On a Dime

Josh Brown (thereformedbroker.com) is a must follow for those who live and breathe the markets as I do. His post from last Friday says so much, so well I had to repost it. Hopefully it sounds familiar.

 On a Dime

The fundamentals of a company, a sector or an entire country’s economy rarely turn on a dime. They improve or deteriorate slowly, and often imperceptibly, over longer periods of time. And when they turn, even the turn itself can seem interminably long.*

The prices of stocks, however, can and do turn on a dime. They move faster and more aggressively than anything happening with the issuer’s fundamentals. And yes, by extrapolation, entire sectors or country stock markets do the same.

The fact that stocks and stock markets can turn on a dime is one of the most frustrating aspects of investing. Just when most investors have told themselves the same story so convincingly and memorably, the story changes. But not everyone is ready to abandon the story they’ve embraced all at once.

This turning on a dime business also makes technical analysis difficult for people to accept. If everything you thought last week is now the opposite this week, why should I listen to a word of any of it? Smart technicians speak in probabilities and not certainties regarding outcomes. They also describe their opinions in terms of if, then:

If ___ comes to pass, then ___ should be the result. But if ___ doesn’t, then ___ becomes less likely.

If that lack of conviction frustrates you, you probably aren’t cut out for markets, anyway.

2018’s market turned on a dime. The difference between momentum in January versus momentum in December was night and day – there’s no chance the underlying fundamentals of the US economy changes to the degree momentum did during the course of the last year. Here’s Jon Krinsky, looking at Relative Strength (RSI), a widely used measure of momentum – it’s my Chart o’ the Day. Readings above 70 or below 30 are considered to be above or below the thresholds of “extreme” momentum, good or bad…

What a Difference A Year Makes

In January, the SPX’s weekly RSI exceeded 90, its highest on record. In December it hit 31, the lowest since 2011. It’s easy to say that 2019 will settle somewhere in between, but a failure to hold above the 50 level on the next meaningful rally would be a negative tell for the medium-term.

To have the highest RSI on record to begin a year and then end plumbing the depths of recent history – that’s quite a turn. It didn’t announce itself, it just happened. In January, there wasn’t a single indicator that could have warned you. The only preparation for this sort of thing is to be armed with historical context – and the history of markets suggests that anything can happen, at any time. Hence the need to build strategies that can endure all events, even low probability ones.

Source:

Formidable Resistance
Baycrest Partners – January 1st, 2019

* there are exceptions to this, of course. one-drug biotechs absolutely can see their fundamental outlook stop on a dime and reverse, from something like a partnership announcement, an insurance company approval, an FDA approval, etc. There are others.

December 2018 Charts on the Move Video

With the US broad market index having fallen 20% peak to trough, only to be saved by 2018’s closing 3 day rally investors have to wonder what’s ahead. More importantly, investors need to know what’s their plan in case we have not found a bottom.

What’s your risk tolerance?

https://youtu.be/Q0NjOcylLcw

Risk On is Almost Risk Off

The most important chart stock bulls want to keep a close eye on is the ratio of stocks to bonds. When rising, investors willing to accept risk, want to be heavily invested in stocks. When falling, bonds are the place to be as they are providing the best comparative returns.

As you can see, the ratio peaked in 2016 and in the process of changing character. Changing from an uptrend where higher highs and higher lows were the norm to one where lower highs and lower lows are occurring. All is not completely lost for stock bulls as the ratio is in a sideways consolidation and has held its key horizontal support level. Watch out though, if that level gives way that would be a strong argument it’s time to hunker down into less risky assets.

Some Targets

It’s a brutal market with no sign of let up (for now). Because of the spike in the VIX and large selling volume (when seen together are signs of a short-term bottom) a short-term rally is expected. But with algorithm and HFT trading and the BIG money away for the holidays, oversold can get more oversold which is exactly what we are seeing.

As investors we would all love to know when the decline will end but unfortunately, we will only know that in hindsight. What I have done is layered some technical analysis targets onto US index chart in an attempt to come up with downside pattern targets just for perspective. The bottom line is its highly likely the markets are not done falling.  

Targets for all chart indexes are labeled “T1”

Dow Jones Industrials

SP500 -

Nasdaq -

Small Caps -

It’s always good to remind everyone here, once again, that markets go up and down, not up or down. I expect we will get at least one more rally before we find a final bottom, whenever and wherever that turns out to be. When we do put in a final low, coming out of it will not be a straight path like the one down has been. Consolidation and basing will be required to rid the market of the remaining sellers before a new uptrend is established.

Keep in mind, the targets are nothing more than possibilities. In strong downtrends, markets tend to overshoot their targets so it would not be unexpected to find an end to this correction well below the pattern target. This is not a prediction but rather keeping our minds open to the possibilities to adjust our expectations.  Just so we are on the same page, what we want to see is a continued correction and the further the decline the better. No, I am not nuts.. This would set us up for a much more attractive future investment opportunity. The bigger the drop, the bigger the opportunity. Are you onboard?

The Importance of 100

I’ve spoken ad nauseum about the importance of areas of support and resistance. Scanning my charts there is no better example than the $100 price level on the biotech sector ETF, IBB. The more times price touches a level, the more important that level is. As you would expect, when price is underneath the level, it acts as resistance and when its above, it acts as support.  

The reason I bring it to your attention is that (as of now) it appears as if price has broken below. If you were a holder of IBB, you should very seriously consider exiting your position as the higher probabilities are for price to continue lower. The target for the decline is down at 2016 lows near $80, some 20% lower than where we start the day. Of course, since our timeframe is based upon weekly closes (and its only Tuesday when I am actually writing this post), for this target to be validated, we would need to see a close below this level at week’s end and immediately followed by a confirmation close the following week.

When there is a very clear support/resistance level, it makes your investment plan very simple. When above be long, when below, sell or go short.