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Tuesday, 7 January 2020

There Is No ........ QE4

Boy - 'Do not try to bend the spoon. That's impossible. Instead .... only try to realize the truth.'
Neo - 'What truth?'
Boy - 'There is no spoon'

From The Matrix - 1999. 

One thing that has been strange in the last few months is the virtual media silence about the Fed's increasingly aggressive interventions in the interbank market. This has raised a number of questions. We can assume that there must be some kind of significant issue in the banking system, otherwise the Fed would presumably not be intervening on a scale which seems to be as large or larger than previous periods of official quantitative easing. What that problem is seems unclear, and discussion about it seems to be very muted. That might just be because the financial press are clueless, but it also seems possible that the media are respecting some kind of informal gag order from the Fed, who are also keen that this intervention not be described as QE4. That may be because if this was a QE4 intervention, then they might need to explain clearly the reasons that intervention was needed, and they might be reluctant to explain because it might shake confidence. This is obviously a potential news bomb waiting to happen and is worth bearing in mind until this situation clarifies.

With a free press, which the US rather famously used to have, you'd think that would be a major topic of interest right now, but for some reason it isn't. This doesn't seem to be a big issue yet but may become one at some point if interest grows into why the Fed has deemed it necessary to pump hundreds of billions of dollars into banks and bond markets since (Not) QE4 started on 14th October.

All this being said, this (Not) QE4 needs a shorter working name so for the purpose of further discussion I'm going to shorten that to NQE4.

One question that I've been asked in the last few days is that with the Fed intervening in markets every day to buy bonds, buying about $9 billion worth so far this week, another $10 billion between Thursday and Friday last week, whether it's possible to get any significant decline on equities going. SPX is up slightly under 10% since NQE4 started on 14th October and NQE4 shows no signs of stopping anytime soon, so soon enough this intervention may need to be counted in trillions. Whatever the name used that is a very serious intervention, and judging by the effect of similar looking interventions in QE1 through QE3, are likely to put an overall bid under equity markets while depressing bond prices, and we have been watching bond prices decline over this period as well. The trajectory of this intervention on the Fed balance sheet looks roughly equivalent to QE3 so far, though it is averaging over $100 billion per month so far, with QE3 having averaged slightly about $92 billion per month through 2013.

Why do bond prices decline while the Fed is buying bonds on a large scale? I have a couple of theories but no real knowledge. What I can say is that bond prices have tended to decline during QE periods and rise as they end and for a while after they end. That is what actually happens, why is another matter. I wrote a post about this called 'The Great Brain Robbery' in May 2014 part way through the huge rally in bonds after the end of QE3  That's worth a look if you are interested or just want to read something amusing about the idiotic things that analysts can do when they act as a flock of clueless sheep rather than trained humans with higher than average intelligence.

In terms of the short term though SPX now has a fixed RSI 5 daily sell signal and there were five of these in 2019 , a memorably bullish year, and these all reached target. I've pulled an SPX daily chart from my first post of 2014, just after 2013, another very memorably bullish year with QE3 running through it from start to finish, and you can see here that there were five of these signals in 2013, and they all reached target.

The volume spike that I noted in December is also a significant topping or bottoming indicator. Of the last three volume spikes as large on SPX as that spike in December, the first was the high in October 2018, delivering a 20% decline into December 2018. The next was the spike at that low in December 2018, delivering a bull move of 38% so far, and the third was at an interim high in March 2019, that delivered a 3% decline from high to low. If you look at the 2013 chart you'll see that these volume spikes were also good at picking interim highs and lows then.

In the short term therefore I don't have any real concern about NQE4, as previous QE periods didn't stop similar setups from delivering then. It is a reasonable expectation that at minimum that this signal reaches target and that SPX should drop at least 100 handles or so from this high to the next low.

My concern, if the Fed continues to pour in tens of billions of dollars per week into markets, is that it will be hard to sustain any larger downtrend while that continues. 2013 saw a rise on SPX of 27% or so on QE3, after a 12% rise in 2012. Last year's rise was over 30% but NQE4 may mute any retracement of that move that we see this year. I'm definitely keeping that in mind. A healthy paranoia on the bear side seems advisable. On to the markets. :-)

On the SPX daily chart both RSI 14 and RSI 5 sell signals have fixed and a topping setting is forming here that may take SPX down 100 handles or so into the 3160-70 area. As I've been explaining above, that target looks very credible. It may be that will be all we see for the time being though. We'll see.

SPX daily chart:
On the hourly chart the 60min RSI 14 sell signal hasn't reached target yet and SPX has tested for the third time in three trading days the important short term trend support at the 50 hour MA, currently at 3235. On each of those days the close has been back over the MA. When that changes then the downside opens up.

SPX 60min chart:
In terms of the pattern setup and H&S may well be forming here and on a sustained break below 3215 the H&S target would be in the 3170 area. The H&S is a bit messy and if the 50 hour MA continues to hold as support SPX could still retest the highs. If seen however that should be the second high of a double top and I'd expect any new all time high to be marginal and short lived.

SPX 15min chart:
I was planning to have a look at the January Barometer stat today, but felt it was more topical to look at declines during QE periods instead. I'll be covering the January Barometer next time and (spoiler alert), that stat looks a lot more impressive than the extrapolation from the first five trading days of January that I was assessing in my last post. I'll likely write about that at the weekend.

For this week I should mention that Stan and I are doing two free public webinars. The first, an hour after the close tomorrow (Wednesday) is looking at trading commodities this year using current examples and setups, and the second, an hour after the close on Thursday, is our monthly free webinar looking at FAANG stocks and key sector ETFs. If you are interested in attending either or both you can register for those on our January Free Webinars page.

Sunday, 29 December 2019

The First Five Trading Days Of January

The holidays are ending and volume should be coming back into markets next week as players return. New Year's Day on Wednesday is obviously a holiday as well, and the five trading days after that will be closely watched to deliver an indication of how the rest of 2020 might go. I'll be looking at that stat closely later in this post but first I'll review SPX and NDX and the position as traders return for the last two trading days of 2019. I would note again that the last trading day of the year is the only historically strongly bearish day in December, with SPX closing down 67% of the time, and Nasdaq down 15 of the last 19 years.

I have a couple of quick announcements to make as well, the first being that Stan and I are doing our end of year free public webinar looking into the year ahead an hour after the regular trading hours close tomorrow (Monday). If you'd like to attend you can register for that here. We'll also be doing our usual monthly free public Chart Chat next Sunday I think and I'll post that link on my twitter feed once I have it. Lastly we are still running our annual Xmas sale on annual subscriptions at 20% off the usual price, so at a 33.33% total discount. That's drawing to a close so if you are interested you should check that out here. On to the markets.

On SPX the daily chart on Friday closed with both the RSI 14 and RSI 5 at high levels, suggesting at least a retracement soon, and some negative divergence on NYMO, setting up a possible RSI 5 / NYMO daily sell signal if SPX retraces a bit and then retests the high to set up negative RSI divergence on both RSI 14 and RSI 5. Decent odds we see that play out over the next few days.

SPX daily chart:
On the hourly chart SPX is testing support on the short term rising wedge from the 3070 low. An RSI 5 sell signal has fixed and an RSI 14 sell signal is brewing. On a break down I'd expect this setup to deliver a retest early next week of key short term trend support at the 50 hour MA, which closed Friday at 3218. From there ideally SPX would make a marginal new all time high and then fail into a larger move down.

SPX 60min chart:
On NDX the daily chart looks similar to SPX on RSI, and I'd expect the same retrace and high retest scenario there. I'd note though that the current high is at high quality shorter and longer term rising wedge resistance, and any higher high we see on NDX may therefore be very marginal before NDX starts a move back to larger rising wedge support, currently in the 7900 area.

NDX daily chart:
On the hourly chart you can see that trendline resistance in more detail and I'd note that weak RSI 14 and RSI 5 sell signals have both already fixed. Obvious first support at the 50 hour MA, which closed Friday at 8682.

NDX 60min chart:
Nothing has changed on the bigger picture scenario, where we see a top forming here for a decline into April, and then likely retests of these highs from there.

Now if you have a horror of statistics you might want to stop reading here, and I'll wish you the very best for 2020, as I'll next be having a look at the famous traditional first five days of January as a predictor for the full year, and I'll be doing that the old fashioned way, by looking at the historical numbers.

I'm taking my numbers from my newly arrived Stock Trader's Almanac 2020, and I get a lot of the numbers I use from there, including all the historical stats for particular trading days that I refer to regularly in my posts. These are a very useful reference for traders and if you would like one then you can buy them at Amazon.

Now the stats shown for this in the Stock Trader's Almanac cover the last seventy years, including 2019, which I am happy to assume for the purposes of this analysis will close green, as it seems unlikely at the time of writing that SPX will close 2019 below the 2018 close at 2506.85. If SPX should surprise me by falling over 22.6% in the next two trading days I will need to amend my numbers slightly.

The Stock Trader's Almanac is keen on this warning system and gives it an 81.8% accuracy rate for green years from the last 44 years, with some excuses for years where special circumstances led to false signals. That's all well and good but I'm using their numbers to get a fuller view of how this stat has performed.

First I had a look at the last seventy tears in total, and I'd note first that 51 of those closed green, so 72.86% green closes is the random chance baseline against which performance needs to be measured. On that basis there were 45 green closes for the first five days of January, and of those 35 closed green, giving a performance of 77.78%, significantly better than random chance. Having said that though I felt I'd get a better view if I eliminated the three years (1970, 1984 & 1987) where the gain for the full year was less than the gain in the first five trading days of January, as counted from from that point, each of those years then closed lower, and on that basis the adjusted performance was 71.11%, performing slightly less well than random chance would suggest.

On the bear side 1950-2019 delivered 19 (or 27.14%) full year red closes, and there were 25 red closes for the first five trading days of the years in the 1950-2019 period. Of those 25 closes, eleven delivered red closes for the year, which at 44% was quite a lot better than random chance. There were no years where the red close for the year was less than the red close at the end of the first five trading days of that year.

Secondly, having noticed that this stat started with an impressive run of wins 1950-69, I stripped those out and just considered the last 50 years 1970-2019. Of these 35 years closed green (70%) and 15 closed red (30%). In terms of the first five trading days there were 33 green closes, of which 25 closed the year green, so the rate was 75.7%. I again then stripped out the three years where the full year's decline was less than the decline in the first five trading days and that accuracy rate dropped to 66.67%, again less than random chance should have delivered. Not impressive.

On the bear side there were 17 red closes for the first five trading days of the year, which translated into 6 red yearly closes. That translates into a 35.3% accuracy rate, significantly better than the 30% random expectation, but much less impressive than for the longer period including 1950-69.

Looking at the numbers I noticed that there was another impressive period for this system in 2000-9, so I looked in detail at that. For those ten years there were six green yearly closes (60%) and four red (40%). In terms of the first five trading days of those years there were five green closes, delivering four green years, so 80%, 33.33% better than the 60% for random chance, and there were five green closes delivering three red years, for a 60% accuracy rate, 50% better than the 40% for random chance. This was a banner decade for this system, and it was such an interesting decade for markets that I wondered whether this system was still famous mainly because people remember it working well then. That brings me to my last sample group, the most recent decade 2010-9.

Assuming that 2019 closes green there will have been seven green yearly closes over this period (70%) and three red closes (30%). On the first five trading days of those years eight closed green, and of those years five closed the full year green, delivering an accuracy rate of 62.5%, significantly less than the 70% that random chance would suggest. However there were only two years where the first five trading days closed red, and both of those years closed green, delivering an accuracy rate of 0%, against an expected 30% for random chance.

So what's the overall verdict here? Well in terms of green closes for the first five trading days of the years over this period, only the period 2000-9 delivered accuracy numbers that were better than random chance, which makes this January system somewhat worse than useless for predicting bullish years. The bearish year accuracy rate was generally better, but that good performance was confined to the periods 1950-69 and 2000-9. Outside those periods performance was worse than random chance would suggest, most particularly in the last ten years during which time this was entirely useless at predicting years that would close down.

Overall the positive reputation of this system seems undeserved and I'd recommend disregarding it as a predictive tool. Next week I'm planning to cover the January barometer system, which attempts to predict yearly performance from the close at the end of January. We shall see if that fares any better. Everyone have a fun New Year's Day and a great new year in 2020! :-)