| The Futures/Intermarket Report June 22, 2007 |
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| Written by Matt Caruso CMT | |
| Sunday, 24 June 2007 | |
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The Futures / Inter Market ReportTrading the World’s MarketsJune 22, 2007 Finding Stock Market TopsStock markets around the world have been in a strong bull market for almost 5 years now. Equities in the U.S. made a major bottom in 2002 and since then stock investors have experienced a strong appreciation in stock prices with only several corrections along the way, none which can compare to the fall in prices during the 2000-2002 bear market. Although investors would have made a great deal of money being long stocks the past 5 years, wouldn’t it have been nice to have known in advance when the corrections in the bull market were going to occur? Better still, wouldn’t it be better to know when to enter short in a bear market to capture the most profits possible in the subsequent decline? What I use to determine such turning points in the market is not a statistical model to explain stock movements; rather I look at what investors are indirectly telling me through their buying preferences. The stock market is composed of multiple sectors which include; Consumer Cyclicals (XLY), Consumer Staple (XLP), Energy (XLE), Financials (XLF), Health Care (XLV), Industrials (XLI), Materials (XLB), Technology (XLK) and Utilities (XLU) which can all be traded as ETFs, for more information on these please visit: www.sectorspdr.com . It is important to understand that investors have a choice in which sector they want to put their money, and their preference says a lot about what they think the market is going to be doing in the future. The Consumer Cyclical sector is composed of stocks such as Time Warner, General Motors, and Carnival corp. These companies sell products that are not essential to consumers and when times are economically tough. When people are not doing well monetarily they will not purchase their products and save their money for more essential products ad services. The Consumer Staples sector is composed of stocks such as Procter & Gamble, CVS Caremark Corp., and Walgreen. Regardless of how people are doing monetarily, they still need to buy toothpaste at Walgreen’s but they don’t need to buy a brand new Cadillac from General Motors.
Studying the preference of investors between these 2 sectors can tell us a lot about what they expect the future to be. If investors prefer Consumer Staple stocks, then they are not optimistic on the future and therefore unwilling to risk a great deal of money. If investors prefer consumer cyclical stocks then they are optimistic and willing to risk a greater amount of money for greater potential returns. The easiest way to study the preference of investors is to study the relative strength(RS) between the Staples and Cyclicals. This is achieved simply by dividing the Staples sector (XLP) by the Cyclical sector (XLY), as can be seen in figure 1. When the RS line is climbing, Staples are outperforming Cyclicals and when it is falling, Cyclicals are outperforming Staples. As you can see by the red line, there are clearly times when investors prefer one sector over the other. What is important however is the turning points in the RS line, or in other words, when investors begin to shift their preference from one sector to another. I have drawn equidistant lines in figure 1, each line is spaced 176 days apart. The lines coincide quite well with direction changes in the RS line and point out most time where preference of investors is shifting in favor of the Staple stocks. These same turning points also coincide with most significant market tops in the S&P 500 as can be seen in the bottom part of figure 1. In order to see the preference of investors clearer, I have “detrended” the relative strength line in figure 2. As highlighted by the blue lines, when the RS turns higher, prices top and when it turns lower prices tend to rally. This chart shows that investor opinion can help pinpoint market turning points, and it does so in a consistent manner, approximately every 176 days. We are currently 146 days from the last bottom in the RS/top in the market and if this market rhythm is to continue we should see another bottom in the RS and top in the market in about 30 trading days which calls for the Market to make a top in the August – September time period.
The August –September time period is traditionally the weakest time of the year for the markets. There is a seasonal tendency for stock price to make a high in August- September and to bottom in October-November. Figure 3 & 4 highlights the seasonal top in the Dow Jones for the past 7 years. This seasonal tendency and the cycle in the Staples & Cyclical relative strength all point to a potential top late summer. It is important to monitor trend as well because price is the final arbiter and a trend reversal in rice would also be need before prices can experience a correction. However, a change is relative strength at the end of summer and the seasonal tendency at that tine of the year for prices to fall is probably a good reason to lighten up on positions or take profits. Any trend reversals in price and relative strength between the XLP & XLY during that time period should be monitored with greater concern.
Figure 3 Dow Seasonal. Chart by Genesisft.com
Figure 4 Dow Seasonal. Chart by Genesisft.com ------------------------------------------------------------------------------------------------------------------------------------------ DisclaimerTradeSystemGuru.com obtains information from sources deemed to be reliable; |
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| Last Updated ( Tuesday, 10 July 2007 ) |
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