Financial Market Commentary

One week ago, on May 8, we implemented the trades suggested by our student analysts from Spring 2012. Based on a sluggish call on the US economy (link here), which they published in February 2012, the students recommended reducing exposure to the materials, energy and consumer discretionary sectors by selling our positions in:

• Nucor (NUE)
• Schlumberger (SLB)
• Lowes (LOW).

The student analysts also recommended increasing our exposure to the information technology sector by initiating new long positions in:

• Microsoft (MSFT)
• Accenture (ACN).

The chart below shows the performance of the student recommendations. After the first week of trading, our 2 new long positions in MSFT and ACN are outperforming our 3 sell recommendations, which are all in negative territory.

This semester’s Student Investment Fund class has just added Microsoft (MSFT) and Accenture (ACN) to their Buy list. Next step is to identify entry points for these stocks. Our investment process accomplishes this by using some basic long- and short-term technical analysis indicators. A chart of MSFT’s weekly closing price, along with the 50- and 200-week moving averages of price, is shown below.

MSFT began a new long-term uptrend in early 2012 when its price broke above its 50-day moving average. Although MSFT’s price has retrenched recently, the long-term uptrend remains intact. This is corroborated by MSFT’s relative strength indicator (RSI, top panel of the graph) vs. the market of 60 (> 50 indicates relative outperformance), and their positive MACD (lower panel) of 1.45.

After establishing the stock’s long-term trend, we move on to an analysis of their short-term trend. The chart below shows MSFT’s daily price along with their 50- and 200-day moving average.

MSFT remained in a short-term uptrend from the start of the year through mid-March (rising channel delineated by the parallel red lines), when its price broke below the lower channel. Since that time MSFT has been consolidating in a range defined by support at $30.10 and resistance at $32.75. MSFT’s weak short-term price momentum is further confirmed by their RSI of 45 and their weakening MACD, which recently turned negative at -0.2.

The chart above provides a closer look at MSFT’s MACD. Note how the MACD crossing below the MACD signal line in early February provided an early warning of MSFT’s deteriorating fundamentals. Most recently, the MACD has bottomed and is trending sideways, but remains well below the signal line. MSFT’s weak short-term price action suggests that better entry points may lie ahead. (MSFT traded at $31.44 in the pre-market session on 04.18.12. One strategy for acquiring shares would be to sell the May $31 put contracts for $0.70. If MSFT closes below $31 on May 21, you would take delivery of 100 shares of MSFT at a net cost of $30.30 per share.)

Next we’ll apply the same process to Accenture (ACN), shown in the chart below. A 3-year chart of ACN’s weekly price shows that the stock has been in a significant long-term uptrend. Although the stock is currently trading near the low end of the uptrend channel, the long-term uptrend remains intact. This is corroborated by the price above its 50- and 200-week moving average, an RSI of 56.8, and an MACD of 2.16 (above its signal line).

A 6-month chart of ACN’s daily price, depicting its shorter-term trend, is shown below. This chart tells a different story. ACN has broken below its short-term uptrend channel, and the price is just 57 cents above its 50-day moving average. ACN’s daily RSI of 42.9 indicates a deteriorating short-term trend. ACN’s faltering price momentum is corroborated by its MACD of 0.44, which broke below its signal line in late March and continues to decline.

The chart below provides a closer look at ACN’s MACD. The late March break below its signal line is evident. The evidence suggests that, similar to MSFT, it may be possible to acquire shares at a slightly better entry point.

[Epilogue: The US stock market surged on 04.17.12, and ACN closed at $64.14. With a sell in May and go away late spring pullback lightly, continued patience in acquiring shares of ACN is recommended. ACN's May $62.50 puts are selling for $0.90. Writing 1 put contract would provide investors with a net entry point of $61.60 if ACN closes below $62.50 on May 21. If not, the investor gets paid $90 to wait another month and observe the price action going into the summer months. Alternatively, the August $60 puts were selling for $2.75 -- writing these put contracts provides an investor with $275 up front, and if the Information Technology sector gives back some of its gains from Q1 2012, and ACN closes below $60 on August 18, you could acquire shares at a net cost of $57.25.]

It was “risk-on” in Q1 2012 in the US Stock Market, as Information Technology, Financial, and Consumer Discretionary stocks led the way with returns of 13-15%:

Five sectors earned less spectacular returns of 3-5%: Health Care, Telecom, Consumer Staples, Industrials and Materials:

Energy and Utility stocks earned returns of -3%, as oil and natural gas prices softened considerably. Note how Energy was a big gainer until late February:

Thus far 2012 has been more or less a carbon copy of 2011. More speculative sectors led the way early, fueled by Fed chatter of endless rounds of Quantitative Easing. The question is, of course, will investors rotate into safer sectors later in the year, as they did in 2011′s version of Sell in May and Go Away, or will the Fed-fueled bull market conditions persist for the summer and fall?

[This post is a guest column written by Tom Cleveland of Forex Traders. Tom's bio appears at the end of this article.] Ben Bernanke is in big demand these days.  Not a day goes by that he is not making a speech, testifying in Congress, or conducting a private interview for later public consumption.  Reminiscent of that investment banking commercial of old, when Ben speaks, everyone listens.  Soon we may be treated to Ben’s dietary preferences or what saxophone music he likes, as if these new bits of data will reveal if a “QE3” program is definitely in the works.

Why all the fuss?  Money, and lots of it!  Never in recent history has one man and his “merry band of bankers” weighed so heavily on daily market sentiment.  Investors, analysts, and fund managers across the planet hang on his every word or shift in body language. Global financial markets have reached a critical stage in their development, either resting on a precipice or a launch pad ready to take off, depending on the degree of optimism or pessimism that “colors” your present outlook for near-term prospects.

A simple survey of the investment scene is in order.  The diagram below provides a look at the past two years and how “QE2” reshaped the investment playing field:

A variety of ETF correlations are presented that depict the market reaction to the last program of quantitative easing, “QE2”, as it was dubbed by the press.  In May of 2011, the world was reeling from the full disclosure of potential credit problems erupting on the European front.  The Fed subsequently launched its $600 billion security buy-back program to add stimulus to credit markets.  These actions ignited rallies across the board, from precious metals and oil to stock valuations both far and wide.  The only “casualty” was the U.S. Dollar.  Expanding the money supply reduces the global purchasing power of a nation’s currency.

When QE2 ended in June of 2011, the crisis in Europe escalated, bringing uncertainty and volatility to financial markets.  Many investors scurried for the exits, choosing to sit on the sidelines, while Ben’s “gift” provided the stimulation the market needed for another broad-based rally.  Positive economic data confirmed that a recovery was really taking shape in the U.S. market, although the housing sector has been stubborn, refusing to shed its “shadow” inventory, even with interest rates at all time lows.  Disposable income has yet to rally, a necessary action to ensure an increase in mortgage loan qualifications.

Fast forward to the present, and we find ourselves in “consolidation” mode, once again across the board.  Will another dose of stimulus in the form of “QE3” come down from on high?  Only Ben knows for sure, and he does not easily share his thoughts for the imminent quarter at hand, despite the large magnifying glass that is pointed right at him.  Many analysts thought an update in December GDP figures and prior jobless claims would tip Ben’s hand, but the market barely moved a notch.

Bernanke and his fellow board governors are tight-lipped on the topic, although now everyone is on the edge of their seats waiting for hints from each man’s speaking engagements.  The truth is that the past is not their concern.  The current stage of development and leading indicators are more a reference point for where their feelings actually lie.  Employment data has surprised Ben and others, suggesting that we may be getting ahead of ourselves, as if that were a bad thing.

If we truly have “borrowed” a bit of growth that was not to come until later, is that reason enough to go to the “QE3” pump?  A big change in direction is imminent, but which way?  Stay tuned!

Tom Cleveland has over 30 years of experience in the international payments industry and currently manages his consulting business and represents ForexTraders.com through various guest columns.  Tom’s writing on business issues has appeared in the NY Daily News and BusinessInsider among others.

The state of the “recovery” in six compelling charts. After the recessions that began in 1990 and 2001, it took 30 months and 45 months, respectively, to regain the number of jobs lost. It’s been forty-five months since the start of the Great Recession, and  the US is not even close to regaining all the lost jobs.

The number of US civilians dropping out of the labor force is rising at an increasing rate.

 Four years after the start of the Great Recession and the number of Americans on Foodstamps continues rising.

Home prices in the vast majority of the cities most affected by the housing depression continue to fall.

Unemployment rates are soaring in Spain, Greece, Ireland and Italy, despite the fact that these countries have accomplished next to nothing regarding their crushing debt problems thus far. What will unemployment in these countries look like after a few years of austerity?

 The chart below shows that fixed income returns were positively related to credit quality in 2011 (which ended the year in “risk-off” mode). Thus far in 2012, fixed income returns have been negatively related to credit quality (suggesting an abrupt shift to “risk-on” mode).

Is it time to take some profits from the overbought US stock market and play a little defense? Note that equity markets started 2011 with a similar risk-on surge, only to correct sharply in the spring and even more sharply in late summer and early fall.

Despite a slow start to the week, US equity markets remain in “risk-on” mode thus far in 2012. The performance of the top sectors (Financials, Technology and Telecom) are shown in the graph below. These sectors have posted total returns of 9-10% in the first 6 trading weeks of 2012.

The next set of sectors, Consumer Discretionary, Industrials and Materials, have averaged about 8% over the same period:

Lagging behind for the year are Energy, Health Care, Consumer Staples and Utilities, with those last 3 being the classic “risk-off” defensive sectors.

Will the market’s preference for the risk-on trade be the story for 2012, or will 2012 repeat the pattern seen in 2011, where the risk-on sectors led the way early, with the defensive sectors taking control in the second half of the year?

Markets were elated over the higher-than-expected gain in Total Nonfarm Payrolls in January. That large gain, of course, was only discernible after a “seasonal adjustment,” made at the discretion of government statisticians. Below I’ve charted Total Nonfarm Payrolls since 2005 without any seasonal adjustments (NSA):

The graph shows that there are predictable declines in total employment in July and January, due to abrupt changes in summer and holiday jobs. These abrupt changes are easier to see if we look at the change in Nonfarm Payrolls NSA:

Minus the discretionary “seasonal adjustment,” the economy actually shed 2.7 million jobs in January. The seasonally-adjusted (SA) Nonfarm Payrolls number does not measure the actual number of jobs created or destroyed. The SA number instead measures what total employment WOULD BE if it weren’t July or January. And it’s important to note that much of the seasonal adjustment process occurs based on the discretion of government statisticians. Who couldn’t possibly be under pressure to produce evidence of a stronger economy during a presidential election year. No way.

To help reconcile the large difference between the seasonally-adjusted and non-adjusted data, I also graphed Total Tax Collections and Income Tax Collections by the States:

If the economy were adding jobs and more people were working again . . . shouldn’t the states be collecting MORE total taxes, especially income taxes? Maybe we should start seasonally adjusting more data, so these annoying divergences — that make absolutely no sense — would be harder to document. Further notice in the above graph how Total State Income Taxes are falling faster than Total Taxes, which suggests FEWER people are working and paying Income Taxes, not more.

“Ladies and gentlemen, boys and girls — in the blue corner, we have the non-seasonally adjusted data. In the red corner, we have the discretion of government statisticians. The referee has explained the rules to each fighter.”

But my question is: Does the “audience” that trades and invests based on the discretion of government statisticians understand the rules? Do they even pay attention to the rules? And if they could only choose one, would they choose a.) accurate data or b.) the increasingly-addictive rush of dopamine associated with another triple-digit gain in the Dow?