Eyeing Small Caps

With the recent methodical (and much needed) pullback in the US stock market, I have been amazed at how orderly it has been. There has not been the type of volume patterns or fearful unloading of stocks that normally occur …. Yet.  The couple of days where the indexes were down big early in the day, the bulls stepped in at the end and rallied prices.  The question I keep asking myself is this due to the unusually strong market (and is this as bad as its going to get) or are we biding time waiting for the other shoe waiting to drop to kick off the next, much deeper correction?

No matter where I look when I scan the market, I see the same story, overbought conditions combined with negative divergence warnings and sitting right on or just above support. Small cap stocks are no different as you can see in my chart of IWM below. At the price high in March, RSI momentum registered a divergent lower high (negative divergence). Since that time, price has formed lower highs and lower lows as it slowly grinds lower and sits slightly above (blue horizontal) support. It shouldn’t take much imagination to see this topping action is/has formed a head and shoulders pattern. Additionally, In the bottom pane, the ratio of small cap stock performance to the SP500 index shows it too, sits right on the supporting uptrend line.

If the bears take control and price breaks support with conviction to the downside, the first level of support is the 200-day moving average (T1), after that the head and shoulders pattern target (T2) is a potential place where we could find buyers reversing the trend. Beyond that if we really get a head of steam south, T3, last November’s low is where I would be looking for a counter trend bounce. I am not saying we are in for a much deeper pullback here because no one knows, but the current setup and market conditions (divergent overbought highs) almost always lead to a correction. What we won’t know until after the fact is if that negative divergence will be worked off over time (price holds support and we chop sideways) or via price (we see prices experience a much deeper pullback).

Whether it be first out of the gate higher after a selloff or the first to top out after a strong bull market run, small cap stocks can be the proverbial canary in the coal mine which is why I watch them so closely.

Time for a Different Approach?

Whether you are an Obamacare advocate or not, the following chart screams out the need for a fundamental shift in the way we handle health care it if we expect to fix the crisis.

I know I will hear from some saying life expectancy is not the best or only measure of a good health care system and I can agree.  But our standard response of throwing more and more money at a problem clearly has not provided the best outcome so maybe it’s time to reset and try a different approach.

I’m Here to Collect $93k

While not tops on the list (that honor goes to Alaska), California has the second highest public pension unfunded liabilities totals, estimated at $1T (yes you read that correctly it is one trillion dollars with a T). Which, as it turns out, is approximately $93k per each CA household. Oh, and by the way, this is up $15k since 2014 alone. Bad investment returns apparently are to blame. 

I’ll pause here and let that sink in. Every household will be responsible for contributing $93k to meet these commitments!

The bottom line is that either the pension payouts will need to be lowered or taxes will need to be raised to meet the obligations (or some combination thereof). Which do you think it will be? Do you have your checkbook handy, just in case? And no, there is zero chance we will be able to “grow our way out of the problem” so don’t go there. And unlike Social Security, California will not be able to print money and bail out the system like the Government can and will likely be forced to do with Social Security.

Much of the blame for this mess rests squarely on the “experts” who, when establishing the annual funding levels, used an investment rate of return that was unrealistically high which helped keep contributions to a minimum throughout the years. Their model may have been reasonable some 40-50 years ago when the pension systems were established but not in a dynamic, changing world. The most frustrating thing about this mess is that it is not a new revelation as it has been known about it for years (and decades).  But rather than address the issue, those same experts and politicians just kicked the can down the road. So if you ever wonder why, under most circumstances I recommend tapping into your pension as soon as you have access because it is my belief most pensions will fall short of being able to meet their full obligations for the reasons above. As such I am a full believer you should take what you can while you can. As Stevie Guitar Miller sang, “Take the Money and Run”

To read more on this future crisis go to  

http://www.kersteninstitute.org/blog/stanford-universitys-pension-tracker-pegs-total-california-pension-debt-at-1-trillion-or-93000-per-california-household-in-2015-up-19-from-2014

Leaving the Island

An Island Top, one of the most reliable patterns, occurs when a upward trending price "gaps" above a specific price range and then is confirmed when the price "gaps" down below to the original range. That “island” that is created can be made up from one day or a cluster of days (formed by several bars rather than one) which is a much more powerful signal. The island cluster would look something like this example:

With that in mind, below is the chart of the 20-year Treasury bond ETF, TLT. As you can see, TLT was in a confirmed uptrend and gapped up on June 27 and spent the next 58 trading days above the gap (encompassed within the red box). Last Friday, Sept 9, you can see price gapped below the box and through the up gap of June 27, creating an island.

Island tops have an historical success rate of 77% with an average decline from the successful formations of -21%. While nothing is guaranteed, this pattern's high probability outcome if validated with follow through in the next few days, the market’s concomitant rise in volatility and poor seasonality is a warning that bond holders are likely in for some near term pain

How Much Do You Spend on Taxes?

How bad is the tax burden in America? According to the Tax Foundation, people will spend more on state, municipal, and federal taxes than the annual financial burdens of food, clothing, and housing combined, according to its data.

The calculation is based on the date of Tax Freedom Day, the point at which Americans have gone enough days to pay their annual taxes, beginning from the first day of the year. This year, that date will be April 24. It is worth noting that U.S. tax payers are better off than those in several other countries.

The organization’s researchers explain:

·         This year, Tax Freedom Day falls on April 24, or 114 days into the year (excluding Leap Day).

·         Americans will pay $3.3 trillion in federal taxes and $1.6 trillion in state and local taxes, for a total bill of almost $5.0 trillion, or 31 percent of the nation’s income.

·         Tax Freedom Day is one day earlier than last year, due to slightly lower federal tax collections as a proportion of the economy.

·         Americans will collectively spend more on taxes in 2016 than they will on food, clothing, and housing combined.

·         If you include annual federal borrowing, which represents future taxes owed, Tax Freedom Day would occur 16 days later, on May 10.

·         Tax Freedom Day is a significant date for taxpayers and lawmakers because it represents how long Americans as a whole have to work in order to pay the nation’s tax burden.