Tuesday, July 3, 2012

Warning: U.S. Stocks Could Be Headed Lower

Traders use a variety of techniques to time the markets. Successful traders usually rely on relatively simple strategies to deliver market-beating returns. Right now, the stock market is setting up for a short-term sell signal that is highly accurate for a short trade. A short trade is taken when you believe the market will decline and you sell stocks or an ETF that you do not own. You will eventually have to buy the stock or ETF in order to close out the short position, and if you buy at a lower price than you sold for you earn a profit on the trade. A short trade actually reverses the usual buy-sell order and sells first with the intent of buying later at a lower price.

Trading on the short side is difficult because the stock market has a long-term upward bias. The S&P 500 index has gone up 57% of the time on a weekly basis and about 60% of the time on a monthly basis since 1950. The average gains in up weeks or months are much larger than the average losses which explain why the index shows an annual average gain of 7.27% over that time. When dividends are considered, the average annual gain jumps to 10.92% -- traders who are short have to pay the dividends on their positions, another factor that works against short positions.
If you find a winning strategy on the long side, you usually can’t just “flip the rules” to create a short strategy. For example, buying the SPDR S&P 500 ETF (SPY) when it closes above the 10-month moving average is a very profitable buy signal. However, it is not profitable to go short on a close below the 10-month moving average.
While it is difficult to trade successfully on the short side, it is not impossible. One strategy that does work is surprisingly simple and that indicator is very close to a sell signal right now. In the past, it has been right 71%. This system uses the MACD indicator on the daily chart of SPY.
The Moving Average Convergence-Divergence (MACD) indictor is used to identify the direction of the trend in momentum. When the indicator is moving down, as it is now, prices usually follow. The chart of SPY shows that the next major move is more likely down than up because the price is below its 20-day moving average, MACD is below zero and the indicator should complete a bearish crossover if prices fall in the next trading day or two.
Signals based on MACD and whether price is above or below its moving average are both testable. In this case, a MACD sell signal occurs when the indicator (the green line) falls below its moving average (the red line in the chart) while MACD is below zero and the price is below its 20-day moving average. On its own, MACD signals are tradable and would deliver a very small profit. Trading short based only on a moving average is almost always unprofitable. When combined, the market conditions generate trading signals that are right more than 71% of the time and a trader would make money selling short after the signal and exiting the trade a week later. Short-term holding periods are best for short trades. The signal actually identifies profitable short trades about 60% of the time with holding periods of up to a month.
This indicator points very strongly towards at least short-term market weakness. Traders should be looking for a chance to profit from this and even those not wanting to accept the risks of going short SPY could use an inverse ETF like ProShares Short S&P500 (SH) to profit from a quick down move. Very aggressive traders could use ProShares UltraShort S&P500 (SDS), but this is a leveraged ETF and should never be held for more than a few days because of the way those funds are structured.

A Once in a Decade "Buy" Signal With a Profitable History

The best contrarian indicator you've probably never heard about just flashed a "buy" signal. Contrarians buy when everyone is selling and sell when everyone is buying. They profit from fear and greed and take positions contrary to the emotional factors driving many investors.
Some contrarians use sentiment surveys, for example, to analyze the mood of the market. There are several organizations that ask traders whether they expect stocks to go up or down and this survey data can help traders identify significant turning points. Unfortunately, this is not a fool proof strategy. The crowd is right for a time and the extremes in sentiment can only be known with certainty in hindsight.

This indicator is different. It rarely gives a buy signal so most traders aren’t even aware of it. That doesn't stop it from being wildly profitable. Traders could have booked an average gain of 35% in a year and 100% after three years following this indicator.
Here's the thing. It's only given a "buy" signal eight times in the past 97 years, and right now it's saying to buy one of the most "hated" countries in the world.
Recent test results from Mebane Faber (author of The Ivy Portfolio) shows that buying a country after a very steep decline can be profitable. He used fundamental data to test this idea. Faber found that whenever the 10-year cyclically adjusted price-to-earnings (P/E) ratio falls below 5 for a country’s stock market, the country is a buy. This is the P/E calculation favored by Robert Shiller in his book, Irrational Exuberance.
Faber found that this P/E ratio fell below 5 only eight times in his database of 32 countries with records that goes back to the early 1900’s in some cases. After this rare event, the market was up an average of 35% a year later and 100% within three years.
Today, we have the ninth signal from this indicator as the CAPE reached a value of 2 for Greece. The news from Greece is bad but the market has already turned up so now could be the perfect time to take the trade.
For US traders, there aren’t many trading options for Greece. There is only one ETF available that offers direct exposure to the Greek stock market. Global X FTSE Greece 20 ETF (GREK) has a short trading history of about 7 weeks which makes analysis difficult. It holds 20 Greek stocks.The ETF is now 25% above its lows and could indicate the worst news has been factored into its price.
Given the short trading history of GREK, it’s not possible to define a stop loss based on support levels or indicators. For now, all we have is a 20-day moving average. In a few weeks, there will be enough trading history to calculate a 50-day moving average and that could be used as a stop level. This is a long-term trade with big potential, but traders should expect volatility as the situation in Europe unfolds. The 50-day moving average, when it can be calculated, should give the trade room to run.
A year from now, the news may be better and value investors may be rushing into Greece. That could be the time for contrarians to exit a trade with a significant gain.

A New Buy Signal for Oil Stocks

Oil stocks today look just like gold stocks did last month.

You remember how the gold sector was set up last month, right? The sector was brutally oversold. Many gold stocks were trading at valuation levels we hadn't seen in years. They were lagging way behind the action in the metal. And even the most die-hard gold bugs were giving up on the mining stocks.

Now, of course, we know last month was an ideal time to buy gold shares. (My S&A Short Report subscribers booked a 112% gain on major gold producer Seabridge Gold in just two days.)

So the question is... If you had the chance to buy into that setup again, would you do it?

It looks like we're going to have that chance in the oil sector.

Oil stocks look like death. The AMEX oil index is down 10% in the past two months. It's down almost 20% since March. Oil services giants like Halliburton (HAL) and Baker Hughes (BHI) are trading at less than 10 times earnings. It's hard to find any analyst, anywhere, who'll say something good about the sector.

And as we saw with gold stocks last month, the bullish percent index for the oil sector (BPENER) has just whipsawed into, out of, and back into a buy signal.

Take a look...

Remember... a bullish percent index (BPI) measures the percentage of stocks in a sector that are trading with bullish point-and-figure chart patterns. A BPI is typically overbought when it rallies above 80, and it's oversold when it drops below 30.

Buy signals occur when a BPI drops into oversold territory (below 30) and then turns higher.

The red circles on the chart above represent buy signals. As you can see, BPENER triggered a buy signal in late May. But that signal reversed – similar to what happened to gold stocks in early May – and BPENER dropped to a lower low.

We got a second buy signal earlier this month.

This is nearly identical to the action we saw in the gold sector bullish percent index last month. In fact, the whole setup is nearly identical.

The only problem is that this latest buy signal reversed as well. But I'm watching this for another turn higher to signal a good time to buy.

Oil stocks are brutally oversold. They're trading at dirt-cheap valuations we haven't seen in years. Sentiment toward the sector is bearish.

This may not be the absolute bottom for the oil sector. But we're close to at least a short-term bounce.

John Embry on Gold, Silver, Currencies and Commodities

The Hera Research Newsletter is pleased to present the following insightful interview with John Embry, Chief Investment Strategist of Sprott Asset Management LP, where he plays an instrumental role in the corporate and investment policy of the firm. Mr. Embry, who is a world renowned expert on the gold market and on gold and precious metals mining shares, currently focuses on the Sprott Gold and Precious Minerals Fund. Mr. Embry has researched the gold sector since 1963 and has more than thirty years of industry experience as a portfolio management specialist.

After graduating from the University of Manitoba with a Bachelor of Commerce degree, Mr. Embry began his investment career as a stock selection analyst and Portfolio Manager at Great West Life, where he later became Vice President of Pension Investments for the entire firm. After 23 years with the company, he became a Partner in United Bond and Share, an investment counseling firm acquired by Royal Bank in 1987.

At Royal Bank, Mr. Embry was named Vice-President, Equities and Portfolio Manager at RBC Global Investment Management, a $33 billion organization where he oversaw $5 billion in assets, including the flagship $2.9 billion Royal Canadian Equity Fund and the $250 million Royal Precious Metals Fund, which was the #1 ranked fund in Canada for its 2002 net performance of 153%.Hera Research Newsletter (HRN): Thank you for joining us today. Let’s talk about gold stocks.

John Embry: Gold stocks represent a tremendous value in relation to the price of gold and to the fundamentals of the sector. There has been tremendous shorting activity by hedge funds and, as a result, dedicated gold funds have experienced redemptions. Retail investors, who are natural buyers of these stocks, have been annihilated by the price action. This has created one of the finest opportunities, if not the finest opportunity, that I have ever seen.

HRN: Do you have a short term price target?

John Embry: I don’t look at short term price charts for gold. In a market as heavily interfered with as this one, charts can be made to look any way you want in the short run. As I see it, if you don’t like gold at these prices, then you must like currencies. My partner Eric Sprott often says, the U.S. dollar is the best looking horse in the glue factory. If the U.S. dollar is the world’s strongest currency, that’s the best endorsement for gold that I can think of.

HRN: Do you believe that currencies are losing value?

John Embry: The fact is that economies are slowly melting down. The problem is excessive debt in almost every corner of the world. The only way to deal with the debt is through aggressive growth, but fabricating growth through more debt won’t work. The idea that you can get the economy to move forward by creating even more debt just doesn’t wash. We can’t service the existing debt, even at artificially low interest rates. I don’t see any easy way out. We have to get the excessive debt out of the financial system. Either policy makers are going to create mounting inflation or there will be a deflationary debt collapse.


Time Warner Inc. (NYSE: TWX)

Time Warner, Inc. operates as a media and entertainment company in the United States and internationally. It operates in three segments: Networks, Film and TV Entertainment, and Publishing. The Networks segment provides domestic and international networks, premium pay and basic tier television programming services, and digital media properties, which primarily consist of brand-aligned websites. Its premium pay television services consist of the multi-channel HBO and Cinemax premium pay television services. The Film and TV Entertainment segment produces and distributes feature films, television and other programming, and videogames; distributes home video products; and licenses rights to its feature films, television programming, and characters. The Publishing segment publishes magazines and books; and operates various websites, as well as engages in marketing services and direct-marketing businesses. The company's brands include TNT, TBS, CNN, HBO, Cinemax, Warner Bros., New Line Cinema, People, Sports Illustrated, and Time. Time Warner Inc. was founded in 1985 and is headquartered in New York, New York.

To analyze Time Warner's stock for potential trading opportunities, please take a look at the 1-year chart of TWX (Time Warner, Inc.) below with my added notations:

After dropping significantly lower during the fall of last year, and then rallying higher in the winter, TWX has been traveling sideways for most of the last 5 or 6 months. During this time, the stock has repeatedly hit resistance at $38 (blue). On Friday the stock finally broke through that $38 resistance and should be heading higher overall from here.

The Tale of the Tape: TWX recently broke through its $38 resistance. A long position could be entered on a pullback to $38 with a stop placed under that $38 level. A close back below $38 would negate the forecast for a move higher.

This Week's Market Outlook: 94% Chance The S&P 500 Ends Week Lower

S&P 500 Near Resistance and Overbought, Setting up a Short

Look for stock markets to reverse after Friday’s news-driven rally. Traders should expect large rallies like that to be at least partly reversed in the short-term. Friday’s move pushed the S&P 500 into overbought territory when looking at the one-month relative strength (RS). Over this time frame, high RS is best used to spot short trade candidates. RS measured over periods of three months to a year should be used to find long trades.

SPDR S&P 500 (SPY) has reached this overbought level 50 times since 2001. The result? A week later SPY closed lower 94% of the time. SPY was lower on the day following this signal, which will be Monday, 100% of the time. Barring more major news, we have a very high probability short trade in SPY this week. That makes ProShares Short S&P500 (SH) a buy and aggressive traders should consider ProShares UltraShort S&P500 (SDS), an ETF designed to move twice as much as the underlying index on any day.

For SPY, the critical levels to watch this week are shown in the chart below. A close above $136.45 negates the short trade. Support is at $132.99, and a break below that level could see prices retest the recent low near $127. Based on market history, SPY should break the initial support this week.

Explosive ETF: Egypt Delivering Gains (more)

Chart of the Day - Dr Pepper Snapple Group (DPS)

The "Chart of the Day" is Dr Pepper Snapple Group (DPS), which showed up on Friday's Barchart "All-Time High" list. Dr Pepper Snapple on Friday posted a new all-time high of $43.88 and closed up +0.64%. TrendSpotter has been long since March 30 at $40.21. In recent news on the stock, Wells Fargo upgraded Dr Pepper Snapple and raised its target to $45-47 from $36-38 on expectations for earnings growth acceleration in 2013 due to lower commodity costs. Dr Pepper Snapple Group, with a market cap of $9 billion, is one of the largest beverage companies in the Americas. They manufacture, market and distribute more than 50 brands of carbonated soft drinks, juices, ready to drink teas, mixers and other premium beverages across the United States, Canada, Mexico and the Caribbean.