Trader’s Narrative

The sentiment landscape has changed much from just a month ago:

Sentiment Surveys
The AAII sentiment survey came in this week at 53% bulls - unchanged from last week. Not only is this a very high bullish reading for this indicator, it is the level at which the market topped out last October. Furthermore, the fact that it has remained firm in the light of this past week’s market performance should be sending chills down the spines of bulls.

From a contrarian point of view, I want to see the retail investors (AAII respondents) become fearful as the market is falling and remain so even as it rises. The fact that they have now quickly shuffled over from extreme bearishness to bullishness and maintained it for two weeks, even as the market fell, reinforces my belief that we are in for some trouble.

In contrast, the Investor’s Intelligence survey is showing 44.4% bulls and 32.3% bears. There was a slight increase in the bullish numbers and an even larger increase in the bearish camp. Still, according to the current II we aren’t anywhere near bullish extremes. Take for example that the bull/bear ratio is 1.37 - it was more than 3.0 when the market topped last October.

Rydex Nova/Ursa Ratio

In case you’re not familiar with this indicator: before the onslaught of ETFs, Rydex’s Ursa and Nova were the ticket if you wanted to time the market. The are mutual funds but they settled twice daily (I don’t think they do anymore) and you could switch assets between them or other Rydex funds with no penalty. Like other contrarian indicators, when the fast money crowds to one side, the smart thing to do is to jump to the other side.

Right now the ratio is showing an abundance of optimism from the Rydex fund timers. Something which makes me wary. On its own this wouldn’t be enough to really concern me but it is just one more in an ever growing list of short term indicators which suggest some sort of correction or pause at best.

Fund Flows
The only bright spot, from a contrarian perspective, in the sentiment overview is the mutual fund money flows. According to AMG Data, one of the largest and most accurate providers of this sort of data: domestic (US) mutual funds reported net redemptions (outflows) of $8.6 Billion. This dovetails with the panicky behavior we’re seeing in Canada.

With interest rates so low, and cash being basically a negative return investment, you won’t be surprised to learn that money market funds had the largest monthly outflow in April ever on record: $78.7 Billion. Some of the cash flowed into municipal bond funds ($4 B), no doubt in search of a higher yield. But I suspect much of it, perhaps even the vast majority, was the US consumer’s retrenchment.

Finally, among the sectors, real estate funds received the largest inflow of money since February 2007 - which was exactly the worst time to buy REITs or anything else real estate related in the stock market.

So while this beleaguered sector has valiantly fought back from the January 2008 lows, it may be about to top out (again). Look alive out there.

While US REITs breached their long term (200 day) moving average in early May, the Canadian REITs have just breached their’s. They have been getting roughed up all this month. But the selling has reached a point which I think has washed out all the weak hands.

For starters, the S&P/TSX Capped REIT Index is now below its 200 day moving average. As it has for the duration of this bull market, this has been a good entry into the sector. See graph below for more details.

Also, the selloff has taken almost all REITs much lower. Had the fall in the index been attributed to one or two large capitalization REITs, I wouldn’t be as confident of a washout. But looking at the percentage above moving averages we see that the sector is deeply oversold. There are only around 16% above their short term (10 day) and their intermediate (50 day) moving averages; and only 40% are above their long term 200 day moving averages.

On June 26th 2006 when we last saw the REIT index dip below its long term moving average, there were 20% above their 50 day and 200 day moving averages with 47% above their 10 day moving average.

With the new uptick in rates in the US and chatter about the end of cheap money, we could be seeing a major trend change with REITs. But evenso, they aren’t going to go straight down. I think this technical oversold picture in the short term is still actionable.

There are two newsworthy events in the sector also. A new mini-REIT has been born: Charter (CRH.un) finished its conversion last month. And Sunrize (SRQ.un) was bought out by Ventas (VTR), a US REIT, so it is off the list.

Click to Enlarge Graph

Here is the new list of Canadian REITs:

Allied Properties (AP.un)
Artis REIT (AX.un) - previously Westfield
BTB REIT (BTB.un)
Boardwalk (BEI.un)

Calloway (CWT.un)
Canadian Apartment Properties (CAR.un)
Canadian Hotel Income Properties (HOT.un)
Canadian REIT (REF.un)
Charter (CRH.un)
Chartwell Seniors Housing (CSH.un)
Cominar (CUF.un)
Crombie (CRR.un)

Dundee (D.un)
Extendicare (EXE.un)
H&R REIT (HR.un)
Holloway Lodging (HLR.un)
Huntingdon (HNT.un)

IPC US (IUR.un)
InnVest (INN.un)
InterRent (IIP.un)

Lakeview (LHR.un)
Lanesborough (LRT.un)
Legacy Hotel (LGY.un)

Morguard (MRT.un)
Northern (NPR.un)
Primaris (PMZ.un)
Public Storage (PUB)

Retrocom (RMM.un)
RioCan (REI.un)
Royal Host (RYL.un)
Scott’s REIT (SRQ.un)
Temple REIT (TR.un)
Whiterock (WRK.un)

Last Monday (May 21st, 2007) I wrote about the deep oversold condition in the US REIT sector and why I thought that it was a bear trap.

So far, according to the CBOE Dow Jones REIT Index (DJR), things have played out according to that script. After reaching just below the 200 moving day average and giving the bears a glimmer of hope, the index reversed up. It formed a beautiful W bottom (double bottom) and after yesterday’s showing it is now once again above its long term moving average.

The snap back provided some really nice wide range days as the shorts scrambled to cover and ended up throwing more momentum behind the uptrend. I’ll show yesterday’s graphs for two REITs which I mentioned in my original post last week.

Here is the intraday chart for Kimco Realty Corp. (KIM):

And here is Vornado Realty Trust (VNO):

Nothing ever goes straight up, or down. While short term, nimble traders can take advantage of shap snapbacks like this one, don’t expect the sector to keep going up day after day.

The REIT sector should consolidate its recent gains and start climbing back up slowly. If you want a good entry for long term holdings, here it is.

Greenspan’s comment which rocked markets yesterday, dominoed into Asia overnight and boomeranged back to the US markets (how many mixed metaphors is that?). But the market didn’t need any help from the Maestro to roll over. We’ve had three days, back to back, where the S&P 500 attempted to rally, only to be driven back by sellers. In Japanese candle-speak it formed three inverted hammers with long upper tails.

As you’ve probably heard ad naseum, the S&P 500 is about to reclaim levels it has not seen since 2000. Does anyone really believe it will plow through that sort of long term resistance without first pausing to catch its breath?

Down days like today are blessings in disguise because they make it easy to identify the really strong sectors and stocks in the market. Nevertheless, the nature of the price decline was a bit surprising.

We saw an extremely low intraday TICK, last seen at the late February 2007 correction and further back at intermediate bottoms (April 2006, May 2004 and the 2002-3 market bottom).

We also had very lopsided market internal: for the NYSE 5 declining issues for each advancer and for the NASDAQ 3 decliners for each advancing issue. The volume was even more crazy with volume in declining issues outpaced advancing ones by 7 to 1 on NASDAQ.

Usually the markets shows this kind of negativity after a significant decline has already been underway and a bottom is being formed. A sort of whoosh cleans out the longs and transfers stocks from weak hands to strong hands. As long as we are still in a bull market, this sort of market internal action is indicative of a buying opportunity.

So what now?

The first strategy is to look for weak sectors and go short (with a short-term timeframe).

A good example is the REIT sector with its anemic relative strength. It made a feeble effort to get back up to its 200 day moving average and rolled over again today. Maybe I’m wrong. Wouldn’t be the first or last time;-) I’m not yet giving up on the bear trap thesis for the REITs but if it plays out, it will work over the medium term (weeks) not over the short term. We’ll see.

The other strategy is to start making a buy list for potential swing trades from among the strong stocks that are undergoing pullbacks to break out levels.

As the funds flow data shows, a lot of the momentum is in the emerging markets. Take a look at Brazilian bank stocks:

• Banco Bradesco (BBD)
• Banco Itau (ITU)
• Uniao de Bancos Brasileiros (UBB)

I’m seeing a lot of attention directed towards the weakness ni the US REIT sector:

• the CBOE Dow Jones REIT Index (DJR) weak relative strength
• DJR formed a clear “head and shoulders” pattern
• the weakness in the real estate market in the US
• DJR just fell through long term support at the 200 day moving average

So the REITs are finished at this point, right?

Not quite.

At the bottom of the March 2007 low, I shared a study by Lowry’s which looked at percentage of stocks above their 10 day moving average. It was wildly bullish at a time when others were panicky and fearful. Like everything I’ve come to expect from Lowry’s, it was top notch analysis.

So lets take a page from their playbook and look at the REIT sector as defined by the CBOE Dow Jones REIT Index and see how many are above their 50 day and 200 day moving averages.

As of Friday last week, only 21% closed above its 50 day moving average and 45% above its 200 day moving average. That tells you things are very oversold in the short term and will probably bounce rather than keep going down.

Keep in mind that quite a few REITs in the index are only above their 50 day and 200 day moving averages because they are being bought out. For an example, see Eagle Hospitality Properties Trust Inc. (EHP). So realistically we are even more oversold than that measure shows.

The REIT sector broke out in the summer of 2003 and entered into an uptrending channel. It has stayed within that channel and everytime it has dipped below, it has been to trap more shorts and zoom higher (the yellow line is the 50 week moving average):

And about that ominous technical formation: when something is obvious to everyone, especially a well known pattern such as a “head and shoulders”, then it probably will not complete as expected. This reminds me of the massive head and shoulders formation on the S&P 500 index which formed in the summer of 2002 at the 950 area (neckline). Everyone and their uncle was expecting it to complete. Had it done so, it would have meant a measured move to 400 on the S&P 500 !!

Obviously, it didn’t. Instead, the market bottomed towards the end of that year and then started on its bull run, which is still ongoing. The market has a tendency to make mincemeat of those who think they’ve “figured it out”. Especially when what they’ve firgured out is blatantly obvious.

Finally, take a look at the 90 day T-Bill rate:

As I mentioned when I wrote about the yield curve flattening, we are seeing a topping formation which may be presaging a cut in Fed funds rates. If we do see a rate cut, that would, once again, breathe new life into the REITs bullish run.

Here are the top 10 REITs in the US - representing more than $136 Billion in capitalization:

Simon Property Group Inc. (SPG)
Vornado Realty Trust (VNO)
ProLogis (PLD)
Equity Residential (EQR)
General Growth Properties Inc. (GGP)
Boston Properties Inc. (BXP)
Host Hotels & Resorts Inc. (HST)
Archstone-Smith Trust (ASN)
Public Storage Inc. (PSA)
Kimco Realty Corp. (KIM)

There are also a few ETFs:

Real Estate iShares (IYR)
Vanguard REIT VIPERs (VNQ)
streetTRACKS Dow Jones Wilshire REIT Fund (RWR)