Dollar Retest

I haven’t spent much time talking about retests in the past but because the dollar is in the process of one, I thought this would be a good time to do some teachin’ to ya’all. Quite often, after a long consolidation and breakout, an investment will struggle after the breakout and then fall back to retest the original breakout level. The reasons for this are numerous and I will leave them to another post but for now the key is recognition and the understanding this is a normal occurrence and provides an objective entry for those not already invested.

Using the US Dollar chart below you can see the dollar consolidated between the lower and upper blue (support and resistance) lines for almost 2 years before it broke out higher and peaked the first week of this year. Since that time it has fallen back to the original upper blue line which has flipped from resistance to now becoming support.

If you are a new reader you may be wondering why I spend so much time on watching the dollar. As investors we are very interested in what the dollar does because it can have a dramatic effect on other assets including bonds, stocks, commodities, energy, etc. Most global commodities are priced in dollars. Because the dollar is now sitting on support combined with the fact it is still in a long term uptrend, we must give the benefit of doubt that this will resolve to the upside.  But we also know there are no guarantees so you need to have a plan in case this thesis is wrong. 

If the dollar were to break down below support and move substantially back into the prior consolidation area, I would view this as a very bearish signal and the potential signal the uptrend is over (and my prior blog post declaration of our next stop for the dollar of 108 being wrong).  There is a saying in TA that states “from false breaks come big moves” and means that when an investment breaks out of consolidation, does not hold and falls back, it usually leads to big moves in the other direction. While the odds are not in stacked in the favor of that happening, if it does, the ramification for investors could be huge.

U.S. Stock Valuations are Rising

One way to measure stock valuations (P/E ratio) is the CAPE ratio, which smooths earnings over a ten year period. This ratio for the S&P 500 hit 28.7 this week, which is in the 94th percentile going back to 1928.

The only periods in history with a higher CAPE ratio were July through October 1929 and February 1997 through April 2002.

While it doesn’t mean prices can’t go higher, because they can, it just means the risk to reward at these levels becomes much less compelling. Also something investors should keep in mind, the higher this goes, the worse the eventual snap back can be.

IPO Hangover

I find most IPO’s follow a similar path of rocketing higher with unabated enthusiasm until they finally succumb to the eventual selling of a Wall Street over-hyped sales pitch. There usually is nothing wrong with the company but rather it’s a matter of running out of buyers as the IPO chasers and company holders take profits. No, not every IPO acts this way but, in my experience, most do which is why I typically avoid them.  But let’s be clear, I don’t avoid them completely because they eventually become very attractive investment targets once they finally bottom from their IPO induced hangover. 

Teledoc, TDOC, is a great example of this “IPO pattern”. (I would recommend readers memorize this as it is one of the market’s best money making patterns that continues to repeat and provide smart investors a way to bank coin). As you can see in the chart below, after 5 short weeks and a more than 65% climb from its IPO, the sellers overwhelmed the buyers and pushed the stock to level more than 50% below the IPO price, where it sniffed the $9 level and eventually formed a divergent low double bottom.

From that double bottom, TDOC quickly rose more than 100% in four short months and has since consolidated sideways in an attempt to digest those gains and build energy for its next move. While the week is not over, a breakout with confirmation (ie, bullish RSI momentum, volume confirmation and along with price) above last September highs (blue horizontal) provides a very attractive and objective entry who’s first upside target is 20+% higher. Assuming it makes it there, the next logical resting point is more than 50% above which is what has me watching this opportunity with great interest. 

A Lot of Nothing

The S&P500 did a lot of nothing last week, continuing 2017’s trend of doing even more of absolutely nothing. That is unless you consider consolidating sideways and allowing the overbought, negative divergence to unwind something. As you can see below, the SP500 has been

sandwiched between 2,240 support and 2,280 resistance since the year started because traders are stubbornly sticking to their positions. Prices move when people change their mind and right now bulls are staying bullish and bears are staying bearish.  Headlines and economic data no longer matter when people stop trading them.

No matter what happens, we are within spitting distance of all-time highs and only the most stubborn bears are claiming the world is falling apart. The more times price tests a level the higher the likelihood it eventually breaks through. This, combined with the potential bull flag continuation pattern has me expecting higher prices in the near term. Markets tumble quickly from unsustainable levels and right now the market seems quite comfortable here. No matter what the market “should” be doing, when confident owners keep supply tight, prices continue creeping higher.

While I am optimistic, one thing does provide me pause, current sentiment.  As we know, sentiment is a contra-indicator and while advisors have reigned in some of their bullishness since the start of the year, it is still too high yet to be a tailwind to higher prices.

A Huge Disconnect

Since the election and into year end, the market has ripped higher. During this same time trailing earnings/share estimates have moved lower, creating the largest divergence during the past 10 years.

The question investors need to ponder is who is right?  Earnings estimates or the market? The larger the divergence the larger the potential correction so making sure you are on the right side of the next move is of critical importance. The good news is we will likely find out the answer to our question real soon as earnings season has already started but will be in full swing next week.

Regardless of what happens, are YOU ready?