Trader’s Narrative

When you take a step back and get a very long term perspective on the stock market, you realize that an apt analogy is a dog pulling on its leash. There is an overarching trend - which is the path set by the owner - but like a distracted puppy, the market can pull in one direction for short, intense spikes.

By watching the relative distance to its moving average we can tell where we are and how probable it is that we revert back to the very long term trend. This is what I referred to when I built a case for being bullish in March 2009: Another Reason We’ve Seen the Market Low. To my shock and horror, on November 20th 2008 the S&P 500 closed almost 40% below its 200 day moving average. It had never done that in the entire history of the index!

And in keeping with every other similar spike down, 60 days later, the index had recovered. In fact, we saw the sharpest rally to match the never before seen spike low.

We’ve now come full circle and are at the other end of the extreme. Last week, the S&P 500 closed 20.27% above its 200 day moving average. To give you an idea of how rare this is, here’s a chart of the S&P 500 relative to its long term moving average from 1950 onwards (click to see the larger version open in a new window):

Not only have we never seen this measure sink so low, we’ve also never seen it recover so fast! It took only 206 trading days for the S&P 500 to go from being 39.79% below its 200 day moving average to being 20.27% above it. The only other time we saw a similarly quick lurch from the abyss to the heavens was when bell bottoms and butterfly collars were the rage.

Back then, it took the S&P 500 only 185 trading days to go from being 28.8% below its 200 day moving average (on October 3rd 1974) to being 21.6% above its moving average (on June 26th 1975). That tidbit may be fascinating to know but I’m sure you’re wondering, so what happens when we are this far above the 200 day moving average?

To answer that, I went through the daily S&P 500 data and marked the appropriate dates where we approached or crossed the 20% Maginot line. Since such instances tend to clump together, I only considered the first date and ignored the repeats during the same month.

So for example, on May 5th 1975, the S&P 500 traded at 90.08 which was 19.66% above its 200 day moving average. Then a few days later on May 9th it closed slightly higher relative to its long term moving average (20.10%). I ignored all such repeats. I then calculated the forward 1 month, 3 month and 6 month returns (excluding dividends) from the first date. Here are the results:
Continue reading ‘What Happens This Far Above The 200 Moving Average?’

Since last year we’ve heard rumors about a “Wall Street” sequel in the works from Hollywood. Amazingly enough, the latest news is that it is in fact going forward and will probably have Michael Douglas reprising his role as the infamous Gordon Gekko.

As any trader knows, “Wall Street” is the classic trading movie which came out in 1987. What most people assume that it came out before the crash in 1987. Which is probably why it has gained a false reputation as a contrarian indicator for the crash. But in fact, the movie was released on December 11th, 1987 when the Dow was around 1,900 - off the lows of Black Monday, but still every one was completely shell shocked.

It looks like the sequel will also come on the heels of a crash of sorts. That is assuming we don’t have another leg down from now till the movie is released

Monday’s free falling market finally brought us some indication of real fear in the market. The indicator that got many talking was the S&P 500 Index volatility index (VIX) being pushed higher than what we saw at the last financial crisis in 1998 (when a few PhD’s from Chicago almost took down the world economy with a little hedge fund called LTCM).

I wanted to take a closer look to see that spike in its proper context. So here is a long term chart of the VIX:
Continue reading ‘The Heartbeat Of The Stock Market Goes Thump’

The TED spread is one of the most basic gauges of fear in the financial markets. TED stands for Treasury Eurodollar because originally it was calculated by taking the US 3 month treasury bill and subtracting it by the 3 month Eurodollar contract rate. Today the spread is calculated by taking the difference between the 3 month US T-bill rate and the 3 month LIBOR rate.

This is an important indicator because while US government issued fixed income is perceived to be “risk free” (or as close as you can theoretically get), LIBOR rates are commercial lending rates and are not. So therefore, the difference of the two isolates counterparty or default risk in the market at any point in time.

Of course, this is a generalized measure of counterparty risk across the financial markets and is not reflective of individual corporate bonds. Think of it as being a measure of credit risk the same way that the VIX is a measure of volatility. I can guarantee that it is one of the ingredients in the “Panic Button” indicator from SentimenTrader. That indicator by the way, has now shrunk back to less than 1 standard deviation away from its mean.

Right now the TED spread is showing enormous stress in the global financial markets:

Today it closed at 313 basis points which means that we have broken through the previous record set at the darkest hour of the 1987 “Black Monday” stock market crash (300 basis points). Ponder that for a second.

On the other side of things, in the summer of 2000 (remember those days?) the TED spread shrank to almost nil as everything was well with the world and everyone held hands singing songs of monetary bliss while basking in the sunshine of the “Goldilocks economy”.