DJIA Average Daily Change

by Bespoke Investment Group

"When in doubt blame it on the computers."

Nowadays, this seems to be the go to scapegoat for any market related problems. Over the last few days, numerous reports have said it is the computers to blame for the whipsaw trading the market has seen in recent weeks.

The explanation sounds plausible, but it is not necessarily borne out by the facts. Over the last 50 trading days, the average daily percentage move (up or down) in the DJIA has been 0.90%. Relative to history, the current level is far from the extreme readings we saw during the Financial crisis when the average daily change rose to 3.71%. Granted, the last few days have been extremely volatile, so if the recent trend continues, we will see the current 50-day average rise much higher.

One could still argue that computers were behind the big spike in volatility during the Financial Crisis, but what would explain the big spike in the 1930s, when the average daily change was also above 3%? Last we checked, there were no computers back then. While HFT and computer trading may be contributing to the recent surge in volatility, it isn't solely to blame. The reality is that when the market goes down, investors step to the sidelines, causing liquidity to dry up. In illiquid markets, price volatility rises.

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Volatility Skew Indicates Further Selling Pressure

by Maceo Story

On a day to day basis the volatility skew is not a reliable signal for the direction of equities. What is reliable though is the trend and the charts below indicate that equities have further to fall within this current downtrend.

Skew VS SPX

The following chart is the skew (with no reference to the vix) versus the SPX. Notice the downtrending channel the skew is in.

Skew Vix Divergence VS SPX

A rather interesting similarity has formed with the current trend versus that of summer 2008 preceding the September / October slide.

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S&P 500 channel support ...

by Kimble Charting Solutions

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Grabbing High Yields Overseas

by Tom Aspray

Despite the market turmoil, these global utility stocks are still trending higher and pay sizable dividends, making them much better alternatives to low-yielding Treasury bonds.

The stock market action on Monday and Tuesday suggests that a panic low may now be in place and that this week’s lows could hold for some time. Even if this is the case, some backing and filling with further wide swings is likely over the next few weeks.

In this environment, and with the prospects of low rates lasting until 2013, I continue to favor high-yielding utility and drug stocks. One of these global utility picks yields over 8%, but let’s first look at the recent market action.

The Fed’s statement on Tuesday’s afternoon added to what was already one of the all-time most volatile days in terms of swings in the S&P futures, as there were five 40-plus-point swings in just one day of trading.

The closing Advance/Decline (A/D) numbers were impressive with 3664 advances versus just 512 declining issues. This caused a sharp reversal in the McClellan Oscillators, which rose from very oversold levels at -440 to just -65.

The A/D lines have turned up but now need to start new uptrends to confirm a significant market low. The S&P 500 could rally further to the 1200-1220 area before we get a decent setback. The S&P futures were down 15 points in early trading Wednesday.

Click to Enlarge

Chart Analysis: TransAlta (TAC) is a $4.6 billion, non-regulated Canadian utility company that has been based in Calgary, Alberta since 1911. It currently yields 5.9% and its short ratio of 23.4 makes it even more attractive. This ratio means that it will take 23.4 days of normal trading volume to cover the large short position in TAC.

• The weekly chart shows a broad trading range, lines a and b, with resistance at $22.66 and support at $19.64 (this week’s low).
• There is initial resistance now at $20-$20.40
• The downtrend in the relative performance, or RS analysis, which goes back to early 2010, line d, has been broken. There is further resistance at line c
• The weekly on-balance volume (OBV) has turned up and is trying to move back above its weighted moving average (WMA). It is well above its uptrend, line e

TransCanada Corp (TRP) is also located in Calgary but is a much larger ($23.4 billion) gas utility company. The stock closed up 5.7% on Tuesday on volume that was more than four times the three-month average. It currently yields 4.5%.

• The weekly uptrend, line f, at $37.94 was broken this week with Monday’s low at $37.29
• The RS line has turned up sharply and shows a solid uptrend, line g
• The weekly OBV will turn up with a higher weekly close (above $39.31). The daily OBV (not shown) has turned up but is still negative
• There is first strong resistance at $40.66 and then further resistance in the $41.50-$42 area

Click to Enlarge

Companhia Energetica de Minas Gerais (CIG) is the largest combined generator and distributor of power in Brazil. It has a market capitalization of $12 billion and has a current yield of 6.4%.

• On Monday, CIG dropped below the weekly uptrend that goes back to 2009, line a
• Once below this week’s low at $16.61, next support is at $15.71, which corresponds to the February 2011 lows
• The RS line has been locked in a narrow range over the past two months but is still well above its longer-term uptrend, line b
• The weekly OBV is below its weighted moving average but is still holding well above the longer-term support at line c
• There is initial resistance now at $18.60 with stronger resistance in the $19.40-$19.70 area

National Grid PLC (NGG) owns and operates gas and electricity networks in the United Kingdom and the US. It is a $33.6 billion company whose revenue has been growing by an annual rate of 7%. The stock currently yields 8.2%.

• The uptrend from the 2010 lows at $36.67, line e, was violated this week
• Initial support is at this week’s low of $45.40 with more important support at the March lows of $43.41
• The RS line moved through its downtrend, line f, in March. It has now moved above the resistance at line g, completing the bottom formation
• The weekly OBV staged an impressive breakout early in 2011 and is still acting stronger than prices. It is now below its weighted moving average while the daily OBV (not shown) is positive
• NGG closed at first resistance on Tuesday with further resistance in the $49.50- $50.50 area

What It Means: All four of these global utility companies tested major support this week and their weekly uptrends are still intact.

The surge into the Treasury market has pushed bond yields to record lows, which given the current inflation rate makes them less attractive than other income sources. Each of these stocks have very attractive yields and are in a sector that, historically, is less volatile than most.

How to Profit: Since a market low has not yet been confirmed, controlling risk is still a factor. Therefore, I am recommending fairly standard stop placement to limit the damage should we see another downdraft.

TransAlta (TAC): Go long at $20.42 with a stop at $19.18 (risk of approx. 5.8%).

TransCanada Corp (TRP): Go long at $38.88 with a stop at $36.06 (risk of approx. 7.2%).

Companhia Energetica de Minas Gerais (CIG): Go long at $17.36 with a stop at $16.13 (risk of approx. 7.1%).

National Grid PLC (NGG): Go long at $46.92 with a stop at $43.18 (risk of approx. 8%).

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VIX Backwardation Commentary

by Bill Luby

My recent VIX Term Structure Evolution Over Last Ten Days post seemed to draw a fair amount of interest from the Financial Times, Forbes and elsewhere, with some pundits claiming that the move from contango to backwardation in the VIX futures was foreshadowing everything from a “full-fledged bear market” to a “systematically important shock event.”

Just five days later, the VIX seems to have peaked, yet the amount of backwardation in the VIX futures term structure has actually increased. Looking at the front two months of VIX futures (which is where investors in the likes of VXX and XIV should be focusing), I note that the front month (August) is now 7.25 points higher than the second month (September) VIX futures. This positive roll yield means that investors who are short VXX and/or long XIV are losing almost 1% per day due to daily rebalancing (rolling) that involves selling the front month VIX futures and buying the second month contract.

This also means that should the VIX spike higher from current levels, ETNs such as VXX of TVIX and others should see enhanced returns due to an increase in volatility plus favorable term structure and roll yield.

One problem with backwardation is that it tends to be fleeting. Of the 59 instances of backwardation in the front and second month portion of the VIX futures term structure going back to the inception of VIX futures in 2004, 37% lasted only one day and 56% lasted no more than two days, fully 83% of all instances of backwardation had ended within six days and only six backwardation events in seven years have lasted more than the current eight days. Not surprisingly, three of those six periods of extended backwardation were from 2008, two were from 2009 and the last one was from 2007.

To state what I hope is the obvious, detailed knowledge of the workings of the VIX futures term structure is mandatory for anyone who trades VIX ETPs. Not only does one need to know what the implications are of the current term structure, but also to have a sense of how that term structure is likely to evolve over time.

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Equity Correlations and Volatility

By Barry Ritholtz

Great chart from JPM (pre August sell off):

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Sources: BLS, FactSet, J.P. Morgan Asset Management.
Data reflect most recently available as of 6/30/11.

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