Sunday, August 29, 2010

Market Wrap Up/Weekly Preview

Today I decided to put down in writing the culmination of the weekly information inputs I use to try and judge what is going on, and how to try to profit from it. I have to say this experience was similar to writing out formal trade ideas for the blog in that not only was it a good learning experience, but I also enjoyed it. I typically kind of make mental notes of things during the week and once the markets are closed over the weekend I am able to piece things together and then look for opportunities accordingly. I like the written document and will experiment with it going forward. I want a full disclaimer in that most of what is below is not original content and not intended to be so, but rather its my way of aggregating much of the data/info I come across during the week in an attempt to make some useful sense of it.

Weekly Wrap-Up Report
Week ending 8/27/10

Indexes: DOW finished down for a third straight week, a Friday rally left it above the psychologically important 10,000 level, but certainly not looking like its in a position of strength. It has some downside to about 9760 before it would test its support line. SPX bounced convincingly off its support once again at 1040. As you would expect this also correlated with a pull back in VIX and sell off in bonds. It’s yet to be seen if this is just a technical bounce, small relief rally, or confirmation that we’re still range bound.

Technicals: see charts above.

Volatility: Remains range bound from 22-28, with a strong move towards its lower range as the markets rallied on Friday. A break below 20 and I would be looking to either get long VOL or perhaps just sell OTM puts betting against continued complacency.

Correlations: During times of crisis or just short-term spikes in volatility we often see stock correlation heading towards 1.0. However, short-term spikes aside, correlations look to be in a long-term uptrending channel starting sometime in the mid 90’s. Historically when this indicator is below 50% you’ve got a better market to pick individual stocks. Conventional wisdom suggests this increasing correlation is primarily due to culprits such as the prevalence of ETFs (which tends to make large basket of stocks all move in one direction), and lower commissions/easy/quick access to market liquidation. The important point to me is that individual stock picking is becoming tougher, meaning that market timing becomes all the more important. Buy and hold seems to be dead and trading ranges seems to be in if you’re looking for profits. While the recent decline in the number of hedge funds can partially be blamed on deleveraging and the financial crisis, I can also make an argument that increasing high correlation makes their traditional model of heavy research and precise stock picking a bit outdated.

Sentiment: See below

Equities: In addition to favorable technicals for short-term bullishness, the percentage of stocks above their 50DMA is at the lower end of its range for the last 12 months, and sentiment is near the March 09 market lows. These are all indicators that I would be short-term bullish. 

Bonds: The yield curve has been slowly flattening during the time the general equities market have remained range bound. The prevailing theory is that there will be little growth and possibly even deflation, thus even these historically small yields could potentially be a great overall return should we face deflation. Friday saw a large one-day widening of yield curves, which his highly correlated to the one-day bullish reversal we saw in equities. The two and 10-year yields recently hit all time lows, surpassing the 08/09 financial crisis when people flocked so heavily to treasuries. In a relatively stable period of volatility, bond yields are either an opportunity or great cause for concern.

Commodities/Currencies: I do not have enough experience in these areas to incorporate anything in to this report. This is an area I need and plan to educate myself further in as I am starting to understand their overall importance due to market interconnectedness. However, the chart below shows that even a basket of commodities as an asset class is also trading in high correlations lately. This is not consistent with historical norms.

Macro News: GDP revised down from 2.4% to 1.6%, but better than the expected 1.3%. This is kind of in line with what equities seem to be signaling, which is that things are bad, but maybe not horrible. The question remains unanswered as to how much of this recent growth is synthetic via stimulus or authentic via natural demand.

Fed: Stands ready to accommodate further in a yet unspecified manner. Regardless of your political stance on this happening, this could be viewed as bullish since equities stand to gain from more interference. This could also be viewed as bearish since its obvious that the economy seems in need of some help. Rates to stay at 0% indefinitely.

Politics: Part of this range bound market might be due to investors waiting to see the outcome of November midterm elections. A Republican victory in the House or Senate would most likely lead to the extension of the Bush tax cuts on dividends and capital gains. This would most likely be bullish for stocks. If the Democrats hold both houses of Congress this would most likely be bearish for stocks as the street seems to think Obama is not business friendly and would not feel compelled to extend the Bush tax cuts.

M&A Activity: Whether it’s the HP/Intel bidding war or the 30% bid up on Potash, it looks like cash rich balance sheets are trying to find growth externally since internal demand growth prospects are very suspect. The key to both these deals is the street seems to think that both are priced too high, with the only winners being the people who own stock of the companies being acquired. If we start to see more of this activity, then we’ll know corporate America genuinely does not see authentic demand in the near future. Taken in context of this week alone there is nothing to glean here. 

Market Preview for Week 8/30/10 – 9/3/10

Looking to see if bullish engulfing candle that materialized last Friday on most indexes receives confirmation. The market has seen nothing but terrible news with the only bright spots being that initial unemployment claims were not as bad as feared but still not good either, GDP revised downward but again not as bad as feared, and getting a bounce at a technical level. My point is that there is more than ample news for the market to sell off but it has yet to do so, and it’s still within the last five month trading range of SPX 1040-1130. The risk/reward at the moment favors getting a bit bullish for the short-term. I have already sold OTM puts on selected names and I would look to sell OTM call spreads should this bounce take us towards the trading range highs. I look to remain largely in cash while taking selective shots where I see opportunity, while waiting for a more definitive time to increase my exposure in either direction.

1 comment:

  1. I think this is a great idea. I know the daily email sizing up the market has really helped me, and is really a launching pad the feeds or will feed into my trading/hedging decisions. Over the next few weeks I am going to make my own market sentiment indicator file.