We Shall See

"A string of Europe's largest firms issued surprisingly upbeat profit reports on Thursday, bolstering an abrupt renewal of investor confidence in the region after months of debt turmoil and fears for the euro."
Reuters, July 28, 2010

The two charts to your left illustrate the 350 largest companies in Europe (IEV). The first chart shows the long-term Mega Trend over the past 5 years, while the second chart shows the past twelve months.

The first chart shows that once the Mega Trend (the interplay between price, 50 day, and 200 day moving averages) is set it tends to remain intact for as long as several years and as short as many months. You can see in the second chart more clearly how the Mega Trend went bearish in mid May. However, the recent summer bounce has lifted the price above both its moving averages and, in the process, turned the 50 day upward toward the 200 day while also enabling the 200 day to stop its descent and go flat.

It is possible (but I would argue unlikely) that the good news noted by the Reuters quote will result in a whipsaw of the mid May bearish signal. Possible is just probable with a very low percentage of occurring. We shall see.

Investment Strategy Implications

Much of the technical analysis reasons for the cautiously bullish view that I have expressed these past few months (between 60% and 90% in equities) is rooted in a deterioration of the longer-term trends, specifically the confirmed bearish Mega Trend calls of the past few months (e.g. IEV) and the standing at the precipice to join the bearish parade by nearly every other index tracked.

Should the fundamental picture improve and the economic deceleration in developed economies turn out to NOT dissolve into a recession and economic conditions in the Eurozone turn out to be not all that bad, we should see continually improving technical analysis readings that reverse the bearish signals generated since mid May. Until that occurs, the advisable investment posture of cautiously bullish will produce stock market gains but lose alpha.

Some may disagree but there are times (this being one of them) when making money on the upside courtesy a perceived counter trend rally but losing relative performance (alpha) due to a less than 100% equity exposure is an acceptable price to pay pending the resolution of the multi month unresolved trading range of stocks.

Short-term Indicator Crossover. Mini Pullback in Stocks Likely.

The short-term indicator tracked (Slow Stochastics) has crossed over in overbought territory signaling a high probability of a pullback in stocks. Since the near-term indicators (Momentum and MACD) are flashing only a half warning sign at this time (see yesterday's blog posting), the odds are that the likely pullback will be modest (see accompanying chart for examples of the four prior pullbacks over the past 3 months).

Should this occur, the pullback will almost certainly be followed by another run to higher current rally highs (above Tuesday's 1115 closing high in the S&P 500). It is during this run that two factors should be watched closely:

1 - Will the near-term indicators (Momentum and MACD) BOTH fail to confirm the higher highs with higher highs of their own (thereby signifying a deceleration in the strength of the move)?
2 - Will other indices (such as EAFA (EFA) or emerging markets (EEM)) fail to confirm and not make higher highs?

If both the internal metrics of an index tracked (in this case, the Momentum and MACD of the S&P 500) AND the external metrics tracked (index to index, e.g. SPX versus EFA and/or EEM) produce divergence signals from the S&P 500, then the odds increase significantly that (a) a decline will occur subsequently and (b) it will be more substantial than the mini pullback the current rally is at risk for.

2 Down, 1 To Go

2 down:

Momentum diverging from price
Slow Stochastics (short term indicator) overbought

1 to go:

MACD still bullish, confirming price

If the first two hold when MACD rolls over, the summer bounce is likely over.*

*For a full bearish call, external divergences (inter market) must be in place as well. At present, unlike the internal divergences noted above there are no meaningful inter market (index to index) divergences. This has been a source of market strength for the summer bounce, surprising many (present company excluded). It is when both internal and external divergences develop that trend reversals have the highest probability of occurring.

Note: click image to enlarge.

Beyond the Sound Bite: An Interview with Diane Swonk

My interview with the Chief Economist with Mesirow Financial and author of "The Passionate Economist: Finding the Power and Humanity Behind the Numbers" includes the austerity versus stimulus debate, the multi-speed global economy, deflation, advisable government policy, and the risks of developed economies deceleration.

The length of the interview is 15 minutes 32 seconds.

Beyond the Sound Bite podcast interviews can be found at the Blue Marble Research media blog. To listen to this interview, click here.

Who Knows?

“Doubt is not a pleasant condition, but certainty is an absurd one”
Voltaire

You got to love those who state with certainty that stocks have made their lows and a resumption of the bull rally is underway. God may favor the bold, but fools do rush in where angels fear to tread.

Who knows if various stock market indices, which have produced a wonderful bounce from the lower end of their trading ranges, will broaden out and help numerous other indices reverse their bearish Mega Trend (“death cross”) signals? Who knows if the US economy has evolved into a private sector driven sustainable path of growth and, thereby, avoid an economic backward slide into hell?

In the macro economic realm, certitude is shared by those who declare that the global economy is fine, that the US economy is fine, that GDP and other key US economic indicators (e.g. unemployment) will be fine (see the accompanying table* from the Fed). Yet, for all the certitude that may be uttered, just about every reliable measure of the stock market and the economy shouts, “Who knows?

What Is Known

Thus far, the macro economic reports and forward earnings guidance from company’s reporting their 2Q10 results paint a fairly clear picture of a US economy that is decelerating**. Since mid May, the majority of US macro economic indicators have been coming in steadily below consensus expectations. Thus far, the magnitude of the shortfalls have been, for the most part, moderate. Whether this remains the case remains to be seen. However, if there is one thing that is a characteristic of our globalized networked economy and markets it's that seemingly small things can become very large in a very short period of time. In bad times, correlations tend to go to 1 rather quickly.

Importantly, an economic deceleration does not necessarily mean a recession will follow. It may simply be the natural process in the transition from the early strength of an economic recovery to the more moderate growth rate in an economic expansion. At least, this is the argument heard from traditional economists, who assume away the unusual circumstances that preceded the current recovery/expansion and apply their well-educated tried and true methodologies that kind of, sort of, worked okay in the past – a past, I might note, that was quite different from the present.

As for stocks, this much is known: The global stock indices have been locked in a multi month trading range that will be resolved with either an upside or downside breakout. An upside break signals the trading range was a consolidation – the bull has been refreshed and ready to run again. Whereas, a downside break signals the trading range was a distributional top and everyone should get out of the pool. Death crosses will abound.

Harmony

It isn’t often that the real economy and the financial economy mirror one another so neatly. In the US economy, the deceleration is quite evident. Both the forward guidance from corporate America and macro economic reports published since mid May point to an economy that is still expanding but at a slower pace. Most areas of the global economy are decelerating that will either become the pause that refreshes or the prelude to a recession that will almost be far more difficult to manage than the cutsey phrase “double dip” suggests. The outcome – continued expansion or recession – remains to be determined.

As for the stock market, we have a trading range whose outcome suggest a bearish outcome but cannot be stated with certainty until such time of a clear breakout signal. Hence, the appropriately cautiously bullish posture expressed previously.

Human nature may prefer those who state they know with certainty to those who say, “Who knows?” However, in highly fluid situations in the social sciences of economics and markets, certainty may be a most expensive attribute.

*click image to enlarge

**This is also the case in other developed economies – Eurozone, Japan – and, from a different perspective, the high growth rates in emerging economies that are being pressed by their respective governments to cool their overheated economies.

Beyond the Sound Bite: An Interview with David Rosenberg

Exactly how bearish is David Rosenberg? The answer may surprise you.

Beyond the Sound Bite podcast interviews can be found at BeyondTheSoundBite.blogspot.com
To listen to this interview, click here

Vinny on Yahoo Finance's "Tech Ticker"

All three Tech Ticker interview segments are posted and can be found at BeyondTheSoundBite.blogspot.com

Beyond the Sound Bite: An Interview Rob Nichols

Continuing our focus on the likely impacts of financial regulatory reform on the financial services industry and the overall economy, we get the perspective from the President and COO of the Financial Services Forum.

While not as well known as some other associations, the Financial Services Forum is "a non-partisan financial and economic policy organization comprising the CEOs of 19 of the largest and most diversified financial services institutions doing business in the United States". Need I say more?

Those interested in hearing the views of this important group from its leader will find this a most productive use of one's time.

Beyond the Sound Bite podcast interviews can be found at BeyondTheSoundBite.blogspot.com
To listen to this interview, click here

Beyond the Sound Bite: An Interview with Todd Groome

In this twilight period before earnings season gets into full swing and the all-important third quarter macro economic reports provide the vital insights into the strength of the US economic recovery, we arranged for a series of podcast interviews with key leaders in various segments of the financial services industry to give their initial thoughts and opinions on the financial regulatory reform bill working its way through Congress.

My first guest is Todd Groome, Chairman, Alternative Investment Management Association. In this interview, we learn how hedge funds, private equity, and other alternative investment organizations might perceive the prospective changes.

Beyond the Sound Bite podcast interviews can be found at BeyondTheSoundBite.blogspot.com
To listen to this interview, click here

Death Cross: Fact and Fiction

Much is being made of the "Death Cross", when an index's 50 day moving average crosses below its 200 day moving average. Those making the most noise on this topic use the simple moving average (e.g. 50 days divided evenly) as opposed to the exponential (e.g. 50 days weighted more toward the most recent days). Therefore, it is worth taking a moment to observe the two versions and how one (the simple) tends to produce false signals than the other (the exponential).

In the recent 2002 to 2008 bull market in stocks, the accompanying top two charts* illustrate how the simple version (on the right) can produce false signals (2, to be exact), whereas the exponential (on the left) did not.

In the current market decline, the simple (on the right) will almost certainly generate a "Death Cross" whereas the exponential (on the left) may or may not.

Not The Only Tool In the Toolbox

It is also important to remember that the moving averages are one of several very useful technical analysis tools that should be relied on, particularly when attempting to forecast major market turns. Since we currently have other important indicators, such as non confirmation divergences (see previous post below) from other indices, it is premature to call the end of the current bull market solely based on one indicator.

(For the record, I use the exponential. Also for the record, I do believe the odds favor a bear market will eventually emerge. However, until I get signals from all indicators followed I cannot make that call. This may cause me to be late to the bear game. However, I would rather be late to a game changer than premature and get whipsawed. Moreover, the prospect of a bounce back rally this summer and how to play it (to gain absolute and relative performance) is enhanced.)

*click images to enlarge