Nesting

When looking for investment opportunities, some of the most interesting setups can only be found when looking across multiple time frames and is why I find it a critical step. If something looks interesting short term but is in a long term downtrend, it is likely that opportunity will only be a winner if managed as a short term trade.  But when something develops in a short term view and is in alignment with the longer term, it not only increases the probability of success but also the expectation of large gains. These are borne out when a short term pattern is nested inside a much larger pattern.  A good example is what is occurring right now with Jazz Pharma, JAZZ.

The daily chart below shows price is ready to breakout above the neckline of this almost 10 month inverse head and shoulders pattern. Notice how price has held above the 200 day moving average, when its support was tested twice in April and May. When combined with the fact that RSI momentum is rising and is within the bullish zone, the weight of the evidence says a break above the blue horizontal neckline provides a compelling upside target in the 191 area above, some 19% higher.  This looks like a great set up.

When looking at the same investment on a weekly time frame something very interesting stands out as you can see below. Nesting. The inverse head and shoulders pattern that I showed above (blue) is actually the right shoulder of the same but much bigger inverse head and shoulders (green) pattern. Notice how the blue (daily time frame) target just so happens to be at the prior 2015 high. This is not unusual. That is where resistance exists. Those that purchased at or near that level in the past and are still holding will provide a huge amount of share supply which will likely either slow or stop a quick move above that level. They are currently underwater and as such, the normal desire to “break even” will induce many to sell, even though now seems like a time to accumulate.

The upside target for the larger (green) pattern has an even more attractive target near 225, doubling the smaller pattern’s return. When nesting occurs like it has here, it sets up the possibility not only for greater returns for the opportunity but also extending its holding period, a benefit for those wanting to be less active. 

Uncharted Territory

Almost every prior stock market crash was caused, or at least exacerbated, by market illiquidity.

As you can see in the chart below, the FED’s recent activity of unwinding their balance sheet by selling a small fraction of their QE accumulated holdings coincided with the most recent 12% stock market consolidation (not the sole reason for the correction mind you).  It is important stock investors understand the correlation between the FED removing liquidity and lower stock prices. When you combine this balance sheet activity with a simultaneous push higher in interest rates we are entering into uncharted territory knowing just how the market will react.  

Regardless, the current consolidation in the SP500 has a clearly defined upper and lower boundary, 2670 & 2530 respectively, making it a much easier task to manage whatever happens.  Above I add exposure, below I decrease.

May 2018 Charts on the Move

The sideways chop continues but for how long? No one knows for sure but i think it will be months before we escape. What about you?

My latest Charts on the Move video which talks about this and a lot more can be viewed here ...

https://youtu.be/ntXq6MnE9rY

Two by Four

I went to my local hardware store over the weekend to pick up some lumber to finish off a task I was doing in the backyard and was caught completely by surprise. Granted it has been a year or two since I last had any need to buy a 2x4 but WOW. Of course, I had to come home, jump on the computer and look at the chart of the of lumber. It’s all so clear now.

 As you can see in the chart below, the spot price of lumber has been in a steady uptrend since its intermediate term bottom in Sept of 2015. Since that time, it has risen almost 170% (~2.5 years) and the most recent touch of the trend line support it has risen parabolically.  We know what happens to parabolic rises (they eventually fall back to earth and typically much faster than they rose), we just don’t know when. 

From the chart, lumber looks as it has more upside. Buyers are in control (as is noticeable in the bottom volume pane) and the strength of its rise (RSI momentum in upper pane) is expanding with no divergence in place. Because lumber can be a good proxy for the strength of the economy, its price can provide an early warning sign for the possibility of a slowdown as such it is garners further scrutiny..

The Trouble with Stocks

It should be no surprise to investors that stocks have been struggling since the short term parabolic rise completed back in late January. The subsequent 12% correction followed by extremely choppy, sideways action is not at all unexpected and is unfortunately far from being complete.  Besides this being “normal” action after a double digit decline and an “easy-peasy” 2017 market, investors should look no further for additional explanation than what is happening in the bond market.

As you can see in the above chart of the 10-year treasury yield, it finally tagged the psychologically important 3% handle yesterday (although it actually closed a whisker below), a full 50 months since its last visit. Round numbers, whether they happen in stock indexes, bond yields or other investments are important as they act as magnets for potential future moves. The fact we hit that level yesterday is not a surprise as the setup unfolded in late January (I blogged about this possibility here). Breaking out of it box and moving higher could be a real impediment for the advancement of stocks. Stock investors need to keep a close eye on the bond market right here because as rates rise, eventually yields become attractive enough that  stock owners throw in the towel shunning the wild volatility involved with owning stocks and instead opting for a more steady, fixed return that bonds have historically provided. As more and more investors switch out of stocks and into bonds, stock prices tend to fall as sellers eventually outnumber buyers.