A Week in Review: Record Volume, Yield Curve, Sectors, Japan, Cash Allocation, & Seasonality 12/4/2017

While Friday made for some interesting trading, the major indices overall remain in up trends and above their short- and intermediate-trend moving average and trend lines. The S&P 500 finished the week up 1.53%, the Dow was up 2.86%, Small caps were up 1.37%, International equities were down 0.37% and Bitcoin saw 12% growth. Here are the charts and news stories I felt were noteworthy from the last week….

Nasdaq Commercial Traders
Typically Commercial Traders are dip-buyers when they’ve previously been this close to holding a net-long position in Nasdaq futures and options. However, over the last several months the Commercial Trader net-position has been inching higher and is now very close to becoming long while Large Traders (funds) are on the other side of that trade, close to becoming net-short.

U.S. Dollar Commercial Traders
What has been a fairly boring chart since the summer as traders have not been moving their net-positions very much in the dollar, until now. As of last week, Commercial traders have now squeaked their position to be net-long, which is some we don’t see happen very often. They have not been long USD since 2013, just before we saw a nice up-trend in the local currency. Before that (not shown on chart) we saw them become net-long in 2012, buying the weakness in the dollar as it got under 80.

Record VIX Option Volume
The CBOE tweeted out this chart on Friday, showing the record number of options traded on the VIX, reaching 3.1 million contracts which exceeds the prior record of 2.6 million contracts traded in a single day that was set earlier this year in September.

Correlation Between Volatility & Equities
Dana Lyons, who constantly produces excellent content on his blog and on Twitter, recently posted this chart on a topic that received a great deal of attention last week – the recent rise in correlation between the $VIX and the S&P 500. In fact, on Friday, as Lyons’ notes, the short-term Volatility Index, which measures expected volatility over a 9-day period compared to the more popular VIX which looks at 30-day vol, rose by the largest percentage amount while the S&P was also up nearly a full percent. As you can see on the chart, short-term volatility is rarely positive on days equities see that level of strength, making Friday’s action quite unique.

Asset Performance When Yield Curve is Flattening
This chart comes from Morgan Stanley and was shared by Dreihaus. There has been a lot of discussion around the impact and implications of the U.S. Treasury yield curve flattening.Based on the research of MS, some of the best relative performance returns during a late-cycle Treasury curve flatting comes from the energy sector as well as financials. Meanwhile, Telecom, Consumer Discretionary have historically under-performed the broader market during late-cycle periods.

Using Volatility and the Yield Curve to Assess the Economy
Speaking of both volatility and the yield curve, the CME put out a really interesting study, looking at the relationship of the long-term trends of both the VIX and the Treasury yield curve as they relate to various stages of economic growth/contraction.What looks similar to a Relative Rotation Graph, the CME compares to the two-year moving averages of the Volatility Index and the yield curve and how they move counter-clockwise; “The cycle has four phases.  As with any circular motion, where to begin is arbitrary, so we will begin at the bottom of the economic cycle and work our way to mid-stage expansion.” The four phases are defined by the CME as:

  1. Recession: yield curve moves from flat to steep (upward slope), equity volatility is relatively high.

  2. Early-stage recovery: yield curve remains steep, equity volatility begins to fall.

  3. Mid-stage expansion: the yield curve starts to flatten, equity volatility remains low.

  4. Late-stage expansion: yield curve becomes even flatter, equity volatility soars as fears of recession dominate investor behavior.

You can see the prior two growth/contraction periods in the U.S. economy move through the above mentioned four stages using the VIX and the yield curve in the two smaller charts below. The current cycle is shown in the third chart. The CME comments they interrupt the data for today’s market as being in “a phase that closely resembles the mid-expansion phases seen during the mid-1990s (1994-96) and the mid-2000s (2005-06).  As already noted, the Fed has commenced removing monetary accommodation.  Yield curves are flattening.  VIX remains unperturbed at extraordinarily low levels. This phase may persist another year or so as the yield curve continues to flatten and the VIX, most likely, remains low for a while longer.”

 

Japan’s Chart Doesn’t Look Great for the Bulls
Looking at the iShares Japan ETF ($EWJ) we can see a potential double top on the daly chart. The re-test of $50 also has come with a lower-high in momentum via the Relative Strength Index (RSI) along with a lower-high in relative performance with the S&P 500 ($SPY). If EWJ continues to move lower I’ll be looking to see we get a test of its 50-day Moving Average which acted as support earlier this year in July and August.

Average Momentum for the S&P 500 Stocks
After experiencing a slight bearish divergence in the average Relative Strength index reading for the stocks in the S&P 500, the composite reading has now moved to a recent new multi-month high, the highest average momentum reading since early 2016.

Sector Relative Rotation Graph
After several weeks of improvement in the energy sector’s relative rotation it’s taken a turn lower, although still in the ‘leading’ category. While the tech sector saw some weakness in several large momentum names, the smoothing of the trend in relative rotation saw an uptick on the RRG for $XLK, along with positive moves in Staples (XLP), Discretionary (XLY), and Utilities (XLU).

Sector Correlation
The correlation of the ten S&P sectors over the last 20 days shows the highest correlated sectors being health care (XLV), industrials (XLI) and materials (XLB) while REITs (VNQ) and Energy (XLE) have been the lowest correlated sectors over the past four weeks.

Sector Performance
Year-to-date most of the S&p sectors are experiencing positive performance, with just the energy sector still seeing red. Only two sectors (staples and energy) are under-performing the S&P 500 through November with technology and health care seeing the strongest growth so far this year.

Narrow Revenue Streams For The Big Five Tech Companies
Barry Rithotlz posted this chart created by BI which looks at the revenue streams of the major five technology companies. Ritholtz notes that the older companies have the most diversified streams, while they narrow as the age drops for each firm; “Microsoft, the oldest and most mature company has the most diversified revenue stream with office the biggest revenue producer at 28%. It follows from there in age: Apple’s biggest line (iPhones) = 63%, Amazon (retail sales) 72%, then Google (Adverts) 88%, and lastly, Facebook(Adverts) at 97%.”

Cash Allocations Continue To Decline
The allocation to cash in Merrill Lynch client accounts has declined to the lowest level in ten years. The prior low, set in ’07 has now been surpassed with August’s cash allocation falling to 10.4% as shown in this chart via John Mauldin.

Positive Returns Through Thanksgiving Setup for a Solid ‘Best Six Months’
This great table shared by Urban Carmel shows that when the S&P 500 posts gains of at least 7% through Thanksgiving, the following six months has seen a positive return 84% of the time. For 2017, the S&P was up 16%, which should setup the next six months for a positive tailwind.

S&P 500 Track Record for December
Dave Wilson shared this chart as his Bloomberg “chart of the day” on November 23rd from Ari Wald, CMT, which shows since 1928, the S&P 500 has never seen its worst month of the year occur in December.

December Is the Least Volatile Month of the Year
According to Jim Bianco, since 1981 the S&P 500 has been the least volatile in December with an average monthly standard deviation of just 3.49%.

Post-Election Year’s in December Also Have Been Bullish
We can’t discuss market seasonality without also mentioned a great point by Jeff Hirsch of the Stock Trader’s Almanac. Hirsch points out that while December has historically been the best month for the S&P and the second best for the Dow since 1950, when looking at post-election years the month of December has been the fifth best for the Dow, the eight best for the S&P 50 and the fourth best for the Russell 2000.

New Home Sales Continue to Climb Higher
The latest data of new home sales in the U.S. shows the strongest sales growth in ten years. Bloomberg notes, “The report showed the U.S. South region continued to recover from a pair of hurricanes. Purchases in other areas of the country, including a 17.9 percent surge in the Midwest, also climbed. The number of properties sold in which construction hadn’t yet started reached the highest level since January 2007, signaling residential construction will accelerate in coming months.”

 

Christmas Trees May Be More Expensive This Year
According to the New York Times, “For anyone who might forget, many people in the United States were not feeling particularly festive in 2008. They bought fewer items as the country slid into its deepest downturn since the Depression. Growers responded by cutting down fewer Christmas trees to sell. That left less space to plant replacements and, ultimately, a smaller-than-usual batch of seedlings. Nearly a decade later, Americans are spending freely again, and the firs, spruces and pines that went into the ground during the recession have reached the seven-to-eight-foot height that makes them ideal for holiday living rooms”

Bitcoin Mining Equates to the Energy Consumption of 159 Countries
With the growing popularity (and price) of the cryptocurrency, the energy used to mine the digital coins has risen 30% over the last month. 0.13% of global energy is now taken up by bitcoin miners, and “uses more electricity than 159 individual countries — including more than Ireland or Nigeria” according to a report by CBS News.

Moody’s Will Now Take Into Account Global Warming Risks For Their Ratings
The rating agency recently released a report that detailed how they will begin involving the impact of global warming on city and state’s when rating their bonds. Bloomberg highlights Moody’s note to clients that “it incorporates climate change into its credit ratings for state and local bonds. If cities and states don’t deal with risks from surging seas or intense storms, they are at greater risk of default.”

Hedge Funds Move Into More Illiquid Investments In Order to Stay Competitive
A recent Financial Times article discussed the latest move by several major hedge funds that have been moving into more less-liquid investment markets in order to seek alpha and produce gains after several years of lackluster performance. With less liquidity obvious comes an increase in risk that could have a negative impact on these funds if turbulence moves into these less trafficked markets.

Off-Topic

Nike Adopts Augmented Reality To Sell Shoes
It’s always interesting to see how retails adjust to new technology in order to increase sales. Nike is the latest retailer to step up their game, adopting AR in order to sell their latest sneakers as reported by the Wall Street Journal, “We saw kids race towards Washington Square Park, phones in hand, to snatch up Jordan 12s. This was an example of a geo-targeted release, where shoppers have to be in a specific location to purchase a sneaker on the app. Footage showed “shock-drops,” another activation in which a push notification randomly flashed on users’ phones, tipping them off to an unannounced sneaker release.”

Mexican Avocado Police
The city of  Tancitaro in Mexico now has an avocado police force. Via Extra Crispy, “BBC News, the avocado force, who carry guns and wear full body armor, are partially funded by a percentage of avocado producers’ earnings—they all contribute a bit of their profits to ensure the safety of their city.”

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.

A Growing Divergence in Performance for the S&P 500 Components

As we approach the final days of April, if you were to look back and try to put your finger on a theme for the last four months, one that you may select could be the growing divergence taking place in the S&P 500. What I’m referring to is the separation in performance that appears to be taking place among the largest of the S&P 500 stocks and the less large (smaller?) stocks that round out the index. Eyeing a long-term chart of the equity market there appears to have been a couple previous examples of this taking place, I’ll get into those later. First let’s look at present day…

Below is a chart of the S&P 500 Index (red line) and the ratio between the S&P 500 Equal weight ETF ($RSP) and the S&P 500 ETF ($SPY) which is cap-weighted. (yes I could have used the indices but I, no big reason why I chose not to. I just naturally gravitate to ETFs). I tweeted out this chart yesterday but I wanted to provide a little more commentary to what’s taking place.

When the Black line is rising that is telling us that the Equal Weighted $RSP is rising more (or falling less) than the cap-weighted $SPY, and when it’s declining the opposite is taking place. The latter is what we are seeing play out so far in 2017 with the largest of the S&P 500 components leading the charge higher.

Another instance we saw this play out was in 2012. During the initial bounce off the low in May we saw the S&P 500 begin making higher lows but it was being done on the backs of the largest components – as we can see with the black ratio line making lower highs from May through August. This divergence was ultimately responded with the market as a whole heading to new highs and the smaller S&P companies once again taking the lead.

The reason that we may attention to which parts of the market are leading and lagging is because it provides insight into the level of risk taking that’s occurring within the market. It’s commonly believed that the larger the company’s market cap, the less riskier the stock (obviously there’s plenty of examples of this not being 100% true all the time). When the market is trending higher many bulls want to see the more riskier portions of the market, such as small caps and mid caps show strong relative performance. And one way we can measure that is by looking at which parts of the S&P 500 are showing that relative performance – the largest weighted or the smallest weighted stocks within the index.

Here’s another example a divergence being formed between the two differently weighted ETFs. Let me first say, yes this is showing the 2007 peak in stocks before the Financial Crisis. No, I’m not calling for a long-term top in the S&P 500, this is just another example of a similar divergence. As with many major market peaks, the are lead by a narrowing of breadth, also known as participation. This showed up in the lack of relative strength among the smaller S&P 500 stocks in June 2007 through the rest of the year. And we know how that played out in the next twelve months….

So there are two examples of a growing separation in the largest and smallest stocks that make up everyone’s favorite equity index. One (2012) was resolved with the market going higher and another (2007) that led to a major bear market. Which one will we see? No idea, and there’s no reason we must replicate either of these instances. The important takeaway is the acknowledgement that the largest companies in the index are what have been leading it higher – that’s where bulls seem to be concentrating their efforts.

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.

Are Semiconductors Warning of Future Tech Sector Weakness?

Back in 2014 I wrote a post (which Bloomberg picked as their Chart of the Day) outlining how semiconductors had replaced copper as the new barometer for the market. For quite a while copper was thought to have had a PhD in economics, as its price movement acted as a good indicator of economic activity. As the U.S. (and the global) economy shift to be more technology-focused, semiconductors took over at head of the class.

With the prominent use of semi’s in the tech space, they become an obvious tool to be used in evaluating the technology sector. Below is a chart showing the relative performance ratio between semiconductors ($SMH) and the S&P 500 ($SPY), with its respective Relative Strength Index (RSI) in the top panel.

Over the last several years when momentum, as measured by the RSI, diverges (making a lower high as the ratio between $SMH and $SPY makes a higher high), a trend reversal often follows as semiconductors begin to under-perform the overall U.S. equity market. This has also led to lackluster performance by the tech sector ($XLK) as well. In the bottom panel of the chart we have the ratio of $XLK and $SPY, and when $XLK is outpacing $SPY (by either going up more or going down less) the line rises.

The opposite is also true, when momentum for the $SMH and $SPY ratio creates a positive divergence, as it did in February of this year and August of last year, the tech sector’s trend in under-performance has reversed.

Since early November, semiconductors have seen a strong performance. and recently the ratio between semi’s and the S&P 500 made an attempt to break to a new high, surpassing its prior October peak. However, the breakout was accompanied by a bearish divergence in momentum and as of this writing, has failed to hold. This false breakout and bearish divergence creates a poor environment for $XLK, as its relative performance often mirrors that of semiconductors. I think it’s also important to note that while the $SMH-$SPY ratio got back to its prior October high, the $XLK-$SPY ratio did not, an additional sign of technology weakness.

smh-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.