Diamonds Aren’t an Investors Best Friend

Diamonds are a relatively rare pattern so I wanted to take a look at one that has recently developed on XLE. The diamond pattern is made up from two back-to-back symmetrical triangles and warn of a potential reversal ahead.  Like their triangle makeup, they are often subject to reversals after a breakout so their management can be challenging.  As you can see in the energy sector ETF, XLE, its price followed the path of lower oil prices, losing 30% from its peak in May of last year creating a double bottom. From there you can see price climbed higher and then began to consolidate which has allowed it the time to develop the diamond.

Price broke decisively lower Wednesday and confirmed the move with larger than normal volume. The follow through on Thursday provided additional needed to tell us this is likely not a whipsaw/fake-out and to expect lower prices ahead. The pattern target is back down at the prior double bottom lows around 59 1/2.  I would expect short sellers to jump on board and add more strength to the downside so I would not be surprised by an overshoot of the target.

There should be no surprise to expect lower prices as not only are we below the (red) 200 day moving average but it has a negative slope which is a huge red warning flag any long investor is fighting the trend.

Remember safety first. Don’t fight the Fed. Don’t fight the trend and don’t eat week old sushi!

Apple - Is it Déjà Vu All Over Again?

As one who took a hankering to chart patterns during the early years of my TA training, I have come learn the value and advantage they provide to those that know how to use them. While they can give insight to possible future moves, their unique advantage is providing risk management rules, the key to long term successful investment management.

Below is the 5-year weekly chart of Apple (AAPL). You can see at the start of 2012 it created, over the next 10 months, a head and shoulders (in blue) topping pattern. Notice how the right should could not rise above the 200 day moving average (dma) which acted as strong resistance. Also, how the moving average began to flatten out at the top of the shoulder and then point down as price broke through the neckline. The dramatic increase in selling pressure (bottom pane) pushed prices down exactly to the pattern target, just under 53 an almost 45% loss from peak to trough.

Moving forward to today at the top right corner of the chart, the similarities between now and 2012 are very evident. Price has created a (red) head and shoulder pattern and finding resistance once again, just under the 200dma. And just like in 2012, the moving average has flattened out and is beginning to point down. If the pattern completes, the loss would be slightly less but still a very significant 40% decline. Based upon prior history, we know this is potentially not a good combination and this set up should be raising a warning flag.

It seems like the shrewd investor who recognized this pattern and past history might be thinking they should get ahead of the curve and sell their position right here. Unfortunately, doing so would be incorrectly applying the rules of pattern development. Granted, if the price does break down and head lower, selling now would garner the investor a greater return (by losing less). But the pattern is not complete and until price confirms a break below the neckline only then is should action be taken as the pattern is then considered complete and actionable. For now, if I were invested (and I am not) I would only this on a watch list due to its bearish potential. There is no one right set of risk management rules and every investor should be creating and following ones that fit their investment style and strategy.

What a Strange World We Live In

Imagine a bank that pays negative interest. Yup, that means depositors are actually charged to keep money in their accounts. I was always taught the borrower was supposed to pay interest, not the lender. As crazy as it sounds, many European central banks have cut key interest rates below zero. For some, it’s a bid to reinvigorate an economy with other options being exhausted. Others want to push foreigners to move their money somewhere else. Either way it’s an unconventional, unproven choice that distorts the financial markets and could have deleterious economic effects if it backfires. In order to keep this post brief I will limit my discussion on the “why’s” but if you want to learn more there is a good article in “The Economist” here

In a world of beggar thy neighbor and a race to see who can devalue their currency the fastest in an attempt to invigorate growth, the US dollar is king. For now, there is little reason to see it abdicating its throne any time in the near future. As such, it continues to play a prominent role in our investment strategy.  How about yours?

You End Up with More by Losing Less

Below is a 20-year chart of the Europe 600 stock index. In the top pane is RSI momentum indicator and in the bottom pane is the index price. Notice how the 400 level in the middle pane has so far acted as a market top three times. In 2000 and 2008 when price hit this level, it rolled over and began a waterfall decline, eventually losing almost 60% each time. Despite the good news that we are still above the blue uptrend line, even to the untrained eye this chart should raise concern. Is the top in for European stocks and will history repeat or will this time be different?  Armed with just this information, what do you think comes next?

Interestingly, European stocks are following an eerily similar path the US stock markets did, but offset by about 2 ½ years. The chart below is a look at the US stock market via the SP500 index from 1996 through April 2013.  Notice any similarities?

In case you did not know how it all resolves, my next chart completes the entire historical perspective for the SP500 through last Friday’s close. We blew right through the upper resistance and sit some 30%+ higher today.

If you add this information into the mix would you change your opinion to the question I asked above? I think a strong case for either a bullish or bearish outcome can be made for European stocks right here. This "crossroad" is no different than what investors face every day. So, what’s an investor to do? Investment markets can and will do anything and the most probable outcome will be that which frustrates and loses money for the majority. Having a predetermined bias of what will happen can have a negative impact on your investment account. The markets don't care what we think or believe. Through the school of Hard Knocks, I have learned the most successful approach to the markets is to have a process that invests with the prevailing trend but is flexible enough to recognize when it is wrong. Being wrong is normal and expected as we are human. Staying wrong is not when it comes to your money. Over the long term, you end up with more by losing less.

China Bears

I think the most interesting part of market analysis is human behavior because so much of what happens in the markets can be explained by human emotions. One of the more fun elements (fun is relative here considering I am talking about investing) is the “Magazine Cover Indicator created by Legg Mason strategist Paul McRae Montgomery.  What he found was when it came to the markets, magazine covers turned out to be a contrarian indicator. The logic behind it goes like this: By the time a particular investment trend reaches the cover page of a major publication, it is so widely embraced by the public that “everyone is in” – i.e., there is no one left to perpetuate the trend. Therefore, the trend is close to reversing… often with a vengeance.

Based upon a story reported by Freemarketcafe.com (now nondollarreport.com), Bloomberg Businessweek holds title to the most infamous cover story ever. In August of 1979, the cover of Businessweek proclaimed “The Death of Equities.” As it turned out, equities were far from dead. In fact, they were on the verge of a major rebirth. Stocks bottomed early in 1980, before taking off on the biggest bull market in history. Just three years after this cover story appeared, the S&P 500 index had doubled. And three years after that, the S&P 500 had tripled.

But in the dark days of the late 1970s building up to the infamous Businessweek cover, the stock market had gone nowhere for more than a decade, most investors believed that stocks were a dud.

“The masses long ago switched from stocks to investments having higher yields and more protection from inflation,” the Businessweek article observed. “Now the pension funds – the market’s last hope – have won permission to quit stocks and bonds for real estate, futures, gold, and even diamonds. The death of equities looks like an almost permanent condition – reversible someday, but not soon.”

Twenty-three years after the “Death of Equities” cover story, Businessweek cemented its “indicator” credentials for all time by running a cover story titled “The Angry Market.” During the two years that preceded this story, the stock market had been very angry indeed. An epic bear market had erased nearly half the S&P 500′s value. But during the two years that followed this story, the S&P soared more than 40%. Three years later, it was up 60%, and five years later, it was up 100%. In fact, the S&P hit the exact low of its 2000-2002 bear market on the day “The Angry Market” cover story hit the newsstands!

Businessweek does not corner the market in being a timing expert. In September 1977, Time Magazine’s cover story warned, “Sky-High Housing.” And while it’s true that American home prices had doubled over the preceding decade, home prices would double again over the following decade… and would quintuple by 2005!

Then, in June of 2005, just as this once-in-a-lifetime housing boom was ending, Time hit the newsstands with a cover story titled “Home Sweet Home: Why we’re going gaga over real estate.”

“Ah, the blistering real estate market,” its story gushed, “where dreams of big bucks come wrapped in aluminum siding… Your house is now your piggy bank, ATM and 401(k)… Folks brag about having bought their home in the ’90s the way they used to brag about having bought Microsoft in the ’80s. Even if you’re not contemplating buying or selling anytime soon, the amazing lift in home values is changing the way we think about the roofs over our heads. Real estate isn’t so much about nesting today as it is about nest feathering.”

But at that very moment, the spectacular American housing boom was already on its way toward an equally spectacular bust. Condominium prices topped out in the identical month this Time cover story appeared – June 2005. Single-family home prices topped out shortly thereafter.

“Homebuilding stocks went a bit higher during the month or so subsequent to that cover story,” Paul MacRae Montgomery relates. “[But] from that point, they crashed 78%-90%… Housing prices [fell] a more modest 28%… But this drop was still enough to constitute the worst drop ever in home prices – worse than in the Great Depression.”

Not content to be dead wrong twice about the housing market, Time went back to the well one more time. On the cover of its September 6, 2010, issue, the magazine declared, “Rethinking Homeownership: Why owning a home may no longer make economic sense.”

“Homeownership has let us down,” the cover story lamented. “For generations, Americans believed that owning a home was an axiomatic good… A house with a front lawn and a picket fence wasn’t just a nice place to live or a risk-free investment; it was a way to transform a nation… [But] The dark side of homeownership is now all too apparent: foreclosures and walkaways, neighborhoods plagued by abandoned properties and plummeting home values… If there ever were a time to start weaning America off the idea that homeownership cures all our ills, now… would be it.”

There are dozens of examples, the above are but just a few. With that as a background I would like to show the August 31, 2015 cover from Bloomberg Businessweek regarding the headline story “The China Bears”.

Below is a chart of ASHR, the American ETF that tracks the Chinese stock market. So far it looks like we can say Businessweek, once again, nailed it.

Whether that week continues to mark the bottom, only our future will know, but in the meantime some things never change.