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II Insight


March 2 2009,   Edited by Tarquin Coe

Global leaders in Technical Analysis since 1947

      

Welcome to the March edition of II Insight.

 
The market certainly kept investors on their tenterhooks during February. It drew out a test of the November low on the S&P until the final trading day of the month. Whether this much anticipated test turns into a larger break remains to be seen.
 
However, big levels can see big rallies, as the 25% rally on the S&P off the July 2002 low in October of that year testified. Like then, its three months since the last low and with the low being tested, now is the perfect time to pull out the toolbox and consult some indicators for clues. We do just that in this month’s report but we also consider the repercussions of level failure and we warn you, it ain’t pretty...
 
Also this month we review the ever popular Advisors Sentiment, consider a bottom in the Commodities Index and we ponder a pull-back in the Greenback. We also explain a fast and simple stock picking strategy that takes literally two minutes (fittingly, it churns out a fast food stock!).
 
Look out for the launch of an exciting new intraday service that will highlight opportunities, both short and long, as they happen.
 
Happy trading
 
Tarquin Coe, Senior Analyst

    

    

 Charts of the Month – divergences pointing to a bear market bounce?

 
Last month we stated “If the indices do get back down to the lows and beyond, we will be looking for bullish divergence in indicators such as breadth”. The broad S&P 500 (SPX) fell to its November low in the final week of February and we are now avidly watching for directional cues from the indicators. One of the biggest strengths of indicators, such as momentum and breadth, aside from detecting oversold and overbought extremes, is that they often develop divergences at potential market turning points.
 
The first chart shows the breadth of the S&P 500, the percentage of stocks in the S&P trading in P&F bull trends.
 
Note the developing bullish divergence relative to the November low. Watch for the indicator to turn up to indicate upside potential.
 
 
 
 
 
 
 
 
 
 
 
 
The investors fear gauge is also diverging relative to the S&P 500. The degree of fear at the November low, measured buy the OEX Volatility Index (VIX), was a lot more severe than the level experienced at the end of February. This implies less selling pressure.
 
It would be bullish if the VIX subsided further, beneath 40.
 

  

 

 
 
 
 
 
MACD, Moving Average
Convergence Divergence, is a classic momentum indicator used for trend following. The indicator plotted here uses traditional parameters, the MACD line is the 12-day EMA (exponential moving average) minus the 26-day EMA, and the signal line is a 9-day EMA.
 
The blue MACD line needs to cross up through the red signal line to confirm the bullish divergence.
 
Note the bullish divergence and cross over just after the November low, providing a buy signal that lasted until early January.
 
 
 
So overall, divergences are developing but they are yet to be confirmed. Gun jumpers at the start line will get penalized and the same advice applies here. Wait for confirmation. Only when the flag is dropped, prepare for a strong rally.

 

    
    

Advisors Sentiment slips but the developing bullish divergence is encouraging

 

Our Advisors Sentiment Index identifies extreme levels of optimism or pessimism. The survey monitors over a hundred independent newsletters from market advisors, categorizing their view as either bullish, bearish or correction. Since its inception 46 years ago, the indicator has proven to be a leading indicator of long-term market bottoms, and is well regarded in the global investment community.

 

The red lines on the chart highlight the success of the Advisors Sentiment indicator over the last two years in catching the peak to trough, up and down movement of the S&P.

 

Last month we discussed the bull-bear difference and suggested that a break in the difference below -10% would be a concern. The survey in the last week of February did slip, down to -16%. However, the fall has so far dropped only as far as the rising trendline from the October low. Also noteworthy, is that we now have a massive potential bullish divergence, as the S&P tests its November low but the BBD trades a good distance above its November low (and the October low). This signal would compliment the divergences highlighted at the start of the report.

 

We are now looking for the BBD to turn back up and make gains for two consecutive weeks. In doing so, the bullish divergence would be confirmed, and with it a great buy signal.

 

 

Readings are published weekly in the Advisors Sentiment Report, analyzed every Wednesday before the open.

The S&P – Make or break? quarterly chart holds the key to long-term direction

 

Last month we stated “With the market no longer oversold and the constant barrage of bad news, there is little to stop the S&P from revisiting its November low at 741”. The fall to a low of 742, on Monday 23rd February, almost seemed effortless, with little fear amongst investors.

 

So the selling pressure may be out of the market, and that could be enough for the market to bounce from here, even if there is an absence of hoards of buyers.

 

That said, the long-term chart reveals the critical level we are now at. Price action on the quarterly bar chart is literally on a cliff edge, as a potential mountainous double-top looms. The pattern portends carnage, with a fall down to 375 for the S&P, slashing another 50% off current trading.

 

However, we are not yet forecasting this gloomy scenario, as the pattern is yet to be confirmed. Confirmation will come with the index ending this quarter beneath the patterns neckline, and strong follow through going into the next quarter.

 

The patterns neckline is the November low at 741, so the end of March will be interesting and could dictate direction for the rest of the year and beyond.

 

 

Each trading day we detail short-term opportunities, both up and down, in the International Equity Index Hotline.  We also provide region specific coverage in the UK Daily Hotline and US Daily Hotline.           

 

CRB tripped at the pithead but has it hit bottom?

 

 

The CRB Index (CRY) is a weighted commodity price index of 19 commodities, with Oil claiming the heaviest weighting.  Its decline from a high of 474 in July of last year has been spectacular. The index has slammed down to a major support shelf at 200, a level that has a history going back to the mid 1970’s. The level provided support during the sideways trading of 1974 through 1978, in 1986, 1992, with a brief break down to 183 in 1999 and 2001.

 

The index now trades just above support at 200. If this level fails, then 183 is the next point that could cushion a fall. Given the sharpness of the decline of the last seven months, a snap-back reaction is anticipated up to at least 250.

 

Now is a favorable time to buy into the CRB as the downside risk is known and stops can be placed near by, exiting on a close below 175 (the January 1975 low).

 

   

We analyze all major commodities daily in the Daily Commodity Hotline, emailed direct to your inbox.

 

USD – a one man band

 

The US Dollar Index (DXY) is a measure of the USD relative to a basket of weighted major currencies (Euro, Japanese Yen, British Pound, Canadian Dollar, Swedish Krona and the Swiss Franc).

 

The Greenback has been a safe haven for the last few months, alongside precious metals, the Yen and Treasuries.  However, all have now quit and left the group, although they forgot to tell the Dollar.

 

The Dollar is unlikely to make further gains, especially since its struggling to break horizontal resistance at 87.5.

 

Consider shorts on a reversal at current levels, as that would see a visit down to 77.5 and if that gives way, the early 2008 lows.

 

We analyze a range of currency spreads in the FX Hotline, emailed direct to your inbox.

    

A simple and fast stock picking Strategy

 

The Investors Intelligence website provides subscribers with a range of tools and features that can be used to identify trading ideas.

 

A month ago we detailed a top-down strategy, using breadth at the index level and drilling lower, through industries, to identify stock opportunities. The methodology picked out Burlington Northern Santa Fe (BNI).

 

Following the pick, BNI rallied 9% but then reversed at gap resistance a week later. As stocks rally it is good practice to place stops at entry to avoid a winner turning in to a loss. This, aside from losing money can also severely damage trading confidence.

 

This month we are going to detail a different strategy making use of the tools available to Investors Intelligence subscribers.

 

One of the key questions any trader should have answered before buying and selling a stock is quite simply - “is this a bear or bull market?”

 

    

 

On the II website, click on the “Charts” tab, “Global indices”, and select “Major World Indices” to the left. This table (illustrated above) can be sorted by daily change, weekly change and so on. However, for this exercise we want to understand the overall condition of the market. What is immediately clear is that all major global indices are in bear confirmed down trends (with the exception of the NASDAQ). Also evident is that, year to date, the indices have sustained double digit losses.

 

Overall the picture is clear, we are in a bear market (obvious but so easily dismissed). The only evidence against the bearish case is the strength in the NASDAQ. Tech is often a market leader, but until other indices reverse their P&F bear trends, the overall market remains in a bear market.

 

At the top of the list is the Dow Jones Industrials, one of the worst performers in the table over the last year. With that knowledge we need sell ideas from that index.

 

Clicking on the “USA” tab, “Signals” and then select “MA Crossovers” will generate a list of moving average crossovers for the last week.  Crossovers are where a faster moving average crosses the slower moving average, providing a buy signal in the case of a golden-cross and a sell signal on a dead-cross. At this point, with the assumption that we are in bear market, we are only interested in dead-crosses.

 

 

The only DOW stock appearing in the list for the 20th of February with a dead-cross is McDonalds (MCD). Clicking on the stock will bring up the chart and from there other chart settings can be investigated. For instance, the P&F chart for the fast food restaurant shows a break of long-term trendline support, good bearish evidence to support the dead-cross.

 

            

 

 

 

 

 

 

 

 

 

The stock has been very much defensive during the market rout of the last year. However, the signals detected here suggest that run may be nearing an end. February has seen a lot movement out of defensives, with investors moving out of Utilities, Consumer Staples and even Healthcare in the final week of February. McDonalds could be joining that exodus.
 
The sell signal will be negated on a golden-cross, where the 50-day exponential moving average crosses back above the 200-day EMA. We will revisit the performance of this sell idea next month.

US Sentiment holds the key
The Advisors Sentiment Survey continues to provide advance warning of major market turning points.  
The analysis and data regularly feature in the international financial press as a key indicator of market reversion.
Examples of these articles can be found on Barrons, NY Times, and Investor's Business Daily.
Read what CNBC said about the biggest switch in sentiment for 7 years.
Want to know more?  Click here  - and you can subscribe for just $335 annually.

Historic Advisors’ Sentiment data since 1963 is also available; please contact us for further details.

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Thank you for the great service!" C.C.
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