Easter (bull)market technical update 2015

ES downside targets

ES downside targets

On the back of a lower than expected NFP, the futures market stumbled a bit on Friday, closing near support. Should support break (around 2031 for ES), then we could get a measured move from the triangle top to about 1954 ES, which also happens to be very strong support from December. I do not believe that we will take out this level without hesitation, so if we get there, this would be an excellent entry point.

We also have strong Fib confluence at around 1997, which would be setting up an excellent bear trap, since it would also have broken support and yet still not fulfill the expectation of a measured move. I think this would also represent a decent entry point for a short term trade.

Small caps outperformance

Small caps outperformance

Recently there was a lot of fuzz about the outperformance of Small Caps (Russel 2000) as is shown in the picture above. Indeed, we can see a nice base that had formed in the relative performance chart and the move still hasn’t met the minimum target, so small caps should continue to outperform.

Mid caps outperformance

Mid caps outperformance

Personally I prefer mid caps. They have shown a more consistent outperformance over long periods of time and have also entered an uptrend, albeit a stronger one, on their relative performance chart.

Interestingly, the strongest bull market of the 1990’s has seen under-performance of small caps and mid caps, but for now mid caps are a good place to be.

Risk correcting

Risk correcting

Risk (Stocks vs Bonds) seems to be correcting sideways, in a well-defined downwards channel. The whole picture is still bullish, looking like a back-test of the 2013 breakout region.

Technology still strong

Technology still strong

Technology is still out-performing the broad market, although the relative chart is getting more tired. It has the looks of a 5th wave, which could conclude later this year or next.

Semiconductors still strong

Semiconductors still strong

Semiconductors, a popular canary due to their strong cyclical nature their position very early in the supply chain, still obey their strong up-trend (relative performance charts can look sloppy). The current pattern is strongly reminiscent of a continuation head and shoulders. Generally I wouldn’t put too much emphasis on the pattern, but combined with the strong uptrend I see no reason to worry yet.

Junk trying to shine?

Junk trying to shine?

Junk (high yield bonds) appear to be back-testing their steep channel break-out on the relative chart (junk vs treasuries).

Oil bottom?

Oil bottom?

After putting in a lower low, Oil got back into its old trading range. This is a very bullish action and could foreshadow a reversal. The news are still very negative, but the chart speaks another tune.

USD/CAD top?

USD/CAD top?

The Canadian dollar also seems to have found a bottom (USD/CAD top). During the past years it has shown very strong correlation to Oil, which makes sense since a strong dollar impacts Oil price and since Canada exports Oil.

Considering the strong contango in the Oil market (extremely high carry cost due to expensive storage), I prefer shorting USD/CAD over a long oil trade. The recent chop has been a godsend, as it allowed me to open and close positions frequently, which will allow me to take a bigger hit should the pair keep rising in a final wave 5.

Conclusion:

The stock market could correct more during the next week or two, but several strong support levels below should arrest this decline, until a steeper correction can be expected.

The US Dollar correction has given commodities and commodity producers some breathing room. Lets see if they can capitalize on this opportunity, or if the dollar will continue its meteoric rise soon.

PBR – waxed Brazilian Oil

PBR accumulation pattern

PBR accumulation pattern (click to enlarge)

PBR has seen an epic destruction of shareholder value during the last few years. Many bounces failed and hopes have been destroyed. The most recent down-leg (top chart) has the markings of a wash-out move. Climactic volume, fast price destruction.

Yet the daily chart (next two) clearly shows a re-accumulation pattern with two successful tests of the low. Both tests set up springs and even the most recent negative candle shows some amount (not much) of buying coming in again.

PBR could be setting up a good risk / reward trade. Clearly the pattern must hold, but we must also give it some wiggle room, as it has the tendency for springs (final undershooting). Nonetheless, the measured move for the initial upside is already holding a nearly 50% upside potential, and if this move manages to break the downtrend, much more could be in store.

Please remember to trade at your own risk. I am not a fan of investing in company stocks due to the larger probability of outsized risks. You need to judge yourself if this is worthwhile your time and money.

Look up – Technical update 2015-02-08

S&P500 E-Mini

S&P500 E-Mini

The technical picture of the market has significantly improved this past week. the S&P 500 is testing the top of the range again and has thus far failed to sell off. The very small reaction we saw to the downside is easily part of the absorption pattern of a renewed push up. Monday should tell us if we are going to move through or if we need a bit more time. I do however expect the market to be successful in pushing to new highs.

Mid Cap E-Mini

Mid Cap E-Mini

Part of that optimism is the Mid Cap performance. Mid Caps were able to made a new high last week, indicating a good breath (wide participation) of this push up.

MDY vs SPY breakout

MDY vs SPY breakout

Mid caps have also broken their under-performance down-trend, as can be seen in the relative ratio above. This seems to indicate that further out-performance of mid caps is likely.

Ratio of mid caps to large caps (red curve)

Ratio of mid caps to large caps (red curve)

Curiously, the very long term out-performance trend (red curve) during the secular bear market that started in 2000 shows that mid caps were a very good vehicle for investors, but often overlooked.

Junk bonds

Junk bonds

Junk bonds also broke their down-trend, probably owing to the recovery in the oil sector. Overall this also seems to indicate a new risk-on period ahead.

Defensive vs. Cyclical ETF

Defensive vs. Cyclical ETF

Defensive themes have broken their relative out-performance trend and are now back-testing the recent lows. This weakness also speaks for risk-on.

Bonds

Bonds

Bonds have finally begun to sell off, as I had suspected earlier.

Oil

Oil

And one last chart shows how crude had a very strong run up after setting up a spring (false break down) and how it broke and back-tested the down-trend line, which is also very constructive for the sector.

 

Bond blowoff and market stress

I don’t have the time for a lengthy expose today, but last weeks long analysis on the bond market is still relevant today. There I mentioned that the bonds are getting quite frothy and that yields could still undershoot a bit in a ending diagonal. We have indeed undercut and made new all-time lows, which has led to massive sentiment spikes in the bond markets.

30y yield ending diagonal wave

30y yield ending diagonal wave

In this chart you can see the underthrow in yields. The move is looking quite tired and I would at least expect a reversal back above the TL, from which a much larger reversal could develop.

classic bond contract

classic bond contract

Bond contracts have overshot to the upside, while wave volume is diminishing. The steepening angle of ascend is looking a lot like a blow off top in the making. However, the decline in the Euro and the extreme low yield in German Bunds must make the treasuries look pretty attractive to European investors still. The markets seem to have priced in a sovereign debt purchase by the ECB. Watch out for an unwind if the ECB disappoints.

Bond Market Sentiment

Bond Market Sentiment

Here is a chart I found in my twitter stream. Unfortunately I forgot the contributor, please let me know so I can give attribution.

We can see that bond sentiment is quite extreme already.

Defensive vs cyclical sectors

Defensive vs cyclical sectors

Defensive sectors are out-performing at quite a steep angle. I would expect a pause soon, which could give the broader market some breathing room.

E-Mini

E-Mini S&P500

E-mini futures look ready for a short term reversal to the upside. Overall the picture isn’t great though and the bounce might be short lived, unless we take out the early January lower high.

XLE weekly chart

XLE weekly chart

XLE has seen quite a bit of distribution recently (volume on weekly chart). Breaking the long term trend is structurally bearish, but a bounce back should be expected.

XLE daily chart

XLE daily chart

The declining wave volume on the daily chart leads me to believe that a bounce will not take long to develop.

Bail Bonds? – TA update for 01/10/2015

The US bond market appears once more at a critical juncture. This week I will look at bond price action, spreads and some ratio charts to see what we can glean from the data. This will also have implications on the stock market.

Bond price action

Lets examine price action first. Below is a daily chart of the traditional bond contract (ZB) with an elliott wave count applied. Although this is the most liquid and most widely analyzed of contracts, it is not the best in terms of price action due to the definition (15-25 years), which results in a sliding of the cheapest to deliver contract and a steep jump in duration when we roll to June contract.

It is beyond the scope of this article to explain, but we will look at other contracts below as well.

ZB daily chart

ZB daily chart

On the relatively short duration we are looking here, the distortions aren’t as radical. Furthermore, I am using prices that are adjusted for roll. I can clearly count 5 waves up of the lows in 2013. However, even though the wave count is complete and even displays a nice fibonacci relationship within it, we are still not seeing the ultimate confirmation of a reversal. The overlap within the structure looks like an ending diagonal.

UB daily chart

UB daily chart

Looking at the UB chart (Ultra Bond = 25-30y), we can see the same structure (please excuse the mis-placed 1 near the top). If it wasn’t for the bullish candle on Friday, I would consider it complete, but this final wave can always extend further.

ZN daily chart

ZN daily chart

The 10 year contract (ZN) still hasn’t made a new high, which is the primary reason to be cautious on the 30 year contract 5 wave structure. However, this looks like it represents a significant flattening of the yield curve, which isn’t a good omen for the stock markets. Lets examine the yield curve next.

Yield spreads

30y - 10y spread

30y – 10y spread

The 30y – 10y spread has seen a significant correction. The falling wedge broke down, which is quite bearish for the spread. Furthermore, the topping formation, the support from the 2008 low in the spread and the long term spread channel all meet at about 0.3%-0.35%, which means that the spread between 10y and 30y yields might see this range eventually.

30y - 5y spread

30y – 5y spread

When we examine the 30y – 5y spread however, we can see that we have already reached the equivalent target. Obviously we see some kind of disconnect between short term yields (suszeptible to expectations of tightening) and long term yields (driven by market fundamentals).

Meeting the target in the 30-5 spread could bring about a retracement of the spreads. This could easily be accomplished by a sell-off in the longer duration bonds, so lets look at the yields themselves.

Yields

Yields have been on a 30 year long slide, and despite the many calls for a sharp reversal, we haven’t seen it yet. The 10 year yield sits below 2%, which many economists feel is extremely cheap and only can go up.

To put this in perspective however, the German Bund (10y) yield is currently 0.5% and the JGB (Japanese Bond) yield is currently 0.28%. So we should keep an open mind about the extremes.

30y yields, weekly chart

30y yields, weekly chart – bullish triple bottom or bearish descending triangle

The 30 year yield looks to these eyes like a descending triangle, which has bearish implications. However, the projected target is very low and the energy indicators seem to indicate that this current down move is nearing an exhaustion period.

The opposite theory (bullish triple bottom) is also supported by the pattern in the 10y yields (not shown) that could resemble an inverted head and shoulders pattern (also bullish).

30y yields, monthly chart

30y yields, monthly chart

The stock market (and in extension most tradable markets) is a tool to transfer money from the many to the few. This means we should also consider the greatest pain outcome. I thus believe that the greatest pain will be caused by a new low that is quickly reversed to set up a spring in yields.

This is consistent with the exhaustion in energy (see fractal energy indicator on chart) and with my overall expectation.

Carry trade in bonds

One of the most fascinating ideas and the root cause for the sometimes bullish positioning of many bond traders is the carry trade. Bonds pay interest and with the cheap borrowing rates of today, it has been a windfall for banks (and in extension bond traders) to borrow cheaply on a short term basis and invest that money in longer duration instruments while pocketing the difference.

As individual traders we can easily participate by buying and holding bond futures contracts, which have the borrowing built-in (through cheap futures margin).

Since the yields are currently near their lows again in the 30y contract, we can generate a good visual representation of the carry trade. Using the continuous bond contract and adjusting for roll, we can compare the difference in price between the two instances in time, which will exactly equate to the profit from the carry trade (in other words, how much we made investing in 3% instrument while borrowing at 0.25%).

Ultra Bond carry trade visualization

Ultrabond carry trade visualization

I am using the Ultrabond contract due to the oddities with the traditional contract I mentioned above (which would result in overly optimistic results).

In the nearly 2.5 years since the 2012 low in yields, we would have made $5.5k per Ultrabond contract. Not too shabby, considering we bought the exact low in yields. However, the drawdown that we had to sustain was about $37.6k/contract.

Therein lies the danger in the carry trade at the current low yield. Even though we might still go lower and bonds might still not be done rising, a sharp reversal in yields will again result in a significant drawdown. And even though the carry trade will over time make up for that again, the carry trade can only compensate for a very modest rise in yields.

The risk/reward in the bond trade doesn’t look nearly as compelling this year as it did at the beginning of last year, even if the Fed will not tighten. Even though I do not personally believe in a quick reversal of the 30 year bond bubble (but rather a process), I would prefer to wait for a better entry than this.

Some ratio charts

SPY vs TLT

SPY vs TLT

Looking at the ratio between SPY (proxy for S&P500) and TLT (proxy for the traditional bond contract), we have broken the uptrend in 2014, which is a clear warning sign for the market in general. We can also see that for 2014 bonds did in fact outperform the stock market and that doesn’t even include the total return for both, which will tilt the scale even further in favor of bonds.

SPY vs EDV

SPY vs EDV

When we compare SPY to EDV (proxy for the ultra bond), we can see a similar pattern, except that we already fell through support. Patternwise the outperformance of the bond funds looks corrective, which could be a wave 4 correction. This would work well with the expectation of a rise in yields in the intermediate term. In the short term however, we could see still a final hurrah in the bonds and an undershoot of these patterns.

Rate sensitive markets

XLU vs SPY

XLU vs SPY

Utilities have broken their under-performance trend. We are making higher highs and higher lows. Utilities are a defensive market play, so this divergence might be a bit troublesome for the markets. We should keep an eye on it.

It also means that Utilities traders are still not expecting an impending tightening cycle.

VNQ vs SPY

VNQ vs SPY

REITs are on a tear. We are very stretched to the upside, but REIT traders also seem quite content about low rates for longer.

Conclusion

Bonds are quite expensive. The risk reward ratio of a long term position in bonds is not given, but this could change quickly should bonds sell off. Meanwhile we can still see an overshooting in bonds (undershooting in yields).

Immediate rewards

In last weeks review, I speculated that 1970 (ES futures) / 1980 (SPX) could arrest the decline. As we got closer, I sent out an alert (http://stks.co/c1N54) and a bullish chart on the day before the reversal (http://stks.co/p1A9X).

Despite my bullish message, I was completely surprised to see that we made a new high within only 3 days. Clearly these markets behave abnormal, conditioning investors to expect impossible recoveries. The last two cases clearly exceeded the norm here.

ES future daily chart

ES future daily chart

The bullish message is still intact, and the seasonal tailwinds could keep this rally going a little longer, but we can see that we are now struggling a bit and may thus need to pull back a little bit first.

ES future hourly chart

ES future hourly chart

The hourly chart shows that we peaked the previous high twice and failed twice. Each high exceeding the previous high, possibly running stops of early bears, before reversing. Although expect a pull-back that should exceed 2050 (to set up another bear trap and take out stops?) before advancing further, the markets are seemingly getting less stable. I would still expect the SPX to make a dash for 2100 though.

Crude futures

Crude futures

Crude futures have broken the down trend (http://stks.co/p1BEf), but curiously stopped at what could become a triangle wave 4 consolidation before we get a final leg down.

Bond futures

Bond futures

Bonds also saw a quick reversal, but the lack of volume and the pattern makes me suspicious. I bought some after ES had retraced nearly to the highs and may lock in my profit.

This will be all for today, since I am taking the weekend off to spend with my family.

Oil sentiment

Here is a quick look at Sentiment in the Oil sector.

Oil futures 12/14

Oil futures 12/14

Oil is starting down again, probably based on the remarks out of UAE about $40 oil. I think this is overblown. In fact, sentiment in Oil suggests that we have already seen the washout move and that we may begin stabilizing sooner than I thought, maybe in line with my high target of $55 from this weekend post.

The DTL still hasn’t been broken, so lets look at sentiment.

Brent Oil Overconfidence Index

Brent Oil Overconfidence Index

Here are three charts from Sentix. The overconfidence index suggests that traders are already positioned one-sided and that we could soon see a short squeeze (overconfidence at or below -7 and at or above 7 is extreme territory).

Oil time differential index

Oil time differential index

The time differential index shows that the longer term bias is far more constructive than the short term worries, which is also supportive of a potential reversal.

Oil Strategic Bias

Oil Strategic Bias

The strategic bias in Oil shows a nice positive divergence into the lows, showing that traders are starting to see this decline as an opportunity. Institutional investors are leading private investors in this indicator.

XLE vs SPY

XLE vs SPY

The underperformance of the energy sector is looking exhaustive here too, although there is little in terms of support for the relative chart.

Oil sector vs Oil commodity

Oil sector vs Oil commodity

The Oil sector (XLE) relative chart to the commodity (USO) looks exhaustive as well, suggesting that a reversal in Oil might eventually outperform the reversal in the energy sector. On the other hand, this also shows that the equities have held up well in the face of the oil decline, as this will indeed present a good opportunity for patient investors.