With the New York Giants’ win fresh in the minds of 111 million Super Bowl viewers, I guess it shouldn’t come as a huge surprise that a slew of financial media outlets are talking about the “Super Bowl Indicator”.

Here’s a bit from the Wall Street Journal:

Robert Stovall of Wood Asset Management in Sarasota, Fla., is the veteran market analyst who has popularized the [Super Bowl Indicator].

“I don’t have any particular expertise in predicting the outcome of sports events,” says the 85-year-old Mr. Stovall, but he nonetheless leans toward a Patriots win, which would mean a down year for the market. “But if the Giants win, a happy feeling should spread through the bulls.”

The so-called “Super Bowl Indicator” predicts that if an NFC team wins the Super Bowl, the stock market will have a bullish year. On the other hand, an AFC Super Bowl victory predicts a bearish year for stocks. In the last 41 years, the Super Bowl Indicator has had an 80% success rate in determining the market’s direction. The Giants’ win, then, should foretell of a bullish year for stocks. So, should you believe it?

Absolutely not…

There are some major holes in the story behind the Super Bowl Indicator (SBI) — ones that may not be readily apparent to most investors. After all, they weren’t apparent to the Wall Street Journal, the Indianapolis Star, Forbes, or scores of other major media outlets that have been gushing about this false prophet for stock performance.

When it comes to the Super Bowl Indicator, it’s important for you to realize that “correlation doesn’t imply causation”. In other words, just because there’s a correlation between two things doesn’t mean that there’s a causal link between them. Just because your cell phone stops working after a power outage doesn’t mean that the outage broke your phone. In the investing world, that’s one of the most important concepts to understand…

And just because there’s no logical link between Super Bowl winners and market performance doesn’t mean that there’s no complex relationship at play. Just because a high correlation doesn’t prove they’re connected doesn’t mean that they’re not.

Incredibly successful traders have been known to look for bizarre links between outside factors in the market. Billionaire hedge fund manager Jim Simons even admitted once that his firm researched connections between sunspots and market performance — but he wouldn’t tip his hand as to what they found out…

So, with an 80% success rate, why is the SBI a bunch of bunk?

Well, the first thing to look at is the possibility that that 80% win rate was due to luck or chance — in other words, is that rate statistically significant?

On the surface, it looks that way. With 41 games played and measured against the following year’s performance, the statistical chance of an 80% correlation being luck is infinitesimally small. But — and here’s the clincher — the SBI doesn’t follow a normal distribution. Put in plain English, there’s a very logical reason why it’s garbage…

You see, historically, the stock market has been trending higher. As a result, we’ve had more up years in history than we’ve had down years — so it’s statistically more likely for any random year in the last 41 years to be a positive year. Now, let’s look at the NFL.

Like stock market performance, the winning conference in the NFL is hardly random. Thanks to a long NFC winning streak between the 1980s and the late 1990s (in part the result of the dominance of the Dallas Cowboys and the San Francisco 49ers franchises during that time period), NFC teams have won more Super Bowl match ups than their AFC rivals. As a result, it’s statistically more likely for any randomly chosen Super Bowl year to have an NFC winner just because a couple of dynastic teams happened to be in the NFC.

When you put those two statistics together, it’s more likely that a year will be up than down, and it’s more likely that the Super Bowl winning team would have been in the NFC than the AFC. So the high correlation between up years and NFC wins isn’t a huge surprise after all…

The fact that the SBI is worthless hasn’t kept otherwise smart people from touting the usefulness of the metric. A professor at Washington & Lee University even went as far as developing an investment strategy that selects different asset classes depending on the winning team of the big game.

“When I present this you can see the smile on their faces ‘You’re not serious are you?’,” says the prof…

Of course, even the good professor hasn’t invested his own money in the Super Bowl Indicator strategy. In fact, of all of the mainstream cheering of the SBI, there wasn’t a single person who actually said that they invested real money based on the indicator — only those who “wished they did.”

That may be the biggest red flag of all — if an indicator’s biggest fans aren’t putting their cash on the line with it, neither should you.

The old joke goes that 68% of statistics are made up. Well, if the Super Bowl Indicator proves anything, it’s that even compelling statistics can be misleading when they’re not approached with mathematical rigor. Regardless of which team you were cheering for last night, do yourself a favor and avoid the indicator everyone’s talking about today.

Cheers,

Jonas Elmerraji
for The Penny Sleuth

Debunking the Super Bowl Indicator was originally featured in the Penny Sleuth.

If there was a single phrase to describe the market in 2011, it would have to be “investor uncertainty”. Investors have been anxious for the last year, and for good reason: incompetent politicians have had significant control over the broad market. Now that we’re in the new year, I think that the single most critical factor for stock performance remains Europe.

First, though, let’s take a look at what’s been going on across the pond. To fully grasp the problems that have been plaguing the PIIGS countries, it makes sense to take a look at what was going on in debt-plagued countries like Greece and Spain for the last several years. In a recent article, Bloomberg reporters took a look at the “Cayenne Crisis” spreading through Spain as the used car market gets flooded with $88,000 Porsche SUVs that middle-class Spaniards realize they can no longer afford:

Juan Ramon Valdivia, 19, who works at his family’s restaurant in Malga on Spain’s sourthern coast, is looking to unload his Cayenne for a less expensive VW or Peugeot.

“This car was the paradigm of how we lived above what we could afford,” Victor Conde, marketing professor at Madrid’s Universidad Nebrija, said.

Teenage restaurant workers being approved to buy Porsches is only part of the problem. The fact that 98% of wealthier Greek swimming pool owners lie on their tax forms is another. And the massive debt loads that a handful of the Eurozone’s least stable economies undertook is the nail in the coffin.

Europe’s debt crisis has remained one of the biggest black clouds for U.S. markets, driving some of the past year’s most memorable crashes. In 2012, it’s still going to be one of the biggest factors impacting uncertainty and volatility in the stock market.

As Europe’s financial instability teeters, investors are betting against the euro. In fact, as I write, short selling in the EU’s currency is at a record high — spurred by investors who are concerned that the PIIGS could take down the whole region’s currency. Worse, they fear that a default on Europe’s sovereign debt could destroy the banks that own huge positions in eurozone bonds.

We’re seeing that play out in the TED spread, a measure of the perceived health of commercial banks. The TED spread is the difference between the interest rates on interbank loans (known as eurodollars) and on U.S. treasuries — when the difference is large, it indicates that investors are factoring in bigger risk to the financial system.

Right now, the TED spread is the highest it’s been since the height of the financial crisis. That tells us that investors are more anxious about the financial system than they’ve been in years. And that’s carrying over to the behavior we’re seeing in the stock market…

Even though stocks have been trading relatively flat for the last week and change, investors should be getting ready for things to get worse before they get better — the financial system can’t be as risky as it is right now without some consequences.

And since the TED spread measures interbank credit risk, those consequences are going to show themselves in the financial sector. You see, even though the TED spread tells us that risk is ratcheting higher under the covers, we haven’t seen that risk get priced into financial stocks by nearly the same amount. As a result, a bet against financials makes a whole lot of sense right now…

One of the easiest ways to do that is through the Direxion Daily Financial Bear 3X ETF (NYSEARCA:FAZ), an exchange traded fund that tracks three-times the inverse of the financial sector’s performance. So, in other words, for every 1% that financial stocks fall, FAZ rallied by 3%. While leveraged ETFs hold additional risks, it still makes a lot of sense for traders who approach this as a short-term, aggressive bet.

We’ll be keeping a close eye on the macro technical environment in the next few weeks — and keeping you filled in here at the Penny Sleuth.

Sincerely,

Jonas Elmerraji
for The Penny Sleuth

Highs in the TED Spread

Why You Should Be Betting Against Financial Stocks was originally featured in the Penny Sleuth.

But it doesn’t have to be that way…

Today, I’d like to show you four simple chart patterns that could help you find your next profitable trade in 2012.

In his book, The Definitive Guide to Point and Figure, Jeremy du Plessis argues that:

“Some authors go on to list tables of patterns, but the need to learn patterns indicates a lack of true understanding of how a pattern is created. There is no point in trying to learn dozens of patterns; it is better to understand what causes them.”

As a market technician, that’s one of my favorite quotes. When it comes to chart patterns, it’s absolutely true that rote memorization will only get you so far. Instead, it pays (literally) to understand how and why patterns are created.

At their most simple construction, patterns are just different arrangements of support, resistance, and trend lines. While I won’t get into too much detail over how those individual building blocks work, you should be able to see a lot in common with the four patterns I’m about to show you. So, rather than trying to memorize the pattern on these four formations, memorize the combination of support, resistance, and trendlines that combine to create them…

1. Ascending Triangle

First up is the ascending triangle, a bullish pattern that’s formed by a horizontal resistance level to the upside, and uptrending support below shares. Those two technical levels form a shape that resembled a right triangle. As shares bounce in between them, they get squeezed closer and closer to a breakout above that resistance level. When the breakout happens, it’s a strong buy signal for shares.

The bearish opposite of the ascending triangle is a descending triangle. In a descending triangle, shares have horizontal support and downtrending resistance. The shorting signal comes when that horizontal support level gets broken.

2. Head and Shoulders

One of the most well-known technical formations is the head and shoulders top. It’s a bearish pattern that’s identified by a peak (the head), with smaller peaks on each side (the shoulders). Even though the head-and-shoulders is likely the most well known technical pattern, it’s still a valuable one: an academic study conducted by the Federal Reserve Board of New York found that the results of 10,000 computer-simulated head-and-shoulders trades resulted in “profits [that] would have been both statistically and economically significant.”

On the opposite side is the inverse head and shoulders, which, as the name implies, is just a flipped version of the head and shoulders top. It’s a bullish pattern.

In both cases, the trade signal comes when shares push through the neckline (sometimes called “shoulder level”) in the chart above.

3. Consolidation

A consolidation channel (sometimes called an “If/Then Trade”) is a channel that’s bounded by both a horizontal resistance level and a horizontal support level. Frequently, consolidation channels come after large moves. They’re an opportunity for a stock to bleed off some volatility and for traders to think about their next moves. Unlike the other patterns we’ve looked at, this setup doesn’t have any directional bias until it triggers.

The trigger happens when shares push outside of the channel. When that happens, the high probability move is to take a position in the direction of the breakout.

4. Double Top

Finally, we’ll look at the double top; as the name implies, it’s a topping pattern (thus it’s bearish). The double top can be identified by two swing highs that peak at approximately the same price level — that price level is a strong resistance level, above which there’s a glut of supply of shares that overwhelms buying pressure. A double top becomes a short signal when shares push through the intermediate trough that separates the tops.

Not surprisingly, a pattern called a double bottom is the bullish opposite of the double top.

While we’re hardly taking an exhaustive look at all of the potential patterns that you may encounter in the market, these four patterns provide a good sample of how the building blocks of support, resistance, and trend create actionable patterns. By keeping these four patterns in mind the next time you look at a chart, you’ll be better able to spot other, more unconventional setups than traders who resort to rote memorization.

Happy trading in 2012,

Jonas Elmerraji
for The Penny Sleuth

Learn These 4 Profitable Chart Patterns was originally featured in the Penny Sleuth.

It’s true that volatility measurements remain well above historic averages. However, the volatile action that has plagued stocks and baffled traders over the past 6 months could subside at some point this year. That means market conditions could become much more favorable to traders. Clearer entry and exit points will materialize when higher periods of volatility subsides — and fewer whipsaws will force traders to cut early losses.

Unless you’ve been living under a rock for the last year, you’ve probably noticed the huge volatility that’s been shoving the stock market in one direction then the other. What you may not have realized is the fact that individual investors aren’t the only ones affected: “…traders who used to profit from price swings are struggling as record stock market volatility shows no signs of abating,” read a recent article in Bloomberg Businessweek.

While the final numbers have yet to roll in, hedge funds are looking to post their second-worst year in history after volatility has knocked around a number of high-profile funds. Victims include John Paulson, who made $5 billion in 2008 by betting against the housing market, and Duke Buchan, whose billion-dollar hedge fund is shutting its doors after coming into the year ahead of stocks by 46% in the last decade. No one has been immune from 2011’s wild ride.

Quite frankly, I haven’t been immune from the volatility either. While my premium trading service’s portfolio booked an average closed gain of 5.39% held over 20.2 days in 2011, that performance number came in well shy of the 19.27% average gain we took home in 2010. While it’s great to beat most investors, it’s still frustrating to trade in this sort of environment.

And it looks like that will remain the case for the time being…

The chart above shows the Bollinger Bandwidth for the S&P 500 — this indicator is a statistical measure of volatility that’s a much less biased measure than popular volatility measures like the VIX. Bandwidth has been inflated lately, rising to a nearly three-year high as recently as mid-September, and remaining above its historical average now. For that reason, it makes sense to expect volatility to remain a factor.

But there is a silver lining to the volatility story we’re seeing right now. You see, market volatility is cyclical — in other words, markets oscillate from periods of high volatility to periods of low volatility.

Looking at the bandwidth chart, it’s clear that volatility has been on the downswing since those September highs.

As a result, I think that we’ll see a return to more normal levels of volatility at some point this year. Although we’ve only seen a handful of trading days in 2012, volatility is already measurably lower. Because of the abrupt drop in volatility, it’s quite possible that a volatility squeeze could pop price action back into swing mode in the near term.

As a trader, you should be watching indicators like Bollinger Bandwidth, not the calendar, to signal calmer waters in 2012. While most high-end charting packages let you apply the indicator, free services like StockCharts.com also enable investors to take a look at the market’s Bollinger Bandwidth with just a few clicks of a mouse.

If volatility does indeed subside in the near future, you should have a much easier time identifying a variety of promising trade setups.

Cheers,

Jonas Elmerraji
for The Penny Sleuth

Why Stock Trading Could Get Easier This Year… was originally featured in the Penny Sleuth.

Most people’s New Year’s Resolutions lists feature the standard self-improvement plans for 2012: lose weight, quit smoking, and travel more. But as a trader, your list of resolutions should look a little bit different. Today, I want to show you a common setup that you should plan on trading this year.

You may have already heard of the ascending triangle, but it’s worth taking a look at this technical trading pattern from a fresh perspective. Not only is it one of the most common trading setups I come across, it’s also one of the highest probability trades on the market if you approach it correctly.

To fill you in, let me walk you though a real life trade that I recently recommended to my small group of members.

If you weren’t already aware, I run Penny Momentum Trader, an elite-level trading research service that issues specific buy and sell recommendations based on technical analysis. On November 2, a textbook ascending triangle trading setup popped up on my radar. I sent the chart below to my readers, and told them to put Raptor Pharmaceuticals (NASDAQ:RPTP) on their watch list.

You can watch the analysis video that I sent readers by clicking on the image below…

11-2 Watch List: RPTP from Agora Financial on Vimeo.

As you can see in the chart, an ascending triangle is a trading setup that sports a horizontal resistance level (in this case, $5) and uptrending support. Essentially, as shares bounce between those two key technical levels, they get squeezed closer and closer to a breakout above $5. That breakout is crucial because it tells us that buyers have regained control of the market for RPTP, and absorbed the glut of supply that had held prices below $5 for so long.

It’s important to note that the chart I sent wasn’t a buy signal in and of itself — actual trading signals don’t come when you spot the ascending triangle pattern. Instead, the buy signal comes when the breakout above $5 happens…

In the case of RPTP, that breakout came on November 30, and I sent out a buy alert to PMT readers that morning suggesting that they buy either shares of RPTP, or a specific call option that had a higher risk/reward tradeoff. Our price target was just above the $6 level.

So, how did the trade pan out?

We hit our price target seven days later, on December 7, and I sent off a sell alert. All told, readers had a chance to book gains of 13.4% on shares of RPTP and more than 43.8% gains on the options recommendation — all in just a one-week holding period.

Even though 2011 was a tough trading year, there were opportunities to squeeze profits out of Mr. Market if you knew where to look. In 2012, I expect that we’ll see a similar environment for the early part of the year — that’s why it’s so crucial to be aware of the trading setups that can actually provide your portfolio with gains in this sort of market. The ascending triangle may be a simple setup to spot, but it can offer up some powerful gains.

Watch out for the ascending triangle the next time you’re looking at charts.

Cheers,

Jonas Elmerraji
for The Penny Sleuth

Chart Smarts: How to Make 44% Gains on This Trade was originally featured in the Penny Sleuth.

To be sure, it’s been a big year for initial public offerings (better known as IPOs). All told, year-to-date IPO announcements are up more than 86% versus last year, with 631 firms filing to make their shares publicly traded as of this morning’s open. But that positive trend in IPOs is hardly the whole story…

In case you’ve been living under a rock this year, you already know how gut-wrenching stock performance has been so far this year. Historically, bad market conditions mean lower values for IPOs, so companies and their underwriters avoid going public when stocks are under pressure as much as possible. As a result, withdrawn IPOs are up 66% versus last year, as financially sound firms pull the plug on their offerings until Mr. Market looks a bit friendlier.

Those who haven’t — the Groupons, LinkedIns, and Zillows — have gotten absolutely shellacked this year since they started trading. And so have their shareholders…

Yes, it’s true that IPOs can hold the keys to truly outsized gains (imagine buying Google back when it cost $85 — now it’s $628 as of this morning’s open), but they’re clearly also fraught with risk right now. Should you avoid IPOs altogether in 2012?

No. But you’ll have to sift out the wheat from the chaff to find gains in newly public stocks in the new year.

While the most-hyped IPO names of 2011 have seen their share prices summarily whacked, smaller IPO names have fared a whole lot better this year. Take nutritional supplement retailer GNC Holdings (NYSE:GNC) for example; this stock was a small-cap when it went public, and investors who bought early have seen their positions rally nearly 68% since March.

Taking a look at the names below, there’s clearly a trend in what’s make an IPO successful in 2011:

Looking at the table above, a few common threads become very clear. For starters, each of the top gaining IPOs of 2011 have been small-cap stocks. Contrast that with the hyped-up names like Groupon, which is down double-digits and went public with a $16.7 billion, or Renren, which is down nearly 82% on the year after offering at a $5.5 billion market cap. Without the hype and over-analysis of Wall Street, smaller firms had more upside to offer investors this year.

Another important trend is the industry that the winners are operating in…

While most of the attention has been on high-tech social media names such as LinkedIn or Thursday’s Zynga IPO, most of the top performers of 2011 are actually in comparatively boring businesses. It’s not that boring is inherently better for investors — instead, the key is that investors are more competent at valuing the fundamentals of a retailer or an energy firm than they are at valuing a tech firm with no profits and lots of intangible assets.

From a due diligence standpoint, it makes sense to focus on industries that we can get reasonable assurance over rather than the high-risk, low-reward tradeoff being offered up by tech names right now.

Despite all appearances, there are clearly still opportunities to be found in IPOs. With 2012 on the horizon, it’s going to be crucial to focus on IPO names that meet the criteria of the recent winners, not the hype that the media is focusing on. Stick with small-cap names in boring industries on your next IPO hunt, and you’ll be better off.

Cheers,

Jonas Elmerraji
for The Penny Sleuth

The Secret to Raking in IPO Gains in 2012 was originally featured in the Penny Sleuth.

Unless you’ve been living under a rock for most of 2011, it’s been hard to escape the European debt crisis that’s ravaging the U.S. stock market. Of course, if you’ve been living under a rock this year, your portfolio may be better off than most investors.

Today, I want to break down the European debt crisis into more manageable pieces, and show you why you should turn off the financial news for the rest of the year…

Like the rest of the developed world economies, European nations have been enjoying a spending spree for a long time, building a massive debt load. Unlike the rest of the developed world economies, Europe’s financial system is tied together with the euro — an important distinction. So while PIIGS countries such as Greece, Portugal, and Spain could leverage the strength of the eurozone to get ahold of mountains of debt, they can’t print money to solve the problem. At least not by themselves.

So while the debt fountain was flowing freely for the last decade, servicing that debt was no big deal; Greece could just take out a new credit card to pay off its latest credit card bill. When the financial crisis hit Europe, though, borrowing became a lot more difficult…

The word contagion has been a popular buzzword throughout the European debt crisis. It’s the idea that the connected nature of the eurozone could cause a financial crisis to spread from the weaker PIIGS countries to the more stable economies of Germany and France. To prevent that sort of a scenario, European countries adopted a Stability and Growth Pact, which restricted member countries’ budget deficits and debt-to-GDP levels. In the real world, the pact has proven unenforceable, and eurozone debt has rocketed as a result.

Apparently, lawmakers’ grasps on reality aren’t any better across the pond…

Today, contagion is a serious concern. While Greece is relatively small potatoes for the eurozone, the prospect of bailing out Italy (Europe’s third-largest economy) would be a different story. The complicated nature of the crisis is exactly why we’re stuck in uncertain territory this month. The jury is still out on the best way to handle the problems in Europe.

Meanwhile, U.S. stocks have been getting shellacked consistently as the impact of the drama in Europe trickles down to U.S. investors. You see, the eurozone is our biggest trading partner, and countless U.S. companies earn euros for their operations overseas. Some prominent analysts have even suggested that the impact of the euro on U.S. stocks is the reason for the high correlations that have existed in the market for the last year.

Frankly, there’s no escaping the fallout from Europe’s debt debacle. Reading most mainstream financial media, you’d think that the fate of Europe was being decided from one day to the next — and that the market was swinging wildly in reaction. Too many investors are “buying” the most recent resolution in the eurozone and “selling” the most recent misstep.

Today’s a perfect example: As I write, stocks are down nearly 2% on worries that Europe is headed for another credit crunch. Headline risk remains too high right now, and investors who try to trade around Europe are bound to get caught up in it all.

Instead, I’d suggest turning off the financial news for the rest of the year. Ignore the headlines, and instead, focus on price action that’s taking place in the broad market. From a technical standpoint, stocks still look reasonably bullish — a low risk-buying opportunity for the S&P 500 comes on a push above 1,292.

Sincerely,

Jonas Elmerraji
for The Penny Sleuth

The Problem With Europe was originally featured in the Penny Sleuth.

In the last five trading days, the S&P 500 has rallied nearly 9%, prompting investors to call out the “all clear” signal as stocks ratchet another 1.4% higher this morning. But investors who pile into stocks this week must have short memories — after all, just two weeks ago, stock had their worst Thanksgiving week since 1932.

That doesn’t mean that you should be running from the market this week — instead, it means that you need to enter your next position with an exit plan in mind…

Whether you’re a buy-and-hold investor or a daytrader, an exit strategy should be something you think about before you ever hit the “buy” button on your trading platform. Not only will a sound exit strategy help you skirt serious losses, it’ll also help you to lock in gains on positions that are already in the green.

It all comes down to one major tool: the stop loss.

Basically, a stop loss (or stop, or stop order, etc) is an order with your broker to sell your shares in a particular stock automatically when its price hits a specific level. While there are several different types of stop losses, these three major types are worth knowing about:

1. Stop Order: Triggers once your stock reaches a specific target price, the stop price.
2. Trailing Stop: Triggers at a specific change in price, measured by either percentage points or dollar value.
3. Stop Limit Order: Similar to the stop order, except for the fact that a limit order is triggered once your stock reaches a specific target price. (i.e. sell high, and re-buy low)

Which order to choose depends on what you’re trying to do. Clearly, the biggest benefit of placing stop losses is the fact that you won’t have to lose sleep over your open positions — if the stocks you own take a big dive, your positions will sell off before any major damage is done. That’s a pretty compelling case for using stops.

But there’s more to an effective stop loss than just that.

Using a Technical Stop Loss

For fundamental investors, a stop loss is an arbitrary level that’s set at some “maximum pain threshold”. In other words, if the biggest loss you’re willing to take on a stock is 10%, you’d set your stop order 10% below your cost price and be done with it.

Unfortunately, there’s a big problem with that mentality…

The problem with placing arbitrary stops is that there’s no logical basis for them. After all, shares could fall 11%, then reverse higher — that’s why it’s important to set your stop levels based on the market rather then on your personal thresholds.

To do that, you need to add some basic technical analysis to your investment strategy. Stops can be very useful when they’re placed under a stock’s support level (the price level that a stock has trouble falling below). That’s because to a trader, a price level below support generally means that the stock could be breaking out much lower. Essentially, you’ll want to place stops just under where you’re likely to find a glut of demand for shares.

To avoid exceeding your comfort zone on a loss, think of your “maximum pain threshold” as a dollar amount rather than a percentage. Then, size your position so that you’re stopped out before your losses exceed that level. Trailing stops, which are typically used to lock in gains, can be used a little bit more arbitrarily.

It’s tempting to follow the crowd right now and buy stocks blindly as they climb higher. But doing that would be a big mistake. Volatility remains a major concern, and it’s very likely that the S&P 500 will see another major drawdown in 2011. Set your stops logically, and you won’t be caught unaware if that happens.

Sincerely,

Jonas Elmerraji
for The Penny Sleuth

Avoid Serious Losses By Knowing When to Sell was originally featured in the Penny Sleuth.

But don’t fall for the bounce in stocks today… for reasons I’m about to explain, Santa’s not coming for investors this year.

Wall Street has an attribution problem. Investors see a big pop in stocks, and they look for the nearest headline as a reason for the move. By that logic, it makes sense to attribute today’s 3% gain to retail sales and hopes for a European fix — but that’s not what’s happening here.

Instead of looking at headlines, let’s look at price action. As of Friday’s close, stocks had moved lower for seven consecutive days, a statistically improbable losing streak for the broad market. At the same time, the size of the drawdown in stocks was important; month-to-date, stocks have shed 7.55% in November. That’s the second-worst November in a decade. So it’s no great shock that stocks are showing us a relief rally this morning. Statistically, Mr. Market was very likely to bounce back hard this week.

But if today’s bounce in stocks is bogus, where does that leave investors as we approach 2012?

As I see it, two major factors are going to dominate trading for the rest of 2011: the technical breakdown in stocks and Europe’s inability to get anything done.

This chart of the S&P 500 gives a pretty good technical picture of what’s going on in the market right now:

Last week’s price action shoved the S&P 500 (our best proxy for the broad market) back into the price channel that had constrained shares for much of the late summer. That means that for stocks to move back to positive territory for the year, they’ll have to surmount a newfound resistance level at 1225, a price ceiling that makes more sideways volatility the most likely scenario to end 2011.

So while today’s upward move is significant from a percentage standpoint, it’s an “easy move” through neutral space. As supply and demand for stocks stand now, it’s very unlikely that we’ll see equity prices push back above that channel before the end of the year.

I’m not saying that we’re doomed for another major crash right now. Instead, it’s likely that we’ll just see volatile churning within the channel — after all, a major pocket of demand exists below the 1100 level in the S&P 500. As long as stock prices stay stuck below resistance 1225, it’s not going to be favorable to be a buyer.

The second big factor affecting stocks this month is Europe. In fact, Europe has managed to take the wind out of investors’ sails every time stocks seemed to be turning higher in the last quarter — and there’s no reason to think that that’ll change in December.

Investor sentiment toward Europe is turning higher today thanks to a report that eurozone leaders had reached a new pact to solve the crisis, including an IMF bailout of up to EUR 600 billion for Italy. But investors are ignoring the fact that Greece, the country that started the whole mess, is asking investors to take bigger losses on its bonds than initially agreed upon.

If the success in negotiating Greece’s debt crisis is unraveling, why is the market celebrating the new debt deal being forged across the pond?

Until the constant threat of a budget meltdown in Europe and at home gets resolved, investors are going to be held hostage.

That’s why, at this point, it doesn’t look like Christmas is coming for stock investors this year. With more sideways churning likely to take us to the end of 2011 (and a bit beyond), it makes sense to reduce your exposure to the broad market and stick with safety assets until stocks break back outside of the channel.

Cheers,

Jonas Elmerraji
for The Penny Sleuth

Why Santa’s Not Coming for Investors This Year was originally featured in the Penny Sleuth.

U.S. stocks opened dramatically lower this morning, pushed down by the announcement that Congress’ super committee wasn’t so super after all. They’re going to miss this week’s deadline to come up with $1.2 trillion in budget cuts needed to stave off more default concerns over U.S. sovereign debt.

Instead, as of this morning, they’ve destroyed $138 billion in stock value as anxious investors sell off on the news.

As a trader, I pay a lot of attention to attribution. More often than not, when news outlets like CNN or The New York Times print a headline about why the market’s moving, they’re wrong. They look at the headline of the day, and pin that as the reason why stocks are moving. In reality, there’s rarely a causal link between the headline and the movement of stocks. But there’s no question that today’s selloff is courtesy of our elected officials.

That’s why short sellers should be saying “thank you”…

Let’s put what’s going on in some context. It’s not just that Congress has triggered significant selling that’s the problem. If we were in the midst of a roaring bull market, Congressional incompetence could be overlooked – but we’re not. Instead, the S&P 500 is at a critical tipping point: stocks pushed back into the red for the year last week, and were sitting just below a key support level at 1225 as of this morning.

So, today’s selloff is much more likely to continue to drag stocks lower.

Frankly, though, today’s selling is muted compared to what Congress has provided for us earlier this year. Back in July, stocks were still up double-digits on the year, then the first debt debacle came, the U.S. teetering on the brink of not being able to pay its bills. Congress proved unable to come up with a resolution then too.

And stocks fell 18% in the next two months:

So, what’s the most likely scenario at this point? With today’s negative open, it’s now increasingly probable that we’ll re-enter the channel that stocks were stuck in for much of the summer. If that turns out to be the case, investors should expect more volatile sideways trading for the rest of 2011.

There was a lot of attention on Congress last weekend after a 60 Minutes piece talked about the fact that members of Congress are exempt from insider trading laws – and that many members made a killing by shorting stocks after closed door briefings by Ben Bernanke and Hank Paulson warned of a coming financial crisis. Now that Congress’ behavior is actively crashing the market, they should be able to make a whole lot more money trading stocks.

So when short sellers sit down in front of their turkeys on Thursday, I hope they say thanks to Congress – they probably paid for that Thanksgiving meal after all.

Sincerely,
Jonas Elmerraji

Why Short Sellers Should Be Thanking Congress was originally featured in the Penny Sleuth.