INVESTMENT EDGE
And will likely continue.
It’s pretty apparent from the major industry group YTD return chart below it has been a tough market for investors as all groups but one are in the red. Without a major catalyst to the upside, I remain market neutral expecting the market sometime later this year move on and make new lows.
With virtually every stock market around the globe either already broken down or sitting precariously on a ledge of support there are times when it makes sense to press down on the gas pedal of risk but this is not one. Scouring hundreds of charts this week I could find little on the long side (plenty of shorts though) that interest me except for a scant few, one being Johnson and Johnson (JNJ).
It’s likely everyone has heard of JNJ and have used one of their products in their lifetime (Tylenol, Listerine, Bandaid, Visine and Baby Shampoo to name a few). An American bellwether, they continually rank as one of America’s most trusted and admired companies from their first product release in 1886.
Unlike most stocks, instead of faltering and creating a lower high after last September’s correction, its price has powered higher and is sitting just a few pennies under its all-time high. In addition to constructive price movement it has formed a cup and handle pattern, the (red) 200 day moving average is positive and RSI momentum (in upper pane) is above the mid line and rising. These are all signs of bullish strength. In a positive investment environment I would be a buyer on a confirmed break above the red horizontal resistance line. I am convinced though if the broader markets were to continue to exhibit weakness and go on to establish lower lows, JNJ would be drug down alongside.
I could be wrong and JNJ powers higher while the broad market chops around trying to find a trend or declines. A nimble trend following trader should find this setup potentially very attractive. But if your main goal is to preserve wealth, I have learned in conflicting situations like these, the odds favor those who sit on their hands and demonstrate patience. Sure, sitting on your hands may have you forego potential profits. But when the broad market decides it’s time to turn higher there will be plenty of opportunities and you will have a rising market as a tailwind rather than a falling one in your face.
Market sentiment in all its various flavors, while not used by many, can be a very powerful tool providing investors an edge. Retail investors have the odds stacked against them as the professionals and computer algorithms are lurking looking for pockets to pick so tools (like sentiment) can help to level the playing field. Like most indicators they are not always right and as such should be used in conjunction with other tools to confirm price. As a standalone tool I have found the more extreme the reading on sentiment the higher the probability it will follow a contrarian path. An example is when a sentiment survey show most investors are bullish, the high probability next move will likely be in the other direction. Similar to when everyone is on one side of a boat the safest place to be is on the other.
The chart below from Sentimentrader (which provides some of the best, unbiased sentiment research available) caught my attention and I thought it worthy of reposting. I had not seen their “smart money” measurement before but find it very compelling because it is based upon price movement not the normal secondary effect of other indicators such as momentum.
The data in the chart is pretty self explanatory as it shows the movement of “smart money” and how it has related to tops (and bottoms) in the stock market. Clearly the most recent movement should have the bulls taking pause. This is one more indicator that supports our belief the longer term trend is likely lower, in spite of any strong short-intermediate counter-trend rallies that may occur. For now it appears as if the smart money has shifted to the other side of the boat.
I wanted to take another look at mining stocks as something very interesting happened last week that has me potentially very intrigued. The chart below shows a long term chart of GDX, the larger mining stocks from its 2011 top. You should notice as it began its decent from its 1-year consolidation, the red 200 day moving average flattened and eventually curled down. Over the entire 5 year decline GDX has stayed below its blue dashed downtrend line and formed 4 separate attempts to bottom. The 4th and (so far) final began mid last year.
In strong downtrends violent, counter trend bounces happen drawing in bullish investors hoping they have found “the” bottom and a path to riches. Unfortunately, the bears have never relinquished control and each time the bulls have been sent packing, their tails between their legs and their accounts smaller than when they started. But we know eventually one of these bounces will find “the” bottom, a trend reversal will occur and a new bull market will begin. But when and how will you know? The simple answer is there is nothing that guarantees a bottom is in but there are some things I would need to see, the more that occur at the same time to feel confident putting client’s investment capital to work.
1. Weekly positive divergence – momentum (either RSI or MACD, or both) is moving higher while price continues to fall
2. Has been recently oversold (RSI < 30)
3. A bottoming pattern is in its late stages or has completed.
4. Price breaks a long term downtrend line to the upside
5. Volume is confirming (rising) the final stages of the pattern
6. The 200 day moving average has flattened and begun to point north.
7. At least one higher high and one higher low has been made.
With that in mind lets take a look and see where we stand
1. Weekly positive divergence – Check
2. Has been recently oversold – Check
3. A bottom pattern is in its late stages or completed – Check
4. Price breaks a long term downtrend line to the upside – Check
5. Volume is confirming (rising) during the final stages of the pattern – Check
6. The 200 day moving average has flattened and begun to point north – Not Yet
7. At least one higher high and one higher low has been made – Not Yet
As of this post, 2 of the 7 items have not yet checked their boxes so while not a slam dunk there are some very positive signs this downtrend could have already ended. It is absolutely not necessary to have all items checked for a bottom to form, it’s just the more that have, the greater your confidence. Would you prefer to have 2- 10’s in a poker hand or 4 - queens?
Looking at the daily chart we see we are currently short term overbought and in need of a rest (pullback) to let this condition unwind. If this were this to occur and price stayed above the blue support/resistance rail just below (as I have illustrated with red arrows), it would put the icing on the cake as it will complete the two unchecked boxes from my list above. A pull back would form a higher low (box #7) and give the 200 day moving average a few more days/weeks to finish its current reversal process (box #6).
The last two weeks for precious metals and the miners has been extremely constructive and promising for long term bulls. While they are not out of the woods yet, I am willing to be a buyer on any pullback that stays above the 16.80 level at which time I would more confidently say the Bottomz In. If that level fails to hold, I see no reason to be long.
I couldn’t close this post out without mentioning a couple of extremely valuable lessons here that investors should take note and burn into memory. On Jan 27, I last posted on GDX mentioning the old adage about from failed breakouts come big moves and as it turns out, this is another example as price has risen almost 50% in 3 weeks. There are lots of reasons why this occurs but that is the subject for a separate post. When this occurs it is my opinion investors need to quickly get out the way before they are crushed underneath the stampede moving in the other direction. I saw the breakdown and shorted the miners. Within two days the market told me I was wrong at which point I closed my short and went long. I was wrong but still made money. Sometimes ego’s get in the way of investing and it becomes hard to accept you are wrong. Not for me because I learned a long time ago, you need to leave your ego (and biases) at the door when investing because a big ego and expecting to make money in the markets make for a bad combination.
Back on Jan 10th I posted about the coming potential for a 10% move in bonds, warning of a breakout from a symmetrical triangle pattern. The big question was which way it was going to break, higher or lower. My expectation was higher but was waiting for confirmation on a breakout.
We got the confirmation I was looking for just a few days later as prices broke out to the upside. Here we are just 5 weeks later and the pattern target was been met. For those following along with me, congratulations 10% moves in bond prices don’t happen that often especially in such a short time period.
So now what? The chart below is a 25 year look at 30-year US Treasury bond prices. What should become immediately obvious is the defined (blue) rising channel price has traded within during the entire past quarter century. A very profitable strategy has been to sell at the top of the channel and buy at the bottom. While it does not look like much, a move from one side to the other can be more than a 25% which, in the context of a “safe” bond investment, makes it much more volatile than investors expect.
Normally this would be a slam dunk decision on what to do with my TLT holding especially considering Friday closed with a very bearish weekly shooting star candle. But with the backdrop of central banks around the world lowering interest rates into negative territory, the potential for a sustained move to the upside is possible. Could this be the ultimate flight to safety as foreign investors use Treasury bonds as a safe haven in an attempt to avoid a local currency meltdown? Or, will the top of this channel hold once again as it has over the past 25+ years? I know what I will do, how about you?
