Tuesday, February 14, 2012

"The only reason a great many American families don’t own an elephant is that they have never been offered an elephant for a dollar down and easy weekly payments." --Mad Magazine

INCREASING NEGATIVE DIVERGENCES SEND AN EQUITY SELL SIGNAL (February 14, 2012): Throughout the final months of 2011, amateurs and hedge funds continued to withdraw money from equities, thereby creating numerous glaring undervaluations. The mantra of "playing it safe" and "going for quality" and "sticking with above-average yields", which became far too popular with financial advisors and analysts in 2011, created steep discounts especially for high-beta, low-dividend, commodity-producing shares which became wildly out of favor in the second half of last year. During January 2012, it was precisely the above categories of stocks which far outperformed the S&P 500 throughout the month, as they compensated for their steep declines during the second half of 2011. This rewarded those who were both intelligent and bold enough to recognize these bargains and to take advantage of them.

However, throughout February 2012, commodity-related shares and other top-performing groups from January have been notably underperforming broader equity indices. Mining and energy shares in particular have been acting poorly during the past week. Insider selling has also significantly increased relative to insider buying. After having retreated through Thursday, February 9, 2012, the U.S. dollar index has begun a moderate uptrend, while U.S. Treasuries may have completed an intermediate-term bottom the same day. GDXJ, a fund of junior gold producers which tends to be among the most reliable leading indicators, topped out on February 2, 2012 and has been sliding ever since. While there are many ways of determining that a bear market is underway, one of the most reliable of those is a sequence of numerous lower intraday highs over a period of several or more trading days.

It remains true that there is a huge speculative worldwide bet on a lower euro. Since any extremely popular position must lose money eventually, the euro will likely rally strongly later in 2012. For now, however, the euro and nearly all currencies of major commodity producers such as Canada and Australia will likely continue in their recent downtrends. The U.S. dollar will continue to move higher until it shakes out those who have recently been betting on a lower greenback. Whenever the U.S. dollar index begins its next downtrend, its retreat will serve as a useful buy signal for equities, commodities, high-yield corporate bonds, and similar risk assets.

In the accounts I manage for myself and my clients, I sold all of my equity funds on Thursday, February 9, 2012. I plan to progressively move back into equities once insider buying increases substantially relative to insider selling, and once investors become fearful of a continued stock-market retreat. Whenever I decide to purchase equity funds, perhaps as soon as late February or early March, I will once again concentrate on the shares of commodity producers and related subsectors, since those will likely reprise their outperformance of January 2012.