Weekly Notes & Research, June 22nd

What a difference the Fed can make! The FOMC meeting on Wednesday turned the markets around and dropped below support by the close on Thursday. Of course that wasn’t enough we had quadruple expiration on Friday to create even more fun. I should have gone on vacation this week ! The update this week will focus on the damage done and what the outlook is going forward.

We started the week looking for a trading range to develop as investors worked through the multiple issues facing the economy, earnings and the global markets. That worked right up until Mr. Bernanke could not explain what he meant by cutting stimulus. How much? When it would start? etc. Details, details, details… who needs them? Evidently investors would have liked a few more than the received and that led to selling.

Interest rates continue to be a challenge for the broad markets as they have pushed higher throughout the week. This problem will need confidence in the Fed before we see the upside slow. At some point the Fed will have to build a bridge of confidence between the fear that is disrupting investors belief versus reality. That may take some time more than more explanation from Mr. Bernanke.

The result is volatility has returned to the markets and it is not being received well. This is evidence to the fact that investors hate uncertainty, and that is what the Fed has created short term. The swings sent some running for the exits, Friday held above the 1570 support. Plenty of talk already about being oversold and that may lead to a bounce for a few days, but the downside is in play for now.

More changes for the website implemented! Two weeks ago we started the new weekly notes and research! That is this page which used to be update nightly, but we made the change to make the updates focused on trading plan for the week. Why? The goal is to make the research simple to use and easy to follow. Over the weekend you will be able to review the written update and video relative to the coming week. Daily you can review the trading notes in the morning for specific actions and ideas. Nightly watch the video update to gain insight into the actions taken and explanations of each posted opportunity on the Watch list or Notes. The models will be updated each morning in conjunction with the Trading Notes for ease of following. I am looking forward to the new format as it will focus more on specific ideas and opportunities! Any feedback is always appreciated.

Sector Moves of Note:

  1. The Bank ETF (KBE) and Regional Bank ETF (KRE), both sub-sectors of the financials have held up well in the two days of selling. Both charts have formed a consolidation wedge and offer an opportunity for the upside to continue. Both pay a dividend near the 2% level, but have avoided the path of other interest sensitive assets. Why? If rates rise and banks can produce profits from loans versus the free money from the Fed, maybe they grow versus cut costs to keep earnings in line with expectations. How it will play out is another issue altogether, but this a opportunity to watch going forward. For those willing to accept the risk and manage the positions long term the large bank stocks offer a positive growth picture going forward. Citigroup, JP Morgan Chase, Wells Fargo, and US Bancorp are examples of large bank stocks to consider. On the regional bank side PNC Financial, M&T Bank, Keycorp, and Regions Financials are worth tracking. Scanning these sectors will turn up more prospects to own as this unfolds.
  2. Volatility (VIX) spiked on the selling this week and remains elevated. If the index moves below the 18 mark look for a short term rally or bounce in stocks. SVXY would be a upside play relative to the index.
  3. Interest rates have continued to spike higher (see bonds below) and that may well present some opportunities if and when they calm or peak short term. XLU – Utilities has taken the brunt of the impact from higher rates. The sector was down more than 10% from the highs. IYT – REITs are equally lower and looking for support. HYG, TLT, IEF, LQD, ITB and FRA are other components hit by the push higher in rates. They are all worth putting on a watch list for opportunities as the bottoms are established.
  4. The S&P 500 index broke support at 1597, broke the trendline from the November low and broke below the 50 DMA. Pretty convincing move on the downside as a result. How the index shapes up for next week is the key. Recapturing the 1597 level would be a positive push. However, the downside risk remains in play. A bounce is likely to be only that a bounce and then resume selling with a target of 1540 near term. Patience is the key for this to unfold.
  5. The commodities are all over. The lack of a trend in the sector makes it a dangerous place to play. Natural gas (UNG) moved back towards the $21.15 break level on the upside, but retreated and sold lower into the close on Friday. Watch $19.90 support to hold. Crude oil retreated to support at the $93.20 level and held on Friday. I don’t like the play other than a potential trade or bounce on the upside back towards the $96 level. DBA and DBB both are broken and nothing worth watching other than a short play. With the current dynamics in play this is not a sector to own currently.
  6. The global markets are being challenged by the comments from both Japan and the US on stimulus. The downside risk of the global markets is in play with short plays in China and Emerging Markets currently. Looking at Europe and others if this momentum continues. China’s economic picture continues to erode and the downside risk in the country remain high.
  7. The dollar has moved higher on the Fed announcement. This was expected, but not much worth playing on the dollar short term. The short yen play has worked nicely so far and we will continue to track the risk of these trades going forwared.
  8. Don’t assume anything at this point. If the buyers are willing to step in to start the week let it settle and determine if they have staying power or if it is just a trade. The uncertainty is in play and we have to be cautious and wait for the right opportunities to develop.

Economic Data & Outlook:

The big shock of the week came from the Empire State Index which rose to 7.8 versus -1.4 and beat forecasts of 0.9. The Philly Fed Index likewise rose to 12.5 from -5.2 showing marked improvement.  Inflation was up to 0.2% in May showing some signs of concerns. Housing numbers were weaker than expected on both starts and permits. That prompted plenty of comments about the hike in interest rates slowing buyers. Too soon for the rate issue to hit the numbers, but that is a concern looking forward. Jobless claims were higher again for the second week in a row. It is a result of those who fell out of the workforce coming back and looking for jobs again? Could be and it is a data point being closely watched. Overall the data was positive relative to the economy, but didn’t support the Bernanke comments and thus the reaction from investors towards stocks.

There will be plenty of data to digest this week and if if misses the mark it will have an additional negative impact on the markets. New home sales on Tuesday will offer more insight in the housing sector. The calendar link below will take you to the data expectations for next week.

Economic Events & Calendar

1) US Equities:

The break of support puts the downside in control short term. The pivot point is the May 21st high and the break below  1608 which was the previous test on Thursday put the current trend in play on the downside. Technically 1597 support was broken along with the 50 day moving average and the November trendline was broken. All negative and showing a trend shift in the index. The downside leadership is Utilities and Telecom. As you can see on the chart the other eight sectors all followed the index which is a sign of how quickly the drop took place on Wednesday and Thursday.

Friday’s activity showed six sectors still closing in the red. Technology and Basic Materials were the two worst performing sectors. Tech was hurt by Oracle’s miss on earnings and materials were hurt by the decline in commodity prices. The four positive sectors were those hit the hardest by the interest rates worries. Healthcare, Consumer Staples, Utilities and Telecom all ended on a positive note. The downtrend is in play, but I think you will see the buyers make an attempt to push the index higher off the current lows. No definitive direction, but the downside trend is in play and the buyers will have to negate that before I would be willing to go against the trend relative to trading. The longer term trends are still in play on the upside with this being defined as a pullback within the trend. Don’t confuse the two when managing your portfolio.

May 21st Pivot Point:

10 Sectors

Sector Rotation of Interest:

Downside Rotation: The downside acceleration on the week only added to the moves lower in Utilities (XLU), Consumer Staples (XLP), Healthcare (XLV),  Real Estate REITs (IYR) and Telecom (IYZ) since the May 21st high. They are on my list of opportunities if a bounce on the upside gains any momentum.

Consumer Discretionary (XLY), Energy (XLE) and Basic Materials (XLB) joined the downside rotation as well with the volatility equal to the index. Not as interested in a bounce play with these sectors near term.

Healthcare (XLV), Consumer Staples (XLP), Financials (XLF), Industrials (XLI) and Technology (XLK) had been moving sideways will no real signs of leadership since the May 21st timeline.  And they have now joined the downside movement with the broad index.

Sideways Trend: There are some signs in Healthcare (XLV) and Consumer Discretionary of attempting to hold the sideways trading range, but they have some upside work to do if that is going to be true short term.

Upside Rotation: The is not upside movement at this point, but if we get a bounce off the current low watch for the leadership to come from those holding up the best (XLV, XLY) and the those with the biggest downside moves (XLU, XLK, IYZ). The latter being only a trade opportunity on the bounce.

2) Currency:

From the May 17th high (pivot point) we have seen the dollar gradually decline. Thanks to the FOMC meeting on Wednesday the dollar has regained the upside rotation and other currencies have moved lower. The question mark is will it last or is this just a reaction to the news. For now we  will approach it is a reaction to the news. As you can see below we sold our short dollar play and added the short yen and short euro plays. Be cautious as the emotions are high currently.

10 currency

Sector Watch:

  • UUP – Move back above the $22.20 mark was the entry point for the dollar. We didn’t add any positions as to the risk level of the trade. If the dollar tests $22.38 resistance and moves higher it would be an opportunity to add to the position short term with a target of $22.65.
  • EUO – The short euro trade entry was $18.80. Again we passed on the entry here, but looking at adding on a confirmation move above the $19 level or a test of the $18.80 mark that holds and continues higher. Plenty of downside worries about European markets currently in play.
  • YCS – The short yen play off the reversal at $59.75 was the entry which we did post and add to the ONLY ETF Model. A move above the $62.45 would be a point to add to the position.

3)  Tracking Bond Sectors of Interest:

Sector Summary:

The bond market overall is experiencing a sell off that is a direct result of the yields rising quickly. The rise has fear pushing investors to sell bonds in anticipation of even higher rates due to the Federal Reserve uncertainty on quantitative easing. The fact that Mr. Bernanke failed to clarify the outlook for rates and stimulus, the market is deciding for him where yields should be without the Federal Reserve artificially keeping them low. You know the level will be overshot on the upside initially and then settle into a reasonable zone for yields. During this process the selling will continue until which time it is deemed to be a fair value investment for bonds.

  • 30 Year Yield = 3.56% – up 28 basis points for week  —  TLT = $114.40 down $6 (5.2%) for week.
  • 10 Year Yield = 2.51% –  up 40 basis point for week  — IEF = $105.52 down $ $3.49 (3.3%) for week.

Treasury Bonds – The yield on the 10 year bond is up 80 basis points over the last six weeks. At what point do these bonds become a buy? If you believe the economy is not strong enough for the Fed to withdraw the stimulus in place, bonds will snap back 4-8% offering a great opportunity. However, if you believe the Fed will let rates rise as they cut stimulus, the downside may continue to be your play. I believe the opportunity lies somewhere in the middle. The Fed is likely to cut stimulus at least 20% or so initially to curb the amount of buying by the Fed. That means they are still buying and the bond will have to price that in or adjust relative to the levels of the cuts obtained by the Fed. Either way there is an opportunity in bonds short term on the bounce off the lows.

Still own TBT and TBF short term.

Jim’s Notes Article on Bond Yields rising.

High Yield Bonds – HYG = 6.5% yield. Still looking for the low and the bounce play opportunity.

Corporate Bonds – LQD = 3.8% yield. No positions currently. More selling last week is getting attractive for the bounce.

Municipal Bonds – MUB = 2.8% tax-free yield. No positions currently. Watch for the lows to be obtained.

Convertible Bonds – CWB = 3.6% yield. Still in selling mode. Watch for the bottom;

4) Commodities – Sector Summary:

  • Commodity Index (DBC) – Friday broke below the bottom of the trading range. The outlook for commodities remains suspect at best. Not interested currently unless things improve fundamentally and technically. Short plays are working.
  • Natural Gas – (UNG) Pushed back to the 21.15 resistance point and reversed lower. Testing the $19.85 support levels again. If the move breaks lower the short trade is the back on (KOLD).
  • Crude Oil – (OIL)  We warned about the speculation in the price of crude, raised our stops and were taken out of the position, not on the speculation, but the Fed! OIL is testing support at the $21.50 level and could set up for a short term trade on the upside. Watching to see how it plays out. The downside would set up with a break below the $21.30 level.
  • Gasoline – (UGA) Taken out of the trade with the Fed worries. Now trading at the bottom end of the range and could bounce back. Too much risk for my taste at this point and I will pass for now.
  • Gold – (GLD) Resolved the trading range issue with a 6% decline on Thursday. Many are calling for the metal to decline even further? Watch to see how it handles this move and then decide, but the downside is firmly in play.
  • Palladium – (PALL) – The position imploded on itself on the week heading down to $64.80 support. Down 7.2% for the week. Could be a bounce play in the metal, but the risk is too high at this point.

Commodities Rotation Chart:

Still moving sideways without any real leadership up or down. No interest in the asset class at this point.

10 Commodities

DBC – PowerShares Commodity Index ETF (click to view) Composite of 14 commodities tracking index.

5) Global Markets: 

Global markets shifted to the downside faster than the US. The May 21st pivot point lower has been more dramatic than the US markets, but the pivot correlates to the struggles facing the US markets relative to interest rates and the Fed.

The Asian connection is hurting the overall index.  Japan (EWJ) has become volatile as a result of stimulus worries with the Bank of Japan as well. I still like the upside opportunity in the country, but you have to be willing to live with the volatility.  China (FXI) has struggled on the downside (down 14.6% since 5/21) with slowing economic growth that has disrupted investors. Europe (IEV) moved lower on concerns in Europe from China and the US markets.  We have been short China and the Emerging Markets, but we are watching closely as they are oversold. Looking to take half off and tighten the stop on the balance at this point.

The chart below shows the downtrend over the last week.

10 Country

EFA – iShares EAFE Index ETF (click to view) 10 Developed Countries making up Europe (66.6%), Australia (8.9%) and Far East (24.5%). (Weighting of fund) Not most balanced, but give indication of global markets.

Country Watch:

  • FXP– Short play on China as the downside has been the leader. Sector Rotation Model.
  • EEV – Short emerging markets play has done well and we need to monitor our stops closely.
  • EWJ – Still looking for an upside move from the country. Watch for bounce play to follow through as this unfolds.
  • EPV – Short Europe is posted as possible downside play to the ONLY ETF Watch List.

6) Real Estate (REITS):

Real Estate Index (REITS) – The sector broke down and is still looking for a bottom. Friday offered a small bounce, but we have seen this before. Watch and be patient before adding any positions in the sector. The short trade has done well with SRS. I would pare back on the holding as a bounce could set up short term. The interest rate rise issue is playing havoc on the sector.

Sector Summary:

  • IYR – Looking for support and a reversal move back above the $64.80 level.
  • RWO – SPDR Global Real Estate ETF – Looks just like IYR currently on the chart. $41.80 reversal is of interest.
  • MDIV – First Trust Multi- Asset Income ETF is a good alternative to picking through all the choices of income funds. This multi-assets income fund pays a 5% dividend. Downside looking for support, be patient and let it find the bottom first.

7) Global Fixed Income:

Sector Summary: Downtrend in play and uninterested in the sector currently.  We will continue to watch for the next opportunity, but for now no positions.

  • Watching these funds for a bottom.
  • PAFCX – Spike to the downside.
  • PICB – 3.1% dividend. No reason to own currently.
  • EMB – 4.3% dividend yield. No reason to own currently.
  • PCY – current dividend yield is 4.8%. No reason to own currently.

Watch and play according to your risk tolerance on any position taken. Everyone has different trading styles and you have to find what works for you and your personality. Don’t put yourself in positions you don’t understand or take risk you can’t tolerate. Not every trade results in a profit, but controlling your risk will limit the downside losses.