Monday, October 22, 2012

Bearish tripwires

As the stock markets weakened on Friday, the SPX closed just under its 50-day moving average, an important level of technical support.


The weakness was confirmed by the Dow Jones Industrials Average:


Is it time to sell everything and turn more cautious?


What the bears need to do
Here is what I think the bears need to do in order to gain the upper hand. First, European markets are still holding above their 50-day moving averages and I would like to see them decline below the 50-day MA to get more bearish. Here is the FTSE 100:


...and the Euro STOXX 50, which is an excellent barometer of stress:




Market psychology needs to get more bullish
Moreover, investor psychology needs to get more bullish. The latest AAII readings show bullish sentiment retreating in the face of a market advance (via Bespoke):



The VIX Index needs to stage an upside breakout above 20:


Moreover, the media was full of stories about the Crash of 1987 and how a crash could happen again. This is not the kind of psychological backdrop from which major declines begin.


Risk appetite is not in retreat
Many measures of risk appetite are not in retreat. Consider the NZDJPY cross rate, which is a key barometer of the carry trade:


The ratio of junior gold mining stocks to the more senior golds is showing a range-bound consolidation pattern:


Here in the Great White North, the ratio of the more speculative TSX Venture Index to the more senior TSX Index is rising, indicating rising risk appetite.



Until we see a broad retreat in risk appetite, I am not ready to declare this bull run over.


Earnings and the economic cycle
What about earnings. It is true that this Earnings Season has been disappointing. Josh Brown put it aptly when he wrote:
How's earnings season going? Only 42.3% of S&P 500 reported companies beat Q3 revenue expectations and 57.7% have missed. 64.9% have beat EPS estimates. Sucks.

He concluded:
So, ask yourself:

Is the weak earnings picture for Q3 the start of a new trend toward lower profitability or a bump on the road to full recovery?

Simple question. It will answer all.
Mr. Market's conclusion so far can be found in the relative performance of the Morgan Stanley Cyclical Index against the market.

The relative uptrend is still intact, indicating that it believes that Q3 earnings are only "a bump on the road to full recovery".


Bottom line: Until I see a broader retreat in the major averages, reduction in risk appetite, the public getting bullish, and relative underperformance of cyclical stocks, I am still inclined to give the bulls the benefit of the doubt.

Speaking tactically, however, we may have some weakness this week. Notwithstanding the minor violation of the 50-day moving average, which could set off some selling, last week was option expiry week and option expiry week tends to have a bullish bias (and it did - up until Thursday). The week after (this week) tends to have a mean-reverting bearish bias. Nevertheless, with an FOMC meeting and many important earnings reports from major bellwether stocks coming out this week, there will be lots of volatility. My inner trader is inclined to buy into any weakness while keeping an eye on the bearish tripwires that I outlined.






Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.  




1 comment:

Anonymous said...

Bears don't have to do anything. That's the beauty of markets.