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Brexit: The Great Diversion

The last time I recall so much incessant chatter & focus on a potential market moving event would have to be the Grexit fears a few years back with the big difference being that those worries (of potential fallout from a Greek exit of the Eurozone) was that the markets had priced in a good amount of the potential fallout from such an event, should it have occurred. This time around things are different as the S&P 500 has surged about 16% off the February lows & is only mere percentage points from both its 2016 highs as well as all-time highs. With that being said, I think that it is reasonable to assume that the market has pretty much put full faith in the recent polls and has priced in a REMAIN vote. If so, that leaves very little, if any room for an upside "surprise" rally and a potentially powerful sell-off, should we happen to get a LEAVE vote. Then again, that assumes logic and reason, something that this CB manipulated market has been lacking for years so I'll just leave it at that & wait to see what happens over the next several trading sessions as it isn't the news or outcome of a particular event that matters in trading & investing, rather it is only the market's reaction to an event that matters.

Whether the vote is STAY or GO, my expectation is that, barring the typically post-news noise (volatility), which should subside in a day or so after the results are in, is that the focus on the markets will quickly move away from the Brexit vote and any potential fallout, back towards the most important factor IMO which is the marked deterioration in U.S. corporate & economic fundamentals.

There are two primary disciplines or methodologies for security selection (deciding what to buy & when to buy & sell it) in trading & investing: Fundamental Analysis (FA) and Technical Analysis (TA). The definitions of each, as per Investopedia.com are:

FUNDAMENTAL ANALYSIS: A method of evaluating a security that entails attempting to measure its intrinsic value by examining related economic, financial and other qualitative and quantitative factors. Fundamental analysts attempt to study everything that can affect the security's value, including macroeconomic factors (like the overall economy and industry conditions) and company-specific factors (like financial condition and management). The end goal of performing fundamental analysis is to produce a value that an investor can compare with the security's current price, with the aim of figuring out what sort of position to take with that security (underpriced = buy, overpriced = sell or short). This method of security analysis is considered to be the opposite of technical analysis.

TECHNICAL ANALYSIS: Technical analysis is a trading tool employed to evaluate securities and attempt to forecast their future movement by analyzing statistics gathered from trading activity, such as price movement and volume. Unlike fundamental analysts who attempt to evaluate a security's intrinsic value, technical analysts focus on charts of price movement and various analytical tools to evaluate a security's strength or weakness and forecast future price changes.

Typically, fundamental analysis is utilized by long-term buy & hold investors or fund managers, such as Warren Buffet, while technical analysis is primarily used by swing traders & active traders with shorter time horizons on their trades ranging from minutes to day, weeks & usually not much more than a few months. One of the biggest issues with using FA when actively trading is that fundamentals, even if your analysis is spot on, can take months & sometimes years to become fully reflected in the price of the security. With technical analysis, we are able to much more precisely identify our entry & exit points on a trade.

Although traders & investors employing technical analysis rely heavily on the use of charts, not all charts fall under the category of TA. I have put together an extensive compilation of charts below which fall under the category of Fundamental Analysis & clearly show a marked deterioration in US corporate & economic fundamentals. Long before discovering the "magic" of technical analysis, my background & primary focus was fundamental analysis; first as a business major in college, with degrees in both Multinational Business & Marketing, followed by a 12-year career as a stock broker before walking away from that career to pursue my life's passion (technical analysis & stock trading) & embark on a new career as a full-time trader in 2007. As such, I do incorporate both FA & TA into my analysis, particularly when formulation my longer-term outlook for a stock, commodity or the financial markets.

As I've already exceed the length of my typical posts, I'm going to let the charts below do the rest of the talking but before that, I wanted to share the following link to this article from Reuters which opens with: "The Federal Reserve on Tuesday delivered its starkest warning yet under Chair Janet Yellen that by its assessment U.S. stocks are pricey." (click this link to view full article: Fed Warns U.S. Equity Valuations "Well Above" Median. It would appear to me that is Yellen's way of trying to 'talk-down' the market in order to prevent a catastrophic meltdown once the Fed is soon force to embark on a meaningful (not token, like the last hike) & lasting cycle of rate hikes in order to prevent minimize the damage of once again being caught behind the curve as inflation begins a steady climb, as we've already seen with commodity prices exploding after putting in what clearly appears to be an end of their multi-year bear market earlier this year.

I've been making the case from a technical perspective for some time now that when the U.S. stock market peaked in early-to-mid 2015, that it was most likely the end of the bull market that kicked off with the March 2009 lows. The charts below, using fundamental analysis, help to corroborate the bearish technical case as many of these economic indicators also peaked around the same time, with most if not all showing continued deterioration since without any signs of reversing trend. Click on the first chart in a series to expand, then click the arrow to the right to advance to the next full-sized chart.

 

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Jun 22, 2016 12:33pm|Categories: Equity Market Analysis|Tags: , , , , , |21 Comments

21 Comments

  1. snp June 22, 2016 12:44 pm at 12:44 pm

    great post! now we have polls and posts. lets build something.

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  2. snp June 22, 2016 12:48 pm at 12:48 pm

    advance decline ratio disagrees. if the market goes to new all time highs, how do you see it? the time scale longest correction in market history, or fed muted 7 year cycle complete, or other?

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    • rsotc June 22, 2016 1:18 pm at 1:18 pm

      @snp – A couple of point to that: First, I was going to mention, although that post was already long enough, that I cherry picked the economic indicators to show only those that looked clearly bearish. I will say though, that the vast majority did look bearish with only a few that might be construed a bullish & the bulk of the remaining indicator were simply unclear (neutral). I don’t consider that bias as the point of this or any article is to show supporting evidence to make your case but again, I had originally intended to mention that I’d imagine one could pick a few indicators & make a bullish case.

      On the point of the A/D line, here’s my $NAAD (Nasdaq A/D line) daily which shows a divergent high on the $NAAD as well as the Nasdaq Composite*. (*although the MACD & RSI on this chart are associated with the $NAAD, the $COMPQ also put in a nearly identical divergent high on the daily chart with the most recent reaction high).

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  3. dan123 June 22, 2016 1:05 pm at 1:05 pm

    Great post Randy, thank you

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  4. alshaw June 22, 2016 1:12 pm at 1:12 pm

    if the crb and oil has a bottom there aint no way the sp 500 iwm qqq are going down

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    • rsotc June 22, 2016 1:33 pm at 1:33 pm

      By that logic (the market can’t go down if the $CRB & $WTI goes up), how would you explain the fact that from the June ’14 highs into the Dec ’15 lows, $CRB fell 45% while $WTI crashed by nearly 70% yet the Nasdaq 100 rose by 25%? I’ll agree that historically there was a positive correlation between commodities & equities but that positive correlation flipped to a very clear inverse correlation starting in Q3 2011, most likely as a result of the distortions in the financial markets created by the CB’s excessive & extreme interventions. Maybe the correlation returns, maybe not. One thing for sure is that the Fed will be boxed into a corner, should commodity prices continue to soar throughout 2016 & beyond as they will be forced to raise rates to curtail inflation with a global economy that is completely hooked on free money, just like a heroin addict & there aren’t enough methadone clinics in the world to break that addiction.

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  5. jegersmart June 22, 2016 2:05 pm at 2:05 pm

    At least he stopped posting in capital letters only, even if the content is the same…^^
    If you have been around long enough, you will know almost every correlation lasts only until it no longer does, and when that happens a lot of folks usually find themselves up some creek without a paddle.

    Thanks Randy.

    J

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  6. Eric K June 22, 2016 2:13 pm at 2:13 pm

    Randy,

    This post, the one on Brexit, and previous one on swing trading a sideways market are great and they all speak to a couple of points that I’ve been learning the hard way the past couple of months:

    1. That the markets can remain irrational longer that I can remain solvent (I stole that quote). I believe that the global economy, propped up by central banking mistakes over the past decade, is fundamentally weak (as you’ve pointed out), that we are entering the end of the credit cycle and a natural restructuring of debt needs to occur, and that national (and global for the most part) demographics do not support rapid economic growth for the next two decades at least.I believe that the markets will eventually reflect these fundamental facts, but I have no way of knowing when. And I’m also not certain that when the “when” comes it will be a waterfall event like the most recent past “whens”.

    So I’ve recently taken a core PSQ position and set the stops above the very prominent DT line that you’ve drawn on past QQQ posts. I (think I) will add to those positions as the Qs test that DT line.

    An open invitation to the group to give me feedback on this approach of holding a core short position longish term.

    2. That I’m not very good at quickly repositioning for the rips in this “downward” market, as evidenced by my giving back, in the rip that occurred a couple of weeks ago, a good portion of the gains I made being short (and in the nice dash for trash long trades you found) at the beginning of the year. Many of those losses were due to poor entry pricing, stops getting tripped (all my trades have strict R/R based stops placed immediately upon trading), cutting losses earlyish but having enough correlated trades in play that while individual losses were small, in aggregate they mattered. I could clearly use more guidance on position management, and overall portfolio management.

    Since I believe that a lot of money will be made in this (sideways to slightly downward) market by hitting these multi week movements up and down, that proper positioning, risk management and portfolio management will be critical.

    Open questions to the group:

    — How do you objectively determine when to dump a trade early, before stops get taken out, vs giving it time to run? Are there rules of thumb like “sell all losers on Friday before the close” or objective indicators that should be used to prevent me from sitting on, for example a PCLN trade that looks like it will get stopped for a loss soon.

    — How do you allocate your trading portfolio within your overall portfolio? Do you change the allocation at all when having an overall short bias vs bull market bias?

    — What guidelines do you use to ensure proper diversification among your trades to prevent high correlation (especially in a market like where everything seems correlated – and then it doesn’t – depending on the week)?

    Many thanks to the group. This is a fabulous site.Learning a lot, making a little.

    Eric K

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    • rsotc June 22, 2016 3:16 pm at 3:16 pm

      Excellent questions Eric. On point #1, let me say that I think PSQ (1x short $NDX) is a good choice for a potential long-term swing short position on the markets. Not only do I believe that the $NDX will fall more than the $SPX, assuming the US markets are headed lower in 2016 & quite possibly beyond, but the fact that PSQ does not use leverage makes it a better buy & hold option than SQQQ (3x short $NDX), especially if the markets continue to make a slow grind lower as they have for the last year or so. If so, PSQ won’t suffer from the decay that the leveraged SQQQ will. I also think that too many novice traders flock to the 3x leveraged ETFs for the “juice” but fail to adjust their position size downwards accordingly (by 1/3rd) to account for that leverage, thereby exposing them to potentially larger OR more rapid total dollar losses if the trade starts to move against them.

      On point #2, A couple of suggestions to anyone struggling with managing losses or with discipline regarding stops, as well as for part-time traders or investors that don’t have the time or inclination to continually monitor their positions, would first & foremost to have a trading plan. That means knowing where your entry (or entries, if scaling in) will be, where you will take profits & where you you stop out if the trade goes against you…before you enter the trade. Be selective on the trades that you take, choosing those stocks or ETFs that mesh with your own analysis, market/sector bias, risk tolerance & trading style. In other words, don’t take a trade on a low-priced shipping stock where double-digit intraday price swings are the norm if you aren’t comfortable with a trade that might require a 15% or more stop-allowance if targeting a 50%+ gain. Another suggestion would be to stick with ETFs if you are not able to diversify among numerous positions with individual stocks in order to mitigate any unusually large gap-induced losses that could well exceed your stop-loss order (ETFs hold a basket of stocks & as such, greatly mitigate the risk of a large earnings or news-induced gap).

      Once you’ve found a trade that you are comfortable with & have laid out your trading plan (entry & exit criteria), I can’t emphasis enough the benefits of OCO (one-cancels-the-other) aka OCA (one-cancels-another) orders. Those are orders in which you set your profit target (sell limit) and your stop-loss order on the trade at the same time. When either order is hit, the other order is automatically canceled. A simple set-it-and-forget method that helps to add discipline as well as a useful tool for those that don’t have the luxury or desire to sit in front of a computer every day during market hours. OCO’s are probably the best way to take out a lot of the emotion in your trading as you place the order immediately after entering the trade & then wait patiently until you are either stopped out or your profit target is hit.

      On a related note to the comments above, there are a few FAQs under the “Trading Related Questions” subcategory which I think are worth noting, such as “Why do some trades list multiple price targets?” What I would add to that FAQ would be to factor in the current market conditions in determine whether to target the early price targets (T1 or T2) or to hold out for any higher targets (T3-T4). Although I do my best to factor in the EXPECTED (not current) market conditions at the time the trade might get there, sometimes market conditions change. For example, if I list a swing trade with 4 targets with the final target representing a 40% gain, that is probably because I was expecting a strong trend in the market or the sector to help the trade get there. If market conditions have changed since that trade setup was posted, such as an unexpected trend reversal or we get caught up in a sideways grind that I wasn’t expecting, then it might be prudent to modify your trading plan & either book early profits or tighten up/trail stops to protect gains at that point.

      As far as diversifying your holdings, I think that is just as important in swing trading as it is with investing. It’s not always easy to know in advance when the majority of asset classes will start moving in tight lock-step, such as they have recently, but on balance, if you make a point to spread your positions among various assets classes & sectors with little to no correlation and ideally (especially in a sideways market like we’ve had for the last two years), also keep a mix of both long & short positions (long the most bullish setups, short the most bearish setups/sectors), that should really help smooth out the bumps & at times, you’ll even be pleasantly surprised at times to see both your longs & your shorts going your way in tandem. Hope that helps, let me know if I missed anything.

      -Randy

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  7. sportofkings June 22, 2016 2:17 pm at 2:17 pm

    Good take Randy. On the fundamental side, its hard to argue against leaning Bearish with a peak in the credit cycle, declining demographics along with the rate of change in the charts you posted.

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    • rsotc June 22, 2016 3:42 pm at 3:42 pm

      Thx sportofkings. Like Eric alluded to in his comments above, the market can stay irrational a lot longer than most of us can stay solvent. The main point of that post was to highlight the fact that although the technicals have been warning of some major cracks in the market for some time now, it also appears that the fundamentals are showing a pretty clear turn-down in the economy in what has already been referred to as the weakest recovery in US history (following a recession), if I’m not mistaken.

      While the recovery in the stock market since the 2009 bottom has been anything but weak, the gains in stocks were largely (but not completely) attributed to effects of the ZIRP & QE, which 1) made stocks one of the only viable investment options with money market funds, CD, gov’t bonds & other safe money investments providing near-zero to negative (after inflation) returns and 2) allowed corporations to borrow money at extremely low rates in order to finance stock buybacks in order to increase their share price (a very large driver of this bull market).

      While I fully acknowledge the extra “juice” that all of the Fed’s actions have done to exacerbate the rise in equity prices over the last 7 years, I remain in a small, if not microscopic camp of thinking that the bull market over that time was NOT the result of the Fed’s actions (again, I accept the fact that they acted as a turbo-boost, exacerbating the magnitude of the rise in stock prices). The bull market over the last 7 years, along with the recovery in the economy was simply part of the natural & fairly predictable business cycle (contractions & expansions).

      Just look at any long-term chart of the markets & economic data & one will see that we’ve had a fairly regular cycle of expansions & contractions/recessions in the economy, which correlated with the bull & bear markets in equities. Just as valuations were at extreme highs at the 2000 & 2007 market tops, as the are now, they were also a extreme lows at the bottom of each of the subsequent bear markets/recessions. Markets go up then markets go down. The economy expands, in which excesses are created, then the economy contracts, in which those excesses are purged out in which the next expansion emerges from. Fed or no Fed, stocks were dirt cheap in 2009 just as they are dangerously expensive right now as the were in 2007 & 2000. Yes, stocks were also expensive a year ago by historical measures & even two years ago however, the same economic indicators that I posted above were in much better shape than today.

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      • freezer June 22, 2016 5:57 pm at 5:57 pm

        As you have already said, you used discretion in your data support. That said, it’s a very good case to add to the technicals. Do you still think that a market regression will be a longer, steady decline compared to what we saw in 2008-09?

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  8. joefriday June 22, 2016 2:23 pm at 2:23 pm

    Fantastic..job Randy!..

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  9. snp June 22, 2016 2:25 pm at 2:25 pm

    really good conversation in all aspects.

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  10. charlie June 22, 2016 3:24 pm at 3:24 pm

    Many thanks,Randy, for your poignant fundamental compilation and shrewd technical analysis !

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  11. TXUTrader June 22, 2016 6:48 pm at 6:48 pm

    Another great analysis Randy.

    Like you I’ve been primarily short, but have been making swing trades long in the agriculture commodities to help navigate this choppy market.

    The next few days should be interesting as we see the result of the Brexit vote. I would have liked to see the market give up a bit more today for all indexes to close under their 5 day moving average; however it is interesting that the VIX was up 14% today and broke solidly above its 200 day MA. Also chart for the Dow Transports, an important leading indicator, is looking weak.

    Good luck to all.

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  12. schooner June 23, 2016 12:13 am at 12:13 am

    Excellent chart collection. Thanks!

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  13. TXUTrader June 23, 2016 9:11 am at 9:11 am

    This morning futures are up as early exit-polls indicate that Britain will likely remain in the EU. Does staying justify a rally around the world? (could see why the British Pound would rally).

    One indicator worth considering is Semiconductors Book-to-Bill report as bookings has improved for four consecutive months which has driven rally in SMH. Many people believe that this is a leading indicator.

    Important to consider all sides of the trade.

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    • rsotc June 23, 2016 10:08 am at 10:08 am

      @TXUTrader I hadn’t looked at the book-to-bill report in some time & wasn’t aware of the recent strength but you bring a good point as the semis often lead the tech sector. In addition to book to bill, some will use the chip equipment makers such as AMAT, KLAC & LRCX as leading indicators for the semis & tech sector… all of which have been very strong this year. Not sure how much more upside they have but if they don’t roll over & roll over hard soon, then that would be a potentially bullish sign for the tech sector which, of course, would likely carry over into the Nasdaq composite & $NDX. Thanks for pointing that out & yes, definitely important to consider all sides of the trade.

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  14. schooner June 23, 2016 12:02 pm at 12:02 pm

    Randy — one more thought (actually about your title — the great diversion — not about your charts — I think it will only be a diversion if (as the markets expect at this moment) the vote to leave fails. That’s one of those things that one can call a diversion if nothing happens, but I feel pretty strongly that if the Brits vote to Leave it will be anything but a diversion, it would be hugely upsetting to markets. I guess if nothing happens then it can be compared realistically to Y2K, but like many potential events that don’t play out, they are only diversions in retrospect. I’m making this observation as we watch markets rallying with the expectation that the Remain camp will win. If markets are then “fee” to run to new highs, then it won’t have been a diversion — it will have been an impediment that was removed. If Breixt goes down, and our market then rolls over — we never make new highs — then I think your title will have been exactly correct — I guess we will see soon enough. The fundamentals you laid out so well certainly argue that we should roll over, but as has been true for some time, the central banks have been winning the argument with the fundamentals. I guess we’ll see soon enough.

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    • rsotc June 23, 2016 1:39 pm at 1:39 pm

      As usual, you make some excellent points schooner. I actually considered using another title without the word diversion but decided to go with it. First off, I do agree with everything you said above. To expand on my thoughts, That post could really be broken down into two parts; the opening paragraph, in which I stated; “…With that being said, I think that it is reasonable to assume that the market has pretty much put full faith in the recent polls and has priced in a REMAIN vote. If so, that leaves very little, if any room for an upside “surprise” rally and a potentially powerful sell-off, should we happen to get a LEAVE vote.”

      That is somewhat of a stand-alone statement from the gist of the post in which I think Brexit is a diversion, or probably more fitting, a distraction in which all eyes (and buzz in the investment community) is focused on and more importantly, seems to be acting on (as evidence that the stocks have been ebbing & flowing with the results of the polls). Like most, I think the most probable outcome is a remain vote although again, it appears that nearly, if not all of that “positive” outcome has already been priced into the markets which leaves opens to door to a huge reaction to the downside if the vote happens to go the other way.

      Continuing on the distraction theme, assuming a REMAIN vote, then nothing has changed & with Brexit out of the way (barring any brief 1-2 day celebration rally), I think that the focus will start to turn back to the current trend of deterioration in corporate & economic fundamentals, unless they can conjure up some other distraction for the financial media to feed to the masses. I’m not a conspiracy theorist so to be clear, I do NOT believe that Brexit was something conjured up by the global CB’s to shift the focus away from the deterioration in the economy but I will say that the net effect of such a widely followed event such as Brexit seems very similar to the way that an incumbent leader or regime will start a war or conjure up some potential military conflict when they are clearly losing popularity with the electorate in order to deflect away from their failed economic/social policies at home & boost their approval ratings.

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