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A Technical Look at Fundamentals
08/06/2015 9:00 am EST
The battle between fundamental and technical analysis has been raging for decades, but technician Tom Aspray demonstrates how a twist on the traditional use gives you a different perspective.
Though there has been some improvement in the past 20 years, most fundamental analysts still do not analyze their data using technical analysis. I have found that using trend lines and divergence analysis on fundamental data can often be very useful in confirming your views on the market or on a sector.
In the early 1980s, there was one data series that I regularly watched. It was the number of Help Wanted ads that were in the newspaper. When the number of ads was rising, it was a positive sign for the economy. Conversely, a declining number of ads was a sign that the economy was contracting.
For example, the number of ads turned lower in early 1981 and did not start to rise again until October of 1982. They had formed a clear pattern of lower highs and lower lows (a downtrend), and when it was broken, it indicated that the recession was over. It was consistent with the bullish action in the stock market as it bottomed in August 1982. The recession was officially over in November 1982.
The Help Wanted ads also peaked well before the 1991 recession, but in 2005 the Conference Board replaced it with the Help Wanted OnLine®. The chart shows that the uptrend in these ads, line a, was broken in the summer of 2007 several months before the major stock markets made their highs. By early 2008, it was falling sharply and it was later determined that the recession began in December of 2007.
The downtrend in ads, line b, was broken in the fall of 2009, and a year later, it was determined that the recession officially ended in June. The ads were positive as they continued to show a pattern of higher highs and higher lows into 2013. This was a positive sign for the future growth of the economy.
Another favorite data series from the Conference Board is their Leading Economic Index (LEI), which is made up of ten variables, including the unemployment rate, jobless claims, building permits, stocks prices, etc. It has a fairly good record of predicting recessions over the past 50 years.
The chart from the Conference Board shows the LEI in blue and the CEI or Coincident Economic Index in red. The LEI was rising by November 2001, which was determined to be the end of the dot-com recession. By 2003, it was in a clear uptrend, line a.
In the middle of 2004, the LEI moved above the CEI (point 1), which I saw as a sign of strength. The LEI peaked in 2006 and then formed lower highs in 2007, line b, as the S&P 500 and Dow Industrials were peaking. It was then diverging from the CEI.
The LEI plunged in late 2007 and early 2008 as the uptrend, line a, was broken. In the spring of 2009, both the LEI and CEI had started to improve. By later in the year, both were in clear uptrends. Both lines were rising again up into 2013 though the LEI was well below the highs from 2006.
NEXT PAGE: Consumer Confidence and Consumer Sentiment|pagebreak|
The attitude and the seasonal trend of the consumer is also very important to both the economy, as well as the investor. The chart shows that after the 2003 low, the Consumer Confidence turned higher, and by 2005 lows, there was a clear uptrend, line a.
Consumer Confidence flattened out in the latter part of 2006 and in 2007, line b. Then in the fall of 2007, it started to drop sharply and violated its uptrend, line a. The ensuing plunge in confidence was quite dramatic as it did not bottom out until early 2009.
There were signs in early 2010 that the level of confidence was changing as the last peak before the final low, line c, was overcome. Higher highs were made again in 2011 and the data showed a clear uptrend, line d. In May 2012, it rose sharply to 76, breaking out above the resistance at line e.
This long-term chart shows the Consumer Sentiment from the University of Michigan, along with the Conference Board's Consumer Confidence. I have chosen to draw trend lines only on the Consumer Confidence data (in green), though you can see that the Consumer Sentiment confirmed the changes in trend.
The uptrend from the 1983 lows, line a, was broken in early 1990 as the recession officially began in July and ended in March of 1991. The Dow Industrials peaked in July and dropped 22.8% in the next five months.
The series of higher lows in the Consumer Confidence in 1992 and 1994 was the start of a powerful uptrend, line b, that was not broken until early 2001. Of course, the Nasdaq Composite peaked in March of 2000, and by the time the Consumer Confidence bottomed in early 2003, it had lost over 75%.
The rally from the 2003 lows was much smaller by comparison and the support at line c was broken in the fall of 2007. Both were clearly positive in 2013 but a reading below 60 would have been a reason for concern.
There are quite a few data series that can give you a good reading on the home construction sector and one of my favorites is the NAHB/Wells Fargo Housing Market Index, which is plotted below with the single family housing starts.
The HMI is a monthly survey of NAHB members, which asks them to rate their prospects for single family homes at the present and for the next six months. The HMI peaked in late 1999 and then formed lower highs in 2006, even though the housing starts were continuing to make new highs. This was a significant divergence as it helped create an overly large inventory that made it more difficult for the housing market to recover.
The HMI turned down in early 2006, and then in late 2006, it broke the long-term support (line c) that connected the 1991 and 2003 lows. A few of months later, the additional support, line b, was also broken This confirmed the very negative outlook of the home builders.
The HMI formed higher lows in 2009 and early 2012 (line e). The bottom was confirmed in May as the resistance at line d was overcome. This was noted in a Week Ahead column at the time.
The first hint of a bottom in the home construction stocks occurred on October 18, 2011, when volume surged in the home construction stocks.
NEXT PAGE: DJ Home Construction Index|pagebreak|
From October 2011 lows into June of 2013, the DJ Home Construction Index (DJUSHB) was up over 124% versus just over a 30% gain in the Spyder Trust (SPY). The Index was up 164% on May 15, 2013 but then dropped 40% in less than a month.
On the right, you will see the long-term monthly chart of the DJUSHB and the H&S top that it formed in 2004-2007. The neckline (line a) at 548 was broken at the end of June 2007 and the eventual low in late 2008 was 130.
The Home Construction Index made a low in late October of 2011 at 164.93 and rose for the next two months, closing above its 20-month EMA by the end of the year. At the end of May 2012, the 2010 swing high was overcome on a closing basis. This completed the bottom formation and coincided nicely with bullish signal from the HMI the following month.
The rally in June 2013 took it just above the major 38.2% Fibonacci retracement resistance from the 2005 high. The 50% level was at 624.38. There was initial support at 442 with the rising 20-month EMA at 410.
The weekly chart of the DJ Home Construction Index overcame its 18-month downtrend, line a, in early December of 2011. The relative performance moved through its downtrend (line b) a few weeks earlier as indicated by line 1.
The uptrend that connects the 2011 and early 2012 lows, line c, was tested several times over May-June 2012. The weekly RS line confirmed the January 2013 highs but then broke its uptrend, line d, in April. This is often an early warning sign.
The RS line made much lower highs, line e, in May, which was a sign that home construction stocks were no longer leading the S&P 500 higher. The RS line was then back below its WMA and a drop below the April low would have been consistent with further weakness in the Index.
In terms of price, the DJUSHB had next support in the 440-446 area.
NEXT PAGE: Two Hot Home Construction Stocks|pagebreak|
Let's now take a look at two housing stocks. I have chosen two that made higher highs in early 2013 as several, like Toll Brothers (TOL) and Lennar Corp. (LEN), did not make significant new highs that year.
DR Horton Inc. (DHI) was a $7.39 billion home construction company as of June 2013. From an October 2011 low of $8.03, it made a high on May 15 at $27.75. This was a rise of 245% from its low. In 2013, the weekly starc+ band was tested several times since early 2012, and each time, it was followed by a pullback.
The starc- band was next tested as DHI was below the quarterly pivot at $23.20. The 38.2% retracement support was at $20.22 with the 50% support at $17.88. In a major correction, I would typically expect a further correction to hold between these two retracement levels.
The weekly on-balance volume (OBV) did confirm those highs and then tested its uptrend, line c. There was even more important support at the December lows. There was resistance for DHI at $24.40-$25.70.
The daily RS and OBV analysis turned negative one day after the highs as both dropped below their WMA. They were still negative and well below their declining WMAs in June of 2013.
At the same time, PulteGroup Inc. (PHM) was a $7.82 billion dollar home construction company that bottomed in October 2011 at $3.29. As it was testing the weekly starc+ band in May of that year, it hit a high of $24.47. That was an increase of 643%.
The uptrend, line d, and the weekly starc- band were next in the $18.50-$18.90 area, which was 8.5% below June 2013 levels. The quarterly pivot at $20.01 was also tested. The major 38.2% support was next at $16.32, which also corresponded to good chart support from late 2012.
The relative performance formed marginally lower highs in May than in January, line e. The RS line was also holding well above its April low and the uptrend, line f of 2013. The weekly OBV did confirm those highs, line g, though it could have closed the next week below the support at line h.
The daily studies on PHM (not shown) were still negative, and it would have taken a week or more before they could turn positive.
The home construction industry group has a seasonal tendency to peak in April and then form a final bottom in October.
I hope the technical look at the fundamental data will change the way you process fundamental reports. I think it will help you gain a different perspective on the economy from that of most traditional economists for the rest of 2015 and beyond.
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