Sideways, Up or Down?

When the US stock market is in consolidation and the trend is in question, I like to pay particularly close attention to the message small cap stocks, IWM, are sending. The main reason is because small caps tend to lead the overall market and can provide an early warning both in/out of consolidation and at beginning a new trend. As you can see in the chart of IWM below (bottom pane of ratio of sp500 index to small cap stock index), the small cap index started to decline first at September’s stock market peak and rallied greater than the broad market from December’s low.

The market loves symmetry and as you can see in the middle pane of IWM price movement, the rally from December’s low, the index stopped rising at the same point it failed in the past (look left). At that point, small caps have not only lagged the overall market but started to consolidate (red shaded area) in an attempt to digest December 24 oversold rally’s gains. Notice also, how the falling 200-day moving average acted as resistance as the index failed in its two most recent attempts to move above it. This is normal behavior of stocks in a downtrend. Because of symmetry, I would expect the index to chop around in the consolidation zone for at least a week or more before we know which way we are ultimately headed.

Bulls want to see the consolidation zone hold and the small cap index rally back above the blue horizontal, preferably on larger volume. This would allow the 200 day-moving average to catch up and turn higher. A break higher the first upper target is back at last August’s highs. Beyond that, a much higher target, based upon the inverse head and shoulders pattern, is some 40 points above where we closed yesterday. Bears want just the opposite … a flush down to the bottom of consolidation, followed by a rug pull on greater volume. That downside target would be a retest of last December’s low.

Either way and whichever way it resolves, the overall US stock market will likely soon follow suit.

Inversion Update

In June of last year, I wrote about how the US treasury yield curve was getting close to inverting and how that has historically been an accurate predictor of future recessions. Why it matters to investors is because a recession usually brings falling stock, commodity and asset prices (not all, but most risk assets), something we would prefer to avoid (as much as possible of). Obviously any prewarning we could get would be a bonus and allow to prepare for a high probability slide in risk asset prices. As history has shown, a yield curve inversion tends to precede recessions, unfortunately it doesn’t happen immediately nor consistently, varying from a period from 6 months to two years after the curve flips negative that the recession hits. At the same time yields invert, the stock market tends to continue its climb higher from the day of the inversion until it eventually hits its cycle peak. The timing of that stock market peak varies widely. All we know is stocks eventually peak and then fall. So, in summary, investors will get an early warning of a recession but won’t actually fall into a recession (if at all) until some point in the future which we, of course don’t know when it will occur. Add to that fact we won’t find out we are in a recession until after the fact and even if we do, the stock market won’t care …. until it does. Do I have that right? Ok, so much for the part about being prepared.

The reason I am resurrecting this topic is because, for a brief instance during last Friday’s session, the yield curve flipped negative. The good news, it closed 3 cents above the inversion level, the bad news, in my opinion, it is just delaying the inevitable. All facetiousness aside, investors would be wise to keep a close eye on the yield curve going forward. An actual inverted close and hold would be a time that investors should consider lightening up on risk asset exposure (that is unless the potential for a large drawdown is acceptable and you have time to make it back) and/or make sure you have an exit plan.

The good news is historically there has been ample time to make preparations if investors wanted to do so once the curve inverts. The bad news is, no one rings a bell and sometimes you take an early exit. I need to reiterate as of now we do NOT have an inverted yield curve so I may be nothing more than the boy crying wolf. But when you add this potential to the fact we are into the longest expansion without a recession ever in history, feel free to ignore the warning signs at your own risk.

Pocket Pivots

Pocket Pivots

The pocket pivot concept is, in essence, a favorable early-entry buy point in a stock. Buying pocket pivots are advantageous because the signal attempts to get investors into stock early and often times before it has broken out of consolidation. Stocks alternate between trending and consolidation and an area of consolidation provides an investor an excellent time to enter a stock early in preparation for the next move higher. It also allows investors to add to existing positions in a winning stock, if they so choose, as trending stocks often have multiple pocket pivot points as they move higher.

The basic premise of the Pocket Pivot:

• Institutional buying creates new-high base breakouts, but we also know that institutional buying occurs within consolidations and during uptrends. 

• This buying within consolidations and uptrends in most cases leaves price/volume "footprints".  These footprints are big volume spikes, typically 50% or higher than the normal average daily volume.

• The pocket pivot describes that "footprint," and provides a clear, buyable "pivot point," or "pocket pivot buy point."

• Pocket pivots also provide a tool for buying leading stocks as they progress higher within uptrends, extended from a prior base or price consolidation.

Prices of stocks cannot trend (higher or lower) unless there is institutional activity. The average investor does not have a pile of capital large enough to move the markets, only institutions do. As such, it can be profitable mirroring their movement, which is visible via big volume. No different than tracking elephants. Just look for the big footprints and big piles of ….

Pocket pivots can occur at any time but not all are a buy signal. To increase the probabilities of a profitable outcome, I have found that buying only during (or a breakout of) consolidations provide the highest winning probability.

A good example of pocket pivots can be seen in the AMD chart below. Those that I have annotated were the only ones that met my criteria. Notice that today, AMD registered a pocket pivot buy signal yesterday (note the big volume and break out of the area of consolidation), moving higher by more than 11% on the day.  152M shares traded vs the 10day average of 49M which is a confirmation of accumulation by institutional investors. The good news for is that our core+ accounts purchased AMD earlier in the year during the first pivot breakout. Its been a frustrating few months during this sideways consolidation but our patience has been rewarded. Upside targets are above at T1, T2.

As always when it comes to investing in anything, YMMV.

Curious Minds Want to Know

There should be no question as to why people need to invest. The cost of everything you need continues to rise and your savings need to keep pace. In the chart of US Price and wage changes below, I wonder if the #2 biggest riser, college tuition, includes the cost of paying bribes, proctor assistance, photoshop training and crew lessons? If not, can you imagine how much further ahead of hospital services it will be in the next update?

Curious minds want to know.

20 Rules for Markets and Investing

Whether working with longer-term investors or traders honing their skills, one of the most important things is to insure they have a set of rules. The good news is the rules below are appropriate regardless of your timeframe, strategy or approach. I have to give thanks to Pension Partners director of research, Charlie Bilello, for putting the original list together. I keep it taped to my monitor as it is invaluable in helping to keep the focus. Please note they are in no specific order and level of importance will vary depending upon the individual reader/investor.

1)     1)     Ego is your biggest enemy. Humility is your best friend. (Ego is concerned with who is right while humility is concerned with what is right.)

2)     There is no reward without risk. You can’t have one without the other as such if it seems too good to be true, it is.

3)     The longer your holding period, the higher the odds of your success

4)     Every time is different. You haven’t seen this movie before. No one has.

5)     Price targets are pointless. Forecasts are foolish.

6)     Plans > Prophecies.     Evidence > Opinions.

7)     Cycles and Trends exist.  That does not mean they are easy to predict or navigate but they provide an edge for those that know how to use them.

8)     Focus = fastest way to build wealth (when you have it) and the fastest way to destroy it (when you don’t)

9)     The only certainty is uncertainty. Expect the unexpected. Suspend the disbelief

10)  Time is infinitely more valuable than money. No amount of money can buy the past.

11)  Saving is more important than investing. No savings = no investing.

12)  Simplicity beats complexity on average.

13)  Lower fee beats higher fee on average.

14)  Doing nothing (low frequency) beats doing something (high frequency) on average.

15)  Don’t be afraid to say “I don’t know”. Stay within your circle of competence.

16)  Volatility and sentiment are mean-reverting at extremes.

17)  No one rings a bell at the top or the bottom but many ring it in hindsight.

18)  The strategy you can stick with is the best strategy.

19)  Diversification & asset allocation protect us from our inability to predict the future but also from not having a plan.

20)  Controlling your emotions (fear and greed) is the hardest and most important thing.