INVESTMENT EDGE
It is not necessary to change. Survival is not mandatory. ~W. Edwards Deming
The pessimist complains about the wind; the optimist expects it to change; the realist adjusts the sails. - William Arthur Ward
While one could quarrel with whether Amazon is a technology company or a retailer, it would be very difficult to argue the investment world has not dramatically changed.
The US 30 year long bond peaked in July of last year and the combination of FED threats of multiple (4) interest rate increases and the Trump pro-growth election agenda had the effect of a proverbial “rug pull” out from under US bond prices. In 9 months the T-bond lost 17% (a huge amount for a so called “safe” investment) and shocked many investors as losses piled up.
It seems like political reality has finally set in, and the expectations for a FED rate increase next month is now down to just above 4%. Combine that with the fact that smart money (commercial interest) piled into bonds and are now at multi-year highs in their Treasury bond holdings provides all the reasons why we see bond prices bottoming, reversing course and moving higher. Price broke out of a double bottom pattern earlier this week and was precluded by an oversold divergent low, a high probability “buy-me” signal. The pattern will be confirmed by a hold above the red horizontal breakout level.
If this pattern plays out, it projects to a rally up to the very important support/resistance zone marked T1. Coincidently (and should not come as a surprise) it comes at a time that retail bond investors turned overly bearish (a theme we see repeated over and over in investing – retail investors being on the wrong side of the trade). As always after a major correction, investors patience will be tested as only time will tell if this reversal goes on to eventually form a lower high or instead on to make new highs. Until that is determined, it appears as if the market is giving the “all clear” signal to be long US T-bonds and because the institutions are buying again, at the same time their appetite for equities is weakening
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.
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.
This article title appeared in Motley Fool in April of 2015. Apparently, coal stocks were given some get well medicine because they bottomed early last year and have been one of the best performing sectors since. As you can see in the coal sector ETF chart, KOL, below, it has risen more than 180% since that January 2016 low. In case you are wondering, yes, this is quite typical and more often than not, what happens. By the time “the story” makes it to mainstream media (this was also covered in WSJ, and other more well-known media publications after April, 2015), savvy investors know it’s time to load up … on the other side of the media story boat. And in the case of coal, fading the news outlets was again, a profitable outcome.
The interesting thing is, there is a lot more room to the upside if coal finds a cure. You can see in the above chart, the red smaller inverse head and shoulders pattern played out exactly as expected and hit its upside target, T1. But as can happen when an investment goes through a substantial decline and begins to recover, it creates (smaller) patterns within (bigger) patterns. This time is no different as the completion of the smaller red inverse head and shoulders created a larger, purple, inverse head and shoulders which, if played out. has an upside target some 60% higher. What makes this compelling besides the upside potential, is last week’s confirming breakout from the pattern as it gapped on the open on more than average volume.
