Vulnerable To More Weakness
An extended U.S. stock market was handed some bad European news Monday. From
Hopes for a clear-cut outcome in Italy’s parliamentary elections on
Monday gave way to fears that a strong showing by Silvio Berlusconi and
his center-right allies could trigger a fresh round of political
It is possible another round of elections will be required. Another round of
elections means more uncertainty. Financial markets do not like uncertainty.
Last Week Charts Said “Be Careful”
While today’s weakness in stocks will be attributed to the elections in
Italy, stocks have been shooting up warning flares for over three weeks. One
example is the ratio of small-cap growth (IWO) to Treasuries (TLT) (chart
below). When the ratio rises, small-cap growth stocks are in greater demand
than Treasuries (a.k.a. risk-on). Conversely, when the ratio falls,
Treasuries are in greater demand than small-cap growth stocks (a.k.a.
risk-off). Last time the ratio reached the top of the blue trend channel
(point A), stocks corrected for several weeks (point B). The ratio is
turning down again near point C. If the pattern holds, the ratio could “fill
the white space” as the S&P 500 corrects further.
The February 23 video below covers numerous areas of the market that were
saying “be careful” as of the close last Friday. The video covers the
following ETFs: Russia (RWX) at the 4:42 mark, copper (JJC) 7:25, coal
stocks (KOL) 9:26, materials (IYM) 10:06, U.S. dollar (UUP) 11:26, utilities
(XLU) 13:17, shorts (RWM) 15:11, and small-cap growth (IWO) 16:17.
Unlimited QE May Not Be Unlimited
While it is unlikely the Fed’s easy money policies will be altered anytime
soon, the release of the last Fed minutes showed how easily markets can be
spooked. It is not in the Fed’s best interest to have a mass exodus from
U.S. Treasuries since it puts upward pressure on interest rates.
Consequently, a little jawboning to pull some of the froth out of stocks and
put a bid under Treasuries is part of their game plan. The Fed will not
begin unwinding their massive balance sheet in the coming months, but a
little fear regarding that topic isn’t such a bad thing for Mr. Bernanke and
Risk vs. Reward Matters
If you follow our work, you may get tired of the term “risk-reward”. The
last few trading sessions show why the term is important. After Monday’s
blood bath, the S&P 500 has now “taken back” 38 calendar days worth of
gains. The S&P 500 closed at 1,486 on January 18. Monday’s close was
1,487. We described the market’s poor risk-reward profile in detail in this
portion of a February 16 video.
Sequester Becoming All Too Real
Regardless of your stance on government spending and economic growth, there
is no question that when the government spends less, it hurts GDP in the
short-run. The impending budget cuts will have a negative impact over the
coming quarters. With a massive bid under Treasuries, or TLT, Monday, the
markets may be coming to grips with the short-term ramifications of the soon
to be made spending cuts.
We took profits and raised cash back on January
24 citing a poor risk-reward ratio for investors (see tweet below).
The day we booked gains, the S&P 500 closed at 1,494. We have missed
nothing. Monday the S&P 500 “gave back” all the gains posted over the
past four weeks, closing at 1,487 (below 1/24/13 level).
We will continue to monitor the markets with an open mind. If we see
improvement similar to what we cited back on November
19, 2012, we are willing to redeploy some of our cash. For now, we are
happy to remain patient looking for a better risk-reward pitch to hit. That
pitch could come somewhere in the neighborhood of 1,472 (see chart below) or
it may not come for several weeks.
This entry was posted on Monday, February 25th, 2013 at 6:17
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Chris Ciovacco is the Chief Investment Officer for Ciovacco Capital
Management, LLC. More on the web at www.ciovaccocapital.com
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