A DIY Paradise

My first introduction to Restoration Hardware, RH, was when I received their 17 lb. catalog in the mail last year.  My initial reaction was what a terrible waste of natural resources. Apparently, I was not in the minority and until just recently during one of my daily opportunity scans, I had forgotten all about them.  In spite of the fact they have only been a public company for a bit more than 2 years, their stock has had a very nice run since its IPO as you can see in the weekly chart below.  Notice how price moved in consistent patterns. It moves up strongly, consolidates, breaks out of consolidation and begins the next leg up. Wash, rinse and repeat. Notice how consolidations can either be sideways or downward correcting. This is not unique to RH as all stocks follow the same course. These periods allow the bulls a well-deserved breather and to collect more participants if prices are going to move higher on a break of consolidation.  What should jump out at you in the bottom pane is how well it has performed against the broader SP500 index.

Savvy investors look for company stocks, like RH, who have been in strong uptrends and are consolidating as they present excellent profit opportunities if (this is the operative word) the uptrend continues.  In essence they are patient waiting for the right time but some sort of confirmation that the breakout is real.  Switching to the daily chart there are some very positive things in place.

1.      The moving averages are bullishly aligned and pointing up

2.      The longer term RSI is still in the bullish zone while the short term RSI shows positive divergence.

3.      The current consolidation has the look of a bull flag and is close to breaking above the blue upper channel.

4.      As price has corrected, it has bounced off the red horizontal support/resistance line which lets us know that price is hot and to be respected.  A breach below that level would be a bearish signal. As long as we stay above, its bullish.

5.      Price fell just far enough to close the open gap on the last move up.

6.       It looks as if the MACD is turning back up and will soon move above both the zero and its signal line.

The only piece that is missing and would be the icing on this RH investment cake would be to see a spike in volume on a breakout. 

With an upside breakout target of around 106 and a very clear exit strategy of a break below the red horizontal support line, RH presents a very nice risk/reward that is more than 3:1.  

It’s important to remember none of what I post in this blog should be taken as a recommendation. This blog and all posts are intended to be educational in nature only.

A New Addition

A lot of the ideas I post on my blogs are just that, ideas. I am not trying to sell anything and definitely not making recommendations to buy but rather just trying to educate and make those that read my blog, better investors. These “ideas” don’t always translate to investments that I would add to my client’s portfolios. Mine? Yes! My clients? No.  The reason is my tolerance for risk is different than theirs. That is why everything I post is informational only and should not be treated as a recommendation. 

I scan and screen hundreds of charts a week and before I put any of my client’s hard earned money to work I insure the following

1.      The chart has a compelling technical reason to buy

2.      The risk-reward is at least 3x

3.      The investment has a good long-term outlook (not a day trade)

4.      It has better performance prospects than something already owned (if not, why buy). I want to see an upward sloping ratio chart.

One that hit my radar many weeks ago that I have been patiently stalking that met all the above criteria was Amgen (AMGN). Amgen is a very well-run company in an industry (biotech/healthcare/pharma) that has excellent future prospects. From a technical aspect and looking at the chart below, there is positive divergence on both time period RSI momentum oscillators.  The MACD just crossed its zero line and is moving higher.  Price has been consolidating since early December and just broke out of the bull flag pattern it formed. The upside target for this moves is projected to be about 20-25% (of course the overall market has to cooperate as any sell-off may hamper this move). What gives this more credence is the moving averages are pinching which foretells of a catalyst of a big move coming (they don’t provide direction, just the setup for a big move). Finally, the performance of Amgen vs the SP500 (ratio chart in the bottom pane) has been excellent over the past 12 months (15% better performance) and is still moving higher.

With all the boxes checked, it was all I needed to add Amgen.  All you model portfolio investors, welcome the new addition. 

The Hardest Lesson

After more than 15 years and thousands of investment decisions I can comfortably say “they” are right.  The “they” I am referring to are the Market Wizards, those interviewed in the book with the same name by Jack Schwager. Reading the interviews of the best money managers in the world and that which makes them successful, without question, the two most important elements of successful investing are 1) managing your emotions/biases and 2) managing your positions.

In this week’s post I’d like to take a real life example of a position management decision that affects virtually all my clients at this point in time.  My TLT breakout buy call back in April of last year has handsomely rewarded those who jumped on board.  As you can see in the chart below it is up more than 25% since then.  In the first quarter of last year if I told you bonds would outperform stocks (not only would they outperform but beat by more than 2x) who would have believed me? Even I had my doubts and did not project this big of a run. But that is exactly what happened. I can remember the calls from clients who wanted to insure I hadn’t fully lost it as I added it into their accounts. “What are you doing?” they said. “Interest rates have only go one way to go … and that is up”. “When interest rates rise, the US Treasury long bond will get killed”. “Are you nuts?” Apparently I am but one thing I know is that not only did that bottoming pattern let me know we were likely headed much higher but I also know that when the crowd is on one side of the boat (interest rates can only go higher side) the market teaches the crowd a lesson.  It’s a painful lesson I learned long ago that being a contrarian can lead to outsized gains in many cases for those brave enough to try.

Now from a position management standpoint and the fact that we have come this far I would prefer not to give back the gains so taking profits has been on my mind. But so has letting the position run because a successful trend following methodology has two components 1) cutting your losers early and 2) letting your winners run.  Hmmm, appears we are at a crossroad. What to do, what to do?

Looking at a longer timeframe chart usually helps clear it up for me. In the 20-year look back period for the US long bond chart below, you can see its price has stayed nicely within the channel defined by the blue trend lines.  You should also notice we are approaching the upper trend line, where in the past, the bond has reversed course as it has acted as a ceiling. Ok, so that means it’s time to sell. You can also see in the upper RSI pane, price is more overbought than it has been in the history of this chart. While some may consider this a negative and giving more credence to the sell side, it can be viewed as a reflection of the strength of this recent move and hints it could go higher still since there is no divergence with price. Ok, so that means we should hold the position and let it run.

Well, that didn’t help.  What would one of the best baseball minds, Yogi Berra do?  In these situations he was very, very clear as he said “when you come to a fork in the road, you take it!” Ok, so much for help from Yogi, I still need an answer. Rather than ruin the message of “the hardest lesson” by telling you my plans, learning is best done by doing so I am going to toss this back over the transom and ask what you would do.

Are you a lock in profits and be happy with what you got kind of soul or would you rather let it run since making your investment account larger is something everyone wants individual?

Let me know your thoughts.

Double You - Or is the 3rd time a charm?

Over the past 4 months precious metals mining stocks have carved out a nice W bottom which foretold the story of higher prices ahead.  With a 30% bounce already in the books many are wondering if this is “THE” bottom and it’s time to jump back on the bandwagon.  Looking at the daily GDX chart below you can see it is constructive in that the RSI is bullishly aligned with more room to the upside before it gets into overbought range and the MACD is above its signal line and trending higher. We are sitting right on an important (blue) line that is currently acting as support. If price can stay above this line and move above the 200DMA, the $27.5 price is the likely target for an exhaustion of this current move as it has acted as strong resistance in the past rejecting all pushes higher.

What about the bigger picture?  Is this THE bottom so that we can just buy and hold for months or even years? or should this bounce be considered just a trade opportunity?  To answer those questions I turn to the longer period time period charts for some hints. You can see in the chart below after a one year consolidation in 2011 the miners have just been decimated losing almost 75% of their value from peak to trough. Along the way price has attempted to bottom 3 times (including the current try). The first was a W bottom in the middle of 2012 where price struggled to get back into the consolidation zone and subsequently began its decent in earnest. At the end of 2013 price formed a textbook inverse head and shoulders bottom which, once again, had all the goldbugs calling for a bottom.  Their hopes were dashed once price struggled at the neckline, reversed then continued its waterfall decline.  Looking at today, once again price has formed a very nice bottoming pattern and again bringing the remaining goldbugs (yup, there are a few left) out from under their rocks to proclaim the BOTTOMZ’IN.  It could be, but until price can form a higher high and higher low, the current (down) trend needs to be respected. And, until the ratio of GDX/SP500 reverses course (see bottom pane), there is no real incentive to direct your investing dollars elsewhere.  Therefore it is my opinion any attempt to invest in this bounce should be looked at as a short-term trading opportunity and not a longer term swing.

Do not ignore this chart

A handful of patience is worth more than a bushel of brains.

Because I continue to post bullish setup for stocks, some may think have thrown in the towel and have given up on my watch for a bear market. The fact is that couldn’t be farther from the truth. It’s just that until the weight of the evidence says otherwise, the trend is your friend and you must respect the current trend, which is up. I have learned the hard way picking tops or bottoms is a fool’s game. What is not foolish is having a proven investment process/plan and sticking to it. That said, in no way have I abandoned my vigilant watch to protect my client’s hard earned capital from the ravages of a bear market.  The beat goes on, I have just tried to dampen the bearish overtones.

When looking for clues we are reversing course, one of my default charts I find not only very helpful but historically significant is what I refer to as “risk on/risk off”. It is the ratio of US stocks to US bonds, specifically the SP500 to the 30-year Treasury bond.  While you may be scratching your head wondering why this is worth watching it actually does make sense. In a bear market, money flows out of stocks due to their risk component and into the safety net of bonds, especially US government bonds.  In bull markets, investors are willing to risk their investment capital in stocks due to the chance of making greater returns. So if this ratio is rising, you would expect a bull market in stocks and of course, the opposite when the ratio is falling.

Below is a 20-year look back on “risk on/risk off” in the upper pane of the chart.  The lower pane shows just the price of the SP500 index. Having them stacked on top of each other it allows you to follow how stocks move in comparison to the ratio.  What is hopefully very obvious is how the ratio acted during the prior 2 major market corrections of 2000 and 2008.  During each of those stock market peaks, the ratio high exceeded 14, bearish divergence (ratio was falling while SP500 price was rising) was evident and a nice topping pattern was formed as the ratio rolled over (changed direction from one of rising to falling).  Fast forward to a look at the ratio today you see the EXACT SAME SETUP. The key going forward is if this is truly a market reversal and it picks up steam as it did in the past two occasions, once the horizontal red support line is breached, stock prices could be in for a major beating.  While I want very much to pull the plug in anticipation of this occurring, I am going to find some patience somewhere and insure I get confirmation before jumping the gun. So far this correction has only been 5% and exiting all long equities positions over a 5% correction makes no sense.  Normally a 5% correction would be considered a very normal ebb and flow within the context of price movement.  In fact, I would consider it just noise.

Excuse the brevity of this post but I need to spend some serious time looking for that patience (where o where did I put it?). If this correction picks up steam I will present some other indicators in future posts I use to compile the “weight of the evidence” providing me “the” confirmation signal to step aside. Until then, we need to accept that corrections are a major part all bull markets and respect the fact the current market is bullish.