Trader’s Narrative

While we all like to think of ourselves as rational beings, making decisions based on sound judgment, the truth of the matter is much more unsettling. We are, for the most part, rather peculiar creatures, prone to irrational and emotional biases. What makes this even more disturbing is that the edifice of our economic and financial system is built on the foundation of a rational, utility maximizing individual.

The most recent sentiment overview shows an amazing turn of events. Even as the stock market has gone on to rise almost 60% from its dark depth 8 months ago, a moderate correction was enough to plunge the majority of retail investors into a new state of capitulation.

Even more curious, instead of investing more as the stock market recovered, which is the norm, the US retail investor has completely given up on equities. Here is an updated chart which I originally shared two months ago (Equity Mutual Fund Outflows):

If anything, the exodus of US retail investors (mutual fund owners) has intensified. The data for the full month of September shows redemptions of almost $13 billion - the most since February, just before the spring rally started. And to make it even more bizarre, the frenzy of bond buying is getting even more frenetic with net purchases of $55 billion (in September).

The data for the latest data (3 weeks in October shown in darker colors) promises a continuation of the same trend, if not a new record. So far, October had net equity redemptions of $11.5 billion.

Almost the same can be seen from insiders trading activity. These more ‘in the know’ individuals have continued to sell shares of their company’s stock almost as fast as they could. While there are many reasons for an insider to sell (diversification, divorce, etc.) the fact that we aren’t seeing an uptick in purchases is telling.

So why is there so much pessimism around this latest stock market rally?

Loss Aversion
A concept from behavioural finance offers a possible explanation for the bizarre fund flows pattern, bearish investor sentiment and insider selling. “Loss aversion” is a concept from prospect theory which explains that people prefer to avoid losing, rather than take a proportional risk to receive a gain.

Think of it this way. Given an event which triggers either a loss or a gain of the same amount, for some strange reason, we prefer to avoid a loss, rather than receive a gain. In other words, we prefer to keep what we have (not lose some or all of it), rather than add to what we already have. For most people, losing is much more painful than gaining is pleasurable.
Continue reading ‘What If Wall St. Threw A Party, And Nobody Came?’

Let’s check in with the latest Lowry Research proprietary indicators. As persevering readers will recall, Lowry arrived late to the (bullish) party with their intermediate buy signal in August. Since then, they’ve continued to monitor their indicators and diagnose the uptrend as healthy: Rally Continues Strong. No indicator, whether proprietary or otherwise is perfect and no one has a crystal ball.

HAving said that, personally, I respect the oldest technical analysis firm on Wall Street not just for their heritage but also because they refuse to be swayed by emotion and always root their approach in a methodical study of the market.

Here are some notes from the latest interview with Tracy Knudson of Lowry Research (you can listen to the whole podcast at the bottom):

• S&P 500 bouncing off its 50 day moving average
• near term, we could get a move down to that MA
• around 1045-1050 which is a converging support area
• the trendline from March and July lows also meets in that area
• this area will act like magnet to draw market lower
• volume is sending a clear message: weakness on upside and more strength on downside
• S&P 500 tried several times to clear the 1100 level
• it has approached that level on contracting volume
• but volume expands on downside days
• this telling us demand weakening and selling more intense
• so the market is gearing up for a correction
• last short term pullback occurred in late Sept to early October
• that began with a downside reversal day
• this is when the market made new high then wasn’t able to sustain it and made a new low

Continue reading ‘Lowry Research: Turbulence Ahead, Uptrend Intact’

Everyone is excited that the Dow Jones Industrial is above 10,000 - again. While that nice round number may be where most of the attention is, there is another level which we’ve hit that is more significant.

But before I get to that, it is remarkable that every single major index has reached a new high. That includes the Russell 2000 and important sectors like the Philadelphia Bank index (BKX), Semiconductors (SOX) and even the Dow Jones Transportation index managed to reach a new higher close (while not exceeding the intra-day high on September 19th 2009). Also reaching a new yearly high is the Mid-Cap S&P 400 index as well as the Small Cap S&P 600 index. All in all, it would be accurate to say that a rising tide has lifted all boats.

But while everyone is partying like its 1999, excuse me for being a kill joy. The S&P 500 index has once again risen so far above its own 200 day moving average that it gives us reason to believe that all these new highs have stretched an already exhausted trend to the breaking point. Or at least to the resting point.

I presented a historical view of what happens when the S&P 500 is this far above its long term moving average. You can find the details in the previous link but the concise version is that this is not a good time to be long equities.

This rally was launched in early March 2009 when the S&P 500 was almost 37% below its long term moving average. Now it has reached 20% above it. Twice.

The first time in recent history was last month (September 16th) when it hit 20.27%. Not long after we had a very shallow and short lived pull back. And with today’s close it is 20.46% - once again above that magical 20% mark.

By the way, the S&P 500 managed to eke out a +2% advance in the 30 days that followed that first signal in mid September. That’s slightly better than the -1.16% historical average.

Since 1950 to now, we’ve seen very few times that the S&P 500 index has traded 20% above its long term moving average. In fact, the market usually tends to bounce between +20% and -20% like a ping pong ball. To see a large chart showing this, check the link above.

So what we are seeing is rather rare. And the consequence has been historically that the market will have to go sideways or correct. What it can not do is continue to sustain the pace it has so far:

The tendency for equities to remain within a +/-20% band of their long term trend persisted even during the birth of the super-bull market in late 1982. Then, the S&P 500 was barely able to nudge past the 20% mark, reaching a high of 23.28% above its 200 day moving average in early November 1982. While the index itself reached a high of 143 at that point, it was only by February 1983 that it was able to leave that level behind for good. So during one of the most powerful rallies, the S&P 500 basically tread water for 3 months. That is a persuasive precedent demonstrating the power of this simple indicator.

The other insight from this indicator is that at the top we tend to see a clustering of instances at or near +20%. This is indicative of the nature of market tops as they take much longer to form than bottoms. So far we’ve seen 3 instances of +20% during 30 days. We may see a few more. But the message provided by historical patterns is the same. At best we pause to allow the turtle-like 200 day moving average to catch up to the hare-like S&P 500. And at worst (for the longs) we correct sharply lower taking price down to meet the rising long term trend.

Either way, this is not exactly the time to pass around the party hats.

Last week I presented a historical study of what happens when the S&P 500 is this far away from its 200 day moving average. If you missed it, click the link to check it out in full.

According to the study, when the stock market has trended enough to set off this indicator, it has trouble continuing its heady ways in the months that follow. The average 6 month return is -5%.

If you look at the data carefully, it becomes apparent that certain date ranges contain a lot of repeated instances where the S&P 500 index is 20% or more above its long term moving average. We’ve just traversed one of these periods from September 16th to the 22nd. Between those dates there were 5 consecutive days were the S&P 500 was at this threshold (or very very close).

The last time this occurred was at the end of July 1997. But the best example was of tenacity in this indicator was in late 1982, just as the great generational super bull market was launched. Although the expected consequence of such an overbought condition is for the market to hit a wall, or at least to pause, during the start of the great bull market, this was not the case. While it continuously flashed red, the stock market continued to climb higher and higher, acting very out of character.

So the question is whether what we are seeing is a repeat of that atypical market action. In other words, do bull market rules apply?

Although there is no way for me or anyone else to prove it definitively one way or another, I highly doubt that what we are witnessing is the dawn of another rare secular bull market based on one variable: valuation.

I mentioned a lot of ratios, statistics and data before but putting all those numbers aside, here is a simple chart which sums up the strange voyage we have taken, from fully priced perfection to panic induced forced liquidation and back again:

That doesn’t look like a great launch pad for the next generational bull market. Heck, even bonds are priced for perfection. At best, we are going through a cyclical bull market - otherwise known as a bear market rally.

It is only six weeks since Lowry Research gave an intermediate trend buy signal. Since then the market has gained appx. 6%. Here is update on where the oldest technical analysis firm on Wall Street stands. You can listen to the Bloomberg podcast at the end of this post.

If you’re new to Lowry’s, many of the terms below may be confusing. For example, Pim refers to “Lowry stocks” which is a misnomer. What he means is OCO (operating company only) breadth, which is Lowry’s response to the pollution on the NYSE. This measure strips out ADRs, CEFs, REITs, bonds, ETFs, etc. and only shows market breadth for operating companies. For more background like that, as well as an explanation of Lowry’s proprietary indicators, take a look at my post late last year outlining Lowry Research’s position on the then market conditions.

Here are some notes from the recent Bloomberg interview with Tracy Knudson of Lowry Research:

• from Lowry’s market newsletter: “strong rallies but there are flaws”
• potential growing selectivity within the rally
• breadth momentum % above 10 day moving average declined last week as
• this indicator was at 88% (time of interview) - extremely overbought
• now it is lower at 82.6% (see chart above)
• also there are overbought price momentum indicators
• demand volume weak: NYSE up volume 52% (Sept 15th) of total up+down volume
• this is another blemish on the aging rally
• S&P 500 trading envelope: overlay 21 day moving average then +/-3% range
• this provides and indication of overbought/oversold condition
• right now the S&P 500 index is hugging its upper trading envelope
• we’ve seen this happen before during the rally - this is the 3rd time since early June
• each time as the S&P hugged this upper envelope, we also had deterioration in the momentum indicator (% above 10 day MA)
• the confluence of waning breadth momentum and the overbought condition lead to corrections
• the first correction was 7%, the second less
• not a signal of an important market top but evidence mounting for a correction
• LT indicators are telling us the correction will be short term & shallow correction
• new highs in advance/decline line, and Lowry’s proprietary indicator: Buying Power index continues in an uptrend
• as well Lowry’s Avg. Power Rating index which measures demand across stock market has tripled since March low
• strong indications of demand so correction will probably be shallower than 5-10%
• price momentum is also very overbought (short term condition pointing to correction)
• traders have been expecting a correction since the market can’t move up in a straight line
• but the market has been very resilient
• even so, we haven’t seen panic buying which precedes important corrective points
• if we see complacency and sharp move higher = panic buying and look out below
• have not seen true panic buying from the March lows
• OCO advance/decline line is confirming new highs in major market averages
• no divergence - that would be seen at an important market top
• any selling is met with a renewed wave of buying which overwhelms it
• watch to see if “buy the dip mentality” fades - watch for waning intra-day resilience
• Nasdaq advance/decline line was lagging but is now at a new high as index leads
• this rally has not run its course
• during a pullback, if market internals deteriorate proportionally more than the market, we’d reevaluate our stance

Tracy Knudson of Lowry Research (Bloomberg):
Pim’s interview with Tracy is at the beginning of the podcast so just press play and listen: