A Change in Character?

After peaking just before Christmas of last year with negative RSI momentum divergence, NTES, has gone on to fall more than 40% before it bottomed in late May. Since that time, it has begun to make higher highs and higher lows, the indication of a change in character. Price currently sits just under the neckline of an inverse head and shoulders (IHS) bottom reversal pattern and the long-term (red) downtrend line. While price is still under a falling 200 day moving average it recently crossed above its 50dma which has now curled higher.  These are all constructive elements an investor would like to see before attempting to catch this falling knife

A confirmed (with higher volume) break and hold above the green horizontal resistance, the upside target for NTES is the March high (at T1), a nice 20%+ gain. A confirmed entry with a stop just below July 11th ‘s low provides a better than 4:1 reward to risk ratio.

While the NTES setup is compelling, the recent move off the right shoulder was not ideal.  from a volume standpoint so it makes this IHS pattern suspect. While volume plays an important role in the Head and Shoulders Top, it plays a crucial role in the Head and Shoulders Bottom. Without the proper expansion of volume, the validity of any breakout becomes suspect. Volume levels during the first half of the pattern are less important than in the second half.

• Volume on the decline of the left shoulder is usually pretty heavy and selling pressure quite intense. - Check
• The intensity of selling can even continue during the decline that forms the low of the head. - Check

After this low, subsequent volume patterns should be watched carefully to look for expansion during the advances.

• The advance from the low of the head should show an increase in volume – Check
• After the reaction high forms the second neckline point, the right shoulder's decline should be accompanied with light volume as it is normal to experience profit-taking after an advance. - Check

Volume analysis helps distinguish between normal profit-taking and heavy selling pressure.

• The most important moment for volume occurs on the advance from the low of the right shoulder. – Sort Of

The most recent advance from the right shoulder started well but is ending with lighter volume than desired. For a breakout to be considered valid, there needs to be an expansion of volume on the advance and during the breakout.  While increasing volume confirms the breakout and pattern, just because it isn’t there does not mean the pattern won’t play out to completion, it just means the probability is not as great and why it is suspect.

When 10 is More than 100

Through the first half of the year, as you can see in the chart below, just 10 stocks (2%) of the SP500 index have made up more than 100% of the indexes return this year.

While this is not what stock bulls want to see, it isn’t necessarily negative … at least not yet. Ideally, the more stocks participating and contributing to the indexes (positive) return the better. What would be healthy for higher future stock prices is to see strength rotate from the above 10 companies and across a wider breadth of not just companies but also sectors.

June 2018 Charts on the Move Video

Yawwwwwwwn.   Sideways chop within the Jan -Feb consolidation range until we see a catalyst. I thought maybe trade war fears would be enough to break the trend but apparently not.  Bulls are still in charge.  I don't expect to see a resolution for months so until then, sit back, enjoy the summer and check out this month's Charts on the Move video at the link below  ...

https://youtu.be/FLo_AyzWVeA

Inversion

When economist talk about the “yield curve” they are really just referring to a plot of yield versus varying bond maturities. An inverted curve is when the difference between the yields of long term bonds (usually 10 year) rates to short (usually 2 year) is negative (short term yields are higher than long). This is a very closely watched benchmark by knowledgeable investors because we know every recession that has occurred in the US over the past 60 years has been preceded by an inverted yield curve, according to research from the San Francisco Fed. Curve inversions have correctly signaled all nine recessions since 1955 and had only one false positive, in the mid-1960s, when an inversion was followed by an economic slowdown but not an official recession, according to the Fed’s data. 

While the US yield curve is still positive (NOT inverted) the global curve just recently inverted for the first time since 2007 where its inversion lasted briefly (less than 6 months).  I have not seen any studies that show if global yield curve inversion has the same strong correlation to economic slowdowns (recessions) as it has in the US, so the implications of the crossover may or may not be of significance.   

As a minimum though, it raises a warning flag for investors to take the portfolio off autopilot and have a plan. There is no question, a recession, if it were to ensue around the world would likely drag the US along. Economic slowdowns are rarely ever good for stock prices and when combined with us being in the latter stages of the 2009 economic recovery cycle while stock prices are at very extended valuations, next year looks like it could be shaping up to present challenges investors have not had to face in many years.

Dead Money

Those that have followed me for a while know I frequently use the 200-day moving average (DMA) in my analysis to assess the direction of the trend. If the average is rising, we are in an uptrend and want to stay in that investment as it will likely bring higher prices (and further gains). On the contrary, if the average is falling we want to avoid the investment as it will likely lead to continued lower prices and losses (unless you happen to be short the position).

But what about the other option where the average is moving sideways? A good example of this can be seen in the chart of Starbuck’s, SBUX, below.  You can see the (red) 200 DMA flattened out in April of 2016 and has gone nowhere since (a more than 2-year period). The stock is actually down more than 12% since that time, mostly due to last week’s double-digit decline. The US SP500 index, in comparison, is up more than 35% during that same period.

As investors we are risking capital for one reason only, to make money. A rising or falling 200 DMA identifies environments in which investors can do exactly that. A flat one, on the other hand, is one to avoid as investment capital becomes dead money  

As a side note on SBUX, if price breaks and holds below that very significant green horizontal line of support, a new downtrend will have begun and the first likely target of the decline will be at T1.