Why Seasonality is Secondary

Some great trades can come when different sets of data align themselves at the same time. I often look at and write about price, relative strength, Commitment of Traders (COT) report, and seasonality when viewing a sector or asset class. Seasonality can be a great resource for screening and finding the bullish and bearish periods of time based on historical. However, 2014 has been a great example of why we can’t rely solely on seasonality.

A few weeks ago I wrote about the breakout in price for the Internet sector ($FDN) which was happening during a bullish period seasonality. Since then we’ve seen $FDN continue to rise.

However, when we look at the overall U.S. equity market, seasonality hasn’t been as helpful. We came into this year with the 2nd and 3rd quarters being historically the worst quarters in the Presidential Cycle. Over the last three months the S&P 500 ($SPY) is up nearly 6%. Looking at one-year seasonality, May to October hasn’t been the stronger period of trading. But 2014 has seen new all-time highs even during this bearish timeframe.

If all we looked at was the historical seasonality of the market and used that solely as our bearish/bullish bias, then so far this year would leave us scratching our heads in confusion. However, price is what pays and must always be respected. Each week in my Technical Market Outlook post I start with the overall trend of the U.S. equity market and then take a look at breadth and momentum to understand the ‘health’ of the trend. This helps keep us honest and check our emotional bias at the door. While seasonality is currently saying we should have a bearish slant, price is saying something different which makes seasonality a secondary indicator.

Emerging vs. Domestic Markets

The ratio between the iShares Emerging Market ETF ($EEM) and the SPDRs S&P 500 ($SPY) has produced some interesting setups this year. While $EEM hasn’t been the strongest performer YTD, by applying some methods of technical analysis we are able to get an idea of where strength may or may not show up.

From the peak in relative performance against $SPY last October, Emerging Markets underperformed for the next five and half months. During that time we saw the Relative Strength Index stuck in a bearish range, which supported the down trend in the ratio between $EEM and $SPY. While a positive divergence in RSI began to develop in January, the momentum indicator was unable to break above overhead resistance until late March. The break in momentum resistance also coincided with the break in trend line resistance for the price ratio. $EEM was able to then outpace the S&P 500 for the following month.

Starting in April we can see in the chart below that the ratio between emerging and domestic markets began making lower highs and higher lows. This creates a symmetrical triangle pattern. Oftentimes we see the resolution of this type of pattern to favor the previous trend. But what’s interesting about this particular triangle pattern is that it was formed after a ‘trend’ (if you want to call it that) that lasted just one month. is that really enough time to obtain the overall bias?

I’ll be watching to see which direction this period of consolidation breaks and whether Emerging Markets or Domestic markets are able to win out in the end.

EEM SPY

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.

Did We Just See A False Break in Emerging Markets?

Last Friday I tweeted out this chart that shows the ratio between the iShares Emerging Market ETF ($EEM) and the S&P 500 ($SPY). I noticed that the ratio was approaching previous support as shown by the red arrows and the blue line. This was an important juncture for emerging market bulls, they needed to break this level to keep the music playing.

Well it seems the bears bulled the plug as the ratio between emerging markets and the S&P 500 produced a false break as it made an attempt to keep from turning previous support into resistance. At the same time we saw the relationship’s Relative Strength Index (RSI) work off ‘overbought’ status which is a sign of heavy buying as traders pushed up the relative performance of $EEM against $SPY. Going forward I’ll be watching to see if we get another rest of this resistance or of we see emerging market once again under perform U.S. equities and we get a re-test of the March low.

EEM SPY

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.