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Moved the Blog September 4, 2010

Posted by michaelarold in Uncategorized.
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I have been moving this blog to

http://michaelarold.blogspot.com/

WordPress doesn’t offer to integrate Java Scripts, a functionality I need going forward.

Please update your links accordingly.

Thank you

Michael Arold

Keep an Eye on Basic Materials September 4, 2010

Posted by michaelarold in Market Commentary.
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Since July, the Basic Material Sector has shown great relative strength vs. overall market. A lot has been written about the current trading range of the S&P between 1020 and 1130. Every major cyclical sector had been operating in their own range. Basic Materials are not only very close to breaking out, but also recently started an intermediate term uptrend, indicated by the rising 20 and 50 day moving averages:

The sector has been very volatile, but I would new sector highs, which we could even see next week, would be bullish for the overall market.

Covestor Portfolio Commentary September 4, 2010

Posted by michaelarold in Portfolio Commentary.
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It has been a crazy week: US equity markets rallied from completely oversold to slightly overbought within three days.

The S&P is now approaching the upper boundary of its latest 1020-1130 range, which means I had to scale back on my long positions. Of course it is not fun to sell winning trades, but letting profits run simply doesn’t work in the current news-driven market environment. Let’s keep in mind, that despite the impressive recovery in the last three days, the market is not healthy. I want to see a robust market, where negative news are absorbed and reaction is muted. The real test will come in the next two weeks: markets need to consolidate and the if equities can manage to work off overbought conditions in an orderly fashion, we might see great high probability setups in a lot of stocks.

Until we get into a more healthy environment, we need to grind out returns. MercardoLibre (NASDAQ: MELI) is an example of my last weeks swing trades:

The stock is in a nice uptrend with rising relative strength vs. the S&P. Actually, this is a perfect swing trading condition: we buy the pullbacks to the 20 day MA and sell the new highs (“buy the dips, sell the rips”). Not very exciting,  but that is what’s currently working.

What makes me a little bit more excited is when bigger underlying themes start to emerge. I’m especially monitoring the metal and agricultural commodity sectors, which have acted very strong lately. Two positions in the portfolio are the Agribusiness ETF MOO and Cliffs Natural Resources (NYSE: CLF). I took partial profits in CLF last Friday, but plan to increase the position again on any weakness.

In terms of Gold, I took partial profits in my long position after a nice run. Gold is now at resistance at $1250 and either a breakout or an consolidation would prompt me to increase the position again.

Key to all the price action might be the Dollar next week:

It looks like the Greenback changed direction and the Dollar Index is heading to the  80 level. Such a move would support higher equity prices and indicate increased risk appetite of investors.

Also note that Treasuries are about to break their intermediate term uptrend:

Further weakness in Bonds could indicate that investors have started to move back into equities.

Another “indicator” I’m looking at is the relationship of cyclical to defensive stocks to gauge investors risk appetite. I’m looking at the ratio of Financials to Utilities. In fact, any combination is currently telling the same story (e.g. Industrials to Consumer Staples, Technology to Utilities, etc.):

I want to see these ratios to break their downtrends or at least get into a bottoming process. The XLF:XLU might be close.

Overall, we are about 50% long, 50% cash at this point with positions in BIDU, NFLX, FFIV, MOO, CLF and UGL and I’m planning to add to the long portfolio after some consolidation.

What the Utilities/Financials Ratio is Telling us About the Markets August 30, 2010

Posted by michaelarold in Market Commentary.
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Looking at the ratio of Utilities/Financials gave us valuable insights about the Equity markets in recent years. Financials for obvious reasons and Utilities as a proxy for defensive investor behaviour. It is quite interesting to plot this ratio against the S&P 500:

Note how both have been moving in opposite directions in the last years. In 2007, the ratio actually “front-ran” the big market decline, indicating weakness in the Financial sector before the overall market took notice. If a declining XLU:XLF should indeed be necessary to confirm  a market rally, the recent picture doesn’t look too positive:

Note that at the beginning of February, XLU:XLF started to decline and a two months rally followed.

What’s concerning is that the ratio has been trending up nicely since April and even last Friday with a strong rallying S&P, Utilities were outperforming Financials. Should this trend continue, it will be only a question of time until we’ll see new market lows in the next weeks, in my humble opinion.

Recent NYSE TICK Textbook Examples August 30, 2010

Posted by michaelarold in Swing Trading Method.
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Stocks sold off in the morning last Friday. Unfortunately, I closed some of my longs during this period, but managed to recover during the afternoon rally.

It could have been a nice profitable day if one would have watched the NYSE TICK. The indicator didn’t confirm the selloff for two reasons:

1) there was only one reading below 1000. A sustained decline would require multiple readings.

2) Divergence between Index and TICK, which started in the afternoon session of the prior day.

The afternoon session on the other hand was supported by multiple +1000 readings, thus showing broad participation.

In summary, the last two trading days have been full of  textbook examples for the applications of the NYSE TICK:

Covestor Portfolio Update August 26, 2010

Posted by michaelarold in Portfolio Commentary.
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Yesterday, I adjusted various positions in the Trading Portfolio.

The latest housing numbers and durable good orders turned out much worse than consensus estimates. However, stocks didn’t really sell-off. When negative news don’t lead to declining prices, it is a sign that a short-term reversal could be at hand. As a consequence, I closed most of my short positions (Russel 2000 (TWM), Financials (SKF) and Navistar (NAV)) and went long the S&P (UPRO), Lazard (LAZ) and Bidu (BIDU). On the long side, I finally sold the second half of my
Potash (POT) position. I don’t see a compelling risk reward/ratio at this point, since more than $160 will be difficult to get out of potential acquirers.

I do not expect a major rally, but these trades are simply to profit from “reversion to mean”. It will be interesting to see how markets react to Thursday’s job numbers, but any result in line with estimates might spark a rally due to oversold conditions. But even if initial claims come in worse than expected, hope for additional stimulus might put a floor under the market.

Other positions that are currently in the portfolio:

McDonald’s (MCD): my favorite trade right now. The market loves dividend plays these days and McDonald’s is a growth story as well. Great price momentum.

Gold (UGL): a position I have been in for the last three weeks and I plan to add more if momentum accelerates, which might happen if Mr. Bernanke shows up in his helicopter the next days.

Starbucks (SBUX), short: recently broke down from a significant technical top-formation. I initiated a small short position and plan to add more on rallies.

So in the next days, I probably will reduce long exposure quickly and look for some compelling short setups. Unfortunately, every trader will do that so the rally might end faster than we hope.

One position I’m looking forward to get in during the next days is the Long Utilities/Short Financials pair trade to benefit from over/underperformance of both sectors through a market neutral trade. Investors are chasing divdends and banks will be under pressure due to the flattening yield curve.

Quick Quantitative Study: What Happened Recently After Capitulation? August 25, 2010

Posted by michaelarold in Market Commentary.
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In case we get a major sell-off in the next days: a brief study on what happened recently after “capitulation days” (prices declined more than 2.5%): the S&P ended higher 6 out of 7 times since April. So on these days, you either want to close all short positions or (if you are aggressive) even open Index Longs to play the bounce. The odds are on your side (at least when looking at the data of the last 6 months, which granted, is a very short period to make predictions based on statistics).

Here’s a  chart with entries and exits:

Trade of the Week: Short Brunswick Corp. (NYSE: BC) August 24, 2010

Posted by michaelarold in Trade of the Week.
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Brunswick is a global manufacturer of recreational products. The marine segment is the company’s core business and Brunswick is also manufacturer of fitness machines, bowling equipment and billiard tables. I don’t quite see how you can create synergies by building boat engines and billiard tables, but anyways.

The company operates in a segment of the market, which is extremely vulnerable to the overall economic situation and especially unemployment. BC is therefore a great vehicle to play the “struggling US consumer” theme.

Four analysts are following the stock with an average price target of $21, which is way above the current level of 13 bucks for the stock. On the other hand, short sellers are piling into their positions: over 20% of float is held short and the number rose from June to July. Why are so many investors shorting the stock? Probably because of evaluation: BC is trading 30X 2011 earnings, which is BTW two times the forward PE of Apple!

So who is right: short sellers or analysts? I think we could see downgrades from the later because analysts still expect rising consumer demand and lower unemployment this year.

At this point, I’m comfortable shorting the stock: BC has a relative large market cap, compared to the industry (1.3 bn) and the company is currently not a
takeover candidate. But even in a takeover event, we cannot expect premiums like in the case of e.g. Potash or McAfee. Granted, BC is a short squeeze candidate due to the high short ratio, but I can’t see a short-term catalyst, which would push the shorts out of the stock.

The technical picture is offering a compelling risk reward ratio for a short-term trade: stop-loss @ $15, 1st target $12, 2nd target$10:

So you Think Markets are not Trending? Check out XLU/XLF August 23, 2010

Posted by michaelarold in Uncategorized.
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The S&P hasn’t shown much direction in the last months. However, the relationship of some sectors has been trending very nicely: check out Utilities vs Finanicals, which are among the strongest and the weakest sector over the last couple of months.  If you would have shorted Financials and went long Utilities, your equity curve
would have looked somehow like this:

I like the relationship for another reason: a sustainable market rally would need to be accompanied by a trend reversal in that pair. Right now, the implications
are rather bearish.

Market Commentary: Mixed Signals August 23, 2010

Posted by michaelarold in Market Commentary.
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Not only are we seeing mixed signals from the economy – record earnings, weak leading economic indicators – also the market is currently not easy to read. As a consequence, I’m extremely careful with going long here and try to balance out with short positions. Or even better – don’t trade at all.

On the (slightly) positive side are market technicals – key indexes and sectors are at major support levels, so I’m expecting at least a short-term bounce. Important sentiment indicators signal either an excess of bearishness (CBOE equity put/call ratio), which is bullish or a higher level of complacency (VIX), which is bearish.
Granted, the latest VIX price action can also be interpreted as bullish (discussion maybe in a separate post).

Towards the end of last week, however, I eliminated the hedge in terms of the Russel 2000 short position. I will not hesitate to put this trade back up
should we see a quick bounce from current levels: the index is forming a series of lower highs and lower lows on the intraday 60-min chart, which means small
cap stocks are in a downtrend.

I’m still short US Financials. Reason is the latest underperformance vs. the overall market. The following chart in fact shows that Financials have been the weakest sector over the last 30 days (in fact over the last 90 days):

One theme I’m looking at is the latest M&A wave. Unfortunately, activity in this space couldn’t inspire the market so far. I’m using Lazar Ltd. (NYSE: LAZ) as a proxy to see if that theme is gaining any traction. The chart looks quite bullish at least:

Another theme is Gold: the yellow metal is knocking at the 1250 level again. Should Gold break above, I will increase my long exposure. Note that I closed my short position about three weeks ago after the Bernanke’s “unusual uncertainty” comments:

Next theme is interest rates: some “market gurus” , like Doug Kass have been shorting the long end and got crushed. I good trader, however, needs to be patient
and wait for confirmation through price action. I would like to short TLT, but the price trend couldn’t look more bullish at this point:

My overall feeling about the market is extremely negative (I do my best to let my feelings not interfere with what I’m seeing in price action) and I still believe
the market could see another nose dive until the rest of the year. In a nutshell, I believe there is a DRAMATIC shift going on in the US economy since the US  middle
class currently is getting killed. The only reason why the consumer-focused economy didn’t break down yet is because Joe Small is tapping into his retirement savings to keep paying the bills (there are scary statistics out there, which support this point). Other statistics show that the traditional optimistic sentiment of Americans is fading: the number of people who believe that their kids will be worse off  than their parents is at record high. Another sign of pessimism, which could translate into lower consumer spending ahead. Finally, I don’t believe that upcoming potentially negative GDP numbers are baked into equity prices yet.

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