October 2015 – Andrew Thrasher

Two Charts That Say the Yen Is Headed Lower

Posted on October 29, 2015 by Andrew Thrasher, CMT

I rarely discuss currencies on the blog, but the setup taking place in the Japanese Yen is one that is hard to ignore. Let me explain…

I’m going to dive into two charts for the Yen, the first is below and is a weekly chart of the Currency Shares Japanese Yen ETF ($FXY) going back to 2012. You can see the clear down trend that’s taken place in the Yen. That trend has been helped to be defined by the 50-week Moving Average, which is very close to the 251-day Moving Average. I like to watch the 251-day MA because that’s the number of trading days (on average) in a calendar year. We can see this long-term Moving Average was tested during the short bounce in 2012 and again in 2014. Also, while looking at price action, $FXY has been struggling to get above the prior 2015 high at $82. Both of these levels of resistance are likely to make it tough for buyers to push the Yen higher.

Next, we have momentum – specifically the Relative Strength Index (RSI) indicator. This momentum tool has recently tested the peak level in momentum back in 2012 and marks the top of the bearish range that momentum is currently oscillating in. With price sitting under two established levels of resistance, its hard to see momentum getting enough juice to breakout of this range.

So we know what price action and momentum are doing, the next chart I want to show depicts the actions traders are taking in the Yen market, based on COT data.

Commercial traders have been net-long the Yen for a couple of years. This positioning comes after spending a few months net-short back in 2012 right before the Yen began to fall at the same levels mentioned above when $FXY hit its 50-week Moving Average. Once again, we are seeing Commercial Traders are getting close to moving net-short as they turn increasingly bearish on the Japanese currency. Will the move, if it happens, to becoming net-short by this classification of traders mark a repeat of 2012 and send the Yen lower? We’ll see.

It’s often said that the Commercial Traders are the ‘smart money’ within a market but I think it’s painting with a quite a big brush to call the whole group ‘smart money.’ However, what they are is big money, and when those with deep pockets shift their bias like what’s happening in the Yen, it makes it extremely difficult for those on the other side of the trade. I’ll be watching over the coming weeks how the Commercial Traders get positioned, and if they do indeed become net-sellers of the Japanese currency.

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.

The Make Or Break Moment For Stocks

Posted on October 20, 2015 by Andrew Thrasher, CMT

With the recent rise in stocks the major averages have begun digging their way out of being in the red by double digits. From the September low, the S&P 500 ($SPX) has bounced roughly 8% with another 5% to go before getting back to its prior high. While its made significant improvement from what many believed to have been the ‘edge of a cliff’ we are not quite out of the woods yet. On August 24th, when markets were “in turmoil” and traders were beginning to pull their hair out from stress I wrote a post, That Was Unlikely The Market Top & Where I See Things Going From Here. In which I laid out my thinking that I expected the market to whipsaw for a bit before potentially testing the low and bouncing higher. It seems that’s the scenario we’ve seen play out thus far. However, we can’t ignore the warnings that preceded the decline and the possible impact they can still have on financial markets.

So with all that, I thought it’s time to show a few charts for the broad market and explain my view on equities based on where we are and the environment we’re in. From a seasonal standpoint, we are exiting the historically bearish six month portion of the year, giving equities a bit of a tailwind but the major indices are also approaching critical levels of potential resistance. Can seasonally give enough of a boost to push past and move back to new highs?

Below is a monthly chart of the S&P 500 along with two Moving Averages and a momentum indicator, going back to 2005. Looking at the far right portion, the latest set of data the market’s provided us, we can see that in August the S&P broke through the 20-month and 10-month Moving Averages after a small divergence appeared in the Relative Strength Index (RSI) indicator. I show the 10- and 20-month MA’s because they have acted as support during the up trend and are commonly referenced when traders define a trend, either up or down.

In 2007, the monthly RSI went from being over 70 to having price break through these two Moving Averages price bounced back up and tested what had been support. Except support that had been provided by these MAs had become resistance and the RSI failed to get back above 50 before price continued into a bear market. Looking at present day, we had the RSI bounce on its mid-point, a bullish sign that momentum may still be in a bullish range. Price has been able to re-take the 20-month Moving Average but still remains slightly below the 10-month. I’ll be watching to see if we get a close above these two important levels.

Another example of this occurred at the 2000 top…. Price broke below these two Moving Averages in late 2000 while the Relative Strength Index dropped under 50. An attempt to regain the 20- and 10-month MAs was made but failed and momentum was unable to get back above its mid-point. A bear market then followed as the 10-month Moving Average that had been support during the up trend switched to act as resistance during the multi-year down trend.

Zooming in a bit, below is a weekly chart of the S&P 500 since late 2012. We can see a similar setup with the 50-week and 20-week Moving Average. Where they had once been support but are now is being tested as possible resistance. These shifts in being support and becoming resistance help show a change in psychology and market sentiment. It doesn’t require an understanding of what’s going on in China, Washing DC, or individual corporate board rooms – just price.

I call these next few weeks ‘the make or break’ moments for stocks because how they act around these moving averages, in my opinion, will help give traders a better idea about if the market is in the process of shifting from a bull to a bear market. I don’t believe that decision has been made, not when we are this close to a prior high, at this very moment. A fail at these levels of potential resistance, following declines in breadth and momentum, would check quite a few boxes that have led to prior bear markets – while they aren’t requirements they do act as a fairly consistent road map. If price can move above these levels then it’s likely we see the prior high tested and taken out as the bulls remain in control. Price is what matters so that’s what I focus on.

What Separates Small Corrections From Large Declines in Equities

Posted on October 2, 2015 by Andrew Thrasher, CMT

As traders and portfolio managers its our job to manage risk. That risk is often associated with downside declines in major asset classes, however we most often discuss the drops in equities. Josh Brown recently wrote a post about outlining how market declines are healthy and they are often followed by rebounds. The point Josh makes is a good one and is something most (if not all) investors should listen to: sticking to long-term investing with the understanding that you’ll likely experience short-term swings.

‘Healthy’ Corrections vs. Large Declines in Equities
What got me thing was something Josh said about the inability to know if a decline in the equity markets is going to be a small correction or full blown bear market. Again, Josh is correct that we can’t know for sure what’s coming in the financial markets. But I began to wonder if there’s any commonalities among more protracted declines that aren’t present before small “healthy” corrections. One tool that I often refer to on the blog and on Twitter is breadth, specifically the Advance-Decline Line. I focus so much on this indicator because understanding the level (or lack there of) of market participation can be a great resource in understanding the financial markets… at least that’s my opinion!

Back in late-July I wrote a post called The Greatest Risk of Market Peak since 2007. In this post I share the chart (among many) of the S&P 500 and the NYSE Advance-Decline Line, noting the divergence that had been created, meaning the A-D Line began declining before the equity market eventually peaked. This turned out to be a great signal of the forthcoming volatility in stocks and the 10+% decline in U.S. equities.

It’s been a while since we’ve seen such a divergence but as Ryan Detrick notes, it’s much more common to experience 10% corrections. In fact, we’ve experienced 30 of them since 1960 as Ryan points out.

So is there a way to separate common corrections from larger declines?
Using the Advance-Decline Line may be one way, but like all tools…it’s not perfect. Below is a table showing market declines going back to 1980. I used the data from Yardeni for the decline amounts and the number of days the declines lasted. The rows highlighted in yellow are the periods that saw greater than 19% drops, as you can see we’ve experienced seven of them since 1980. Of those seven, all but one experienced a negative divergence between the S&P 500 and the NYSE Advance-Decline Line. While the ‘healthy’ single digit to small double digit moves, like we saw in 2010 and 2012, did not see a divergence in breadth.

2011 was the only >19% drop that was not preceded by a peak in breadth. I’d also like to point out that there was in fact a drop in market participation before the 1983 14% decline.

Now does this mean that every time the NYSE Advance-Decline peaks before price we are in for a bear market? No. But what does have me concerned is that when participation of individual stocks in an up trend does peak before the major indices and prices then begin to fall it has typically (at least since 1980) led to a larger correction than what many would deem ‘healthy’ and what we have experienced so far this year.

How I View This
I do not view this type of data with blinders on. I take it as an input into my bias on the market. I recognize we are about to enter the bullish period of seasonality and that there are some bullish pieces of market data such as positive divergences in momentum and potential double bottoms in equity prices. October is also one of the historically strongest months for stocks since the start of this bull market. But if the August low does break, I know in the back of my mind that breadth was weak coming into this and we could be in for more pain than many traders expect. But I hope we don’t see lower prices, I’d much rather see equities rise and the party keep going – it’s much healthier to be optimist, but I refuse to be a blind optimist.