IBM – The Dow’s Alpha Stock is on the Verge of Breaking Down

IBM is the Dow’s biggest powerhouse and one of the most important companies for the U.S. stock market. The blue chip has shot up 300% in four years and is sitting just above important support. A breakdown here could have far reaching ripple effects.

IBM is an “alpha stock.” Like an alpha dog or alpha male, alpha stocks lead the pack.

What makes IBM an alpha stock? There is IBM’s storied history and $217 billion market cap, but what ultimately makes it a leader is the 11.28% weighting it carries in the Dow Jones Industrials Average and Dow Jones Industrials Average ETF, also called Dow Diamonds (DIA). IBM is also the fifth largest component of the S&P 500 SPDR (SPY).

Unlike other indexes, the DJIA is price weighted, the pricier the stock, the heavier it’s weighted in the average. IBM trades at 190 and influences the Dow’s movements more than any other stock.

Only two other companies are as influential (or more influential) as IBM: Apple and Exxon Mobil. We know that Apple’s 30% haircut put the entire U.S. stock market in a funk, so what’s IBM’s message?

Long-Term Technical Outlook

IBM lost about 10% over the past three months. This sounds like a lot, but when put in context with a long-term chart, it’s no more than a drop in the bucket. Since November 2008, IBM soared from 69.50 to 211.79, a 303% increase.

The first quantitative easing (QE) intervention also commenced in November 2008, but surely any correlation between the two is purely coincidental. Regardless of the cause, the down side potential for a blue chip stock that’s tripled in four years is much greater than 10%.

Short-Term Technical Outlook

The short-term chart shows IBM toying with long-term (green trend line) and short-term support (black channel). A break below 190 would trigger a sell signal (stop-loss just above 192) with a possible short-term target of 177 – 182.

To me, the structure of the decline since the October high suggests that prices ultimately want to head lower. Trade above 190 allows for limited near-term strength, but only a move above 198 (channel rising) would unlock more bullish potential. A drop below 190, on the other hand, could be the straw that breaks the camel’s back.

Simon Maierhofer shares his market analysis and points out high probability, low risk buy/sell recommendations via the Profit Radar Report. Click here for a free trial to Simon’s Profit Radar Report.

Will Small Caps Lead the Market to All-time Highs?

Market timers often watch small caps for clues about possible trend reversals, but thus far the Russell 2000 Small Cap Index is going strong. Here’s a closer look at seasonality and support/resistance levels for the Russell 2000.

It’s said that major market tops are often preceded by weakness in small cap stocks. This premise makes sense, as small cap stocks are most sensitive to the ebb and flow of liquidity. As a liquidity gauge, small cap indexes like the Russell 2000 could be the canary in the mine.

The truth is in the pudding. Does this theory hold up against the facts? The chart below plots the S&P 500 Index against the Russell 2000. I guess the key point is how you define a “major” market top.

Small cap weakness foreshadowed the 2007 top, but wasn’t obvious at the 2010, 2011, and 2012 highs (at least not on the weekly chart).

What about today? Small caps are going strong and the canary is chirping and frolicking.

The second chart provides a closer look at the Russell 2000 (corresponding ETF: iShares Russell 2000 ETF – IWM).

The Russell 2000 climbed back above the green trend line originating at the October 2011 low.

Recent prior peaks supply various resistance levels (red lines) and today’s decline drove prices below the green November 15 support line (an early warning signal), but starting in mid-December small caps tend to outperform large caps. January is one of the strongest months for small cap stocks.

Historical seasonal patterns suggest that more strength lies ahead for small caps. Technicals support this view. This may drive small caps to new all-time highs (less than 4% away), but I doubt it will be enough to push the Dow and S&P to all-time highs. A break below technical support at 836 (green trend line support) would warn that this year is different.

Simon Maierhofer shares his market analysis and points out high probability, low risk buy/sell recommendations via the Profit Radar Report. Click here for a free trial to Simon’s Profit Radar Report.

Gold and Silver Plummet – Why and How Much Lower?

Gold and silver are the de facto “flight to safety” trade. Concerns about inflation (QE4) or the fiscal cliff were supposed to drive precious metal prices higher. This didn’t happen, here’s why:

It’s been a terrible week for gold and silver. Fundamentally precious metals should have rallied following the Fed’s announcement of QE4 (What is QE4?). Here’s the fundamental rationale.

The Fed’s plan to spend an additional $45 billion of freshly printed money (QE Tally – How Much Money is the Fed REALLY Spending?) is supposed to create inflation. In theory, gold and silver are “default inflation hedges”.

Investors trust this theory and put their money where their mouth is. How do we know this? Assets in the most popular gold ETFs – SPDR Gold Shares (GLD) and iShares Gold Trust (IAU) – soared to an all-time high.

However, a theory (in this case the theory that QE will lead to higher gold and silver prices) remains only a theory until proven correct.

What Caused the Gold/Silver Mini Meltdown?

Contrary to this theory, the December 16, Profit Radar Report noted that:

“Holdings in gold-backed exchange-traded products reached a record 2,629.3 metric tons. However, all this gold buying hasn’t done much for gold prices. In fact, with so many buyers already committed, there are now fewer buyers out there. Despite seasonal tailwinds, the sentiment picture suggests at least a shakeout sell off.”

For those interested in trading gold, here’s the trade recommendation provided by the same update: “Unfortunately our UltraShort Gold ProShares (GLL) order wasn’t triggered last week. Now aggressive traders may go short gold with a move below 1,690 (around 163.80 for GLD). An approximate buy trigger for GLL (a 2x inverse gold ETF) would be 61.50.”

The corresponding trade setup for silver was as follows (updated chart shown below): “The dashed gray trend lines illustrate past instances where break downs and break outs resulted in low risk entry points. The green support line just below current prices (@32.30 – around 31.20 for SLV) may provide a low-risk entry to go short for aggressive traders. The only available short silver ETF is the 2x inverse UltraShort Silver ProShares (ZSL).” ZSL jumped from 45 to 52.

How Low Will Gold/Silver Fall

I honestly don’t know how much farther gold and silver will fall. However, the two charts below show that both metals reached respective support levels.

No one has ever gone broke taking profits and more often than not, it pays not to get too greedy.

Gold provided a nice 50-point drop and silver declined more than 10% in less than 3 days (nearly 20% for ZSL). We locked in all of our silver profits and half of our gold profits. The remaining half of short gold positions is equipped with a stop-loss that guarantees profits.

Semi-weekly updates and trade setups for gold, silver, the S&P 500, and other asset classes are provided via the Profit Radar Report.

Simon Maierhofer shares his market analysis and points out high probability, low risk buy/sell recommendations via the Profit Radar Report. Click here for a free trial to Simon’s Profit Radar Report.

Glaring but Misunderstood QE – How Much the Fed is Really Spending

QE1, QE2, QE3, expiring Operation Twist, and now QE4. Which of those programs are “sterilized” (non-inflationary) and which ones devalue the dollar? If you’ve lost track, here’s a quick visual summary.

Will Operation Twist be replaced by outright QE was a question addressed here early in December. As it turns out, the Fed decided to do just that.

We now have multiple layers of QE working simultaneously. What’s the total amount being spent and will inflation finally take off?

QE Tally

There are three official tranches of quantitative easing (QE):

1) QE3, announced on September 13, 2012. The Federal Reserve will buy $40 billion per month worth of mortgage-backed securities.

2) QE4, announced on December 12, 2012. The Federal Reserve will buy $45 billion per month worth of longer term Treasuries (corresponding ETF: iShares Barclays 20+ Treasury ETF – TLT).

QE4 will be replacing Operation Twist in 2013. Operation Twist is considered “sterilized” or cash neutral QE. Operation Twist simply reshuffled the balanced sheet (sell shorter term in favor of longer term maturities). It did not expand the balance sheet.

Unlike Operation Twist, QE4 will be financed by “non-sterilized” or freshly printed money. This process increases the Federal Reserve’s balance sheet and the amount of money in circulation.

3) Reinvestment of maturing securities. In a December 12 press release, the Federal Reserve stated: “The Committee is maintaining its existing policy of reinvesting principal payments from its holdings mortgage-backed securities and, in January, will resume rolling over maturing Treasury at auction.” This amounts to roughly $25 billion/month of sterilized QE.

In total, the Federal Reserve will buy $110 billion worth of Treasuries and mortgage-backed securities every month until the unemployment rate drops below 6.5% and inflation remains below 2.5%.

The first chart below illustrates QE3, QE4, and reinvestments separately and how the three layers combined compare with QE1 and QE2.

The second chart provides a more detailed glimpse of the Fed’s balance sheet (and a mere glimpse is all mere mortals are allowed).

The Fed’s balance sheet as of November 21, 2012 stood at $2.84 trillion and is expected to balloon another $1 trillion over the next 12 months.

Currently $966 billion or 34% are invested in agency debt, mainly mortgage-backed securities. In other words, one of every three dollars in circulation is backed by toxic assets, the same stuff that caused the “Great Recession.”

Inflation

Inflation, where art thou? The Fed’s balance sheet exploded from below $1 trillion to nearly $3 trillion, but inflation (let alone hyper inflation) has been a no show.

Will the current round of QE deliver on inflationist’s predictions? I doubt it.

Simon Maierhofer shares his market analysis and points out high probability, low risk buy/sell recommendations via the Profit Radar Report. Click here for a free trial to Simon’s Profit Radar Report.

Financials at 22-Month High – What Does this Mean for The S&P 500?

Pssst, no one is talking about it, but one industry sector has quietly climbed to new 22-month highs – Financials. Will their run continue, how can you tell when it’s over and how will it affect the stock market?

The financial media can’t see the forest for the trees or the stairs for the cliff.

So much ink is being spilled reporting Obama’s and Boehner’s latest comments, hints and lunch menu, that the media missed the financial sector’s march to new 22-month highs.

Will financials continue to edge higher, and what does the financial sector strength mean for the S&P 500 and other broad market indexes?

The chart below provides a nutshell summary of the Financial Select Sector SPDR ETF (XLF).

1) Marks the technical breakout from a multi-week trading range. The Profit Radar Report expected this breakout on August 5, when it said:

“Financials are currently under loved. Of the $900 million invested in Rydex sector funds, only $18 million (2%) are allocated to financials. With such negative sentiment a technical breakout above 14.90 could cause a quick spike in prices.”

2) Shows that XLF never broke below the bold October 2011 trend line and never triggered a sell signal.

The strength in financials was one reason the Profit Radar Report maintained that the down side of the post September correction was limited and exited all short positions at S&P 1,348 and S&P 1,371 (and went long at S&P 1,424 last week).

3) Volume over the last couple of days has been solid.

4) RSI is lagging the September 14 high water mark and will be running into resistance. RSI may also set up a longer-term bearish divergence if it isn’t able to beat the September high.

XLF accounts for 15.42% of the broad SPDR S&P 500 ETF (SPY) and has the power to be the tail that wags the dog.

This price/RSI divergence in XLF might harmonize with my expectation for a large-scale market top sometime in Q1/Q2 2013.

There’s a newly formed support line (not shown in chart), which should be used as stop-loss for long positions.

No doubt by the time the media moves the spotlight on financials’ performance, the lion’s share of the gains will be already over.

Simon Maierhofer shares his market analysis and points out high probability, low risk buy/sell recommendations via the Profit Radar Report. Click here for a free trial to Simon’s Profit Radar Report.

S&P 500 and Gold Sport Two Misleading Sentiment Anomalies

Groupthink tends to create losses for most and juicy gains for a select few. The S&P 500 and gold show some compelling sentiment extremes that could be misleading if viewed in isolation.

I love a good “reverse lemming” or contrarian trade. Investor sentiment is one of the best tools to spot a contrarian setup.

Even though the market has been stuck in a rut, there are a number of sentiment extremes. Many of those sentiment extremes however, parade some curious anomalies.

Love to Hate Gold

Last week Bloomberg reported that: “holdings in gold-backed exchange-traded products reached a record 2,629.3 metric tons yesterday,” an extreme sign of gold optimism.

More people than ever flock into ETFs like the SPDR Gold Shares (GLD) and iShares Gold Trust (IAU). The fiscal cliff, QE3 and QE4 probably have something to do with that.

Gold futures traders on the other hand are quite bearish. Only 10% of futures traders are bullish about gold.

I have never seen such polar opposite sentiment for the same asset class.

Let’s Buy Stocks Before They Drop

Bank of America just reported that its private clients (retail investors) are selling stocks at the fastest pace in 19 months (see chart below). Such eagerness to sell tends to occur around bottoms not tops.

The behavior of option trades is the exact opposite of BofA retail investors. According to the ISE exchange, traders bought 208 calls for every 100 puts.

Such a rush into call options has pretty consistently led to lower prices in the past.

If you spend more time looking at other sentiment gauges, seasonality, technical patterns, cash flow, cycles of stocks vs. broad market indexes, and correlations between asset classes, you’ll find even more anomalies.

The thing is, anomalies – curious and unique as they might be – cause analysis paralysis, they don’t provide trade setups.

When in doubt, stay out or sign up for the Profit Radar Report to find low-risk trade setups. Low-risk setups provide sizeable profit potential in exchange for negligible risk, even in environments like this.

Simon Maierhofer shares his market analysis and points out high probability, low risk buy/sell recommendations via the Profit Radar Report. Click here for a free trial to Simon’s Profit Radar Report.

P/E Ratio Based Valuations are Beyond Deceptive

P/E ratio analysis used to be a time-tested, go to valuation parameter. Recent changes however, have turned the P/E ratio into the most deceptive value barometer around. Here’s why.

The P/E ratio is based on profits and only reliable as long as the “P” in P/E are actual profits. In a world where Wall Street thrives on manipulation, do P/E ratios still apply?

To illustrate: Wells Fargo is trading around $33 a share with earnings per share of $3.18 and a P/E ratio of 10.40. This is cheap, isn’t it?

But how do we know that Wells Fargo’s profit is really $3.18 a share?

As of December 30, 2011, Wells Fargo had total assets of $1.313 trillion and total liabilities of $1.173 trillion. You and I don’t know what the assets and liabilities are, and I venture to say that Wells Fargo doesn’t even know.

How much are the millions of homes Wells Fargo financed before the housing bust really worth? Again, we don’t know, but we know that due to an FASB (Financial Accounting Standard Board) rule change, Wells Fargo and every other corporation in the U.S. can now overstate the value of their under water assets.

FASB Rule 157

FASB rule 157 applies to fair value (or mark-to-market) accounting. Fair value is (or used to be) defined as “the price that would be received to sell an asset or paid to transfer liability in an orderly transaction between market participants.”

In 2008 the market turned disorderly and on April 9, 2009, the FASB (strong armed by Congress) changed rule 157 to suspend the fair value rules when the market is unsteady.

Instead of reporting the current value of an asset (market-to-market), corporations are now allowed to pick a price they believe the asset will be worth in the future (mark-to-make-believe).

Cause and Effect

What effect would this have? A March 2009 Bloomberg published this assessment:

“By letting banks use internal models instead of market prices and allowing them to take into account the cash flow of securities, FASB’s change could boost bank industry earnings by 20 percent. Companies weighed down by mortgage-backed securities, such as New York-based Citigroup, could cut their losses by 50 percent to 70 percent, said Richard Dietrich, an accounting professor at Ohio State University in Columbus. ‘This could turn net losses into significant net gains,” Dietrich said.’”

Is that really what happened? Let’s see which companies drove earnings growth for the S&P 500 in 2012.

The chart and data below was compiled by Morgan Stanley’s Adam Parker. According to his research, ten stocks are driving about 88% of the entire S&P 500 earnings growth.

Six (seven if you consider GE a financial stock) of the ten companies belong to the financial sector (Bank of America, AIG, Goldman Sachs, Wells Fargo, JPMorgan Chase, Citigroup).

Without Apple and the financial sector, earnings growth for the S&P 500 would be next to zero. A bad year for Apple and a return to fair value accounting could easily double the P/E ratio.

Based on P/E ratios, does the S&P 500 still look cheap?

Simon Maierhofer shares his market analysis and points out high probability, low risk buy/sell recommendations via the Profit Radar Report. Click here for a free trial to Simon’s Profit Radar Report.

European Markets Between 5-Year Highs and 90% Declines

Germany’s DAX 30 just hit a near 5-year high, while other European exchanges are down more than 90% from their all-time highs. The SPDR Euro STOXX 50 ETF has arrived at a critical juncture.

“Luegen haben kurze beine”. So goes a German saying. Translated: Lies have short legs or more appropriately, lies don’t travel far.

Much like the Federal Reserve, the European Central Bank (ECB) has been busy pumping money into the economy. This is supposed to keep government bond interest rates low and prevent entire countries (you know which ones) from defaulting on their debt.

Germany’s DAX 30 just closed at the highest level since 2008, Britain’s FTSE 100 is within 10% of a 5-year high, and France’s CAC 40 eked out a 1-year high.

But lies don’t travel far, or ECB money doesn’t travel far (connection between “lie” and “ECB money” intended) and hasn’t reached the exchanges of Serbia, Slovakia, Macedonia, Bulgaria, etc. The major indexes of at least eight European countries are trading more than 70% below their all-time highs.

The chart below, published by the European Elliott Wave Financial Forecast, shows 16 European markets and their exchanges.

The SPDR Euro STOXX 50 ETF (FEZ) – which includes 50 of the largest companies from France, Germany, Spain, Italy, Netherlands, Belgium, Finland and Ireland – is still trading 50% below its December 2007 all-time high.

More importantly though, FEZ is within striking distance of double resistance (red lines in the chart below). How FEZ reacts to this resistance cluster may well set the tone for weeks to come.

Simon Maierhofer shares his market analysis and points out high probability, low risk buy/sell recommendations via the Profit Radar Report. Click here for a free trial to Simon’s Profit Radar Report.

From Boom to Bust – Is Apple All Downhill from Here?

Apple has gone from the first ever 1-trillion dollar baby to stock investors can’t sell fast enough. Is Apple’s sell off overdone? Here’s one key point and a piece of technical analysis that may well hold the answer.

Downhill, up the creek, or to new highs? What’s next for Apple?

The iPad is selling like hotcakes, the iPad Mini tops many holiday wish lists, and Apple is projected to sell 53 million iPhones this quarter, a 40+% increase from Apple’s previous one-quarter record of 37 million.

Considering those numbers, is Apple’s recent 28% drop overdone?

That’s the wrong question. A better question is whether Apple’s run to its $705 all-time high was simply overdone?

The Disconnect between Sales an AAPL Shares

A September 18 article here on iSPYETF addressed an obvious but ignored math flaw in AAPL shares three days before the stocks all-time high. Here’s what I mean:

On September 13, Apple unveiled the new iPhone.

On September 17, Apple sent out an e-mail announcing that iPhone 5 pre-orders topped two million.

From September 13 – 17, AAPL soared 3.5%. Did this move make sense? Let’s calculate:

The profit margin on the iPhone is about 58% (according to a document obtained by Reuters). The average price is $299. The profit on 2 million iPhones sold at $299 is $347 million.

The 3.5% September 13 – 17 rally increased Apple’s market cap by some $24 billion.

Did anything material change in Apple’s fundamentals to validate this rally? No. The same article warned that Apple is due for a reality check, which will drag down the Nasdaq and technology sector.

So is Apple’s decline overdone?

Flawed Math is No Indicator

We surely won’t get the answer from Apple’s (holiday) sales. The math didn’t work on the up side and it won’t work on the down side.

Three factors that likely contributed to the most recent leg down are:

1) Profit taking before a seemingly inevitable tax increase.
2) The psychological effect of the death cross (although it’s not always as bearish as it sounds).
3) The increase of margin requirements by some clearing firms.

The most important factor is simply that the higher a stock rallies, the further it can fall. Apple’s run from below 20 in 2004 to above 700 in 2012 was just “too much of a good thing.”

Despite the set back, AAPL is still up 33% YTD and Apple’s market cap still $100 billion bigger than its closest market cap competitor.

Short-term Technical Outlook

Technical analysis of Apple and the AAPL chart warned of a top above 700 and a bounce of the November 16 low at 506 (summary of my Apple analysis can be found here).

The current chart is somewhat inconclusive, but selling has been heavy (see chart) and it seems to me that Apple is heading for a new low, perhaps around 480 – 490. Nevertheless, the down side seems limited and a new low unconfirmed by a new RSI low would create a bullish divergence and possibly prove as a springboard for a more sustainable rally into Q1 2013 (even without new low AAPL is likely to rally in Q1 2013).

 
Simon Maierhofer shares his market analysis and points out high probability, low risk buy/sell recommendations via the Profit Radar Report. Click here for a free trial to Simon’s Profit Radar Report.

Will The Fiscal Cliff Really Send Stocks Spiraling?

How will the fiscal cliff affect stocks? Investors are preparing for the worst-case scenario, but the stock market rarely delivers on investors’ expectations. What exactly is the fiscal cliff and how should you trade it?

“Fiscal cliff hopes buoy the markets” and “Fiscal cliff concerns drive stocks lower.”

The fiscal cliff is everywhere and thus far I’ve refused to write about. Everyone talks about this cliffhanger, so isn’t it already priced in? Is the fiscal cliff really as bad as it’s hyped up to be? Here’s my 2-cent contribution to the subject.

First off, fiscal cliff is the wrong label. It should be dubbed a fiscal shot in the foot. It’s a self-inflicted problem, or better yet, a problem imposed by incapable politicians upon the American public.

The Fiscal Cliff – A Twofold Problem

Neither the annual deficit nor the even bigger U.S. debt problem are new issues. It’s just that the divisive political climate moves politicians to hang out our dirty financial laundry in plain sight and turn previously discreet negotiations into public spectacles.

The debt ceiling issue came up in July/August 2011. At the time, the United States had reached its $14 trillion debt ceiling. Republicans and Democrats couldn’t agree on a balanced budget, so they simply increased the debt ceiling by $2.4 trillion – or 17% – to $16.4 trillion.

To make their failure and the new debt ceiling increase more palatable (and to give the public hope that the next round of negotiations will be different), both parties agreed on automatic spending cuts and tax increases. Those spending cuts are slated to take effect January 1, 2013 (called sequestration).

The cuts/hikes one two punch is one component of the fiscal cliff. That the new $16.4 trillion deficit ceiling is no longer adequate is the second. The fact that the U.S. deficit increased 17% in 18 months should be the third (but it’s ignored for now).

Will Washington Get it Done?

The token deal of August 2011 came last minute and obviously just postponed the inevitable. It even made things worse.

Standard & Poor’s downgraded the U.S. credit rating because the (2011) budget debate showed that: “American’s governance and policymaking is becoming less stable, less effective, and less predictable than what we previously believed” (quote from Standard and Poor’s).

We are already hearing statements like “the cuts/hikes don’t take immediate effect” or “congress can change laws retroactively,” so an early or even timely solution seems unlikely.

Is the Fiscal Cliff Really that Bad?

Can stocks fall off the fiscal cliff? They sure can. The image below explains the financial impact of the tax cuts.

Any fallout should be cushioned by bullish seasonality. The 2011 deficit negotiations and S&P downgrade happened during one of the weakest periods of the year. The 2012 negotiations occurred during one of the strongest times of the year.

Other factors to consider are how much of the worst-case scenario is already priced in? Fear over an increase of dividend taxes appears to have driven the post election sell off (the SPDR S&P 500 ETF– SPY – fell 9% from its September high).

Lets not kid ourselves, higher taxes and lower government spending – and any combination thereof – is bad for the economy. There will be consequences and the stock market will react.

But right now the reaction is expected. The stock market likes to prey on unsuspecting investors (not prepared ones). The stock market may wait for a more “opportune” time to douse investors.

Here’s how I approach the fiscal cliff: I don’t know if the negotiations will be fruitful or embarassing. I don’t know how much of the bad news is already priced in. But I do know that a move above resistance will unlock more up side, just as a move below support will lead to increased selling. With strong December seasonality the up side deserves the benefit of the doubt until proven otherwise.

I rather be guided by price action around support/resistance than by politicians. Key support and trigger levels along with a multi-month forecast is outlined in the Profit Radar Report.

Simon Maierhofer shares his market analysis and points out high probability, low risk buy/sell recommendations via the Profit Radar Report. Click here for a free trial to Simon’s Profit Radar Report.