Tag Archives: Signals

Investors’ optimism after the Greek election proved to be short-lived as indicated by the sell-off in the stock markets and other risk assets. The Fed extended operation twist trough the year end instead of adopting QE3 while the BOE decided of leave the size of asset purchases as it is although the voting results showed that the members were more divided. Absence of aggressive monetary stimulus announced by central banks also intensified concerns over the path of global economic recovery. Financial markets were lifted on Friday on bargain hunting and the ECB relaxed terms for collateral. There were also increasing speculations that the central bank could announce another set of long-term loans.

Financial markets were pressured for most of the week as investors realized that victory of the pro-bailout party with a pro-bailout coalition government in the Greece would not resolve the sovereign debt crisis in the Euro zone. G-20 leaders failed to come up with solid solution to the problems although they pledged to help. Emerging economies committed more money to the IMF’s rescue fund but the market reactions were mild. A recovery was, however, seen on Friday amid bargain hunting after weeks of weakness in the financial markets. Meanwhile, the sentiment was also lifted by the ECB’s move to ease conditions of collateral.

The ECB, in order to make it easier for banks to borrow money, announced to lower the minimum rating threshold for mortgage-backed securities to BBB- from A-. According to the statement, the asset-backed securities will become eligible collaterals: 1) auto loan, leasing and consumer finance ABSs and ABSs backed by commercial mortgages (CMBSs) which have a second-best rating of at least “single A” in the Eurosystem’s harmonized credit scale, at issuance and at all times subsequently. These ABSs will be subject to a valuation haircut of 16%; 2) residential mortgage-backed securities (RMBSs), securities backed by loans to small and medium-sized enterprises (SMEs), auto loan, leasing and consumer finance ABSs and CMBSs which have a second-best rating of at least “triple B” in the Eurosystem’s harmonized credit scale, at issuance and at all times subsequently. RMBSs, securities backed by loans to SMEs, and auto loan, leasing and consumer finance ABSs would be subject to a valuation haircut of 26%, while CMBSs would be subject to a valuation haircut of 32%.

Crude Oil: Crude oil prices plunged for a second consecutive with the front-month WTI crude closing below 80/bbl for the first time since September last year. The equivalent Brent crude contract breached the 90 level at one point before ending the week at 90.98. The change of term structure (to contango) of Brent crude forward curves suggested the weakness in crude fundamentals. Global macroeconomic uncertainty has been the key reason sending the price lower. However, the recent sell off in oil prices has probably overextended. For a long period of time, stocks and crude oil prices have displayed significant positive correlation. However, the recent decline in crude oil prices has significantly derailed from the normal path, suggesting the S&P 500 index would have to fall to a bigger extent and the US economic outlook would have to deteriorate further to justify the fall in crude oil prices.

Meanwhile, the sell off in crude prices might have unnerved oil producing countries as the breakeven prices are being approached. Should the decline continue in coming weeks, we expect the OPEC would implement some price defending measures, i.e. production cuts.

Natural Gas: Nymex natural gas gained rose for a second week as US inventory increased less than expected. Moreover, the National Hurricane Center forecast there is an 80% chance that a tropical depression or Tropical Storm Debby will be formed around the Gulf of Mexico during the weekend. The DOE/EIA recorded that gas stockpiles increased +62 bcf to 3006 bcf in the week ended June 15. Stocks were +680 bcf higher than the period last year and +641 bcf, or 27.1%, above the 5-year average of 2365 bcf. Separately, Baker Hughes reported that the number of gas rigs dropped -21 units to 541 in the week ended June 22. Oil rigs increased +16 units to 1 421 and miscellaneous rigs stayed at 4 units and the total number of rigs was down -5 units to 1 966 units. Directionally oriented combined oil, gas, and miscellaneous rigs stayed unchanged at 233 units while horizontal rigs increased +3 units to 1 165 and vertical rigs slid -8 units to 568 during the week.

Precious Metals: Gold was not able to regain its status as the safe-haven asset and fell below 1600 again as hopes of QE3 dissipated. The Fed announced after the two-day meeting that it would extend its Operation Twist program through to end 2012. It has committed to sell Treasuries with remaining maturities of 3 years or less while simultaneously purchase an equal amount of US Treasuries with remaining maturities of 6 to 30 years. The total amount would be worth of $ 267B based on the current trend. Policymakers remained dovish in the economic outlook and viewed that ‘low rates of resource utilization’ and ‘a subdued outlook for inflation over the medium run’ would ‘warrant exceptionally low levels for the federal funds rate at least through late 2014′. Meanwhile, the central bank pledged to ‘take further action as appropriate to promote a stronger economic recovery.

The move disappointed those investors who had hoped that the Fed would expand the balance sheet. The next trigger for gold price to move higher would be the “fiscal cliff” at the year end. By that time, expiry of a range of tax cuts would likely hurt consumer spending. According to the Fed chairman Ben Bernanke, “the so-called fiscal cliff would, if allowed to occur, pose a significant threat to the recovery”. The fed might by that time feel the urgency to announce more aggressive accommodative measures to boost the economy.

I find it helpful to step inside sector performance when assessing the health or potential weakness ahead for the broader Stock Market.

Let us take a look at recent signals before and after the sharp May stock sell-off along with what signals appear currently.

First, let us compare the Consumer Discretionary (Retail) Sector with the Consumer Staples Sector, both of which give us clues as to “Risk-On” or “Risk-Off” trends in money flow.

Here’s the Daily Chart of XLY – Consumer Discretionary Sector:

We’re not looking to do complex technical analysis when we’re studying this type of Sector comparison.

The goal is to use simple trendlines and descriptions to arrive at a conclusion of strength or weakness and the interplay between these two Sectors.

Despite a rally to new highs in late April, the XLY ETF continued its sideways motion and eventually broke sharply lower – with stocks – in mid-May on stronger volume to the downside.

Currently, the fund is retracing up into the confluence resistance near the $ 44.00 per share level – a level which we’ll be watching closely.

One can view the XLY Chart to assess strength in Retail or Consumer Discretionary stocks as part of a “Risk-On” or Bullish market environment.

To view “Risk-off” or a cautious/bearish market environment, we can look for relative strength in the Consumer Staples Sector using the XLP Fund:

In general, the Consumer Staples sector – and stocks within it such as Proctor and Gamble (PG) and Kraft Foods (KFT) – is less volatile than the Retail Sector fund which includes companies such as Amazon (AMZ) and Starbucks (SBUX).

Looking at the chart, we see a similar consolidation pattern from March to present, but we do NOT see the distinctive spike to new highs in April nor the sharp decline in May as we saw in XLY.

We’re also not seeing big differences in volume as we saw with a steady surge of selling volume in XLY.

It’s difficult to see clear differences in price performance by looking at the charts individually, so to get a better picture, it’s often best to overlay price performance of these funds, usually along with the S&P 500 index.

This is what the color-coded chart below reveals:

Let’s remember a basic principle when looking at the chart above:

Retail (XLY) tends to outperform during periods of Market Strength while Staples (XLP) tends to outperform during periods of Market Weakness.

During the early 2012 stock rally, we saw Retail/Discretionary – the Green Line – steadily rising ABOVE the Red Line or the Staples Sector.

This was true until early April when a surge of buying pushed the Staples Sector above the Green/Retail Line – that was an early sign of potential weakness.

From April, during the sideways move in the Stock Market (and these funds), the Staples Sector outperformed the Retail Sector with the exception of the tiny blip at the start of May.

Strength in Staples is often a sign of potential future market weakness, as was the case here.

In combination with the examples I showed of broader trends in Distribution Volume (April 11th SPY Volume Update and the May 11th SPY Volume Update), the “Risk-On” vs. “Risk-Off” Sector Performance showed similar caution or warning signals.

The sell-off in May was forecast as likely in part by the strength in Consumer Staples along with a trend of distribution volumr in stocks.

Continue watching the Relative Performance of XLP and XLY in conjunction with the S&P 500 for further clues as to broader “Risk-On” aggressive or “Risk-Off” safety themes.

Corey Rosenbloom, CMT
Afraid to Trade.com

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