S&P 500 (SPY @ 183.65) is looking less bearish but has yet to take out its recent highs

Friday 14 February 2014 2:00 p.m. New York time
The S&P 500 has done far better than I expected a few days ago, recovering all the ground it lost since its breakdown at 180.93 (on the SPY) and then some.  I covered my short position at 179.98 (the trailing 10-day high) 4 trading days ago for a small profit.  We now remain flat - in the gray area between a covered short and a new long position, which would not be declared until the 20-day high is exceeded (currently 184.77).  The 5.7% rally from 173.71 is more impressive than I expected, but the market will do what it will do, not what you want or expect it to.  It is more important to adapt to the unfolding situation than to dig your heels into an entrenched position.
A few caveats remain:
  - volume on up days continues to be less than on down days, and to be declining, indicating a market that is attracting fewer convicted buyers;
  - the average gain after the blast off from the 173.71 area has been progressively less;
  - the market is approaching resistance at the old highs around 184.94 and is currently in congestion - an old brief trading range between 181.34 and 184.94.


Consolidation and a pause or pull-back are more likely at this point than a continued parabolic ascent, but stay tuned. 

China, by the way, is pausing after gapping across a downtrend line.  We shall see if it can break out, but the chart does not look convincingly bullish.  A continuation in the downtrend would shift the focus in the United States from relief over the Congressional debt ceiling authorization to continued worries about a slow down in the world's 2nd largest economy.

S&P 500 (SPY @ 175.38) continues to look extremely bearish

Feb 5, 2014 SPY @ 175.38 before the market open:  the market's high-volume 2% sell-off on Monday confirms that this decline is not over and likely will continue for some time.   Click on either of the charts below for more details.

  

China (FXI @ 34.14) continues to be the center of this storm.  If Chinese stocks continue to sell off and worries about Chinese growth and even stability rise, then it will be very hard for the United States stock market to rally. 

 

S&P 500 (SPY @ 178.89) looking extremely bearish

1/24/13  The S&P 500 (SPY @ 178.89) is looking extremely vulnerable to a sharp sell-off for several technical and fundamental reasons.  The technical reasons are most obvious:

   - two gap down days with the last day representing a 2% drop;
   - violation of and close solidly below the trailing 20-day low;
   - very heavy volume on down days;
   - close at low of 2% drop;
   - only 3% off high after very extended (19.8% since July lows) advance;
   - solid violation of breakout point at A that was almost a mirror image of the most recent sell-off, meaning all the price action from mid-December to the present could be viewed as a bull trap (a failed breakout); 
   - "2b" top (minor) in place when prices took out the 184.69 recent high but collapsed back at 184.94.


  - violation of a 5-week flag formation above the breakout point at A, and more recently a violation of a higher, tighter 5-day flag formation.

   - implied volatility (VIX) surging off of an extremely low level (low levels of implied volatility are loosely correlated with bull markets (and complacency); higher levels are associated with choppy or falling markets; surges in VIX occur when prices plunge.

Note that the sharp rise in the S&P 500 in the past year is not bearish per se since the market tends to perform better when it has risen or fallen sharply over the past year and most market gains followed modest gains and losses.






Extending the lookback period to 3 years also does not raise alarm bells per se.   The S&P 500 rose 47% over the past 3 years, putting it in the top quartile of trailing 3-year returns since 1948, but the average subsequent 12-month change in the S&P 500 didn't turn dismal until the 90th percentile of 3 year S&P 500 changes (58.3% and above).

	n:	Past 3 year S&P 500 change from:	… to:	Next year's S&P 500 change:
Min-10%	7	-40.1%	-13.95%	17.47%
10-25%	9	-14.0%	6.82%	4.69%
25-50%	15	6.8%	27.55%	9.86%
50-75%	16	27.6%	44.03%	6.79%
75-90%	9	44.0%	58.34%	8.35%

Fundamental reasons, although less reliable in my book, are  overall bearish.
  China, the world's second-largest economy, is showing signs of stalling and even of a credit crunch of sorts.
  Europe, a United States major trading partner, is still mired in extremely weak growth with high, persistent unemployment.
  Major problems seem about to implode the economy of Turkey.
  Interest rates in the United States have risen sharply.  The yield on the 10 year Treasury note has doubled from 1.394% in July, 2012, to 2.735% currently (although the yield topped 3% in December, 2013).  The year-over-year change in the 10 year yield is 37%, putting it in the top decile (which ranges from 22% to 76%).   When the annual percent change in the 10 year yield has been 22% or higher, the market has only gained .1% per month on average (1.2% annualized).  For comparison, the median percent change in yield (ratio minus one, not difference) since 1953 has been 1.44%, and the market only rose on average the next month following months in which the yield change was at that level or below.  The stock market tends to be very inversely sensitive to changes in interest rates, doing poorly when rates are rising and making most of its outsized gains when rates are falling.  

	n:	10 year Treasury yield 12 month change from:	… to:	Next month's average S&P 500 change:	Annualized:
Min-10%	72	-48.2%	-20.78%	1.71%	22.6%
10-25%	107	-20.8%	-11.58%	0.60%	7.4%
25-50%	179	-11.6%	1.44%	1.04%	13.2%
50-75%	179	1.4%	11.36%	0.51%	6.3%
75-90%	107	11.4%	22.19%	0.10%	1.3%
90-Max	71	22.2%	76.28%	0.10%	1.2%

  Of course, these are general trends with notable exceptions, such as 2013, when the S&P 500 surged despite surging interest rates.  Nevertheless, rising rates create a serious headwind going forward and eventually they tend to be discounted.   As the yield on the 10 year Treasury approaches that of the earnings yield (1 over the PE), investors at the margin will prefer Treasuries to stocks, putting pressure on stock prices.  In fact, whenever the earnings yield exceeds the 10 year Treasury yield by 4.2% or more, the market returns a whopping 33.9% annualized on average since 1953.   Currently the earnings yield is 2.5% greater than the 10 year yield, putting it in the 75th to 90th percentile. 

Why stops matter : FXI and Apple

Two recent trades that illustrate the absolute, table-pounding necessity of sell stops.

First China (FXI):

I went long @ 38 in December when the 20-day high gave a buy signal.  I then rode it out, moving the 10-day low up in lockstep with the price until my stop was hit just below 41 in late January for a nice, easy lay-up.   When FXI rallied for the next few days, it would have been easy to have regrets or think the stop was too tight, but when it failed to take out its prior high, that was a sign the stop did exactly what it was supposed to:  it didn't get out at the very top (no one can do that and in my opinion, no one should try), but it forced me to take profits and limit risk.
Today, China gapped down, its fourth down day in a row after making a 2b top (failing to take out the past top actually).  The stop did what it had to do.

Apple offered quite a bit of excitement over the past several months on both the long and short sides. I was not trying to catch every wiggle and squiggle, only take advantage of a few high probability moves.

I bought in August even though Apple was making a new high (no stock is ever too high to buy or too low to sell), then the trailing 10-day got me out in September, locking in a tidy little profit.   To be honest, I regret not having then followed through and shorted Apple but I let the fundamental story distract me from the reality unfolding on the chart in front of me.  However wonderful the company, however reasonable its valuation and high its hoard of cash, someone was selling Apple in an orderly way.  An ideal trade would have shorted Apple from the sell signal at 640 to the trailing 10-day buy stop above 560 a month later but I left that money on the table.  Nevertheless, you should never assume any move is over - once the trend has changed, look for an opportunity to reenter, as I did even though prices were substantially lower when I did.  The gap to below 460 was a sign that prices should subsequently fall lower - substantially lower before recovering, but it is dangerous to take a position right after a gap down.  Better let prices settle down a bit, as they did.  After two days of weak reaction to the sell off that didn't even take Apple to the lower edge of the gap, I went short (bought puts - I highly recommend options rather than shorting the stock outright because with options your risk is limited to the price of the put and if your time horizon is short, you won't lose a lot of money in time premium wasting away).   Three days later I had almost a 50% profit in the option position and Apple was approaching possible support, so I pulled the trigger and got out.   It's rallied a bit higher since then to above where I bought the put but I will wait before re-entering.  The point is that paying attention to stops (and also to support offered by trailing 10 or 20-day lows) can serve you very well.