Friday, January 18, 2008

Charts: The Bad and the Ugly

The entire market endured a painful week; it is difficult to find a price chart which is looking good. This leaves the bad and the ugly to dwell on. One major mega-cap in a down draft is CSCO. The recent chart is an excellent illustration of agony from a technical perspective.

On Thursday, CSCO plunged 3.26% to $24.33 reaching a 52 week low on high volume. The fall greatly exceeded that of the NASDAQ (down 1.99%) and DOW (2.46%). The stock has recently adopted the unfortunate habit of regularly underperforming the broader market on both upside and downside days.

Despite the robust fundamental valuation characteristics offered by Cisco, the technical indicators present a rock-solid bear case. Fundamentals drive the long term prospects of a company; while technical indicators mirror short term price action reflecting the fear & greed in the market.

When viewed from any angle, the chart for CSCO does not spin a good story for the upcoming months. A complete chart for CSCO with many technical indicators is displayed in the figure. At first glance the entire array of information is daunting; however commentary below will break down each of the technical indicators pane-by-pane and explain their significance in context of the price action for Cisco.

There is an old expression that “bears live below the 200 day moving average”, the top pane of the chart shows that the CSCO stock price is under both the 200 day and 50 day moving averages. Even worse the 50 day moving average (black line in top pane) has recently dived below the 200 day (red line) reinforcing the bearish price action (see Screening to Win: Moving Averages for more information). The recent lows were reached on high volume adding emphasis to their significance. A horizontal line drawn across the chart at the $25.25 level will show the stock has broken below the previous support in the March to June timeframe. (Outlook: Bearish – for moving averages, new 52 week lows on high volume, and break below support levels)

The Relative Strength Indicator (RSI) has continued to trend down to lows near the 30 level demonstrating the lack of strength of the stock. The trend is down with no reversal seen which would indicate potential for a new uptrend. (See Screening to Win: RSI for more information). (Outlook: Bearish)

The Moving Average Convergence Divergence (MACD) indicator is below the Center Line (zero level). The black line indicator is below the signal line, these are both bearish indicators. Furthermore both the MACD signal and indicator lines are in a downtrend, never a good sign. (See Screening to Win: MACD for more information). (Outlook: Bearish)

Chaikin Money Flow (CMF) shows that money is effectively flowing out of the stock. While CMF has come off of its lows, it remains at levels below -0.2 demonstrating little conviction for improving pricing. (Outlook: Bearish)

The Rate of Change (ROC) indicator remains below the zero level showing that the short term pricing momentum is negative. The reading near the -10 level underlines the lack in strength in recent pricing. (Outlook: Bearish)

The Stochastic Indicators (STO) exhibits some hope for CSCO stock pricing. Readings below 20 are generally considered oversold. This indicates that the stock price may bounce in the short term after all the recent selling action (See Screening to Win: Fast and Slow Stochastic for more information). However the bounce is not likely to be strong or long-lived unless the other indicators start demonstrating improvement. (Outlook: Neutral)

The Money Flow Index (MFI) is not below the 20 oversold level, eliminating hope for a bounce. MFI is in a downtrend and falling rapidly (See Screening to Win: MFI for more information). This leads to the expectation of more negative price action for the stock as money “flows out”. (Outlook: Bearish)

Williams %R is an oscillator which is presented on a inverted scale. Levels below 80 are generally considered oversold. The level below for a significant period of time increases the probability for a short-term positive bounce in the pricing of CSCO stock (See Screening to Win: Williams %R for more information). However this would have to be correlated with other indicators to show any possibility of a long term trend. (Outlook: Neutral)

The Average Directional Movement indicator (ADX) shows the price trend for CSCO stock is strongly negative. The black ADX line now above 30 shows the strength of the movement and the red –DI line shows that the momentum is very negative. (Outlook: Bearish)

The Aroon Oscillator is normally choppy but shows the trend in price action. The level below -50 with a oscillator continuing to fall to new negative levels is a bearish sign for upcoming price action. (Outlook: Bearish)

In summary, the price chart and technical indicators all present a case that further downside price action will occur over the upcoming weeks. Nearly all the technical indicators can only be considered to reflect a bearish case, and the couple of indicators which evaluated as neutral merely indicate the possibility of a short term price bounce, which is likely to be under $2. Keep in mind that technical indicators are normally only reflective of short term price action in the market. However a large number of bearish indicators build the case that price recovery over the next 90 days is unlikely.

This is further reinforced by running models based on Monte Carlo, standard deviation, options modeling, momentum, mean returns, and other quantitative factors. Many studies utilize quantitative spreadsheets which combine many of these factors to evaluate the price potential of stocks over the upcoming 60 or 90 day timeframe. A recent run on CSCO shows an 18% probability of hitting $20 within the next 90 days and a mere 4% probability of hitting $30 in the same timeframe.

The basic spreadsheet building blocks for quantitative price modeling are available at This website, put together by professor Peter Ponzo, is an excellent resource. Some useful price modeling spreadsheets at the site include:

Price Prediction – Options Modeling

Price Probability - Modeling

LaPlace Transforms – Price Predictions

Predicting Prices – Standard Deviation / Mean Returns

Naturally there are upcoming events that hold the potential to disrupt the current negative price trend. Cisco stock tends to move dramatically around the quarterly conference calls; the next call is coming up February 6th. Many times these calls serve to mark a change in trend. However there are several fundamental factors conspiring against Cisco for 2008. The domestic market sales to financial institutions and other troubled sectors are likely to drop as the economy slows. Many of the good figures relative to international sales in the past year were driven by the weakening dollar. This trend is likely to reverse in 2008; a strengthening dollar will have a negative impact on the reported international revenues for most multi-national firms.

The Cisco story also indicates why it is important pay attention to insider sales. When CSCO stock was over $28 during the past year, there was an obvious increase in executive stock sales based on the regular press announcements. The quarterly reports also appeared to show that the rank & file employees were also executing stock options at an unprecedented rate. Many fundamental analysts view this type of activity as a potential leading indicator for stock price underperformance.

Certainly Cisco has some tremendous valuation attributes which makes the company the envy of the Tech Industry. The admirable cash flow, market strength, reasonable ratios, and other attributes exemplify a company with excellent long term potential. Technical indicators are good for evaluating short-term price action; however the long term price of a company's stock is always driven by the underlying fundamental factors.