a long-term bull market. Since the EMAs are in a bullish configuration, it is less likely that a full bearish outcome will transpire, but we could see a decline to suport at the 200-EMA or the rising trend line drawn through the August and October lows.

The Weekly chart presents a positive picture with a rising PMO and positively configured EMAs.

Bottom Line: The Dollar Index has been particularly vulnerable to the alternating extremes of attitude within the investing community of panic and relief brought on by the global debt crisis; however, while the charts refelct this volatility, they also seem to reflect a tendency toward a positive outcome in the long run.

ULTRA-SHORT-TERM CLIMAXES ATTRACT ATTENTION

On Thursday the S&P 500 broke down from a triangle formation, which is a kind of continuation pattern. Continuation patterns are so named because, when the pattern ends, prices are normally expected to continue in the direction they were trending before the continuation pattern (consolidation) began. In this case, the breakdown was not what was expected, and puts a bearish shade on a picture that been bullish since the October low.

A positive aspect to the price breakdown is that a number of ultra-short-term indicators hit climactic oversold readings the same day. On the chart below we can see how these oversold spikes generally coincide with the start of rallies of at least short-term duration.

Climaxes are a sign of either initiation or exhaustion. An initiation climax signals that price will begin moving in the direction of the climax, while an exhaustion climax occurs at the end of a move. Immediately following a climax, prices can chop around for a day or two before the followthrough begins.

The question, of course, is what kind of initiation is this one? With an intermediate-term buy signal in effect, we look for a bullish interpretation, which would be that the breakdown was actually a shakeout, intended to turn people bearish just ahead of a rally. Unfortunately, we are still on a long-term sell signal, which means things could be about to get nasty again.

Another negative is that intermediate-term indicators (see chart below) are still overbought and need to move to at least the neutral zone. As you can see on the chart, this can happen without accompanying price deterioration about half the time.

Bottom Line: The market just failed a test by breaking down out of the triangle formation, but the technical damage is not serious, and a decline to the 1175 area to clear intermediate-term overbought conditions could be absorbed without major technical damage being done. On the other hand, if the ultra-short-term oversold spikes have produced sufficient internal compression, yesterday's breakdown could prove to be the final shakeout preceeding a new rally. In any case I view the recent decline as a correction within the rally that began in October.

DOLLAR-WEIGHTED VOLUME

Over 10 years ago I developed an indicator called Dollar-Weighted Volume (DWV). It could be that I reinvented the wheel, but I am not aware of anyone else who uses this indicator. DWV is variation of On-Balance Volume (OBV), which was developed by Joe Granville. DWV is calculated by multiplying the daily volume of each stock in a given market index by the closing price, then adding (or subtracting, if the stock closes down) the result to the cumulative total of DWV for the index. The resulting indicator is an expression of the trend of money rather than just volume.

DWV is a short-term indicator. On the chart below we show the SPX version, and you will note that the DWV and the price index run pretty close together, with tops confirming tops and bottoms confirming bottoms. What we look for are positive/negative divergences and for instances where volume doesn't confirm price, meaning that volume either leads or lags price. When this happens, look for a change in the short-term price trend.

The annotation on this first chart shows how DWV failed to make a lower low along with price (negative divergence), indicating that DWV was beginning to dry up during the selloff.

The annotations on the next chart shows price making a lower top compared to DWV making a higher top. This represents a minor blowoff as prices fail to respond to higher volume. This goes contrary to the belief that volume leads price.

The next chart shows a minor blowoff to the downside in June. More recently we have price making a low beneath the prior low, but this is not confirmed by DWV (positive divergence). This implies that price will continue trending upward in the short term (days to weeks).

I think that DWV is only good for short-term comparisons because it has an upward bias over the longer term. Note above that the December price lows are higher than the August through October price lows, whereas the comparable DWV lows are equal. That could be interpreted as a positive divergence, but it could simply be a symptom of the upward bias. The long-term chart below clearly demonstrates the upward bias.

Bottom Line: Dollar-Weighted Volume is a unique indicator because it expresses volume in terms of dollars, and it can be a handy tool for identifying short-term price trend changes. Beside giving us positive and negative divergences, it can also alert us to times when blowoff conditions exist, cases when leading volume is actually signalling a trend reversal.

RYDEX CASH FLOW RATIO OVERSOLD

One of the ways we have of measuring sentiment is by tracking cash flow into and out of Rydex mutual funds through the use of our Rydex Cash Flow Ratio. The Ratio is calculated by dividing cumulative cash flow (CCFL) of Bear funds plus Money Market funds by the CCFL of Bull funds. We display the results on a reverse scale chart so that high Ratio readings coincide with price lows.

The chart below shows that at the October price lows the Ratio went lower than any time since the 1999 correction. Recent Ratio lows were more extreme than two previous bear market lows, and extremes like that are a sign that sentiment is getting very bearish. Unfortunately, the recent Ratio low exceeded the normal range of the last nine years, so we have to wonder if the limits of the range are expanding permanently.

The above chart displays our entire history of the Ratio, and obviously the range was much wider in the early days. The reason for this was that there were fewer assets in Rydex funds back then, which allowed for a more volatile Ratio.

The chart below shows the components of the Ratio calculation. Note that as the market was topping, Bull CCFL fell and Bear CCFL flattened. Then as the market crashed, Bull CCFL decreased, and Bear CCFL increased, as expected.

The really significant feature on the chart is the sharp increase in Money Market fund assets as people ran to safety. The next most interesting feature is that (see the thumbnail chart on the lower righ corner of the chart) all that recent inflow has moved out of the Money Market fund and, presumably, back into the Bull funds.

Bottom Line: The Ratio is well off its recent lows, but it is still reflecting very strong bearish sentiment, and this is confirmed by Investors Intelligence Advisor Sentiment and NAAIM Sentiment as well. This taken with other indicators we discussed earlier this week, we believe that the Ratio has signalled an important price low.

GOLD MINING STOCKS VERSUS GOLD

QUESTION: Carl, I have read a lot of articles recently indicating gold miner stocks should go up and outpace gold. So far nothing but a drop in goldminers. Would it be possible for you to show charts of GDX and GDXJ with your comments on one of your daily posts? Thank you for a great website.

ANSWER: Back in the day before precious metals ETFs, gold mining stocks were considered a convenient surrogate for exposure to precious metals. The XAU (Gold & Silver Mining Index) is composed of large-cap members of this group. First let's compare a long-term chart of the XAU with one of gold. Note that the XAU and gold ran pretty close together from 1984 until about 2000. Then from the lows of 2000 gold rallied about +1400% versus only +125% for the XAU. (The Price Relative line has been trending down since 1996.) An interesting point is that both indexes had major corrections in 2008 -- about -70% for the XAU and -25% for gold.

I think we can say that in the past there has been a passing similarity in price movement between the two indexes, but it has been a similarity in direction, not magnitude. Why the difference in performance? Well gold is a commodity, and gold stocks are, well, stocks in companies that mine gold. As stocks they carry all the baggage of the companies they represent, and they tend to be affected by the movement of the broad stock market as well.

As an aside, let me say that I have a strong dislike for gold mining stocks as trading/investing vehicles. They tend to trade in broad, volatile trading ranges, and they defy my attempts at trend following. This can be seen on the charts of the two ETFs you requested.

As for specific issues, GDX recently had a failed breakout attempt, a bull trap, and is about to challenge the bottom of the one-year trading range. GDXJ has executed a classic head and shouders pattern and has a minimum downside target of about 22.25.

Bottom Line: The price of gold is already 'baked into the cake' of gold mining stock prices. There could be some future management initiatives that may take better advantage of higher gold prices as regards the bottom line, but I wouldn't count on a major rise in gold stocks driven by a move to correct the lag in gold stocks versus the price of gold.

There are plenty of opinions available on stocks, sectors and markets. Take them all with a grain of salt, then look at the chart!

GOLD DOUBLE TOP: START OF CORRECTION?

In the last month or so gold has formed a double top that could be the start of a much needed correction for the metal.

Specifically the chart below shows an Adam & Eve double top. The first top is sharp and spiky, and the second is more rounded, depicting a labored attempt to reach the previous highs.

A neckline is drawn across the July price low, showing the support level that needs to be penetrated in order for the formation to "execute" (trigger expectations of lower prices). If it does execute, the minimum downside target would be about 1600. This target is estimated by measuring the distance between the first top and the neckline, and then projecting the same distance from below the neckline. It is interesting to note that the less accelerated rising trend line drawn across the January and July lows is rising at a rate that could provide support around 1600 if the correction proceeds. A steep rising trend line has been penetrated, increasing our expectation of further decline.

Gold is in a bull market, so bearish formations are less likely to execute; however, the parabolic rise seen on the monthly bar chart below is strong evidence that a correction is necessary -- a vertical ascent is not sustainable.

A typical resolution for a parabolic ascent is a total collapse back down to the level of the basing pattern that preceded it, but, given the fundamentals supporting gold, I think other options are more likely. A healthy correction like the one in 2008 is an outcome that would satisfy the need to stunt the vertical advance. Another outcome would be a high-level consolidation, which is where prices move into a trading range, in this case say, between 1600 and 1900 over a period of years, but, again, I think the fundamentals argue against that.

Bottom Line: I wouldn't dare say that gold can't continue higher, but the recent vertical movement of gold cries out for a correction to digest the advance. The recent formation of a double top gives us hope that a correction is beginning.

Take care,
- Carl

P.S. Be sure to read the Site News section of this newsletter for a special coupon that you can use to get a FREE MONTH of DecisionPoint.com service!

BEAR MARKET RULES APPLY

It is a concept that we stress on a periodic basis, and we got another illustration this week. Technical indicators must be interpreted within the context of the overall market trend.

On August 17 the S&P 500 Index 50-EMA crossed down through the 200-EMA, declairing by our definition that the long-term trend was down and that we were in a bear market. When this happens, we remind ourselves that "bear market rules apply," and that we should expect negative outcomes more often than positive ones.

As of yesterday many of our short-term indicators were overbought and topping -- the chart below shows what the STO-B and STO-V looked like yesterday. And even though prices had broken above the previous August top, we expressed doubts about the viability of the rally in our daily blog because internals were negative.

While we just recently had technical confirmation that we are in a bear market, the bear has actually been around since the May 2 top, and the coincidence of price and indicator tops was an early clue that the up trend had stalled and may have been in trouble. Since the price break in August we need to consider overbought indicator tops as being cracks in thin ice.

- Carl

LONG-TERM SELL SIGNALS

On 8/2/2011 our mechanical Thrust/Trend Model generated a medium-term NEUTRAL signal for the S&P 500 Index just in time to avoid the market break on 8/4. (Neutral means to be market neutral -- in cash or fully hedged.) After the breakdown we believed we had entered a bear market, but we had to wait for the long-term component of the Trend Model to generate a mechanical SELL signal to make it "official", which it did as of 8/17/2011.

A long-term sell signal is generated when the 50-EMA of a price index crosses down through the 200-EMA (generally known as the Death Cross). At Decision Point we don't consider the long-term sell signal to be a demand for action. Rather it is a flag that says, "Hey, folks, we're in a bear market now. Act accordingly."

Below is a daily bar chart of the S&P 500 with the recent crossover circled on the right. Just to show that it is not a perfect indicator, I have also annotated on the left two 50/200-EMA crossovers that occured in August and September of last year, both of which were bad signals.

Am I concerned that this latest signal will be wrong? Not really. Its value is primarily in that it tells us to adjust our expectations from bullish to bearish. In a bull market it is best to stay positive and expect bullish outcomes, even during corrections. In a bear market, if we expect negative resolutions, we will be right most of the time.

It is a long-term sell signal, but it doesn't mean to go 100% short on the day of the signal, rather we should look for short- and medium-term opportunities to go short to develop. This is where we have a margin of safety when working with these long-term signals -- we look for opportunities. If we don't find many, our exposure will be limited.

Reviewing major market indexes I see that we have long-term sell signals on The S&P 500, S&P 100, NYSE Composite, Russell 2000, Wilshire 5000, S&P 400, and S&P 600. We are still waiting for the Dow, Nasdaq, and Nasdaq 100 indexes, but their prices are well below their 50-EMA and 200-EMA, which means sell signals are virtually inevitable.

A recent CNBC article urges: "Don't Fear the 'Death Cross' in This Fast-Moving Market". In other words, keep right on thinking like a bull. That's just silly. We have objective evidence that the market has entered a bear phase, so we should take that evidence at face value until the evidence changes. The fact that we ahd two bad signals in 2010 is no reason to ignore the current signal because the model has a pretty good record over time. In 2010 Timer Digest ranked Decision Point #4 for Long-Term timing over a 10-year period, with a gain of +77.64% versus a loss of -4.74 for the S&P 500. (Past performance does not guarantee future results.)

Bottom Line: Long-term SELL signals abound on the major stock indexes, which means we are by our definition in a bear market. It is now time to pass our analysis through a bearish screen, to assume that most surprises will be to the downside, and to look for opportunities to sell short. This is a perfect example of technical analysis being a wind sock, and we have no choice but to plan our approach accordingly. If the wind changes, we will adjust.

 

FINDING VOLUME

READER COMMENT: I have written to you before regarding your comments on volume ("where is the volume?”) which imply that volume "confirms" a move.  To me, like many others, volume no longer means anything, or at least not what it used to mean.

 See the recent speech by Andrew Haldane at the International Economic Association Sixteenth World Congress, Beijing, China, 8 July 2011, courtesy of the  the Bank of England; the speech addresses trading volumes here and Europe in the last decade, with special reference to the Flash Crash.  

Q: Where is the volume?  A:  It is whatever the quant algorithm says it will be---at least until the algorithm changes.

The speech can be found at http://www.bankofengland.co.uk/publications/speeches/2011/index.htm.  It is the 08.07.11 speech, entitled The Race to Zero.

RESPONSE: First let me recommend that our readers read the referenced speech. It offers great insight into the Flash Crash, and offers the conclusion that there is still nothing that can stop another one. This is a conclusion to which I had come because of the absence of anything but speculation on the subject.

If I understand correctly, you assert that high-frequency trading (HFT) has changed the nature of volume and has rendered useless. In part I agree -- I don't think volume has the same strength of meaning as when we were all charting with a pencil on graph paper, and we were able to say with some certainty that expanding volume confirmed the price move. Now we have to say that this may or may not be the case.

Nowadays I don't necessarily look for volume to confirm daily moves, because volume doesn't play a primary role in my decision making, but overall I do expect a bull market to have a level of volume that reflects broad market participation. Specifically, I watch a number we call Percent of Average Daily Volume. This is the result of dividing the 250-EMA of daily volume (the average of about a year's volume) by today's volume.

Here is a chart of the 2003-2007 bull market. Note how consistently the volume bars exceed the 250-EMA of volume line. Also, volume steadily expanded from the bottom to the top.

Now, here is a chart of the 2009-2011 bull market. Note the frequency with which the volume bars failed to reach the 250-EMA line, and the persistent down slope of the volume bars over the last two-and-a-half years. This has been the source of my complaint about volume. It has reflected that something was wrong (at least radically different) internally.

The final chart makes your point regarding HFT. Note that the volume for this bull market has actually been much higher than that of the prior bull market. So while I have been asking, "Where's the volume?", it is because of daily evidence that volume has been contracting away from the 200-EMA. I failed to look at the bigger picture.

Bottom Line: The 2009-2011 bull market was a confusing creature based upon consistently weak volume relative to the 250-EMA of volume, and because of gradually fading volume as prices rose higher. Absolute volume is now much higher than in the past because of HFT, which can represent as much as 80% of daily volume; however, in my opinion, the downslope of volume is still an indication of fading participation and is useful input for our analysis.

BULL MARKET HAS WEAK LEADERSHIP

While this bull market has rallied +105% from the 2009 low (basis the S&P 500), I have had a sense that there was something "squishy" about it. One thing was the absence of convincing volume, something analysts have been complaining about since the bull market began. Recently, when looking at our Blue Chip 152 Top 10 Index, I found some surprising evidence of just how dysfunctional this bull has been.

The Blue Chip 152 is a list of stocks that includes the stocks in the S&P 100, the Dow 65, and some Nasdaq favorites. Some years ago I got the idea to track the top 10 relative strength stocks, believing that this would provide a a short list of stocks that would always be upside winners. Boy was I wrong about that. Just look at the chart.

While the Top 10 have tended to perform better than the SPX in bull markets, they perform far worse during bear markets. The reason is simple. Market leaders tend to retain their leadership in bull markets -- once a stock rotates into the Top 10, it will stay there quite a while until it is forced out by a stronger stock, which in turn persists in its leadership position.

In bear markets the story is very different because the majority of stocks are are in decline. Stocks with high relative strength are just not declining as fast as other stocks. As a stock enters the Top 10, it is likely that it is peaking, rather than being in the middle of a strong up move, so the Top 10 stocks as a group are more likely to be moving into accelerated down moves.

Here are some charts of the Top 10 and the S&P 500 which allow us to compare bull market gains and bear market losses. Note that during the 2002-2007 bull market the SPX gained +105% versus +336% for the Top 10. Now compare that with with current bull market gains of +105% for the SPX (already equal to the last bull market) and +119% for the Top 10 (way behind its performance during the last bull market). While the Top 10 is ahead, it is really lagging its normal performance. The reason for this is that there is faster rotation in and out of the Top 10, which is caused by weaker than normal performance of the leaders.

Bottom Line: If your impression of this bull market has been that it doesn't "feel right", your impression is not without basis. The Blue Chip Top 10 Index shows us that the leadership has been weak and lacking in persistence compared to the previous bull market.

QUESTION ABOUT DISTRIBUTIONS AND THE TREND MODEL

QUESTION: Carl, is it okay to use the Trend Model on bond fund NAV's to manage risk, or is it inappropriate because you can't factor in monthly payouts? I own PTSAX, Bill Gross' total return investor class bond fund, and it looks like the 20-EMA is ready to cross down through the 50-EMA. I don't want to sell it if I can help, but I will if I have to. Gross is probably the best out there but the fund has been seeing some noticeable weakness of late.

ANSWER:  Distributions occur with stocks and mutual funds, and it is important for investors to understand what they are and how they affect prices. When a company or mutual fund makes a distribution, they are transferring company/fund assets to shareholders, and prices need to be adjusted to reflect the fact that the company/fund no longer owns those assets. (Note: A dividend is a distribution.)

The distribution where this is most obvious is a stock split. In a 2 for 1 split the company distributes additional shares to shareholders so that they will own twice as many shares after the split. On the day of the split (the ex-distribution date) the price of the stock is halved, and historical prices are divided by two. If historical prices were not adjusted, the chart would be useless because on the day of the split it would show a 50% decline. Click here to learn more.

Our Trend Model is driven by exponential moving average (EMA) crossover, so it is important that the historical data of a given mutual fund is adjusted for distributions. As with most bond mutual funds, PTSAX makes small monthly distributions and PTSAX historical data are adjusted each time by StockCharts.com, whose data we use.

As for applying the Trend Model to a particular price index, we would want to select a low volatility index. PTSAX certainly fills the bill in that regard. It "tends to trend" rather than jump all over the place. In the case of a mutual fund we cannot sell it short, so we are only concerned with 20-EMA and 50-EMA crossovers. When the 20-EMA crosses up through the 50-EMA, it is a buy signal. When the 20-EMA crosses down through the 50-EMA, it s a signal to exit the position.

These rules do not work perfectly, but they are designed to keep us invested when the trend is favorable, and to eliminate exposure when prices have exhibited sufficient weakness to cause concern.

Bottom Line: Historical prices must be adjusted for distributions or they will be useless for purposes of technical analysis. This is not a recommendation for you to take any specific action, but I believe that our Trend Model is suitable for use with PTSAX, and that it will help you sleep at night knowing that buy and sell decisions are guided by an objective timing tool.

WHAT'S "UUP" WITH THE DOLLAR

While the U.S. Dollar Index didn't do so well Friday, it is getting ready to generate a Trend Model buy signal. Note on the chart below that the 20-EMA is less than a hair away from crossing up through the 50-EMA, which will mechanically generate the buy signal. Note also that the Index broke above the top of a descending wedge formation. Friday's decline, so far, was the expected snapback to the line, which is now support. Unless there is more followthrough to the downside, I'd have to say this chart is bullish.

Now let's look at the chart of the Dollar Index Bullish ETF (UUP), which is supposed to track the Dollar Index. Note that the price barely penetrated the overhead resistance on an intraday basis, and failed to close above it. More interesting is that the price relative line has a gradual downward slope and a steep drop in the last three weeks. This means that UUP is normally weaker than the Dollar Index, and it has been exceptionally weak more recently.

So what should we believe, the Index or the ETF? The ETF trades on supply and demand like a stock. The Dollar Index simply tracks the U.S. Dollar's strength against a basket of currencies. If I'm going to try to forecast the future path of the dollar, I'll use the Dollar Index chart. If I'm trading the ETF, I'll use the UUP chart.

Is UUP giving us advance warning that things are about to go south for the dollar? Possibly, but for now I'll believe the Dollar Index, because UUP has historically underperformed the Index. If the Index continues higher, UUP is certain to follow.

For more clarification, let's look at the Dollar Index weekly chart. The price breakout looks pretty solid, and the PMO has crossed up through it EMA. We should have positive expectations unless this picture changes.

Bottom Line: The Dollar Index has been performing well for about six weeks, and technically we expect it to continue for a while. UUP doesn't look as promising, even though it is supposed to track the Dollar Index, so we would take our trading clues from the UUP chart. I think this conflict could be resolved as early as next week.

TIMING SIGNALS SHOW MARKET WEAKENING

For over three months the market has been chopping around and making very little progress. In the process internals have been weakening, a fact that is reflected in the signal table below. In our Decision Point Alert Daily Report we track mechanical timing signals on 27 market and sector indexes. In addition to the broad market indexes, we track the nine SPDR sectors and their equal weighted counterparts, which normally perform differently than the cap-weighted indexes.

Of those 18 sector indexes 10 have switched from buy signals to neutral over the last few months. Four had signal changes today. The technology buy signals that just closed were only 5.5 weeks old and were the result of whipsaw that typically occurs during the topping process.

Let's remember that the sector SPDRs are actually formed by breaking the S&P 500 stocks into nine sector groups. While the S&P 500 is on a buy signal, we can see that it is being supported by only four of the nine sectors -- Consumer Discretionary, Consumer Staples, Health Care, and Utilities. Let's look at those charts, remembering that their current buy signals will be closed when the 20-EMA crosses down through the 50-EMA.

Consumer Discretionary is looking a bit shaky, but the rest of the charts show good separation between the 20/50-EMAs.

Bottom Line: We are seeing a gradual breakdown by sector within the S&P 500. While most of the remaining buy signals will have some durability, there are fewer sectors supporting the index than there are pulling it down.

 

POSSIBLE MARKET TOP

A reader recently called me a perma-bull, which is amusing, since by nature I'm usually disposed toward bearishness. I will, however, remain bullish until our mechanical timing model switches from a buy. The model will be bullish until the 20-EMA for the S&P 500 crosses down through the 50-EMA. We can see on the chart below that those moving averages are converging, but there is plenty of room before a crossover will take place.

While the model provides discipline, we are still permitted to look at indicator charts and speculate about the future. For example, on the chart above we can see a rising wedge pattern, which is a bearish pattern that usually resolves to the downside. There is still room and time for prices to bounce around inside the wedge, and the rising trend line is still holding, so this is not strongly conclusive.

Below is a Percent Buy Index (PBI) chart for the broad market. It shows the percentage of buy signals for the 100 Dow Jones market sectors. While it is still at a relatively high reading, there is a negative divergence between the PBI and the price index. This shows that the price advance is being undermined because fewer sectors are participating.

The next chart is the weekly bar chart of the S&P 500 Index. The concern here is that the weekly PMO has topped and is falling below its EMA (green line). There is also a negative divergence between the two PMO tops and the price tops. This is really bearish.

Bottom Line: The S&P 500 has not yet given the fatal sign of breaking down through the rising trend line drawn from the August 2010 low, but there are internal indicators that are giving strong evidence that an important top may have been made on May 2. That is to say that we could have begun a substantial correction, or the bull market may be over.

CITIGROUP 10-FOR-1 REVERSE SPLIT

On Monday, May 9, Citigroup (C) stock will undergo a 10-for-1 reverse split. What this means is that 10 shares of C will be merged into one share, and holders of C will own one-tenth as many shares, but each share will be worth ten times the value of pre-split shares. Most people understand the concept, but many do not realize that a reverse split is essentially a negative event.

Let's take a look at the Citigroup monthly bar chart. Ugh! In about two years it went from an all-time high of 51.54 to what was probably an all-time low of 97 cents. In the two years since the low it has not been able to get above 5.00 except for brief periods.

I don't know the detail on Citigroup per se, but typically reverse splits are done to jigger the price up to a "respectable" level. For example, many investment funds are not permitted to buy stocks that are under a certain price, like 5.00, so after the reverse split C will open on Monday at around 45.00 (10 times Friday's close). All historical data are adjusted as well, so the chart will look just as ugly, only with much more downside potential. (Geeks Note: Whereas pre-split prices are multiplied by 10 for the reverse split, volume is divided by 10 so as to keep the price-volume relationship consistent.)

As a general rule reverse splits are not beneficial to future prices of the stock. Let's face it, Citigroup's chart tells us clearly that, whatever was wrong with the company at the top, is still a problem. Also, a stock trading this close to zero benefits from what I call "ground effect", meaning that the zero line tends to create a support zone several points above it. Reverse splitting the price up from 4.50 to 45.00 removes that support and allows more room (i.e 45 points downward) for the market to discount the stock price in order to reflect how bad off the market thinks the company really is. Yes, the price will be at a level where fund managers will be able to buy it, but will anyone want to?

AGING BULL

It is a rule-of-thumb that the average bull/bear cycle lasts about four years trough to trough -- 2.5 years of bull market followed by 1.5 years of bear market. Like most of these kinds of rules, it is good to keep them in mind, but don't try to set your watch by them. For example, the last bull market lasted five years, and the bear market that preceded it lasted two years. As it so happens, the last bear market lasted almost 18 months, which makes it fit the template almost exactly.

That doesn't mean the current bull market will also come in on the average, but we must take note that it is now two years and two months old, and is becoming vulnerable to the law of averages.

The market is also becoming vulnerable to the next six-month period of unfavorable seasonality, which begins at the end of this month.

Bottom Line: The current bull market is getting a bit long of tooth, and the specter of six months of negative seasonality lies just ahead. This is not a happy coincidence, especially combined with the fact that volume has been weak for many months. Our mechanical timing model has us on a buy signal for now, but I would take it quite seriously if that were to change.

GLOBAL MARKETS ENHANCE PERSPECTIVE

(This is an excerpt from Friday's blog for Decision Point subscribers.)

If nature abhors a vacuum, technicians abhor "V" bottoms. Once prices bounced out of the March lows, the technical expectation was that, after a week or two of rally, prices would turn down again and the March lows would be retested. At this point, those expectations seem to be a fading dream.

Looking at global markets we can see that "V" bottoms abound, and that in some cases the February highs have already been exceeded.

There could be some doubt that the rally can be sustained, and that, perhaps, a double top will form and that there will indeed be a retest, but I seriously doubt that will happen. Recently I conquered my tunnel vision with the S&P 500 Index and looked at global markets. What I discovered was that quite a few do not have "V" bottoms at all. Rather there is a large number of double bottoms (a solid technical bottom formation), which demonstrate broad-based strength in world markets. The graphic below is a bit daubting, but you only need to scan it briefly to see my point.

Bottom Line: Despite the precarious nature of "V" bottoms, the broader picture reveals a preponderance of solid double bottoms, which leads me to believe that the "V" bottoms will lead to higher prices without the benefit of retests.

PREPARING FOR THE "BANG!"

(This is an excerpt from Friday's blog for Decision Point subscribers.)

 My wife is something of an insomniac, so she listens to a lot of nighttime talk shows -- not the best cure for insomnia, I'll bet. Recently she told me about the comments of some guest on some talk show -- sorry, but that's as good as I can do for attribution -- who had an analogy for the U.S. financial woes. He said we are like a person who makes $50,000 a year, spends $75,000 a year, and has $375,000 in credit card debt. Hopeless is what it is.

From Mauldin and Tepper's Endgame: The End of the Debt Supercycle: There is a limit to how much debt you can pile on. As the work of Reinhart and Rogoff points out in This Time It's Different (2009), there is not a fixed [emphasis mine] limit for debt or some certain percentage of GDP where it all breaks down. Rather, the limit is all about confidence. Everything goes along well, and then "bang!" it doesn't.

"Confidence" has always been the keyword in financial markets. We get a daily diet of economic news with a determined spin about how the economy is gradually improving, but in the background the Fed and the politicians keep digging a deeper hole of debt. And the story is the same around the globe -- governments trying to exacerbate the threat of horrible levels of debt by piling on even more debt.

The real question is if the collapse really will be a "bang!" moment, of whether there will be some kind of advance warning upon which we can act. As a technical analyst I believe there will most likely be a gradual deterioration ahead of the "bang!", and we must assume that the deterioration has gone too far when the 20-EMA crosses down through the 50-EMA. To illustrate this point, let's look at two of the most catastrophic financial events in the last 100 years -- the 1929 Crash and the 1987 Crash.

The first chart is of the Dow Industrials in 1929. Note that the 20-EMA crossed down through the 50-EMA about two weeks ahead of the Crash. Some will complain about the two whipsaw signals earlier in the year, but this kind of activity characteristically precedes major tops and part of the cost of doing business if you want to avoid major declines. To mitigate the damage of these whipsaws, our timing model only generates a NEUTRAL signal (instead of a SELL) when the crossovers occur above the 200-EMA.

Next is the 1987 Crash. It is hard to see, but the 20/50-EMA crossover occurred four days ahead of the crash. Again, there was a short whipsaw earlier in the year.

Bottom Line: Catastrophic market events are usually a big surprise to most people, but they rarely take place without giving some advance technical warning signs. The moving average crossover has been a reliable, though by no means perfect, signal for impending trend changes. It is certainly one way we can attempt to be prepared ahead of the "bang!".

DOLLAR INDEX BREAKING DOWN AGAIN

(This is an excerpt from Friday's blog for Decision Point subscribers.)

 The U.S. Dollar Index is in immediate danger again, so lets take a close look at charts from all three time frames, beginning with the daily bar chart. The most important feature on the chart is the bold rising trend line near the bottom. That is a long-term rising trend line that we will see on the longer-term charts. Note that in November the Index bounced off that line only to retest and penetrate it just a month later. The November breakdown was a bear trap, resulting in a strong rally, which ultimately failed.

The decline from the January top has resulted in a test and retest nearly identical to the previous one, and we are left to wonder if this latest breakdown will be another bear trap.

I am assuming that this is more serious than the first. As of 1/20/2011 the US Dollar Index is on a Trend Model SELL signal. And the PMO configuration is less promising than the oversold PMO bottom in October followed by a PMO positive divergence in November.

The weekly chart below shows the entire rising trend line and demonstrates that it is important support. The weekly PMO is negative and falling.

Finally, the broader context of the monthly chart shows that the rising trend line forms the bottom of a reverse pennant formation. A decisive breakdown from that pennant would have serious implications regarding the potential downside.

Bottom Line: The Dollar Index has broken down through important long-term rising trend line support. A similar breakdown in November proved to be a of no consequence, but technical indicators are less favorable this time around, so we should expect the decline to continue longer-term, although, a short-term snapback toward the line would be a normal technical reaction.

 

 

S&P 500 NEW HIGHS

The daily number of New Highs and New Lows (NHNL) refers to stocks reaching their highest or lowest price during the most recent 52-week period. Below is a NHNL chart for the stocks that compose the S&P 500 Index, and we can learn a few things from it.

First, we can see that the main problem is that new highs are contracting as prices move higher. This is a negative divergence and is also almost certain to be a setup for a price decline.

Another feature on this chart is that the new high structure for this bull market is much more massive than at any time during the 2002-2007 bull market. Even though they represent a contraction from earlier new highs, the most recent new high readings are nearly as high as the highest new high readings of the the preceding bull market. This attests to the strength of the market rebound off the bear market lows in 2009.

Note also that the price advance from the 2009 low has taken about half the time as the same amount of price gain took during from the 2002 lows -- we're talking 22 months versus 54 months. Again, this has been a very powerful move.

Another thing I wanted to mention -- something that has nothing to do with the subject of NHNL -- is the Flash Crash Correction. I have named it thus because I believe that its depth and duration were more exaggerated than they would have been were it not for the Flash Crash. In hindsight we can see that this event took place in the middle (so far) of a strong bull market. Notably, there was no significant deterioration before hand that could have given us a credible warning. We are told that it can't happen again. I wonder.

Bottom Line: New highs are presenting a negative divergence, but the level of new highs remains very high, and the strength of the price advance better than normal, in spite of the Flash Crash Correction. Corrections are inevitable, but there is no indication that the next correction will be unusually difficult.

EQUAL-WEIGHT INDEXES STILL LEADING

(This is an excerpt from Monday's blog for Decision Point subscribers.)

 One of the things I constantly flog in this blog is that equal-weight indexes usually perform better than cap-weighted indexes. The reason they perform better is that smaller-cap stocks normally perform better than large-cap stocks, and the smaller-cap stocks carry a heaver weighting in equal-weight indexes, thereby enhancing performance.

Here is an excerpt from yesterday's Decision Point Alert Daily Report. In the bottom section we track 27 indexes, 22 of which are pairs of cap-weight/equal-weight indexes. Note that, with the exception of Materials and Utilities sectors, all sectors and indexes generated buy signals about the same time. Also note that, where paired indexes generated buy signals on the same date, all the equal-weight indexes have out performed their cap-weighted counterparts, except the Nasdaq 100.

The most astonishing difference is in the Health Care sector, where the Health Care Equal-Weight ETF (RYH) has a profit of about double that of the Health Care SPDR (XLV) -- +18.2% versus +9.2%. Here is a chart of RYH with a relative strength comparison to XLV. Since the beginning of the bull market the trend of relative strength has been up, but you can see that the equal-weight index is noticeably weaker during declines.

This next chart is just the flip side, showing XLV with a relative strength comparison to RYH.

Finally, let's have a look at the Rydex S&P Equal-Weight ETF (RSP). It was up about 150% in the 2002-2007 bull market versus only 100% for the SPX. And since the current bull market began, RSP is up about 146% versus only about 86% for the SPX. Pretty amazing.

Bottom Line: In general, equal-weighted ETFs continue to perform better than their cap-weighted counterparts, yet their volume remains relatively low, indicating that investors/traders have never heard of them. "Invent a better mousetrap and the world will beat a path to your door." So far that is not the case with equal-weighted ETFs.