INVESTMENT EDGE
A February follow through pushed stocks higher. Stocks are overbought and overstretched while sentiment is at an extreme. Add to that the potential (now sitting at 80% probability) the FED raises rates, stocks are facing some headwinds. Sounds like a perfect recipe for a short to intermediate term pullback.
My latest market video can be viewed at the link below
Back at the end of April in 2015 I wrote about the potential topping pattern developing in the price of beef. At the time, the futures Live Cattle Subindex was ~$80 and looked very vulnerable to lower prices. I wrote that if the head and shoulders pattern played out it projected a target price of $63, which would be a healthy 21% drop. As you can see in the chart below, price not only hit the $63 initial target but continued lower down to $54 before it eventually bottomed in Sept of last year while forming positive RSI momentum divergence.
Since that time, price has moved higher and has now formed the exact same reversal (but inverse) pattern that developed at the top. In addition, the 200 day moving average is flattening and given additional time and a continuing uptrend, will curl northward. Interestingly, a break and hold above the (blue horizontal) neckline will be technical confirmation the pattern is in play and the upside target is right back where it was at my original post in 2015, $80.
If the charts are correct you should expect this summer’s BBQs to cost a bit more than last year.
With the stock market stretched and in need of a pullback, I thought it a good time to look back at what oil is doing since it’s been almost 4 months since we last checked in. As I wrote last October, I expected oil to break higher out of the $50 consolidation range which had developed after forming the double divergent low bottom. It took almost 8 weeks, but it finally broke out to the upside at the end of November (and was confirmed with big volume), peaked its head just above $55 in January and then immediately stalled out. It looks like my $77 dollar upside target will have to wait.
Consolidations that occur immediately after breaking out of a consolidation are nothing out of the ordinary. It is a reflection of a market very much in equilibrium. What makes this most recent consolidation of interest is its tight range ($52-$55) and the fact it has lasted 10 weeks. The greater the time period, combined with the small range, pinches the Bollinger bands and warns that whenever it does breakout it will likely be very a powerful move. Unfortunately, it doesn’t tell us which direction it will go or when. I still give the benefit of the doubt the next move will be higher since that is the direction of the trend prior to consolidation.
Digging a little deeper for some additional ammo to confirm the expectation for oil higher oil prices, we see in the seasonality chart below the fact we are just coming into a time which is normally very bullish for oil. Over the past 30 years the period from March through October has seen oil’s price rise an average 15%.
But what about that nagging fundamental data that shows the world is awash in oil and inventories continue to climb? What about the laws of supply and demand that we learned in econ 101?
As written in the Financial Times …
“A mystery is confounding the US oil market: when inventories rise, prices rise, too. That is not the way it is supposed to work. At 518.1m barrels, stocks of crude sitting in commercial tanks are the highest in records dating to the early 1980s. Fundamentals tell us that excess supply should weigh on markets and drive prices lower. But this year a loose pattern has emerged after the US government releases weekly oil data: surprisingly large increases in crude stocks have prompted spurts of buying.”
Are we living in the Matrix?
What’s an investor to do? First and foremost, recognize that price is all that matters and there are always times when fundamentals, logic and common sense don’t matter. As such Its prudent to use them with caution. Times like this typically occur during fundamental shifts or when irrational exuberance has taken control. The risk averse approach is to sit on the sidelines and watch. The bolder and riskier style is to recognize that uncertainty can offer a chance to pile up big profits and consider throwing caution to the wind and jump in. If the second option is your style, whatever you do insure you have an exit strategy determined before entering and follow it to a tee. Because when it ends, and it will eventually, it usually leads to an equally nasty move in the other direction.
Scanning as many charts as I do, quite frequently there are “themes” that arise. One that continues to present itself since the Trump win is that of inflation. Interest rates have risen as are commodity prices and their related stocks. When you speak of inflation its always prudent to check in with Dr. Copper. Why? Because it is reputed to have a Ph.D. in economics because of its ability to predict turning points in the global economy. Because of copper's widespread applications in most sectors of the economy - from homes and factories, to electronics and power generation and transmission - demand for copper is often viewed as a reliable leading indicator of economic health. This demand is reflected in the market price of copper. Generally, rising copper prices suggest strong copper demand and hence a growing global economy,
As you can see in the 5-year chart of the price of copper below, price bottomed at the beginning of 2015 and formed a divergent momentum low which warned the extensive multi-year downtrend may be coming to an end. As typically occurs after a bottom, price chopped around for more than a year, trading within a tight 35 cent range and formed a symmetrical triangle. The week before the election it broke out to the upside on slightly higher than average volume. With triangles you always have to be concerned whether the breakout will turn out to be a fake out since they are so unreliable. The answer to that question came the following week (and Trump was elected) as it had its greatest weekly rise over the past 5 years on enormous volume.
Since that breakout and while the bulls caught their breath, price consolidated, successfully back-tested its (red) support/resistance line and appears to have broken out last week.
The chart is staying the short to intermediate term copper prices are likely higher and has the room to move potentially significantly higher if the trend continues. Those not having futures accounts have limited investments to capitalize on this potential move. There is one ETN (JJC) that attempts to mirror its price but it is fairly illiquid and as with all ETNs has inherent contango issues. A better bet would be to look at the copper miners/producers as they typically do as well as, if not better than, the ETN in tracking its price. Keep in mind though, while prices do move in directional lockstep, they are a leveraged play and move significantly greater (both up and down) on a percentage basis than the base metals price.
I haven’t spent much time talking about retests in the past but because the dollar is in the process of one, I thought this would be a good time to do some teachin’ to ya’all. Quite often, after a long consolidation and breakout, an investment will struggle after the breakout and then fall back to retest the original breakout level. The reasons for this are numerous and I will leave them to another post but for now the key is recognition and the understanding this is a normal occurrence and provides an objective entry for those not already invested.
Using the US Dollar chart below you can see the dollar consolidated between the lower and upper blue (support and resistance) lines for almost 2 years before it broke out higher and peaked the first week of this year. Since that time it has fallen back to the original upper blue line which has flipped from resistance to now becoming support.
If you are a new reader you may be wondering why I spend so much time on watching the dollar. As investors we are very interested in what the dollar does because it can have a dramatic effect on other assets including bonds, stocks, commodities, energy, etc. Most global commodities are priced in dollars. Because the dollar is now sitting on support combined with the fact it is still in a long term uptrend, we must give the benefit of doubt that this will resolve to the upside. But we also know there are no guarantees so you need to have a plan in case this thesis is wrong.
If the dollar were to break down below support and move substantially back into the prior consolidation area, I would view this as a very bearish signal and the potential signal the uptrend is over (and my prior blog post declaration of our next stop for the dollar of 108 being wrong). There is a saying in TA that states “from false breaks come big moves” and means that when an investment breaks out of consolidation, does not hold and falls back, it usually leads to big moves in the other direction. While the odds are not in stacked in the favor of that happening, if it does, the ramification for investors could be huge.
