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The folks at the St. Louis Fed – about whom I can’t say enough good things — produce a proprietary Financial Stress Index, a full explanation of which can be found here [PDF].

A full deconstruction of the Index is, frankly, a bit above my pay grade.  What’s not, though, is exploring the correlation of the Index to the S&P500 and discovering that while it’s generally well-correlated, that correlation has increased dramatically since the recession began at the end of 2007, as can easily be seen in the chart above.  (I’ve inverted the S&P500 to better display the correlation.)

The question I need to explore, of course, is whether — or how — this information might be useful in the context of equity exposure.

Note that the Index can dip below zero, and that it is still well off its lows.  Should “financial stress” continue to ease — the Index is updated weekly — it would suggest to me more S&P upside.  The biggest caveat, of course, is that all correlations work — until they don’t.

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BR: I would add that peaks in economic activity precede recessions — they start with economic stress rather low. So if we extrapolate from the (very limited data) above, we still have 12-24 months before the real heavy stuff starts coming down.

That said, 2 is not a statistically significant sample

His writing tends to be a little technical and chart focused; We spent some time chatting on the phone last week about his approach, and I suggested breaking a few topics into bite size, easy to understand, bullet points. This is the first of what hopefully turns into an ongoing series.

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When should traders be in or out of the market?

There are times when traders should NOT be in the market. There are other times when the market is rocking and traders should get aggressive. How can you tell the difference? Here are 5 helpful tips.

Note: I’m a trader, not an investor. I am looking for superior out-performance by being in the best stocks I can find during healthy times.

1) Accumulation and Distribution Days: When should traders go to cash? Follow the big boys! The big institutions control the market, so pay attention to their actions by tracking accumulation and distribution days. When institutional selling builds up over a short period of time (2-4 weeks) AND leading stocks start to break down, that is a great sign to start raising cash. Why? Because 4 out of 5 stocks move in the general direction of the market. I don’t care how good the company is, when the market’s in a downtrend, you don’t want to fight it.

2) Uptrends and Downtrends: Don’t get caught up with the terms Bull and Bear market. Just recognize if we are in an uptrend or a downtrend. For example, use the 50-day moving average on the NASDAQ Composite as a general indicator to be in or out of the market. Above the line usually means we’re in an uptrend and it’s a green light to be in stocks…below the line, downtrend and red light.

3) Scale In: When conditions start to improve, SLOWLY scale back in. There’s no reason to rush. Take a few positions and test the waters. If the rally is for real, there will be PLENTY OF TIME to make money. If you are wrong, at least you can get out quick with minimal damage and protect your portfolio. Think Defense First!

4) Buy the Strongest Earnings & Sales Growth: When markets are in a confirmed uptrend, what stocks should you buy? Be in the best! Don’t settle for low rate stocks. Look for companies that have strong earnings and sales growth. Why be in dead-money stocks with little growth potential? We’re in this to make money, right? So be in stocks that have a higher probability of moving up!

5) Fundamentals AND Technicals: Why does it only have to be one or the other? Why not USE BOTH! We want as many factors as possible in our favor when trading the market. Therefore, start with strong fundamental companies AND combine the proper technical timing to identify ideal entry points to effect your best risk vs reward trades.

These are my 5 measures for when to be in or out of the market. Note I do not rely on a single factor, but instead use multiple disciplines to facilitate trading, protect my capital and maximize returns.

Using every weapon available significantly improves your chances of surviving — and thiving — as a trader.

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Fahmy holds seminars for active traders who want to improve their returns (I will be discussing trader psychology and cognitive errors at the next NY seminar). Readers of the Big Picture who are interested will get a $500 discount on the full day event. Go to TradingBigWinners.com and enter the promotional code: “bigpicture500” for either the Los Angeles (2/18) or the New York (3/3) seminars. (I am only speaking at the NY event, and cannot get to the LA event — maybe next time).

Well, belatedly, here is the Chart of the Day‘s look at duration and intensity of Market Rallies:
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UPDATE: Februry 12, 2012 7:33pm

Patrick Neid in comments astutely observes that using the Oct 2011 vs March 09 is rather incorrect and/or misleading. If we use March 2009 as a start date, this is a much older rally.

I will tag CotD and ask them what is the basis of the starting days — did the Flash Crash or the August 2011 correction end that rally?

Positives:

1) Initial Jobless Claims fall to 358k, 12k less than expected and the 4 week average drops to 366k, the least since May ’08
2) Job Openings in monthly BLS data rise to match the highest since Sept ’08
3) MBA said avg 30 yr mortgage rate falls to new low of 4.05% and refi’s jump 9.4%
4) German Factory Orders in Dec rise a bit more than expected
5) China’s PPI moderates to a gain of just .7% y/o/y, the slowest rate since Nov ’09
6) Indonesia unexpectedly cuts rates to 5.75% while RBA and SK sit pat

Negatives:

1) Greece on brink, AGAIN, unemployment rate in Nov hits 20.9% from 18.2% in Oct
2) German exports in Dec, the main driver of their economy, falls 4.3% m/o/m vs an expected decline of just 1%, German IP falls 3% vs est of flat from Nov
3) Euros being redeposited with the ECB overnight remain around 500b, matching the amount borrowed under the LTRO
4) BoE votes for more QE, brings asset purchase program up to 325b pounds. The most famous English economist, John Maynard Keynes once said this in a book of his, “Lenin is said to have declared that the best way to destroy the Capitalist System was to debaunch the currency. By continuing a process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens…while the process impoverishes many, it actually enriches some…Lenin was certainly right…The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose,”
5) US inflation expectations in TIPS continue to drift higher
6) Feb UoM confidence moderates 2.5 pts after Jan jump of 5,
7) Avg gallon of gasoline at the pump rises to most since Sept.

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Early relief that we can finally put the Greek drama behind us morphed into a European markets sell off. EU finance ministers are still holding back final approval of yet another rescue package. Greece’s commitments to get their fiscal house in order are leading to frustration with the country’s bickering politicians.

In Asia, continuing signs of the slowing China economy added to concerns. Some China Bears have been forecasting a crash, and the Shanghai and Hong Kong markets have performed poorly the past few years — peaking near 32,000 in September 2008, diving to March 2009 low of 11,500. The Hang Seng is still off by 33%, hovering around 21,000.

Is this a consolidation phase, or the beginning of the end of the bull market? I am positioned for the former, but cognizant of the potential for the  latter.

More shortly . . .

I thought that was an interesting observation.

While I am not sure who is bearish (Hussman, Shilling, Edwards, Faber, Belkin & Rogers) I do think this rally is rather hated, and has been for many quarters.

Here wee are with stocks making multi-year highs.

“Buy Strength” I was always taught . . . “Sell weakness.” Yet it seems no one wants to buy strength — people want to buy lower.

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That’s our open thread for tonight: Where are the Bears? And what does this mean for the next 12 months of equity action?

However, it is a pretty long list of things that seem to be improving — or at least not getting worse:

• Housing starting to recover
• Labor market improving
• Credit expansion unfolding
• Low dollar
• Low rates
• Pent-up demand
• US mfg renaissance
• US energy sector booming
• Double-dip fears minimal so far this year
• Inflation receding around the world
• Europe financial strains have eased
• Liquidity is building in the world economy, eg, corporate cash
• There’ve been 83 stimulative policy initiatives announced around
the world over the past 5 months, eg, Indonesia cut rates
• The Fed has rates on hold at zero and is doing Operation Twist
• ECB is scheduled to further expand its balance sheet on Feb 29
by as much as + €1t
• There are no particular problems at the moment such as Japan
disasters, Thailand floods, supply-chain disruptions, gasoline
price spikes, and debt ceiling crises

What do you think? Is the data objectively getting better, or is this merely a selective list of positives?

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What say ye?

Source:
S.E.C. Is Avoiding Tough Sanctions for Large Banks
NYT, February 3, 2012

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Happy Anniversary! Here we are, exactly 5 years to the day from the beginning of the credit crisis.

Jim Bianco dates the crisis as formerly beginning on February 8, 2007 when HSBC’s Household International announced huge losses due to subprime lending. HSBC had to restate its 2006 earnings significantly lower. Bianco adds that while most people were asking what a subprime loan was, HSBC was “patient zero” of the crisis.

To underscore this was indeed the start, HSBC ended this lending unit March 2009, literally hours before the stock market bottomed.

A move above 12,900 in the Dow Industrials would surpass the April 2011 highs, and the bulls would like to see that confirmed by the Trannies getting over 5630.

As we see from the indices via The Chart Store below, both the Industrials & Trannies are on the verge of that breakout. Just note that Classic Technical analysis requires you wait for the breakout/breakdown confirmation, rather than anticipate it.

Caveat: I am not a Dow Theorist, and this is a grossly oversimplified explanation. For more details, Wikipedia has an excellent primer on the major tenets of Dow Theory. Or check out Richard Russell’s The History of the Dow Theory.

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Click to enlarge:

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Source: The Chart Store