Overbought


A Complete Look at Apple and the Markets

Sunday, September 29, 2013 (5:30 pm)

We wanted to provide an updated outlook for both Apple and the broader markets. While our medium-term outlook remains fully in tact, we’re seeing a number of conflicting signals in the near-term.

APPLE OUTLOOK

APPLE: A REPEAT OF 2011? As we reviewed our charts, we came across a very similar price and technical pattern to the current price action. Look at the July-Sept time frame in 2011 versus 2013 below:

AAPL 2011 vs 2013

Let’s take a look at the similarities. The numbers refer to the points on the price chart within the purple boxes, while the letters refer to the RSI/MACD technical indicators.

  1. The bottom. Negative 5-10 MACD (a) and 25-30 RSI (A);
  2. Consolidation at 50 DMA;
  3. Consolidation at previous 6-month high price;
  4. Sharp rally to high price. 15-20 MACD (b) and 80-85 RSI (B);
  5. Sharp pullback to near 50 DMA and Point 3. 40 RSI (C);
  6. Rebound, which forms on a gap up. 55 RSI (D).

Now that we’ve looked at all the similarities between the two time periods… where do we go from here? Let’s look back to 2011. After the shares performed in an extremely similar manner to the current price action, the shares dropped to create a double bottom at the 50 DMA. In the current case, there is a lot of support in the $474-$476 range, with the 50 DMA, 10 DMA and long-term trend line all within that $2 range. Below that price, additional strong support rests at $465. After an initial drop, the shares saw a strong rally over the ensuing four weeks to create a new high print.

Conclusion: While the near-term presents some uncertainty, this is additional evidence pointing toward our longer-term bullish outlook for the shares.

APPLE: DESCENDING TRIANGLE. If there is near-term downside, it will likely come in the form of a breakdown from the descending triangle below. The 100% measured move is roughly $15 with a target near $465 – right at the point of very significant support that has formed with multiple touches over the past 10 months.

AAPL Triangle

The real disappointing aspect of this potential would be the invalidation of the island bottom reversal. The island reversal is a very bullish longer-term pattern if it remains in effect. It’s important to note here, though, that while descending triangles typically have a bearish tilt, all triangle formations (ascending, symmetrical, descending) are known as continuation patterns. Continuation, in this case, would be to the upside. On the other hand, this $465 target does seem to fit fairly well with the July-Aug 2011 comparison above.

Conclusion: The descending triangle, while technically bearish in bias, can also be viewed as a bullish continuation pattern. No real conclusion – we need to see which way it breaks.

APPLE: BULL FLAG. Another viewpoint of the current price action, looked at from the lens of a longer time frame, is that this could very well be a bull flag in the forming. A bull flag takes place after a significant rally, when the shares consolidate downward for a period of time before resuming their bullish climb. It is typically combined with declining volume throughout the pattern. We’re seeing that exact situation here: a downward consolidation after a strong rally that is taking place with dramatically declining volume. Furthermore, the MACD just turned bullish (which we’ll discuss more below).

Conclusion: The clear-cut bull flag on declining volume, in combination with the bullish MACD is a very bullish sign for near-term price action.

AAPL BF

APPLE: MACD TURNING BULLISH. Apple’s MACD has begun to turn up in the daily chart. We’ve indicated those instances in the past where the MACD has very clearly turned up (bullish) or down (bearish). We did not include those cases where it didn’t make a strong move. The MACD has been a fairly reliable indicator over the past year as to the near- to intermediate-term price action. Most of the buy signals (blue) have led to 50+ rallies in a short amount of time. Similarly, the sell signals (red) typically led to fairly strong pullbacks. This is an important one to keep an eye on.

AAPL MACD

Conclusion: Combined with the other technical indicators discussed, this is a bullish signal.

APPLE: DOUBLE BOTTOM BREAKOUT. Don’t lose track of this chart. The price action, in the intermediate-term should be viewed as bullish as long as Apple holds the $465 price level (double bottom breakout point).

AAPL Double Bottom

Conclusion: The $465 price point is clearly important here. Even if the shares break down from the descending triangle described above and hit the $465 trend line, we believe that price level will hold. While the near-term is cloudy, again, the longer-term should be viewed as bullish. If the bull flag scenario comes through to fruition, we believe the $515 level will be a magnet. If that level is exceed, $545 should likely come next before or around October earnings.

APPLE: CUP & HANDLE. As discussed last week, shares of Apple have created a much larger pattern known as the cup and handle. If Apple can take out the $515 level, the 100% measured move of this pattern is $640, which happens to be the high set last February and again re-tested (after the all-time high was put in) before last October’s earnings announcement.

Conclusion: To remain valid, the price should remain above the $465 level, and relatively quickly retrace back to the $515 neckline.

AAPL C&H

FINAL APPLE CONCLUSIONS. In the near-term (days and next couple of weeks), there are two factors working against Apple. One is the descending triangle and the other is the comparison to 2011. Both point to a test of the $465-$470 level (which, don’t forget, is only $10-$15 below the current price). However, it’s important to look at the contradictory bullish indicators. The bull flag with declining volume, the bullish turn in MACD, the triangle (yes it’s descending, but all triangles are continuation patterns), and the double bottom breakout. The path of least resistance, in our view, is up in the near-term.

In the longer-term, we have very high expectations that shares of Apple will provide strong returns due to the much larger chart patterns: double bottom breakout, which formed over five months, and the cup and handle, which formed over ten months.

BROADER MARKETS

SPY: SIGNIFICANT DIVERGENCE. As we mentioned last week, the SPY has formed significant negative divergence with BPSPX (the bullish percent index). It created a three-push pattern, with each successive high price occurring on a lower high in the BPSPX. We also saw the third push up occur on an extremely overbought NYMO. The last time we saw this formation was in July 2011. We saw a 25 point drop in the SPY within the next month.

SPY NYMO

SPY: SUPPORT & RESISTANCE. SPY has strong support at the $167.50 level, which coincides with the 50 DMA. We fully expect a test of this level in the coming days. The SPY has also formed a head and shoulders pattern. A strong break below the $169 support line equates to a breakdown in the H&S pattern, which has a $3.50 100% measured move target of $165.50.

The last time we posted this chart, the SPY was testing the $169 support level. We provided an expectation (blue dotted lines) that had the SPY re-testing the $170.25 level before pulling back to our near-term target of $167.50. That has come to fruition thus far.

SPY NT

INDU: NEGATIVE DIVERGENCE. The Dow Jones has also created negative divergence with its MACD. Below, you can see the last three times we’ve seen significant negative divergence, which lasted many months. Each led to a significant pullback in the markets. This is additional evidence that the broader market is setting up for a pullback this fall.

INDU Divergence

VIX: THE BOUNCE, AS EXPECTED. As we projected last week, the VIX bounced off its long-term support line. There is no clear direction in the VIX from here.

VIX

FINAL MARKET CONCLUSIONS. Taken as a whole, we expect a significant decline in the markets to take place in October or November. With the Fed continuing with its $85 billion monthly asset purchase, against all expectations, we expect the market to begin rationalizing this decision. The economy is in a weak state – weak enough that the Fed is unwilling to back off (even slightly) from its massive asset purchases. It’s interesting that all of these technical indicators are flashing “potential crash ahead” just as the government is set for a shutdown AND may be unable to avoid a national debt “default” (while it wouldn’t technically be a real default, in this market perception is reality).

Now, doesn’t this conflict with our outlook on Apple? While – we’ll be honest – it is hard to fathom the largest stock in the world could swim upstream while the market experiences a correction, we have seen the opposite occur for most of the year. With the stock at an extremely low PE multiple (almost half that of the broader markets – 12x vs 19x), we believe the downside is extremely limited, and investors may actually re-allocate capital from the broader markets to the name. It’s large cash position, low valuation and upcoming EPS resurgence will make this stock outperform during any correction.


A Bearish SPY Perspective (and Apple Update)

Sunday, September 22, 2013 (6:00pm)

It’s been a while since our last post. We’ve found it to be more efficient to post our views and thoughts in real-time on Twitter (you can follow us @three28capital). We’ll start posting here again from time to time.

APPLE. After rallying over $120 points in just six weeks, Apple spent a few weeks consolidating before eventually gapping down on news that the iPhone 5c wouldn’t be the “cheap” iPhone everybody was hoping for. It blew through the 10, 50 and 200 DMA’s, but found firm support at the 100 DMA. Since hitting $448 last week, the shares rallied $30 to re-take each of those moving averages. It’s now sitting firmly at the 50 DMA (just below the $468 level).

We’re expecting a press release before the market opens tomorrow to announce first weekend sales figures for the iPhone (both the 5c and 5s will likely be consolidated into a single, round number). With the shares sitting at the 50 DMA, this number will be the determining factor behind whether the shares drop – and likely re-test or exceed the $448 low – or rise and re-test the August highs.

One thing we’re watching closely is the potential inverse head and shoulders pattern that has been forming over the past couple of weeks. If the shares bounce up to the $475 level, we fully expect $505 to come quickly thereafter. It will really depend on the number released tomorrow.

AAPL

S&P500. We have a much more bearish viewpoint on the broader market in the medium-term. After the Fed choose not to begin the process of slowly unwinding the stimulus, the market shot up, creating new highs. However, the percent of stocks making new 52 week highs continues to decline. That percentage is measured by $BPSPX (bottom of chart below). During each of the three successive bumps higher in the SPY, the BPSPX has made lower highs.

Furthermore, at this new high SPY print, the NYMO went into extreme overbought territory (red line at the top of the chart). The last time we saw both of these occurances at the same time (BPSPX negative divergence, whereby it creates lower highs as the SPY creates higher highs, along with an extremely overbought NYMO) was during August 2011. See the chart below to see what followed.

SPY

VIX. Additionally, these two strong bearish signals (one nearer-term and one medium-term), are joined by the fact that the $VIX (market volatility) is reaching its long-term support line. This suggests that volatility will rise and the market will fall.

VIX

SPY RISING CHANNEL. Lastly, here’s a look at the long-term SPY rising channel. Aside from a few quick bounces outside this channel (which lasted for only short amounts of time), the SPY has been relatively well-contained within its borders. Recently, however, this three push-up pattern (blue) has become more clear. A steep, two-legged decline is likely to follow.

SPY Channel

If this three push-up pattern were to fail, however, the top trend line currently sits at $175 – meaning that the upside right here is already limited. It’s important to consider both upside and downside potential when looking to take a position in the broader markets. At this point, the upside looks fairly limited, while the potential for downside is becoming more and more open. We’ll continue to update our thoughts as the market progresses.


A Counter View on “The Great Rotation”

February 20, 2013 (11:00 pm)

Sorry for the lack of posts over the past 10 days or so. We’ve been watching the markets closely, and have tweeted a few trades that we’ve entered. There just hasn’t really been anything that we’ve been compelled to post. The market was grinding slowly higher, and there weren’t many set-ups that were very compelling. But we’re back, and expect that the cracks we saw today are only the beginning.

The “Great Rotation” has been widely discussed by the financial media recently. In essence, it calls for a rotation out of the bond market and into equities. This rotation would be driven by two factors: (1) the artificially low yield in the bond market created by the Fed’s enormous asset purchases, and (2) the re-entry of the retail crowd to the equity market. Those that believe in this Great Rotation expect equities to continue to appreciate as demand increases for these securities. Likewise, they expect bonds to depreciate as investors sell bonds to purchase stocks. They are the new perma-bulls. If this rotation is actually happening, how could you not be fully invested in stocks?

There are a variety of charts we’ve been reviewing that lead us to believe that this melt-up rally (whether driven by an actual rotation out of bonds or not) will soon end. And that end will precede a much more significant market correction. Let’s start with our short-term views, and slowly work our way to the bigger picture.

SPY Rising Channel. Since the middle of November, the SPY has been in a very well-defined up-trend. Today’s break down marks the first significant crack since the fiscal cliff ordeal. We’ve illustrated levels of support to keep an eye on.

SPY Support

SPY Trend Lines. We’ve outlined three trend lines formed throughout this three-month rally. Importantly, note how the SPY is becoming oversold on the RSI as its reaching the middle trend line. The Chi-Osc is extremely oversold. It wouldn’t be surprising to see some additional downside tomorrow morning followed by a rally out of oversold conditions. This could be a re-test of the recent highs. Before a more significant correction, we would first expect to see a failed re-test of the highs.

NT Oversold

QQQ Consolidation. Similarly, the QQQ is nearing oversold RSI conditions on the 60 minute chart (and is also extremely oversold on Chi-Osc). An interesting trend is that each consolidation period is shorter in duration and tighter in price than the last (i.e. the green consolidation area is only a matter of days and a much smaller price range than the blue consolidation area, which lasted many weeks). Significantly, the current consolidation area broke down this afternoon and now is squarely within the previous one. However, we’d expect at least a brief rally out of oversold conditions in the coming days.

QQQ NT Oversold

SPY Rising Wedge. As we’ve detailed previously, the SPY has formed a very long-term rising wedge. The shares are currently butting up against the top trend line. Additionally, the price has formed negative divergence on RSI (meaning the buying momentum is not confirming the upward price move) and is taking place on falling volume. We expect this top trend line to represent very significant resistance, which supports our view of a coming correction.

SPY Rising Wedge

NYSE McCellan Oscillator. The NYMO has formed negative divergence, falling while the SPY is rising. This is a very significant development. This signal has accurately called a number of serious corrections in the past, and is also widely used to indicate market bottoms.

NYMO Divergence

SPY Potential Downside Targets. If the market does correct over the coming weeks and months, the chart below illustrates our view on where a correction could likely go. We’ve looked at two alternatives. The first examines a 100% measured move of the previous correction (green bar). The second uses a 61.8% Fibonacci retracement of the entire rally. Interestingly, both alternatives get us to the $140ish area, which represents very significant longer-term support (see the first chart above). It would make sense for this to be fully completed by the early May time frame.

SPY Targets

QQQ Head and Shoulders. So we broke out of the $67.75 resistance level only to fall back below it. This potential pattern is still squarely in play.

QQQ H&S

Near- and Intermediate-Term Recap. So lets quickly sum up our views. Since the downward momentum this afternoon was so strong, we expect a to see a lower low ahead, bringing us into oversold conditions. The market should bounce out of these conditions, which would represent a re-test of the highs. If this re-test fails to achieve a higher high, an intermediate-term correction will likely follow. This could see a completion of the QQQ head and shoulders pattern and it could bring the SPY to the lower trend line on the chart below.

Longer-Term Bear. This chart illustrates a very long-term 3 push up pattern that the SPY may be forming. The second peak established a linear trend line that the shares simply couldn’t reach during the third push up. The upward momentum is clearly slowing. This is magnified by the RSI. While the shares have made three subsequent peaks (none of which could even get near the trend line), the RSI hasn’t climbed above the level that it hit during the first peak. What may be more significant is that the RSI reached the same level on the downside during the second trough even though the price reached a significantly higher level. Both of these negative divergences indicate that buying momentum is decreasing and selling momentum is increasing as the SPY continues to rise.

SPY 3 Push

Conclusion. The Fed minutes that were released today indicated that a number of members are looking to reduce the Fed’s asset purchase program before the end of 2013. This could be the straw that breaks the camels back. As market participants look ahead to a world with less central bank intervention, cash will likely become king. We aren’t trying to suggest that this will happen tomorrow or next week. But it’s important to look sufficiently far into the future to think about portfolio allocations. As we continue to reach new highs on the S&P500, Dow and NASDAQ, it’s a great time to book profits and take some risk off the table. A slight decrease in long positions, additional cash and some longer-term puts are a good idea for conservative investors. Intermediate-term shorts may prove very profitable for those more aggressive traders.


Warning Signs

February 7, 2013 (4:45 pm)

As we’ve discussed at length over the past couple of weeks, it looks like we’re reaching an intermediate-term top in the markets. There have been a number of warning signals that have been yelling “Caution – Decline Ahead!”.

  • Insider Selling: The Vickers Weekly Insider Report calculated the sell-to-buy ratio for NYSE-listed shares at 9.2-to-1. This means that insiders of these companies, on average, sold more than nine shares for every one that they bought. The last time it reached this level was in late July 2011, just before the debt-ceiling debacle drove a serious market correction.
  • Newsletter Sentiment: Newsletter writers are recommending a record level of exposure to the equity markets (currently 76% – a level last seen in the summer of 2000, just prior to the dot com bust).
  • Investment Manager Sentiment: Investment managers were polled by NAAIM on their level of exposure to the equity markets. It currently sits at 104%. That’s right… it’s over 100% allocation. That means that, on average, investment managers are buying equities on margin.
  • Seasonality: February is historically a weak month for the markets.
  • Bollinger Bands: The SPY and QQQ both leaped above their upper Bollinger Bands in early January. These bands measure two standard deviations from the 20 day moving average. This means that the acceleration in price was enormous, and is typically used as a signal that things moved too far, too fast.
  • Volatility: We’ve seen volatility collapse over the past few weeks. Recently, the $VIX (a measure of volatility) has found a bottom and has been inching up. In the past, when the $VIX bases and begins to rise while the market is still making new highs, it has indicated that a near-term correction is around the corner.
  • Reversals: We have seen a number of significant reversal days. When we witness these reversals of reversals after a sustained bullish or bearish trend, it indicates that the trend is coming to an end. The bulls and bears have become evenly matched here, and the bullish reign is likely over.
  • Breather: The SPY has climbed over 13% over the past ten weeks and is due for a breather.
  • Dow 14,000: When the market nears a major milestone, it’s rare that it doesn’t at least take a shot at that level. Over the past few weeks, Dow 14,000 has been the jackpot that many were looking at. They just wanted to touch it to see what it felt like. Now that we’ve reached that milestone and tried – and failed – to hold the line, the bears have a much strong chance of taking over.
  • QQQ Head and Shoulders: The QQQ head and shoulders pattern that we first mentioned a couple of weeks ago is very real. When you see such a clear cut pattern, it’s normal for a significant number of market participants to simply wave it off. It’s almost too obvious, and the market never gives us that much visibility. But that’s when you see them come to fruition (interesting reverse psychology, huh?). It becomes so obvious that participants brush it off, because… well, it’s so obvious. The apex of the right shoulder (where we are now) sits right at very significant resistance. Without an incremental positive development in the underlying fundamentals, it will be hard to push above the resistance level.

Stocks to Watch (Part 3)

January 14, 2013 (6:00 pm)

We made some trades in our Long/Short and Multi-Strategy Portfolio’s during today’s trading session. We’ll explain those trades here, along with some other charts we’re watching.

Boeing: We got back into a BA short position today at $76.62. We previously shorted the first break of the rising wedge, and were surprised by the quick reversal off the $73.50 level. We held the short position expecting it to be a re-test of the lower trend line. On a subsequent breakdown, we covered our short position at a small gain. The chart pattern became too messy for our initial thesis.

However, this morning it ran back up to that lower trend line where it again faced resistance. We entered a new bearish position here expecting the resistance to hold. We will cover the position if the shares again re-take the rising wedge and have a stop at $77.12 ($0.50 above our initial position).

BA

Bank of America: We took a bearish position in BAC as it broke through an 8-week rising channel. It may be forming a symmetrical triangle here as it consolidates at lower levels, which is a bearish indication. We will continue to hold this position unless it is able to retake its 50 DMA on volume.

BAC

Chipotle: We took a bearish position in Chipotle as it broke down from a multi-week rising wedge. It has since rebounded slightly and has re-tested the lower trend line twice. It failed both times. We expect lower prices from here.

CMG

Google: We covered our short and put positions in Google late this afternoon. We initially took these positions after it formed a clear negative divergence with RSI as it tested the upper trend line of a multi-week rising wedge. We took profits today in the put positions (26% gain) and short positions (3% gain) only three days after we got into the positions. The shares are becomming oversold just as they’re now reaching the lower trend line. They will likely find support there in the near-term.

GOOG

Netflix: We took a short position in Netflix this afternoon as it reached the upper trend line of a multi-week rising wedge. It did so as it approached overbought conditions. One potential outcome is a false breakout to the upside as it jumps into overbought territory before falling back into (and eventually below) the wedge. Another outcome is consolidation within the wedge until earnings. Of course, the last option is for the shares to lose the lower support line. We are fine holding our short positions through any of these three eventualities and expect lower prices in the intermediate-term.

NFLX

Nike: We entered a long position in NKE this afternoon. It has formed an ascending triangle and broke out this morning. One thing we’re watching for is confirmation of this breakout. We placed a stop at $52.72 ($0.50 below our opening price) in case this turns out to be a false breakout.

NKE

Research in Motion: RIMM has formed a fairly substantial ascending triangle and broke out on Friday. A 100% measured move would have brought the shares to $14.50, which would have been a huge move. It raced past that measured move, and we believe it is overextended here. We shorted the shares at $14.89 as it hit extreme overbought conditions. It should retrace at least 50% of its recent move.

RIMM

VIX (Market Volatility): A few important findings in the VIX chart. First, market volatility is approaching the lowest RSI levels seen over the past year (orange). It moved down so quickly that it almost jumped below its lower Bollinger Band. Second, it has formed a long-term trend line (blue). Each of the past two instances where it touched this trend line over the past year, the SPY saw a 2 point decline within the following week. Just something to keep an eye on.

VIX2

Conclusion: Our outlook remains bearish on the markets through the intermediate term. A majority of the charts we review have a bearish bias, either due to bearish chart patterns or overbought technical indicators. We will continue to keep in mind that the Fed is pumping liquidity into the system. However, a significant pullback is due within the next few weeks. We don’t expect a re-test of the November lows, but do expect to fill the gap created on the positive outcome of the financial crisis. Let us know your thoughts in the comments.