The Daily Trading Report

Everyone these days seems transfixed on the behaviour of the Baltic Dry Index, perhaps too much so. Does anyone realise how the Baltic Dry index is calculated? In essence there are four dry bulk carrier classes ranging from the super large Capesize class to the smaller Handysize class. There are relatively few capsize vessels compared to handysize vessels. So demand and supply of capsize vessels can vary dramatically relative to that of handysize vessels. Now the Baltic Dry index is made up of the largest of the four shipping classes (capesize, panamax, and supramax), the smallest class (again handysize) is not included. So what is the point of all of this? Well don’t take too much notice of the Baltic Dry Index, it is often misleading due to the erratic demand supply behaviour of capsize vessels. You would be much better off studying the demand and supply characteristics of the Baltic Handysize Index instead.

Now doesn’t the behaviour of the chart below (the ETF SEA) look remarkably like the Baltic Handysize Index! Of course beauty is in the eye of the beholder………..to us simple folk it looks like shipping rates are set to move higher and along with it shipping stocks. Perhaps it does not take a rocket scientist (economist) to work out that commodity prices are also set to lift-off over the coming weeks!

The after-hours earnings announcement from Alcoa that topped analysts’ estimates suggests that resource stocks are in all probability still cheap. It is quite likely that steel stocks such as Nucor and US Steel will also beat estimates if Alcoa’s results are anything to go by.

We have been watching the behaviour of the ETF SLX over the last few months and have been rather surprised at how strong it looks from a technical perspective and given the average price to book ratio of the constituents at 1.28x we still believe that the steel sector offers compelling value.

Take careful note of the ETF SEA. A break above the 14 level will generate a powerful confirming bullish signal for the steel sector. We believe that it is only a matter of days before the ETF SEA breaks through given the recent behaviour of Baltic Freight Rates

Our wealth creation portfolio is up 16.20% since the beginning of the year with approximately 40% of the volatility of the S&P 500. This portfolio is not leveraged.

Subscribers to our paid service are privy to our portfolio, sector weightings, and trade history.

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It appears that capital flows into emerging markets remain strong and there is no credible evidence that the strong absolute and relative (to developed markets) trends are about to come to an end anytime soon.

Emerging equity markets are now higher than they were at the time of the Lehman’s collapse and have yet to show any deterioration in upward momentum. We believe that there is more upside to come in equities because the underlying breath of the market is strong. Small cap emerging equity indices are only a few points away from multi-week highs suggesting that even the highly risky “rats and mice” stocks are continuing to make new highs. Usually prior to any significant correction the underlying market turns down. From a relative perspective emerging market equities continue to outperform the S&P 500, with EEM less than a 2% away from a multi-week high against the SPY.

Emerging bond markets also show no deterioration in upward momentum from both an absolute and relative perspective (relative to US investment grade bonds). The relative outperformance of emerging market sovereign bonds (to US investment grade) also suggests that the appetite for risky assets remains “positive” for whatever reason.

On the emerging market currency front CEW is less than 1% away from another multi-week high signalling a new high for emerging market currencies in general against the USD.

Note the appearance of the two foundation members of the emerging market universe. The South African Rand and Brazilian Real are more or less at multi-week highs. Having spent considerable time in both countries over the last 10 years we question as to how they can still be regarded as “emerging”. Anyway we think the classification of “emerging” is merely semantics.

Given that equity, bond and currency markets are all confirming each other with levels either at or very close to new multi-week highs, we think that more upside is likely in anything emerging market cover the coming weeks. We don’t know what the future holds, but we do know that markets move in trends and we know a strong trend when we see one.

Our wealth creation portfolio is up 16.32% since the beginning of the year with approximately 40% of the volatility of the S&P 500. This portfolio is not leveraged.

Subscribers to our paid service are privy to our portfolio, sector weightings, and trade history.

By the time the average investor wakes up the greatest buying opportunity for real estate stocks in recent (if not modern) history may well be over. There is something powerful and broad based which is driving real estate and related stocks higher. The big real estate ETF IYR is getting closer to pulling back all the losses incurred since the collapse of Lehmans some 12 months ago. Furthermore, IYR is now clearly outperforming the Dow (and the S&P 500).

Could this be just another dead cat bounce for real estate stocks? Given that anything with a real estate/home building connotation is flying right now (take a look at the performance of the Russell 2000 real estate and home building indices) we think that the real estate sector has entered another bullish phase. Obviously this won’t sit well with many fundamentalists who would argue that consumers are still maxed out with respect to credit……but it is happening!

Our wealth creation portfolio is up 19.06% since the beginning of the year with approximately 40% of the volatility of the S&P 500. This portfolio is not leveraged.

Subscribers to our paid service are privy to our portfolio, sector weightings, and trade history.

There has been considerable debate as of late regarding the prospects of shipping stocks (albeit lack thereof). We are very interested in shipping stocks due to their “out of favor” nature and cheap valuations. Most shipping stocks are trading below their book value, obviously for good reason. From the charts below one notes that on an absolute and relative basis shipping stocks (using the ETF SEA as a proxy for world shipping stocks) are virtually unchanged since October last year.

One really needs to see some sort of evidence of a bullish breakout before getting too excited about the prospects of shipping stocks. However, that being said, we believe that the next big move for shipping stocks is to the upside…..and big it is likely to be (given that SEA has tracked sideways for almost 11 months. We are reasonably confident that a break to the upside will occur given the behavior of coal and mining stocks (as per the charts below). Over the long term at least we find it difficult to believe that basic materials and coal stocks can keep rising without associated advances in shipping stocks.

It is interesting to note that the ETF SEA now has options attached to it. So exposure can also be gained via options trades.

Our wealth creation portfolio is up 17% since the beginning of the year with approximately 40% of the volatility of the S&P 500. This portfolio is not leveraged.

Subscribers to our paid service are privy to our portfolio, sector weightings, and trade history.

A pull back is necessary to shake the weak hands out of the market. From mid July to mid August US stock markets have advanced in a rather parabolic fashion with barely a negative day worth noting. So a pull back in the market should be seen as necessary and healthy. In fact we would not be “moved” if there was at least another 5% downward movement in the S&P (to the 950 level), and would see the weakness as a buying opportunity rather than selling.

What would make us “scared” about the longer term prospects of the stock market? The key to understanding the true intention of the market is to observe how markets work off an overbought or oversold position. With respect to a bull market, if the pull back in the major market indices is accompanied by a lack of conviction in the overall market (i.e. the advance decline line holds out or at least shows a general reluctance to participate in the downside of the S&P 500) then we would conclude that the weakness in the S&P 500 is merely a short term correction and unlikely to result in any material (albeit tradable) downside.

Below is the NYSE Advance Decline Line and the Value Line Index. Note how the Advance Decline line is virtually unchanged and the Value Line has already pulled back all of Monday’s losses. If the market was genuinely bearish then we should have already seen a breakdown in the AD line and the Value Line should not have been so quick to pull back the losses sustained on Monday.

Granted it is still early days but given how the market has behaved over the last few weeks we see the weakness in the S&P 500 as nothing more than a correction in an “ongoing” bull market.

Our wealth creation portfolio is up 17% since the beginning of the year with approximately 40% of the volatility of the S&P 500. This portfolio is not leveraged.

Subscribers to our paid service are privy to our portfolio, sector weightings, and trade history.

With major market indices registering multi-week highs it does not take a rocket scientist to figure out that equity markets have probably moved into an overbought condition. From a technical perspective we find the best indicator of the degree to which a market is overbought or oversold is the 200 day moving average ratio (the ratio of stocks trading above their 200 day moving average). In the past whenever the NYSE and NASDAQ moving average ratios moved above 80% there was a better than even odds of the major market indices closing lower 6 months hence. Currently 88% of stocks on the NYSE and 75% of stocks on the NASDAQ exchange are trading above their 200 day moving average.

So do these ratios suggest a bearish stance towards equities? Given that 200 trading days ago takes us back to mid November which was one of the low points in the S&P 500 it would not have taken much for 80% of stocks trading in the US to move above this point. So it is difficult to argue that, even with more or less 80% of stocks in the US trading above their 200 day moving average, the US stock market is in an overbought condition. Indeed at this time there has been no deterioration in the underlying momentum of the market with the equally weighted Value Line Index registering another multi-week high last night. We would begin to worry about the medium term outlook for equities when there is a divergence between the performance of the NYSE Comp and the NYSE 200 moving average ratio. Currently both indices are confirming each other.

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Wait for the average man in the street to start talking about stocks, although a growing number of economists are walking on the bullish side of the fence we have yet to see any evidence of the average man in the street getting bullish about the prospects of the US stock market, yes this is a subjective statement but don’t forget, unlike the physical sciences, we are not dealing with an objective “science” or subject matter.

Our wealth creation portfolio is up 18% since the beginning of this year with approximately 40% of the volatility of the S&P 500. This portfolio is not leveraged.

Subscribers to our paid service are privy to our portfolio, sector weightings, and trade history.

Market internal indicators continue to suggest that equity markets are likely to move materially higher over the coming weeks. The Advance Decline Line and New High new Low Indices for the NYSE, AMEX and NASDAQ are more or less at new highs. Usually weakness in the major market indices, such as the Dow, S&P 500 and Nasdaq is preceded by a break down in market internals. We would be worried about the sustainability of the advance in the S&P 500 if the recent highs in the S&P 500 were not being confirmed by new highs in market internal indicators, obviously this is not the case.

A quick way of looking at the health of the underlying market is to look at the relationship between small caps (the Russell 2000) and large Caps (the S&P 100). If small caps are outperforming large caps then it is reasonably safe to conclude that market internals are healthy. OK so how would we define small caps outperforming large caps? We use the 120 day Rate of Change of the relative of the Russell 2000 and S&P 100. If the 120 day ROC is positive it denotes outperformance. The graph below clearly suggests that the Russell has been outperforming the OEX since mid April and last night the relative closed at another multi-week high. This is all supportive for continued upside.

Whilst market internals remain healthy we see any weakness in the major market indices as a buying opportunity rather than selling.

Our wealth creation portfolio is up 18% since the beginning of the year with approximately 40% of the volatility of the S&P 500. This portfolio is not leveraged.

Subscribers to our paid service are privy to our portfolio, sector weightings, and trade history.

We have been watching commentary regarding the US housing/real estate/construction sectors over the last few months with interest. There seems to be a common theme coming through. That is, a flat refusal to entertain the possibility that we have already seen the bottom of the US housing market, or that the US housing “bubble” has been deflated. It would seem that if you wanted to get yourself dragged off to the nut house by strange men in white coats all you have to do is publically announce that you are bullish the likes of KB Homes, Toll Brothers, or Simon Property Group! Let us look to the liquid markets for indications as to what is happening on the property scene.

If we knew no better (and we are none the wiser), it looks as if the US property market has already bottomed! A number of key indices/indicators are either at resistance levels or have already broken through. Of course you can argue until the cows come home about how bleak the outlook for the US housing/construction sector looks but have you stopped to think what will need to happen to turn you bullish? We cannot help escape the echo of John Templeton’s famous quote “invest at the point of maximum pessimism”. We think that this point is about now.

It is encouraging to note that the ETF IYR has performed more or less in line with the Dow over the last 9 months. Given that there is more bearish sentiment towards IYR than the Dow we think that there is probably more upside potential in real estate stocks than regular “blue-chip” industrial stocks(a dividend yield of 8% also helps somewhat). This may seem to be complete madness, but we just cannot help ourselves. Remember, when everybody thinks alike the opposite is most likely to happen!

Our wealth creation portfolio is up 15% from the beginning of the year with approximately 40% of the volatility of the  S&P 500.

Subscribers to our paid service are privy to our portfolio, sector weightings, and trade history.

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From the charts below we conclude that equity markets are genuinely bullish as evidenced by:

1. The multi-week highs and the strength of the underlying market (as per market internals, small caps, mid caps, and small cap emerging market indices). If the market was weak then we would not see new highs in small cap indices and particularly emerging market small caps.
2. Any weakness in the indices being quickly arrested. If markets were bearish there would be a sluggish claw back of previous losses.

Are markets overbought again? Yes the NYSE 200 day moving average is up at 80%……but be aware if the market starts trending (we think that it already is) then we can expect it to remain overbought for some time. The 200 moving day average ratio is a good indicator for oversold situations but history suggests that it does not hold a respectable record for calling market tops (the actual %age that is). If the moving average ratio started to diverge from the performance of the S&P 500 then we would start to get worried.

What about volume, it seems that markets have been advancing on decreasing volume! Yes volume has been declining ever since September/October last year……but then what do you expect. We had a crash in Sept/October and then again in Feb/March that was comparable to the big one in 87! The volume going through the market over the last three/four months is not materially different than volumes that occurred over the last three years (taking out the volume associated with the two crashes we have just had).

The market is suggesting that it wants to go higher (for whatever reason). We are positioned accordingly.. who are we to question the market’s intentions!

Our wealth creation portfolio is up 13% from the beginning of the year with approximately half the volatility of the S&P 500.

Subscribers to our paid service are privy to our portfolio, sector weightings, and trade history.

Receive these market updates daily with our free newsletter.