ChartWatchers Newsletter

Financials Underperform After The Fed Meeting

It seems that nothing is ever easy in the market, but following price action is really important as we know.

Following the November 1-2, 2016 Federal Reserve meeting, Banks (Financials in general) went ballistic as it looked very probable that the Fed would raise rates at the December meeting. Coinciding with that was the election of President Donald Trump a week later. It is important to note that the rally in Financials started before the election and ended on the next Fed meeting December 14th shown in the chart below. The December Fed meeting, the January Fed meeting and the May Fed meeting all had the KRE at the same level. The March meeting had a 2% gain above the December meeting but gave it back.

Looking back to the September 2016 period, the banks had been in a slight trend of higher highs and higher lows between the September Fed meeting and the November Fed meeting. I have shown that on the chart below. Shortly after the November Fed meeting, the financials and the broad market pulled back for a day or two, then accelerated higher with the $SPX gaining 60 points off the lows before the US presidential election.

Currently the Financials are in the same sort of mild uptrend of slightly higher highs and lows between the March and May Fed meetings. This 2 day post-Fed setup has just happened again. The Friday close saw the $SPX have a sudden surge to new closing highs on Friday to set up the next week which is a little different.

While the outcome of the French election will also be known on Monday, the setup for the banks to go higher here looks similar to just after the November Fed meeting. There are two sideways days in the Bank ETF KBE after the Fed meeting. Do we get an explosive move higher on French results or Fed results?

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Whipsaw Intermediate-Term PMO BUY Signals on SPX and OEX

 I had already figured out what I would write about in today's ChartWatchers article, but that was put on hold when I received a Technical Alert in my email box telling me that we had IT Price Momentum Oscillator (PMO) signal changes on both the S&P 500 and S&P 100.  These signals are generated on the weekly charts.  Now, looking at the DP Scoreboards below, there is a clear story being told. Major markets are bullish in all three timeframes. Of course, the Dow has the a "red arrow" SELL signal left. Let's see how the IT PMO BUY signals came about and look at where the Dow is in relation to the others.

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Create McClellan Oscillators for the Nine Sector SPDRs and the Gold Miners

The McClellan Oscillator is a breadth indicator that Chartists can use to enhance their analysis of an index. StockCharts carries the McClellan Oscillator for dozens of broad market indexes, but not for the S&P sectors. There is no need to fret because StockCharts users can create the McClellan Oscillator using the AD Percent indicators and MACD. You can read more about the McClellan Oscillator in our ChartSchool. 

We first need a base symbol, which can be AD Percent or AD Volume Percent. As an example, AD Percent equals advances less declines divided by total issues. You can find a complete list of these symbols here. I will use S&P 500 AD Percent ($SPXADP) for an example. The chart below shows daily values for AD Percent as a histogram in the top window. The second window shows the EMAs used in the McClellan Oscillator for reference (19-day EMA and 39-day EMA). The McClellan Oscillator is the difference between these EMAs and chartists can plot this difference by applying MACD to AD Percent, which is shown in the third window. MACD equals the fast EMA less the slow EMA. In this case, MACD(19,39,1) is the 19-day EMA less than 39-day EMA. The signal line is hidden because signal line EMA is set to "1". 

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Sector Rankings and Weightings Are Still Market Positive

SECTOR LEADERSHIP... One of the problems facing the current stock market is that some sectors have been rising, while others have suffered large losses. Since the start of the year, for example, technology has gained nearly 14% versus a 6.7% gain for the S&P 500. Energy stocks, however, have plunged -10% this year. Industrial metal miners have lost -6% as have telecom stocks. Obviously there's a tug of war going on within the market as a whole. The question is which side is winning. To determine that, it's not just enough to count how many sectors are rising (8) and how many are falling (3) and by how much. We have to also consider how those sectors are weighted in the S&P 500. That gives us a better measure of how much the winners are impacting the S&P 500 versus the losers. Chart 1 shows the top four sector gainers since the start of year to be technology (13.7%), consumer discretionary (10.4%), healthcare (10.3%), and industrials (7.6%). All four did better than the S&P 500's gain of 6.8%. Four outperformers out of eleven sectors might not sound like much. But those four account for 57% of the S&P 500 weightings. Technology accounts for nearly 20%, healthcare (15%), cyclicals (12%), and industrials (10%). That alone gives an edge to the bulls.

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Earnings Season Favors the Bulls

Recent headlines have focused on tax reform, health care reform, partisan bickering, the president's first 100 days. But in the background many companies have been coming up big when reporting earnings which is why the market has been so strong of late.

While the bears have been hoping for a big pullback the bulls have gone about their business with the NASDAQ hitting an all time high while the Dow and S&P, though lagging, have remained within easy striking range of their respective all time highs.

With strong earnings come high reward to risk trading opportunities as long as you are willing to be patient. For example, take a look at the chart below on EXAS, a company that we issued a trade alert on for our members based on strong earnings, that turned into a nice winner.

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Investment Grade Corporates Outperform Junk Bonds

The green bars in the chart below show the iBoxx Investment Grade Corporate Bond iShares (LQD) trading at a new five-month high after clearing its 200-day average. The red bars, however, show the iBoxx High Yield Corporate Bond iShares (HYG) backing off from its early March high. The fact that investment grade bonds are rising, while junk bonds are weakening, carries a potentially negative message for stocks. That's because junk bonds are more closely correlated with stocks than bonds.

JUNK BONDS UNDERPERFORM... It's often instructive to see what various bond categories are doing relative to each other. That can tell us something about the mood of the bond market, as well as stocks. Right now, that mood is defensive. The green bars in the next chart show a relative strength ratio of the high yield bond ETF (HYG) divided by the investment grade ETF (LQD). The rising ratio since November favored high yield bonds. That's also when stock prices were rising. The falling ratio over the last month shows high yield bonds lagging. That also shows loss of risk appetite between the two bond categories. The falling HYG/LQD ratio also sends a negative message for stocks.

Bank Profits Soar But Bank Stocks Sour

At the time of the last ChartWatchers article, I didn't really see a whole lot to be nervous about.  However, the bullish picture certainly is getting a bit murkier based on developments since then.  After a very strong ADP employment report on April 5th, most everyone was expecting a solid nonfarm payrolls report two days later.  That never materialized, though, as the consensus was for 175,000 jobs to be reported.  Estimates ranged from 125,000 to 202,000, yet the actual number reported was 98,000.   That disappointment occurred when the Volatility Index ("VIX") had closed at 12.39 the previous day.  A low VIX reading (and a VIX in the 12s is a low reading historically) means the market is not expecting much volatility looking out the next month or two.  Bad news in a low VIX environment typically is ignored.  That's one reason that the S&P 500 closed down just two points on the day of the awful jobs report.

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Earnings Take Center Stage

It's that time of the year, a time when all attention is turned to the bottom line of corporate America. It happens every quarter and it always has a major impact on the direction of the market. And the bottom line almost always trumps everything else.

Of course there are other factors that impact the market including economic reports, geopolitical developments, Federal Reserve policies, as examples. But investors mostly care about the performance of stocks they own, including how they hold up in times of adversity, including market turmoil.

As an example, we issued a trade alert on one of the stocks in our "Candidate Tracker" that includes companies that beat earnings expectations and have strong charts. That stock was Apollo Global Management (APO) that crushed its earnings last quarter when it earned $0.98 per share versus $0.69 estimate. And it had revenues of $685 million versus estimates of $477 million. That is quite a beat and you can see in the chart below how the stock has performed:

We ended up with a very nice winner and you can see that even with the overall market struggling mightily at the moment APO has held up extremely well. This shows you the power of strong earnings even when the market is weak.

Of course if the market is in a free fall it becomes tough for even the best of the best to hold up. However, why not key in on those stocks with the strongest earnings and going forward guidance, especially when things are dicey?

We've currently got 200 stocks in our Candidate Tracker and as earnings season progresses we will be adding many more. If you would like to see a sample just click here.

Trading takes place all year long, no matter the market conditions. You're going to have your share of winners and losers. But you need to go out of your way to get whatever edge you can when things are so you might want to pay even more attention to earnings results this quarter than usual.   

At your service,

John Hopkins

How to Track ETF Tracking Errors - Examples for USO and GLD

Most of us are aware of the tracking error between oil and the US Oil Fund. There is indeed a tracking error, but a few charts reveal that this tracking error is subject to fluctuations and can even remain stable for extended periods. Today I will show how to measure tracking errors between ETFs and the underlying asset. Gold and oil will be used for examples, but these techniques can be applied to any ETF and its underlying asset, be it an index or commodity. 

There are two ways to chart the tracking error between an ETF and the underlying asset. Chartists can use a Performance SharpChart to compare the percentage change over time or chartists can plot a ratio to measure the relative performance. We must also choose between the most active futures contract and the continuous futures contract. As a general rule of thumb, I would defer to the most active futures contract when making a comparison. Continuous contracts work well for most metals and currencies, but do not work well for energy-related commodities, such as oil and natural gas. Note that continuous contracts are created by stitching together individual futures contracts. 

Comparing the Percentage Change over Time

The chart below shows the performance for the Gold SPDR (GLD), Gold Futures April 2017 (^GCJ17) and Gold Continuous Contract ($GOLD) over a six month period. All three lines are quite close together and this reflects a very small tracking error. 

Chartists can create this chart by adjusting the settings in the chart attributes section. GLD is the main symbol and it is plotted using “Performance” as the chart Type. This shows the percentage change for GLD over the last six months. I then added Gold Futures April 2017 (^GCJ17) and Gold Continuous Contract ($GOLD) by using “Price (same scale)” as an Overlay. This plots all three symbols using the same scale and makes it easy to compare performance. 

Plotting Ratios to Compare Performance

Chartists can also compare performance by using ratio charts. The ratio rises when the numerator rises more than the denominator and falls when the numerator falls more than the denominator. The top window in the example below plots the GLD:^GCJ17 ratio to compare the performance of the ETF with the futures contract (GLD is the numerator). The bottom window plots the GLD:$GOLD ratio to compare the ETF to the continuous contract. 

Notice that both of these lines are flat, which is not surprising after seeing how close the performance lines were in the Performance Sharpchart above. These three track each other quite closely and there is not much of a tracking error with the Gold SPDR (GLD). There were a few spikes, but we cannot expect perfection. Overall, both ratios were flat over the last six months and this reflects a low tracking error. 

Oil ETF Does Not Track as Well

The next chart compares the percentage change for the US Oil Fund (USO), Light Crude Futures May 2017 (^CLK17) and Light Crude Continuous Contract ($WTIC). This chart looks a little different than the gold chart above and we can immediately see some tracking issues. First, the continuous contract (red) shows a bigger gain than the other two. Second, USO (black) underperformed the May futures contract most of the period. Notice that the black line was below the gray line the last five months. There is clearly a tracking issue between USO and the underlying commodity. 

The next chart shows two ratios to plot relative performance over time. A flat ratio means flat performance and a stable tracking error. The rising ratio means the ETF outperforms over time and a falling ratio means the ETF underperforms over time. Either way, it is a tracking error. The US Oil Fund (USO) tracked the May futures contract quite well because the ratio was flat from mid November to March. This is a bit of a surprise and shows that USO tracks the individual futures contract pretty well. USO did not track the continuous contract very well at all. I am not concerned because the continuous futures contract is stitched together and it often not the best representative for the underlying asset price. 

Tracking Error Can Stabilize

I am not going to get into the reasons for the tracking error in many energy ETFs. In short, it is related to contango and contract rollovers. You can Google “oil ETF tracking issues” for more information. It is important to note that the tracking error is not constant and can stabilize. The chart below shows performance for the US Oil Fund, Light Crude Futures October 2016 and the Continuous Contract. Once again, the Continuous Contract did not track well and should not be used for comparison. As of 19-Sep-16, USO was down 9.27% and the Futures Contact was up 1%. This is clearly a large tracking error, but perhaps it is not as large as it seems. The bottom window on the chart shows a ratio plot to put this into perspective. The USO:^CLV16 ratio bounced around from January to March and this reflected tracking volatility. Notice that the tracking error was quite wide in February and remained about as wide the rest of the time. USO mostly lagged the futures contract. This tracking volatility, however, stabilized from April to September as the ratio flattened. The tracking error was still there, but remained stable for six months. This is just one example and the tracking error will not doubt be different for different time periods and different ETFs.  


Chartists do not need to worry about tracking errors for metal and currency ETFs, but should keep an eye on the tracking error for energy-related ETFs. Similarly, chartists can use the continuous futures contracts to compare performance with the metals ETFs. The situation changes with the energy-related ETFs. Chartists should not use the continuous futures contracts for comparison. Choose instead a near-by futures contract. Even so, there are likely to be tracking errors with energy-related ETFs Traders can minimize these tracking errors by trading short-term, a few weeks to a few months. The chances of a tracking error increase along with the holding period. Anything longer than six months is likely to generate a sizable tracking error.  Thus, energy-related ETFs are definitely not for long-term investors. You can find a symbol list of futures contracts here and a list for continuous contracts here

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Thanks for tuning in and have a good day!
--Arthur Hill CMT

Plan your Trade and Trade your Plan

Scoreboard Weekly PMO SELL Signals Approaching Fast!

One look at the DP Scoreboards and it is apparent there are problems in the short term. It appears that the intermediate term is sitting comfortably on BUY signals. That is true for the IT Trend Models (20/50-EMA crossover signals on daily chart), but momentum had already starting waining on the weekly charts for these indexes and now all of them are vulnerable to IT Price Momentum Oscillator (PMO) SELL signals this Friday.

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