SPX – 1097.91
DJIA – 10,092
October 20, 2009
“It’s the little details that are vital. Little things make the big things happen.”
-John Wooden
Technical Dichotomy
Trend indicators remain positive. Price momentum and robust breadth suggest higher prices lie ahead, but net volume warns this rally could mark the final run to a tradable top. There’s a dichotomy in the stock market’s technical dynamics.
The Market Trend Indicator (MTI) is signaling Uptrend as each key index continues remains above its respective 18% weekly exponential average. The 18% average is 1038.05 for the S&P 500 (SPX) this week and 9586 for the DJIA. The New York Advance/Decline (A/D) line is 8,866 net advances above its 18% average.
The A/D line represents the degree of participation by all stocks on the NYSE, generally referred to as “market breadth.” The A/D line has a long history, generally leading the SPX at tops but lagging at bottoms. The lead time varies considerably. When the A/D line is stronger than the SPX, one can expect good market conditions to continue. The current strength (nearly back to its all-time high) increases that likelihood (but doesn’t insure) that the next intermediate-term downtrend is followed by higher prices next year.
I’ve always tracked the A/D line without adjusting for the number of issues traded, a process which gives it an upward bias. Of course my time horizons in using it in the MTI are much shorter. An 18% weekly exponential average is roughly the equivalent of a slightly-weighed 10-week moving average.
Despite new recovery highs by the SPX, net volume is not in synch with the rally. Specifically, NYSE net volume overbalanced with a (56.8) peak reading following the rally into the September 23 high (1080.15); its peak reading on the rally since is only +47.5.
NASDAQ net volume hasn’t overbalanced yet but its +42.5 peak on the last rally hasn’t overcome a (43.4) hurdle rate. Perhaps the Apple results could have a positive impact today; you’ve got to be impressed with a company whose sales increase 25% (more than 3 million computers, 7.4 million iPhones and 10.2 million iPods) in a consumer-challenged economy.
Net Volume Explained
Net volume helps resolve which way the market is likely to go; it is one of my most important technical tools. It acts as a forecasting barometer, important for its bearing on the future, but not necessarily immediate price changes.
Let’s keep it simple. There is a buyer and seller on every trade. If more buyers than sellers show up at any point, prices rise. If sellers out number buyers, prices fall. Economics 101 – demand and supply. Technical analysis attempts to read the battle between these two forces.
Price is charted vertically on most charts. Volume is typically shown in bars along the bottom of the chart time below price. I always had trouble “reading” bar-type volume charts, so I started experimenting in the mid-1980’s.
Advancing volume is the volume of all stocks that advanced for the day and declining volume is all the volume on stocks that close each day. To determine net volume, I subtract declining volume from advancing volume and divide by total volume.
The result is a percentage that falls in either positive or negative territory. For example, if advancing volume was 780 million shares and declining volume was 525 million shares and total volume was 1.4 billion shares (including the volume for unchanged issues), net volume for the day would be +18.2. If declining volume were greater than advancing volume, the result would be a negative percentage.
The idea to chart net volume horizontally came from George Seamans, a technical analyst in the 1930’s and 1040’s who charted total volume horizontally, a technique later popularized by Richard Arms and known as Equivolume in charting programs today. These are interesting charts in their own right. For example, if volume increases at the top of a rally with no improvement in price, the “distribution” is more apparent than with bar-type volume charts.
I experimented with various moving averages to smooth out the daily volatility, settling on three days as the best balance between smoothing results and identifying change early in the cycle. Whether positive or negative, the percentage change in net volume, when charted, moves horizontally to the right. Green represents positive net volume (more buyers than sellers) and red represents negative net volume (more sellers than buyers).
Net volume shows whether buyers or sellers are winning the battle. Over time I learned that net volume holds the key to the intermediate-term trend lasting weeks to months. Specifically, as long as the net volume on each short-term rally stays above the net volume on each short-term decline, the uptrend remains intact. In a typical rally, net volume peaks early or in the middle of a move. The uptrend remains intact as long as net volume on the rallies exceeds net volume on the declines. Markets sometimes bottom on a peak reading but I’ve never seen a top on peak readings.
Just the opposite is true on a decline when sellers (supply) overpower buyers (demand). Net volume is not a tool to pin point tops and bottoms but rather confirms a reversal early in the move. For example, once the net volume on a short-term rally exceeds the net volume of the preceding short-term decline (not the peak, just the preceding decline), the trend change is confirmed. The net volume signal typically precedes 3-day swing charts (pattern) and moving averages that I use to confirm the change in trend.
A Look at Groups
As for groups, an article in last Friday’s New York Times, The Tech Sector Trumpets Signs of a Real Rebound, highlighted economist Ed Yardini who said, “This will be a technology-led recovery, and the recovery we’re seeing from technology companies suggests the recovery has legs.”
From the “that’s what makes markets file,” Doug Kass’s interpretation was more skeptical, “IBM was bad, AMD was bad, Accenture was weak, Nokia was terrible and Acer delivered weak four-quarter guidance. Intel benefited from inventory restocking, but investors are seeing through that extra ordering. Google was great, though.” The breakouts for IBM, Intel and Advanced Micro Devices didn’t hold but Accenture’s did and Google continued to rally. IBM, Intel and Advanced Micro Devices reversed and didn’t hold their breakouts, Accenture held its breakout and Google continued to rally while Nokia was unable to rally to new recovery highs.
Groups and broader sectors that led the advance to new highs (a sign of strength and speculators want to stick with strength) included Oil, Oil Services, Natural Gas, Energy and commodities in general plus Broker-Dealers, Software, Internet, Networking, Technology, Pharmaceuticals and Retail.
More defensive groups such as Consumer Staples, Food & Beverage, Defense and Gold also led the advance to new recovery high; I think their inclusion of these groups indicates a shift to a more defensive posture at the margin by large institutional investors,
Groups that didn’t follow the rally to new highs (a non-confirmation that indicates weakness) included Airlines (despite being in the top ten group relative strength list), Housing, Basic Industry, Real Estate, Utilities, Biotechnology, Healthcare Insurers (on the opposite side of the coin from drug companies on the impact of government-sponsored healthcare).
Key Markets
In other markets, the long-term government bond market looks vulnerable and using TLT as a proxy, was weak enough to initiate a short position when it traded below 94.60. My recommended stop sell point is above the October 8 high of 99.76. I plan to add to the short position on if and as TLT trades below its September 9 low of 93.52. The easiest way to be short this market is to go long TBF (ProShares Short Barclay’s 20-year+ Treasury ETF) or for double leverage, TBT (ProShares UltraShort Barclay’s 20-year+ Treasuries).
Fundamentally, time is closing in on a Fed exit strategy from its Treasury and mortgage-back bond buying program. I don’t picture a smooth exit amid a pork-barrel laden and “tax-credit in every pot” mentality in Congress, but pressure builds with what appears to be an V-shaped recovery. Beyond the initial bounce, my bias leans towards a cycle shaped like a square root sign because less bad is the “new normal” and that’s a euphemism for hard times.
Dealogic figures that most of the $2.3 trillion raised in debt offerings this year went towards balance sheet repair, hoarding or acquisitions, but it won’t do much to stimulate the economy.
There’s a general flight from currencies and the dollar is the weakest of the lot. Dead cat bounces aside, the U.S. Dollar index has yet to show it can reverse despite an overwhelming bearish consensus. It would take a trade above 77.47 from here to indicate to me that an intermediate-term swing is underway.
As for gold, it’s been a bull market since July 1999 ($252 an ounce, 2nd London fix) and the gold market, is in the psychological phase where gold fever and public participation (already feeling their oats) could take over, much like Internet in mid-1999 and housing in 2005. For speculators, I recommend keeping trailing stops loose for now (just beneath the August 17 low, $932.75 2nd fix) to accommodate any possible correction. The plan would be to tighten up trailing stops if the rally accelerates.
Major U.S. banks and brokers will pay workers about $140 billion in 2009, up from $117 billion in 2008 and above the record peak of $130 billion in 2007. “I determined that if you want to make money on Wall Street, you work there, you don’t invest there.” said Leon Cooperman in a Barron’s interview in July 2008. “They just pay themselves too well. I would rather look elsewhere for investment opportunities.”
“Bid ‘Em Up Bruce” Wasserstein’s career highlights the issue. His 2008 pay package, $20.4 million and mostly in restricted stock, exceeded the combined pay of the next four officers at Lazard. His early death triggered the vesting of his stock options valued around $188 million. Forbes magazine estimated his wealth at $2.2 billion, self-made from a career at First Boston, Wasserstein Perella (sold to Dresdner Bank in 2000 for $1.4 billion) and Lazard. He understood the key to rainmaking was all about ego, golden parachutes and fees.
In a story involving fewer dollars, I was surprised at how little Business Week sold for, even in an Internet-driven new media world. Terms were undisclosed for what Bloomberg paid McGraw-Hill for Business Week but it was understood to be about $5 million plus the assumption of liabilities, which stood at $31.9 million in April.
John Wooden turned 99 last week. I became a fan after I moved to San Diego in 1969 (UCLA games were rebroadcast late at night). “The main ingredient of stardom,” said coach Wooden, “is the rest of the team.”
He talked little about winning but stressed giving your best each day. During a 27 year tenure at UCLA, coach Wooden won 664 games including 19 conference championships, 10 NCAA titles, a 149-2 record at Pauly Pavilion and four undefeated seasons (statistics courtesy of the Los Angeles Times).
I watched a team led by Sidney Wickes, Curtis Rowe and Steve Patterson win the national title in 1970-71 and 1971-72 seasons. Freshmen didn’t play on the varsity on those days but you knew great basketball was on its way when 1970-71 champions were defeated by the UCLA freshman team with Bill Walton, Keith Wilkes and Dave Meyer. The Walton-led teams put together an 88 game win streak.
Conclusion:
The public appears to be tip toeing back into stocks above Dow 10,000 as prices climb the proverbial “wall of worry.” Tactics and discipline are particularly important. There’s no change in my recommend stop sell level under the SPX’s 3-day swing low of 1019.75 on October 2. The equivalent figure for the Nasdaq 100 (NDX) is just below 1656.57, up from 1585.56 previously.
I wouldn’t initiate short positions until the trend turns down. When that occurs, I prefer ETFs tied to small cap indices (going after strength after the top) and cyclical issues in weak stock groups
For investors, it’s time to plan ahead as to what percentage of assets to hold in stocks once longer-term technical tools indicate that the cyclical bull market has run its course. From an old fashioned, long-term “buying a business” approach, it’s virtually impossible for me to find good businesses with a favorable valuation underpinning.
The information contained herein is based on sources that William Gibson deems to be reliable but is neither all-inclusive nor guaranteed for accuracy by Mr. Gibson and may be incomplete or condensed. The information and its opinions are subject to change without notice and are for general information only. Past performance is not a guide or guarantee of future performance. The information contained in this report may not be published, broadcast, rewritten or otherwise distributed without consent from William Gibson.
