Chart Talk {No Place To Hide In The Majors}

Here's a stock performance graph of the major US market averages since last May.  Notice how all of these have traded in lock-step.  That is when one goes up they all go up and similarly they all go down together.  The only difference is the volatility.  Russell 2000 {light Green} which has many more smaller capitalization names than the S&P 500 {light blue} is much more volatile.  Get used to seeing markets trade just like this, particularly in a world where ETFs and passive strategies rule.

Posting schedule will be Wednesday & Thursday this week.

Chart is from Stockcharts.com.

*Long ETFs related to the S&P 500, Nasdaq in client accounts and Russell 2000 in certain client accounts.  Please note these positions can change at any time without notice. 

Market Scenarios {The Big Picture}

Here's the big picture of the S&P 500 going back to the late 1990's.  The section boxed in in blue is what you see referenced in our scenarios.  

1.  Note that green line that represents the market tops in early 2000's and note that barrier was finally erased in 2013.  

2.  Also note how far we've come off the lows in 2009.  The fact that we're experiencing a period of consolidation is not only normal but is healthy.

3.  Finally we explained back on January 20, 2016, that it seems to us this period of consolidation so far is not too much different than what we experienced in markets during a roughly two year period in 2011 through the market's breakout in 2013.  That period enabled stock fundamentals to catch up to valuations.  Probability suggests that's what we're seeing now.  Note that period is not highlighted on this chart but you can see it by clicking on the link above to our January 20th posting.  

*Long ETFs related to the S&P 500 in client and personal accounts although positions can change at any time.  

Possible Market Scenarios {The Scarier Flop & The Flop}.

Today we'll show our final two chart scenarios.  We'll call these "The Scarier Flop" and "The Flop." These are so named because they describe a choppy directionless market that sort of flops around for the rest of the year.  Both scenarios would more or less get you to the same place by the end of the year or early 1st quarter of 2017.  Both show markets that in essence go no place in 2016.  As before, for the basic parameters on each chart please refer to the first post in this series, numbers 1-5. Also again please note that this is scenario analysis and not a prediction or guarantee that any of these events will occur.  It is possible that more than one of these events could occur or none of them might.  You should consult your own financial advisor or do your own research if you are not a client of our firm.  Better yet you can hire us.  In short if you use anything that you see here or have seen over the last few days without some follow up then you're on your own.   

Now to the charts: 

First "The Scarier Flop".

The "Scarier Flop" is so named because it shows a market breakdown first.  It shows a market that rallies to somewhere close to break-even or perhaps even a slight gain for the year by late spring/early summer.   After a rally from this winter's lows, in this scenario we experience a short period of indecisiveness before the market rolls over again, perhaps sometime in the summer as election jitters start to prevail.  In this scenario we again retests the lows set in the January/February period.  While the chart doesn't show this, there is also the possibility that these lows are violated with a potential bottom made between 1750-1800 on the S&P 500.  In this case however, the market then experiences a furious and sustained rally, perhaps due to better economic news or a perceived better outcome to the elections.  In any event, stocks end the year close to where they began, plus or minus a few percentage points.  

This has a probability of occurring based on our understanding of current events of around 50%.

Now here's "The Flop".

This is the easiest chart to explain.  It's a market that finds some level of support over the coming weeks and basically goes nowhere before rallying, likely sometime after the elections are resolved.  It also ends the year close to where the market began 2016 plus or minus a few percentage points.

This in our view has a probability of occurring based on our understanding of current events of greater than 50%.  Part of the reason we think this has the highest probability of occurring is that this is most likely the direction of the greatest pain for investors.  Let me explain.  

Wall Street in aggregate is very bearish on the market and the economy right now.  That means there's a substantial amount of money that is set up to take advantage of what many perceive is an inevitable market breakdown.  There are so many ways for the fast money/hedge fund crowd to do this that it's impossible in this space for me to explain how this can be done.  Likewise nobody should underestimate how easy it is for bullish sentiment to take over once the market starts to gather some positive momentum.  Therefore, a market that is choppy and essentially goes nowhere is an environment where it is very hard for all but the most nimble of investors to make money.  That in general does not include institutions that run billions of dollars.  It's a market that might make day traders happy but almost nobody else.  That's why I think a directionless market is the pain trade now in 2016.  

In any event I've laid out our different scenarios and will acknowledge that there are perhaps others out there that I might not have thought of.  Now we'll just let our indicators be our guide.

Charts are from TradingView.com.  Annotations are mine.

*Long ETFs related to the S&P 500 in client and personal accounts although positions can change at any time without notice.

Possible Market Scenarios {The Bull}

It's hard to believe that we're even publishing a bullish case for stocks given yesterday's market action, but there is a bullish scenario that can be made.  First for the basic chart parameters, see yesterday's chart right below this one, numbers 1-5.  Also I will again give my disclosure before we continue: 

Please note that this is scenario analysis and not a prediction or guarantee that any of these events will occur.  It is possible that more than one of these events could occur or none of them might.  You should consult your own financial advisor or do your own research if you are not a client of our firm.  Better yet you can hire us.  In short if you use anything that you see here or over the next few days without some follow up then you're on your own.   

Now let's take a look at the chart: 

In this scenario some combination of a better economic environment and more positive investor sentiment leads to a improved corporate earnings.  Aggregate corporate earnings estimates start to improve, perhaps owing to improvements in the oil patch.  When measured against extremely low interest rates, stocks carrying a forward market PE of 15-16 times 2017 earnings suddenly seem cheap.  This scenario would be helped along by a positive business outcome to the US elections and perhaps improving economies overseas.  This set of circumstances would also have the potential to be fueled by all of the cash setting in money market accounts or short-term bond funds earning almost nothing.  After a period of indecisiveness {blue lines on chart}, markets enter into rally mode in the late summer/early autumn period.  

Stocks rally to near or slightly above last year's market's highs around 2110 on the S&P 500 in late 2016-early 2017.  This has a probability of occurring of 20-30% based on our understanding of current events.

Stocks rally to near or slightly above the 2150 level on the S&P 500 in late 2016-early 2017.  This has a probability of occurring of 10-15% based on our understanding of current events.  

Stocks rally to higher than 2200 on the S&P 500 in late 2016-early 2017.  This has a probability of occurring of less than 10% based on our understanding of current events.

Chart is from TradingView.com.  Annotations are mine.

*We are long ETFs related to the S&P 500 and to energy although these positions can change at any time and without notice to readers of this blog.

Possible Market Scenarios {The Bear}

I said last week that we'd look at some different market scenarios for the rest of the year.  We're going to examine the good, the bad and the toss-up scenarios this week.  Today we'll start by examining the bear case.  We'll look at what could go wrong.  We are looking at these mainly by using money flow analysis, trying to show you under each scenario what could happen.  At the end we'll give you the current probability that we see of this analysis occurring.  Please note that this is scenario analysis and not a prediction or guarantee that any of these events will occur.  It is possible that more than one of these events could occur or none of them might.  You should consult your own financial advisor or do your own research if you are not a client of our firm.  Better yet you can hire us.  In short if you use anything that you see here or over the next few days without some follow up then you're on your own.   

Charts are from TradingView.com.  Annotations are mine.

Before we do analysis, I think we should discuss the basic parameters you will see on each chart.

1.  Chart is of the S&P 500. 

2.  Basic chart is a weekly chart going back on the left side to 2013.  This is roughly from the period when the market last broke out from its prior level of consolidation.

3.  Arrows are meant to show basic movement over a certain period of time.  Green indicates bullish periods, blue indicates a period of indecisiveness and red indicates bearish periods.  They are meant to show generalized market activity over a certain period of time.  For the trading levels we show with these are approximate and do not show the normal backing and filling that should be expected on a daily basis.

4.  The large box in the top right hand corner shows on a valuation basis what we estimate could be the potential cone of probability for stocks out to the 2017-2018 period.  This is included solely for illustration purposes and to show what could be the market's potential outlook given what we currently know about the economy, sentiment valuation, etc going forward.  This, again, is here for illustrative purposes only.  These probabilities will most definitely be revised over the next several years.  Again there is no guarantee any of these probabilities will be met during the shown period.

5.  Horizontal lines represent significant levels of support/resistance.  The horizontal green line at the bottom of the chart represents  a significant level of support that dates back to the 2001 and 2007 market highs.  This was the line that was penetrated to the upside back in 2013 when this current rally phase of this bull market started.  The green horizontal line at the top represents the market highs we saw last summer.  The red line is the most current level of major support.  This line has been revisited many times in the past three years, most recently a few weeks ago.  The blue lines are intermediate levels of current resistance.

With that, let's get to the chart:

The bearish illustration for stocks looks something like this above.  After the initial decline we've seen this winter stocks stage a recovery into the spring with the potential to trade up to the resistance line in blue that's a bit over the 2,000 mark on the index.  There they hover in a period of indecisiveness in the early summer months.  A combination of perhaps election jitters, slowing economy or perhaps an event overseas sends markets in the late summer/ autumn period into another bout where risk assets are sold.  At some point in this example stocks penetrate that major support line in red.  That leads to a further sell-off, again perhaps exacerbated by more negative news.  

Where the market finally finds it's footing in this example would likely depend on how negative the news has become.  I have illustrated using three yellow shaded boxes, levels where the markets could possibly in this scenario trade towards.  Each of these boxes indicates areas in prior times where the market has found support or experienced congestion.  These levels that the market could trade towards and the probability of such an event occurring are based on our current understanding of events and are assigned below:

Support in the 1750-1800 level on the S&P 500 would mark a decline of 15-16% from our prior highs. It has a probability of occurring by our estimates of 20% based on our current understanding of events.

Support in the  1630-1680 level on the S&P 500 would mark a decline of 20-23% from our prior highs.  It has a probability of occurring by our estimates of slightly less than 15% based on our current understanding of events.

Support  somewhere around 1520-1575 on the S&P 500 would be a decline of 25-30% from our prior highs.  It has a probability of occurring by our current estimates of less than 10% based on our current understanding of events.  

These probabilities again are based on our current understanding of events.  We could raise or lower these numbers over the course of the year based on changes in the economy and changes in circumstances.  We will keep you apprised of our analysis going forward.

Now that I've given you perhaps a good case of the screams, we'll tomorrow look at a more optimistic scenario.  

*We are long ETFs related to this index although these positions can change at any time and without notice to readers of this blog.

Warren Buffet On Volatility

“The unconventional, but inescapable, conclusion to be drawn from the past fifty years is that it has been far safer to invest in a diversified collection of American businesses than to invest in securities — Treasuries, for example — whose values have been tied to American currency. That was also true in the preceding half-century, a period including the Great Depression and two world wars. Investors should heed this history. To one degree or another it is almost certain to be repeated during the next century.

Stock prices will always be far more volatile than cash-equivalent holdings. Over the long term, however, currency-denominated instruments are riskier investments — far riskier investments — than widely-diversified stock portfolios that are bought over time and that are owned in a manner invoking only token fees and commissions. That lesson has not customarily been taught in business schools, where volatility is almost universally used as a proxy for risk. Though this pedagogic assumption makes for easy teaching, it is dead wrong: Volatility is far from synonymous with risk. Popular formulas that equate the two terms lead students, investors and CEOs astray.”

Berkshire Hathaway Annual Letter, March, 2015.

Chart Talk {02.18.16}

Here's an update of the S&P 500's ETF SPY.  Chart is from FINVIZ.com.  Note the following:

1.  Short-term now the market is overbought.  Market clues on direction will be garnered on how the market handles this overbought condition and that next level of resistance right above where it's currently trading.

2.  Major support is in red now around 182 on the ETF.  That is sort of the market's line in the sand right now.  It represents a level now that the market has revisited 3 times in 6 months.  

3.  Blue lines in the middle of the chart are secondary levels of resistance right now.  They will become support if the market manages to pierce through them to the upside.    As stated above the market is near that next level of resistance, currently around 195 on the ETF.   Probability suggests that the first attempt at this should fail.  In that case clues to future direction will be garnered on how the market handles that rejection.

4.  Green line at the top denotes major resistance as it represents previous market highs that failed to advance.  

5.  Yellow shaded areas represents overhead supply.  This level of trapped longs goes now back to last spring and has the potential to be tough slogging for the index as the market moves closer to those prices and tries to slog its way higher.  Theory states that these levels are full of "trapped longs," investors who bought at higher prices and will be anxious to sell the closer price returns to their cost basis.

We're going to take a look later next week at some future probabilities for the markets in 2016 via charts.  

Back Monday.

*Long ETFs related to the S&P 500 in client and personal accounts, although positions can change at any time without notice.

Thoughts {02.17.16-Austin Addition}

{Looking north at downtown Austin from the shores of Ladybird Johnson Lake.}

Will be back with some more detailed "pensamientos" or thoughts on what's transpired since I lit out for Texas over the President's Day holiday. in the coming days  We left snow and cold Chicago for a part business part vacation trip down to Austin, Texas over the past few days.  Here's a few of my observations about that city:

Of course the market ripped higher while I was gone.  Hard to tell if this is a bottom forming event or a classic rip your face of bear market rally.  In either case I prefer to let asset prices come to me.  We got close to that point last week and there are a few things {mostly dividend paying ETFs} that may still be interesting if we don't move much from here.  My judgement though is that it's better right now to wait for the right price.  I think we'll get that opportunity.  If we don't then I'm content to ride a rally higher with our current allocations.

Texas is different.  For one thing it was once it's own country.  Everything is bigger there including the food.  I think I put on three pounds and that's with walking nearly 25 miles during our visit.  Austin is also full of young people.  There is a huge technology industry presence there and it is attracting young technology minded professionals.  It is growing at something like 150 people a day according to our Uber driver.  That it's growing is evident in its infrastructure.  The highways are overloaded and a mess.  There's also a building boom in the downtown.  A lot of Californians have moved Austin to escape the taxes out west.

I've long said that I believe my children will live in a country where there's been a fusion of Canada, parts of the Caribbean, the US and Mexico.  The fusion with Mexico is evident in Austin.  Spanish is ubiquitous {of course it is also now in Chicago}.  The food is Tex-Mex.  Lots of upscale Tequila and not much wine.  Parts of the Hispanic community is deep rooted in the land the farther south you travel in Texas.  Parts of that community have been there a long time.  There's also a heavily German influence in central Texas due to immigration from central Europe in the mid-1800's.  First time I've ever had BBQ with sausage.  They may not know what a bratwurst is in other parts of the South, but they've had it and made it and eat it in Texas.

Vegetables in Texas are for the most part beans in all varieties on Tex-Mex and salsa.  The food was fantastic, but a lot of it.   If you go to Austin you have to go to the "Broken Spoke".  Don't ask.  Just go.  You'll have a blast.  

Back tomorrow.

Hedge Funds Getting Crushed.

Business Insider.com the other day noted that some well-known hedge funds reported very bad January results.  In particular they listed the following:

-Tiger Global Investments:  -14% in January. +6.8 in 2015{Long/Short Fund.}

-Glenview Capital Partners: -13.65% in 2015.  Down more than 18% in 2015.  {Focus on Healthcare.}

-Marcato International:  -12.10% in January.  Down more than 9% in 2015.  {Activist Hedge Fund.}

-Omega Overseas:  This run by the well-known Leon Cooperman.  -9.93% in January.  -10.43% in 2015.  {Long/Short Equity Fund.}

-Pershing Square International:  Run by Bill Ackman.  -9.3% in January.  -16.5% in 2015.  {Activist fund that makes large concentrated bets on stocks.}

-Third Point Offshore Fund.  Run by Daniel Loeb.  -3.4% in January.  -1.2% in 2015.    {Even-driven value investing Fund.}

These are some of the smartest and best in the business.  If they can't make money than it stands to reason that we've been in one tough market.

Out Monday and Tuesday of next week.  Back posting on Wednesday.

Link.  Business Insider.com:  "Some of the Biggest Hedge Fund Names are Getting Scorched".

Something

I was asked the other day by a client if I thought the stock market was going to crash.  This is what I said about that in my most recent investment letter to clients:

"Investors decided in mid-December that their economic projections were too optimistic.  They went into risk-off mode and have sold every rally since then. But this change in market sentiment shouldn’t be confused with a crash. The financial press needs headlines to grab attention.  The return of market volatility since 2015 is a great way to get those eyeballs back watching CNBC or reading the papers.  I’ll define a market crash, as when an unexpected event catches too many investors on the wrong side of the market.   Something important to note is that you usually need a catalyst for that to occur.  That’s usually an unexpected event washing up over the transom that has everybody looking for an exit all at once. Typically these events also resonate well beyond Wall Street.  In 2008 it was the banks, in 2000-01 it was the events around the terrorist attacks and the bursting of the dot.com bubble. Market sentiment may have changed, but so far we’re seeing a pretty typical correction in stocks, not the sort of far reaching event that historically has led to a catastrophic event for stocks.  That’s not to say that stocks can’t decline further, but again a true financial crash is still by our work a low probability event absent that unexpected catalyst.  Even the flash-crashes we’ve seen in the past few years have had more to do with short term issues that have righted themselves almost right away. "

If you define a "crash" as a 1929, 1987 or October 2009 event then we've clearly not had something like that.  Nor have we had an event like the two flash crashes we saw last year and in 2010.  But with all that said, it's hard not to say we've not had "something".  Call it a nascent bear market or a correction.  You can call it a resetting of expectations or whatever, but markets are down big in the past three months.  The S&P 500 has seen about 14% lopped off its value in the last 10 weeks.  The majority of that loss came in the first two weeks of the year.  Those two weeks wiped out most of the market's gains going back to early 2014 and something like a trillion dollars of net worth.

This of course is what usually happens when markets enter a "risk off" mode.  The old saying "markets take the stairs as they march higher and the rapid descent of the elevator lower" certainly applies to what we've recently seen.  The average decline in a correction is something like 14% so by that moniker we're right on par.  But don't tell me we haven't had "something".  We'll monitor our indicators for clues as to see what that "something" brings next.

What Would I Rather Own?

Here's a few well known stocks {their symbols} and approximate percent they've declined  so far as of Monday in 2016:

Chesapeake Energy {CHK}      -51%
Lincoln Financial {LNC}         -32%
Salesforce.com INc. {CRM}    -31%
ConocoPhillips {COP}             -29%
Amazon.com {AMZN}            -29%
Netflix {NFLX}                        -29%
Citigroup {C}                           -26%
Amgen  {AMGN}                    -10%

There are other stocks that we could add above.  Some are better or worse than this list.  Would I rather own the individual securities or an ETF where each individual stock is aggregated with all the other securities included in the underlying ETF?  Hands down I'll own the ETF.  ETFs are no panacea for a declining market.  The S&P 500 ETF {symbol SPY}, to name just one, is down around 9% so far in 2016.  But at least in the aggregate there is a better likelihood of stabilization at some point and eventually a rally when it is again time for the index to advance.  SPY also pays a dividend that right now is north of 2%.  Not sure I can say with any confidence that a stock  like Chesapeake will eventually come back.  If it does it will likely have a long time of hard slogging.  Even though Chesapeake is likely a component of several different ETFs, its participating size is likely so small as to not seriously impact portfolio construction.      The S&P 500 is a millstone right now in any portfolio.  Chesapeake, even if it is a small percentage in an account is a worse drag on performance.

*Many of these stocks listed above are component parts of ETFs that we own in personal and client accounts.  Long ETFs related to the S&P 500 in client accounts though positions can change at any time.

Interesting Stat.

Federal Reserve Chairwoman Janet Yellen will give congressional testimony tomorrow.  CNBC just reported that it has been 55 days since Yellen last spoke.  In that time {which also included the Federal Reserve's first interest rate hike} the Dow Jones has lost 1,700 points.

Wow!

*Long ETFs related to the Dow Jones Industrial Average in certain client accounts as a legacy position.

Response To A Question

In response to a question yesterday from a reader {and not a client} on whether oil companies should be bought based on the chart I posted on energy just below.

1st. I cannot answer that question for that person.  I don't know his investment structure and his own individual risk/reward criteria.  If he wants that answer he needs to do his own research, talk to his own investment advisor or hire me.  After I understand him a bit then I could give him some advice on energy based on his own needs.  

We do not do recommendations on this blog.  I will point out sometimes interesting patterns.  I will let you know if based on what I am seeing about said subject if I am a buyer or seller in a pertinent period of time around that chart if it is relevant.  Meaning if yesterday I was buying energy when I posted that chart I would have let you know what I was doing. I will also disclose whether I am invested in said category for clients and for my personal accounts.  I will also say that these positions can change at any time.  I will not say for example in a post like we put out yesterday you should buy or sell energy.  Our only goal when writing is to try to educate into our investment thought process for clients and friends of the firm.  

2nd.  In regards to energy, what I tried to express yesterday is that the pattern in oil is interesting now to watch.  I think more than anything we need to see how oil reacts to that downward sloping trendline I talked about yesterday.  Right now money flows don't give us any indication on what probability suggests could occur.  For all I know oil could hit that trendline, even violate it slightly, then continue lower, or it could violate that trendline and power higher, or violating that trendline could just be indicative of the beginning of a bottoming process for oil.  The point is we have to wait and see.

Markets are acting better this AM.  Whether this is a bounce off a low and the beginnings of stabilization or another dead cat bounce that will ultimately lead to a resumption of the down trend is again something that we'll have to wait and see.

*Long ETFs related to energy in both client and personal accounts although positions can change at any time.

Chart Talk {Oil}

Long term weekly chart of Brent oil.  I find it interesting that even with all the negative news we've heard around oil recently is that crude has rallied since mid-January.  Not saying that's going to continue but if oil could stabilize then probability suggests that stocks could move higher even if only for a contra-trend rally.  First clues on whether this could be the beginning of a better environment for oil will be to see how it reacts to this bearish downward sloping trend line.  

Chart is from Tradingview.com.

*Long ETFs related to energy in client and personal accounts although positions can change at any time.

Estimate Ranges 2016-2017.

{From our most recent investment letter to clients.}

"The S&P 500, a broad measure of the US stock market, currently trades at 15 times forward earnings assumptions. Stocks have historically traded in a price to earnings valuation range between 14-16 times their forward estimated earnings.  In regards to the current economic environment, we think that investors need to accept that a higher level of higher level of volatility may be here to stay.  We are using an initial estimated earnings range on the S&P 500 for 2016 of $121-124 with a mid-point of $122.75 for this year.  Our current 2016 price cone of probability is 1,700 to 2,150 on the S&P 500.  That is appreciation potential from current price levels of roughly 10-14% when accounting for dividends.  We introduce a preliminary estimate of 2017 earnings ranging between $125.50-130 for the S&P 500.  Please note that there is no guarantee that any of these estimates will be met.  The Cone of Probability is our current assessment of the price range within which we think stocks have the potential to trade during a described period, in this case calendar year 2016.  It is a probabilistic assessment based on many inputs.  Some of these are: earnings estimates, and whether those estimates are rising or falling, dividend yield, earnings yield and the current yield on the US 10 year treasury.   It is not a valuation model as we use this solely for analytical purposes.  It will fluctuate with market conditions and changes to the data inputs.  Index prices can and have traded in the past outside of its range."

Back Monday with some more charts.

*Long ETFs related to the S&P 500 in client and personal account.  Please note these positions can change at any time.