3 Signs of a Weakening Market

1. Small Caps ($IWM) have been severely underperforming over the past 3 weeks, essentially reflecting a new stage in the current uptrend – the so called flight to quality. This is not necessarily a bad sign, but a clear indication of decreasing risk appetite, which tends to feed on itself.

2. The major indexes ($SPY, $QQQ) had 3 distribution days in the past 13 days, which is certainly a reason for caution, but not for turning outright bearish yet.Tops in market averages are a process, not an event. Price/volume action gives enough clues before any major damage is caused.

3. There is a decent number of long setups that look like a Picasso – prior uptrend, followed by 5-20 days of tightening sideways price consolidation near major highs and yet very few of them actually break out. Those that do, are short-lived and quickly fade. Buyers don’t have the conviction to step in and push higher.

There are no reasons to turn outright bearish here. It seems that institutions are waiting for a pullback before allocating more capital. I assume that dips in high-growing names will be welcomed as buying opportunities, but in the meantime I raised cash this morning and pulled out of positions that haven’t performed according my expectations.

7 Things I Learned from Joe Fahmy’s Trading Big Winners Seminar

No matter how much experience you have in the stock market, you can always learn something new that will make you better and more profitable trader. Last Saturday, I drove to LA to attend Joe Fahmy’s Trading Big Winners seminar and I am happy to report that it was well worth it. Here are 7 things that I learned or was reminded of:

1) The names of the big winners change every few years, but their fundamental and technical characteristics stay the same. Stunning earnings and sales growth have been the common denominator of all long-term big market winners ever since the 1920s. This is still the case today.

2) Howard Lindzon also gave a short speech on his market approach. He highlighted three 3 important elements: Staying in the game; Having a Routine and understanding the catalyst behind the stock of interest. He is hunting for his winners on the all-time high list, but he is further pruning by focusing only on companies “I could be the head of marketing”. Howard also recommended to write down your market thoughts on a publicly visible platform like a blog or StockTwits as this will clarify your thought process and it will keep you accountable, mainly to yourself.

3) The market is moved by the big institutions. If a $10 billion fund wants to allocate 1% of its capital to 1 stock, we are talking $100 million – an investment that will certainly leave a trace for the experienced eye, especially if the float of the stock is relatively small; hence pay attention to stocks that are advancing on high volume.

4) You don’t have to be in the market all the time to achieve significant returns. The market is healthy only a few times a year and this is when you should get aggressive. One simple indicator to gauge for market health is the position of the Nasdaq Composite in relation to its 50dma. When the market is in a correction mode, Joe goes to cash and uses the time to either review old trades or just goes on vacation to take a mental break and prepare for the time when the market is healthy again.

5) Relative strength is among the most powerful stock selection technical indicators. Pay attention to stocks that are advancing and making major news highs while the general market is correcting. Also, if your growth stock is not appreciating while the general market is advancing, there is something wrong with it.

6) Taking great risk/reward trades is of utmost importance. Risking $2 to make $2 is not going to get you far.

7) Joe is looking for certain ranges in his setups to improve the probability of being right immediately.

Looking for Real Return In a Nominal World

The latest must read missive comes from Warren Buffett, who eloquently argues that during high inflationary periods, equities as an asset class might be the best house in the worst neighborhood.

It is a public secret that $1 million dollars today is not what it used to be 30, 20 or even 10 years ago. The purchasing power of most currencies has decreased substantially over time as the supply of money by central banks and the demand for credit by the public and private sector have overshadowed the increase in productivity and GDP growth. As a result, investors who have earned 5% a year on their investment for the past 40 years, might be actually in a worse position than they were when they started. Granted, inflation measures cannot account in any way for the technology innovations and improvements in quality that are available today, but nominal vs real return is certainly a topic that needs to be well comprehended by all investors.

Even in the U.S., where the wish for a stable currency is strong, the dollar has fallen a staggering 86% in value since 1965, when I took over management of Berkshire. It takes no less than $7 today to buy what $1 did at that time. Consequently, a tax-free institution would have needed 4.3% interest annually from bond investments over that period to simply maintain its purchasing power. Its managers would have been kidding themselves if they thought of any portion of that interest as “income.”

Warren Buffett continues to publicly bash gold, pretty much calling it the most unproductive asset on planet Earth. I have a slightly different view on the subject as gold could easily be viewed as a currency due to its indisputable liquidity anywhere in the world. Since Buffett started his investment activities in Berkshire Hathaway, gold ($GLD) has increased almost 50-times. This is 13.4% annual return since the Gold Standard was abolished. Of course past results are not guarantee for future performance. In his missive, Mr. Buffett basically claims that gold is in a bubble caused by fear induced, unreasonable expectations:

What motivates most gold purchasers is their belief that the ranks of the fearful will grow. During the past decade that belief has proved correct. Beyond that, the rising price has on its own generated additional buying enthusiasm, attracting purchasers who see the rise as validating an investment thesis. As “bandwagon” investors join any party, they create their own truth — for a while….. “What the wise man does in the beginning, the fool does in the end.”

Not surprisingly, Warren prefers investments in productive assets – companies, which earnings power will trump the hidden inflation tax, companies that are leaders in their corresponding industries and require minimum new capital investment – such as Coca Cola ($KO) and $IBM.

The whole piece is well worth the read.

Source: Why Stocks Beat Gold and Bonds by Warren Buffett

Market Pulse – Uptrend Is Still Intact

$SPY and $QQQ continue to make new highs on almost daily basis as capital has rotated into the energy sector and Oil & gas names have become frequent visitors on the all-time high list.

The trend is still intact.The dips in market averages are short-lived and shallow.Equities still outperform fixed income by a healthy margin; consumer discretionary overshadow staples, signifying improving perceptions of economic growth. Will those expectations materialize is another question, but at the time being the sentiment is optimistic and a good market mood can go a long way.

Under the relatively calm surface, there has been a natural decrease in risk taking. Small caps have slipped against large caps, but the uptrend of the ratio ($IWM vs $SPY) hasn’t been compromised in any way. On the same note, emerging markets have also been lagging as of late.

There has been a slight dip in inflation expectations as ironically the latest positive economic reports have diminished the probability of further quantitative easing. (on a side note, given the monstrous size of banks’ excess reserves, there is absolutely no need of further Fed’s engagement). The trend of the ratio $XLB vs $XLU is still intact and this should be the case in an improving economy.

Another quick way to take the market pulse is by comparing the number of liquid stocks dropping 5% or more in a day vs the number stocks gaining 5% or more in a day. Today, we had 41 pluses and 35 minuses – normal consolidation within a low-correlation market of stocks.

The averages seem extended to the naked eye, but there are no objectively measurable signs of impending serious price correction at this point.

There Are 3 Stages In a Typical Bull Market

“Every truth passes through three stages before it is recognized: In the first it is ridiculed; in the second it is opposed; in the third it is regarded as self-evident.” – Schopenhauer

Typical market uptrends go through three main sentiment stages:

1) “What bull market? The fall is right around the corner”

Most of the signs of an uptrend are already here – money is leaving defensive names in order to chase higher yield, breadth is improving, correlation and volatility decline substantially. Despite of that, many people don’t believe the rally and prefer to short “overbought” names, only to get squeezed by the tidal wave of monstrous accumulation.

The fastest price appreciation happens in stage 1 and stage 3.

2) Acceptance stage 

More and more people gradually warm up to the idea that we are in an uptrend and the market should be considered “innocent until proven guilty. Stocks have been going up for awhile and the minor dips were short lived.

Between stage 2 and stage 3, there is usually a deeper market pullback, which tests the resilience of the rally, shakes weak hands out and allows for new bases to be formed. The deeper pullback is used as a buying opportunity by institutions, which missed the the initial stages of the rally and their purchases push the market to new highs.

3) Everything will go up forever

During stage one, most people are skeptical, because the market has just come from a high-correlation, mean-reversion environment and most are unwilling to see the ensuing change in market character. In stage two, investors gradually turn bullish for the simple reason that prices have been going up for a while. Analysts and Strategists are also turning bullish in an attempt to manage their career risk. In the third stage, most market participants are ecstatic, not only because prices have been going up for a while, but because they personally have managed to make a lot of money. Everything seems easy, the future looks rosy and complacency takes over proper due diligence.