Will European QE Send Stocks Soaring?

It’s not that we need a chart to show that QE pumps up Wall Street, but here is one anyway.

The obvious question is whether Europeans QE will do the same for European stocks as U.S. QE did for U.S. stocks.

Liquidity drives the markets, so the logically answer is ‘yes’.

However, there are a few other variables.

  • U.S. QE was unleashed when the S&P 500 was near 12-year low. European QE was announced when German and English bourses are at or near all-time highs.
  • The situation in Europe is more fragmented and complex than in the U.S.
  • The U.S. dollar was at a multi-year high when U.S. QE was launched. The euro is at a 11-year low.

Despite all the differences, European QE was received similar to U.S. QE. Here’s what one German politician said:

“QE makes the rich even richer. It is a drug for the stock market. It drives up stocks. But the money should flow in the real economy, not banks.” Sounds familiar, doesn’t it.

Here are a few headlines commenting on the ECB’s move:

  • MarketWatch: Why European QE is bearish for US stocks
  • Fortune: Larry Summers: The ECB’s QE won’t work
  • FoxNews: Five reasons why ECB won’t save continents dying economies

U.S. stocks rallied for years despite all the persistent haters (me being one of them).

The stage seems set for a European stock rally.

However, the Vanguard FTSE Europe ETF (NYSEArca: VGK) cautions buyers against rushing in. VKG is about to the reach double technical resistance.

This doesn’t mean it can’t go higher, but buying before a speed bump is rarely prudent. A breakout would be a better reason to buy (and it would offer a good stop-loss level). The charts for five other European ETFs look similar. View Top 5 European ETFs here

What about the regions strongest stock index? Germany’s DAX is trading at all-time highs, and is about 3% above important support at 10,000. Further gains are possible, but a close below 10,000 would put the QE rally on hold.

Unfortunately there’s no ETF that closely tracks the German DAX. The iShares MSCI Germany ETF (NYSEArca: EWG) is severely lagging behind the DAX. Otherwise it would be interesting to buy EWG and short SPY (S&P 500 SPDR) or go long the DAX with a stop-loss just below 10,000.

The U.S. QE experiment has taught us that it’s foolish to bet against the Federal Reserve or its international counter parts … and yet I have a tough time believing that European stocks will take off right away.

Simon Maierhofer is the publisher of the Profit Radar Report. The Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013.

Follow Simon on Twitter @ iSPYETF or sign up for the FREE iSPYETF Newsletter to get actionable ETF trade ideas delivered for free.

Advertisements

Dow Jones and S&P 500 Skew Broad Markets Real Performance

Based on the Dow Jones and S&P 500 it looks like stocks still need to conquer their 2007 highs before being ‘resistance free,’ but that isn’t the case. The Dow and S&P paint a deceptive and less bullish picture than reality.

If you don’t open your eyes to the bigger picture, you open your portfolio to unnecessary losses.

CNBC’s countdown clock will tell you that the Dow is only X points away from its 2007 all-time high. That’s true, but it’s also deceptive.

The Dow Jones Industrial Average is a price-weighted average of only 30 large cap stocks. IBM alone accounts for over 11% of the Dow’s movements.

The S&P 500 is a market capitalization weighted index of 500 large cap stocks that emphasizes the performance of the largest of large caps.

Mega Cap, ‘Mini’ Performance

Fact is that the bluest of the large cap stocks are lagging compared to the rest of the market. IBM is 5% from its all-time high as is Exxon Mobil. Oh yes, there’s also Apple, key player of the S&P 500, trading 36% below its high watermark.

A simple chart illustrates the ‘weakness’ of mega cap stocks compared to their large cap cousins. Figure 1 provides a visual comparison of the S&P 500 SPDR (SPY) and an equal weight S&P 500 ETF (Guggenheim S&P 500 Equal Weight ETF – RSP).

SPY trades about 3% below its 2007 high, equal weighted RSP trades more than 7% above its 2007 high. Why?

The top five S&P 500 components (Apple, Exxon Mobil, GE, Chevron, IBM) account for 11% of the index. Four of the top five holdings are more than 5% from their all-time highs.

The top five equal weight S&P 500 components account for 1% of the equal weight index and allow ‘smaller larger’ caps to pick up the slack of mega caps.

‘Smaller is Bigger’

Smaller is better in this QE bull market (more below). Mega caps underperform large caps, and large caps under perform small and mid-cap stocks.

Figure 2 plots the S&P 500 SPDR (SPY) against the MidCap 400 SPDR ETF (MDY) and SmallCap 600 SPDR ETF (SLY). The message is the same. MDY and SLY are at new highs, SPY isn’t.

What’s the Big Deal?

Stocks are up, portfolios are up, Wall Street is happy and the media is ecstatic, so what difference does it make who or what performs best?

Market tops are liquidity events. When investors stop buying, stocks start falling. Small and mid-cap stocks dry up first as they are most sensitive to liquidity squeezes.

That’s why small and mid-cap stocks tend to underperform somewhat going into larger scale highs. Thanks to the Fed’s artificial liquidity environment that hasn’t been the case.

Based on the strong showing of small and mid cap stocks and the absence of bearish divergences, the Profit Radar Report was expecting new highs even when the S&P traded well below 1,400 in November of last year.

Historic money flow patterns suggests that the overall trend remains up as long as small and mid cap stocks keep up with large caps.

Diversification: The Correlation Risk Trap is Real

A rising tide lifts all boats and liquidity buoys all asset classes. That’s great, but it’s not diversification. In fact, it presents a whole new type of hidden risk. Many ‘diversified’ portfolios today would fail miserably at any sort of Black Swan event.

The purpose of diversification is to reduce risk. The rationale behind diversification used to be that booming cycles of some asset classes offset the bust cycle of other assets.

Diversification made sense in an environment where some asset classes boomed while others got busted, but that isn’t the case anymore.

Today most asset classes ebb and flow at the same time, but at different degrees. This makes diversification less effective and possibly dangerous.

The first chart shows the percentage change of the following asset classes/ETFs since January 2007: S&P 500 SPDR (SPY), iShares Core Total US Bond ETF (AGG), iShares Dow Jones US Real Estate ETF (IYR), and iShares S&P GSCI Commodity ETF (GSG).

In early 2007 stocks and commodities cushioned the decline in real estate prices. In 2008 commodities lessened the sting of falling stock and real estate prices.

Then came quantitative easing and it’s become clear ever since that all asset classes swim in the same liquidity pool. Some swim faster, some slower, but all float with the tide.

Different Approach to Diversification

A less popular, more contrarian and quite possibly more effective approach to diversification involves simple under appreciated cash.

Based on Rydex funds flow data, investors are despising cash like never before. Low interest rates are partially to blame for the great cash exodus, but excessive enthusiasm for stocks is probably the main motivation.

The second chart illustrates basic support (green) and resistance (red) ranges for the S&P 500. The S&P tends to get overbought in the red and oversold in the green zone.

Over the past years, investors did well to diversify out of stocks (and other assets) into cash when prices reached the red resistance range and rotate out of cash into stocks (and other assets) in the green range.

The S&P is about to reach overbought territory and risk is rising. Raising cash may offer more risk protection than diversification.

The Profit Radar Report will provide specific trigger levels indicative of a trend change from up to down.

How to Spot Low-Risk, High Profit Trades

It’s easy to pick out bygone trading opportunities after the fact – hindsight is 20/20. But this article looks at live low-risk trades and provides a tutorial on how to identify low-risk trades and when to lock in profits.

“Buy the best and forget the rest.” This is the mission statement of the Profit Radar Report. “Buying the best” doesn’t refer to the best stocks but to the best profit opportunities.

The quality of trade setups is more important than the quantity, but how do you spot a quality setup? The next few paragraphs highlight three actual quality opportunities for gold, silver and the S&P 500,

Before we delve into the actual charts, I’d like to define what makes a quality setup.

1) High probability trade: I follow three key market forecasting elements (continuous coverage provided via the Profit Radar Report):

I) Technicals
II) sentiment
III) seasonality.

A high probability (usually equal to a high profit trade) setup only happens when all three indicators point in the same direction. Using this technique I identified the following high probability trades:

Sell: April 2010, May 2011 – Buy: March 2009, October 2011, June 2012.

It’s comparatively rare for my three key indicators to align. But that doesn’t mean there aren’t any quality setups.

2) Low-risk trade: A low-risk setup is a trade with significantly higher profit potential than risk of losses. That’s because the entry point is very close to key support or resistance, which provides a powerful and well-defined stop-loss level.

We haven’t had a high probability set up in nearly half a year, so the quality setups highlighted below are all classified as low-risk trades.

S&P 500

The S&P 500 reached our revised up side target of 1,475 on September 14, the day after the Fed announced QE3. We didn’t go short at 1,475 because the new recovery came come absent of a bearish RSI divergence (the April 2010, May 2011 and May 2012 highs were all market by bearish RSI divergences).

The initial phase of the decline was very choppy and difficult to trade. Key support was at 1,396. The November 7 Profit Radar Report warned that: “A move below 1,394 will be a signal to go short with a stop-loss around 1,405.”

The November 14 Profit Radar Report recommended to: “Place a stop order to close half of our short position at 1,348 to take profits.” The second half was closed out at 1,371.

We closed our positions for a 46 and 27 S&P point profit. At no time was the risk greater than 10 points. The 27 – 46 point gain wasn’t as great as if we entered earlier, but we had a favorable risk/reward ratio and most importantly low-risk profits.

Corresponding ETFs are the Short S&P 500 ProShares (SH), UltraShort S&P 500 ProShares (SDS) or the S&P 500 SPDR (SPY).

Gold

In early October gold was sitting atop quadruple support but sentiment had become frothy. The October 7 Profit Radar Report stated:

“According to the latest Commitments of Traders (COT) report, small speculators are now holding the most net long gold positions in a quarter century. Friday’s action also produced a red candle high. Both developments are generally bearish. However, as mentioned in Wednesday’s PRR, gold prices remain above quadruple support (2 trend lines, 20-day SMA, and 61.8% Fibonacci). As long as prices remain above support we’ll give this rally the benefit of the doubt. A move/close below 1,765 will be a signal to go short for aggressive investors with a stop-loss at 1,775” (later raised to 1,777).

When should we take profits? The October 25 Profit Radar Report said this: “Gold dropped to support at 1,700 today. We are getting to a point where it becomes tempting to lock in a 65-point gain. Since gold hasn’t seen a daily bullish RSI divergence yet either, we’ll hold our short position. We’ll sell half of our holdings at 1,680.

We sold half of the gold position at 1,675 in early November and the second half at 1,725 a few days later and captured a 5% and 2.5% profit. Corresponding ETF trades were a) short the SPDR Gold Shares (GLD) or b) buy the UltraShort Gold ProShares ETF (GLL).

Silver

Silver broke above trend line support on July 25 at 27.30. This was a buy signal. Our stop-loss was at no time more than 2% below the entry price (initially red, than green trend line).

In hindsight we could have held on to the position as long as the sharply ascending green trend line remained in tact, but hindsight is 20/20.

We closed the position around 30 and 32 for a 10% and 16% gain in the iShares Silver Trust (SLV).

Future low-risk and high probability trade signals are available 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.

Insider Selling of Stocks is at Highest Level for the Year

Insiders are fearful of an impending sell off. When this happened earlier this year the S&P 500 quickly declined 10%. Other sentiment measures are reaching extremes too, but there’s a silver lining.

All major U.S. stock indexes continue to trade near multi-year highs, but insiders are selling stocks of the companies they own or manage at a pace not seen at any other time in 2012.

Investors Intelligence reports eight sales for each purchase and considers the current rush for the exits “panic selling.” The question we should ask is, “what do insiders know that we don’t?”

Another sentiment extreme can be seen in the high yield bond market, more appropriately called junk bonds. Companies just issued the third-highest amount of junk bonds.

The prior records were set in October 2010 and May 2011. Those two dates are marked in the chart below. I’ll explain in a moment the significance of those two dates.

Mutual fund managers tracked by the National Association of Active Investment Managers report that managers have a median exposure of 95% to equities. This is close to a six-year high and sets an 18-month record.

The Dow Jones just went an entire quarter without losing more than 1%. Jason Goepfert with SentimenTrader took a look at what happens historically when the Dow goes an entire quarter without a 1% decline, while trading close to a 52-week high.

There were 16 such instances since 1900. Over the next six months, the Dow was positive every time with a median return of +6%.

Getting back to the two dates highlighted in the chart above, we are currently in a situation where sentiment is becoming extreme. But just as Advil covers up pain, QE3 tends to neutralize extreme optimism.

Back in October 2010 it took several months before sentiment extremes caught up with stock prices. In May 2011 however, it resulted in a nasty sell off.

From a seasonal perspective October is an interesting month. It has hosted a number of crashes but also a number of important lows.

Looking at stocks, we see that the S&P 500 (S&P 500 SPDR – SPY) has been trading in a well-defined parallel trend channel. The strategy – as long as the S&P remains within this channel – is to sell when it reaches the top of the channel and buy at the bottom.

Once the bottom (of the channel) falls out, it’s probably time to become more bearish.

The Profit Radar Report monitors literally dozens of sentiment gauges, seasonal patterns, and technical developments to identify high probability investment opportunities for the best investment strategy.

Week Ahead for the S&P 500 – QE3 vs. Worst Week of the Year

Last Friday was triple witching and the week after triple witching is notoriously bearish. How bearish? The S&P 500 Index has closed down 22 out of 26 weeks since 1990 (82%) with average maximum losses about 5x as high as average maximum gains.

Historically short sellers of stocks have an 82% chance of making money this week. However, the S&P 500 Index failed to registered a bearish price/RSI divergence at its September 14 recover high.

All recent highs that were followed by a decline of around 10% or more were foreshadowed by a bearish RSI divergence (I use a unique RSI setting to spot divergences – see chart below). So even a bearish outcome this week would likely be followed by higher prices later on.

The purpose of the Profit Radar Report is to identify high probability trading opportunities. With the conflict between bullish technicals and bearish seasonality, there obviously is no high probability set up right now.

One of two things will have to happen to create a better set up:

1)   Prices decline to trend line support to present a possible buying opportunity.

2)   Prices spike quickly to a new high accompanied by a bearish price/RSI divergence to set up a possible shorting opportunity.

Non-leveraged ETFs that can be used to trade the above set up are the S&P 500 SPDR (SPY) and Short S&P 500 ProShares (SH).  Leveraged options include the Ultra S&P 500 ProShares (SSO) and UltraShort S&P 500 ProShares (SDS).

An early tip off to the next developing set up may be a developing triangle. A break out above or below triangle support/resistance should give us a measured target, which may quite possibly set up an even better opportunity than the actual triangle.

Continuous updates and trading opportunities are provided via the Profit Radar Report.

S&P 500, Dow Jones and Nasdaq – The Deceptive Intricacies of Popular Stock Market Indexes

On first glance the performance of the Dow Diamonds (DIA), S&P 500 SPDR (SPY) and Nasdaq QQQ (QQQ) seems to be closely correlated. This first glance assessment, however, couldn’t be farther from the truth. Here’s what separates the indexes from each other and why it’s important.

Index investing or ETF index investing is a popular and low-cost way to put your dollars to work, it’s like putting your portfolio on cruise control.

But driving on cruise control isn’t always the best way to get from A to B and doesn’t mean you won’t get into an accident. It merely means that you delegate speed control to your car.

Your level of commitment to your own portfolio ultimately dictates your style of investing: buy and hold via indexes or ETFs, buy and hold via actively managed mutual funds, or a more active approach to buying and selling.

Regardless of what type of investor you are, you need to be familiar with your investment vehicle(s) of choice, just like a driver needs to know the difference between automatic and stick shift.

Look Under the Hood

The S&P 500, Dow Jones, and Nasdaq are the most popular U.S. indexes and if you are an investor, odds are some of your money is invested in one or more of those three indexes.

Equity indexes are often described as a basket of stocks. Retirees or near retirees are familiar with the term nest egg and the comforting picture of many golden eggs nested up to provide a comfortable retirement.

But what if the basket of eggs is made up of one or two giant ostrich eggs that limit the space for other eggs? That wouldn’t be well diversified and one knock against the basket could scramble most of the retirement.

Hidden Ostrich Eggs

Financial ostrich eggs among major U.S. indexes are more common than you think.

IBM accounts for nearly 12% of the Dow Jones Industrial Average (DJIA or Dow Jones). Technically speaking, the DJIA is an average not an index. The DJIA is price weighted, in other words only the price of a stock matters, nothing else.

IBM is the most expensive stock of the DJIA and moves the index (or average) 20x more than Bank of America (BAC) even though IBM has only about twice the market capitalization (the price per share multiplied by the amount of outstanding shares) of BAC.

The ETF that best represents the DJIA is the SPDR Dow Jones Industrial Average ETF. Its ticker is DIA, that’s why it has the nickname Dow Diamonds ETF.

The Nasdaq-100 and the PowerShares Nasdaq QQQ ETF (QQQ) hide another “ostrich egg,” – Apple. Apple accounts for a whopping 20% of the Nasdaq-100 Index. If you already own Apple or don’t believe Apple is the way to play technology, you may not want to own QQQ.

The S&P 500 Index – represented by the S&P 500 SPDR (SPY) – provides more balanced diversification than the DJIA or Nasdaq-100. Apple, still the biggest player of the S&P 500, accounts for less than 5%. IBM has a weight of only 1.8%.

Considering the different composition of the three indexes, it’s remarkable how closely their day-to-day moves correlate.

The chart below provides a visual of the long-term correlation between the Dow Diamonds (DIA), S&P SPDR (SPY), and QQQs. Illustrated is the percentage change since April 1999 (when the QQQs began trading) to provide an apples to apples comparison of the three indexes.

The SPY and QQQ delivered a near identical return (+38%). The DIA is up 68% since April 1999. Of course the picture looks much different if you start measuring the return from the 2000 highs.

All three indexes and index ETFs share the commonality of having had very sizeable swings ranging from -60% to +60%. The Profit Radar Report advocates an investment approach that capitalizes on larger up moves and turns neutral or short during major down moves.

This approach can significantly enhance your return and reduce your exposure to risk.

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.