$SH Archives | Opportunity Identified

April 4, 2016 | Posted by David Zarling, Head of Investment Research

S&P 500 At Important Juncture

Back in November and December of 2014, we released a 7 part series highlighting the weight of evidence piling up against U.S. stocks. In summary, our research showed a market top was upon us. If you weren’t with us back then, you can catch up and dig into our methods using the links below.

This research proved timely as U.S. equities subsequently stalled, moving sideways for the past 1.5 years.

To show the importance of our findings, as well as highlight its prescience, here is the S&P 500 from a bigger perspective.

If you were reading our research back then, we hope you used it to your advantage. All that being said, this isn’t just a puff-our-chest piece. The U.S. stock market is at an important juncture and we want you to see what we see. As we’ve highlighted in the past, corrections happen in one of two ways: through price -or- through time. It is too early to tell, but 1.5 years would qualify as a correction through time if price can move upward through current levels and sustain new highs. At the same time, further correction through price is still on the table. If the S&P 500 cannot breach this level and move on to new highs, it is very likely a correction between 5-15% will take place.

Here’s a daily chart of the S&P 500 (our U.S. stock market proxy) showing just how important this current price level is to market participants.

The area between 2072 and 2134 has seen sellers show up en masse in the past. In addition, this important index needs to overcome the downward green trendline annotated on the chart above. This dual resistance should be difficult to overcome in the short term. However, price knows more than we do. If price can overcome this area of supply, it would signify buyers’ willingness to test all time highs (2134) from the Summer of 2015. This rally from the early February lows has been fast and fierce. Yet, from a short-term perspective, it is long in the tooth. A consolidation or pullback here could be healthy. At the same time, if we ask ourselves the question, “is this where we want to put new money to work?” We think the answer is a simple, no.

At this important juncture, it’s time to watch closely and let the market signal its next move.

Check back often as we’ll be sure to share our findings as the next leg in the U.S. market unfolds.

Disclaimer: Nothing in this article should be construed as investment advice or a solicitation to buy or sell a security. You invest based on your own decisions.

February 11, 2016 | Posted by David Zarling, Head of Investment Research

The Yen’s Impact On Job Security And Your Portfolio

If you’re a fan of Kyle Bass, founder and principal of Hayman Capital Management, then you’re most likely familiar with his Japanese Finance Minister Index. If not, you probably should be. As a refresher, a Japanese Finance Minister is responsible for the foreign exchange policy of Japan. They carry similar responsibilities that the Federal Reserve Chair holds for the Federal Reserve. For the last decade, the job of Japanese Finance Minister has been tumultuous to say the least. How bad has it been? Let’s take a look at the Japanese Finance Minister Index (this version is from 2012 and doesn’t include two additional changes at this position in the past three years!):

screen20shot202013-05-0820at2012-35-5820pm — Source: Kyle Bass via businessinsider.com

The fact that Japan is on its 12th Finance Minister in the past 10 years should give you an idea of how difficult it’s been to manage their country’s currency during an ongoing deflationary cycle that started 25 years ago. For reference, the Federal Reserve has had two chairs during past 10 years: Ben Bernanke & Janet Yellen.

What does the aforementioned have to do with your portfolio? The Japanese Finance Minister Index lets us know that managing the Yen is more than a difficult job. Some (maybe a former Finance Minister?) might say impossible. And as we highlighted back in October, the Japanese Yen should be watched closely as it gives clues regarding the direction of U.S stocks. If the Yen were to start appreciating, which is exactly the opposite of what Japan wants, we should pay attention. And if the Yen has a strong negative correlation to U.S. stocks, we should be on the edge of our seats and very concerned about a deepening correction in U.S. equities. As we pointed out in our October article:

For many years now, the correlation between the yen and S&P 500 has been -0.9 to -1.0. Meaning, whichever direction one goes, the other goes equally the other direction. So as investors, we should definitely care which direction the yen is heading. If it is dropping in value, that is a positive for the S&P 500 while an increase in yen value means trouble for the S&P 500.

So what has the Yen been up to lately? Let’s take a look. Here is a 4-year chart of the Yen (using ETF FXY as our proxy) along with the S&P 500 (top pane):

We can see that two days ago, the Yen broke out over an area of supply that’s been in place since late 2014. In the past, buyers had stepped in near the 82-83 price level. But a little over 48 hours ago, this changed. Demand for Yen has driven its price to new 52-week highs. Correspondingly, U.S. stocks (represented by the S&P 500 in the top pane) have held up so far, holding near previous areas of demand (shaded gray area). If the Yen continues upward, we expect U.S. stocks to resume their descent. Nothing is guaranteed and as investors and market participants, we must not marry our opinions and keep an open mind. We only care about price. It’s still possible for buyers to step in at this level and save U.S. stocks from further downward pressure. If that takes place, we expect the Yen to rapidly reverse course.

We’ll make sure to provide updates to this scenario as it unfolds, with price targets for both the Yen and U.S. equities.

You can also follow me on Twitter here: @360Research

Disclaimer: Nothing in this article should be construed as investment advice or a solicitation to buy or sell a security. You invest based on your own decisions.

February 1, 2016 | Posted by David Zarling, Head of Investment Research

Make Sure To Look At The Big Picture

At 360 Investment Research, we study price to understand the interaction of supply and demand in the marketplace. When there is more demand than supply, price goes up. When there is more supply than demand, price goes down. This is a simple, but often overlooked, concept that all investors should pay attention to on a regular basis. Studying price is paramount because it gives us an edge in the market and is the only coincident, or even leading, indicator available. Nothing is more current than price.

In market environments such as the current one, it can be a valuable exercise to step back and review price from a big picture perspective. Rather than being shortsighted and look at the past few weeks, we can gather tremendous insight from looking at price over the past 30 years (or more).

Below is a monthly chart of the S&P 500 dating back to 1987. Overlaying the monthly price candlesticks are some proprietary moving averages that do a great job indicating when to be long or short U.S. equities. Check it out:

By function, moving averages lag price. Even though these averages lag price, they are still more actionable than any economic indicator the BEA, BLS, or Federal Reserve can provide (if you’re from any of those agencies and reading this, please don’t take offense). And upon reviewing the most recent crossover, we can see that the S&P 500 is not buyable or ownable right now.

We can look at the same chart, but from a different perspective, by removing the moving averages and studying previous areas of supply and demand. Going through this exercise, we can see that sellers appeared in a big way around the 2100 level on the S&P 500. Likewise, during the recent price correction, buyers stepped in near the low 1800s. Take a look.

Upon inspection, we can see that we’re in “no man’s land” – an area between 1812 and 2134 where buyers and sellers will determine the markets next big move. In order for the market to regain solid ground and not deepen the current correction, demand needs to keep price from breaking the 1800 level and eventually drive price on to new highs. From a historical perspective, a major trendline (in green) dating back to 1987 carries significance. If that trendline is broken, more sellers will step in. And if not enough buyers are available in the 1812-2134 window, selling will intensify and price will seek demand (aka price discovery) through further price declines until demand is reintroduced. The next most likely area of demand is near 1550-1600, which is an area of price polarity where previous supply (the tops in 2000 and 2007) became an area of demand.

We’re not predicting further price declines, but the study of price indicates that there are more sellers than buyers from this vantage point. Until that changes, and buyers step in to take the S&P 500 to new highs, we’re not interested in owning this market.

Until next time, trade safe.

Disclaimer: Nothing in this article should be construed as investment advice or a solicitation to buy or sell a security. You invest based on your own decisions

October 18, 2015 | Posted by David Zarling, Head of Investment Research

Why Is The Yen Carry Trade Such A Big Deal Anyway?

Depending on who you ask, the yen carry trade is either alive and well, or an overused parlance in the investment community.

What is a carry trade anyway?

A carry trade is an investment strategy in which an investor borrows money at a low interest rate in order to invest in assets they speculate will generate a greater return. This strategy is very common in the foreign exchange market and works especially well if asset prices are stable and the currencies involved do not move against the investor. Adding to the fun, many investment houses will ramp up their returns by using additional leverage. The return can be quite impressive if the currency borrowed remains stable or continues to depreciate against the currency used to purchase the investment.

So how does the “yen carry trade” work? In a nutshell:

Large money managers and hedge funds borrow the yen at extremely low interest rates.
Yen are converted to U.S. dollars, which are invested in U.S. Treasuries at a much higher yield than the interest cost for the borrowed yen. That creates a “positive carry” because of the differential in interest rates.
The buying drives up U.S. bond prices and the money managers experience large profits, especially when done with additional leverage (this assumes the yen doesn’t rise in value).
Even more profits are made when (A) The dollar rises vs. the yen and (B) U.S. Treasuries rise in price

Whether one thinks this investment strategy is widely used or not, we can assure you that investors (especially U.S. based investors) should care which direction the yen moves. Why? Correlation. The yen has an impressively high negative correlation to U.S. equity prices (today, we’ll use the S&P500 in our examples). And for our statisticians out there, we know that correlation doesn’t mean causation, but it does have implication. For many years now, the correlation between the yen and S&P 500 has been -0.9 to -1.0. Meaning, whichever direction one goes, the other goes equally the other direction. So as investors, we should definitely care which direction the yen is heading. If it is dropping in value, that is a positive for the S&P 500 while an increase in yen value means trouble for the S&P 500.

As you might have guessed by now, studying the yen is a valuable exercise in determining what type of environment the S&P500 is in. So let’s take a look at it. Here is a 4 year chart of the yen (using ETF FXY as our proxy) along with the S&P 500 (top pane):

It quickly becomes obvious there is an important relationship here. The yen was breaking out from a 4 year downtrend at the same time as the S&P 500 was breaking down from a 4 year uptrend. Lucky coincidence? Maybe. Significantly important? Absolutely. Especially to those who are trying to make money in the markets.

When we move in for a closer look, we find the recent breakout and consolidation of the yen is targeting 86 if overhead supply near 82 is cleared and a return to 77 if the yen breaks below 80. If the former takes place, it is better than an educated guess that the S&P will continue to correct. If the latter takes place, the S&P will continue upward.

At 360 Investment Research, we don’t care about being right. Rather, we care about being on the right side of the trade. In this case, we think the relationship between the yen and U.S. equity prices is an important one for helping us identify opportunities in the U.S. stock market. Let’s keep an eye on the yen and see what happens. We’ll follow-up on this release once the yen picks a direction.

Trade safe.

Disclaimer: Nothing in this article should be construed as investment advice or a solicitation to buy or sell a security. You invest based on your own decisions.

Keywords: yen to dollar, yen symbol, yen carry trade unwind, yen carry trade collapse, yen carry trade example, yen carry trade meaning, yen and carry trade, yen carry trade appreciation

August 25, 2015 | Posted by David Zarling, Head of Investment Research

Falling Knives

A Technical Analyst and a Fundamental Analyst are chatting about the markets in the kitchen. Accidentally, one of them bumps a kitchen knife off the counter, landing right in the Fundamental Analyst’s foot! The Fundamental Analyst screams in pain at the Technician, asking him why he didn’t catch the knife. “You know Technicians don’t catch falling knives!,” the Technician responded. He then asks the Fundamental Analyst why he didn’t move his foot out of the way? The Fundamental Analyst responds, “I didn’t think it could go that low.”

By now, we’ve all read about, watched, or heard about the most recent market action. Or if you’re like me, you see it in the charts as you game plan future trades and exits. As the joke above illustrates, the power of technical analysis is that it helps us identify when to be in or out of any liquid, chartable security. Our whole goal is identifying low risk / high reward trades. We don’t care about being right. We only care about making money in the market so we appreciate knowing when we’re wrong.

For example, when we look at the price action of the S&P 500 on the chart above, we can see that the U.S. equity market had been moving sideways for quite a while. And recently, it broke its lowest upward trend line. Once this trend line broke, there was too much risk inherent in this index. In fact, I would argue that this was a great low risk / high reward scenario to short the S&P 500 using an instrument such as SH or SPXU.

We have an intermediate time bias when we look for opportunities – our time horizon is weeks to months. Our approach does not necessarily match the approach of day traders or long term investors. However, one would think it is beneficial for all investors to know when a 10% loss outweighs the probability of any short term gains. As a reminder, it takes a 11.1% gain to recoup a 10% loss. We think it makes sense for all investors to avoid a 10% loss, even if your time horizon is 10 years.

Trade safe.

Disclosure: The author is long SH.

Disclaimer: Nothing in this article should be construed as investment advice or a solicitation to buy or sell a security. Simply put, you are an adult. You invest based on your own decisions.