Divergences

We all know by now divergence is when price and an oscillator are not confirming (making higher highs together). In the example below, you can see back in September of last year the US SP500 index made a higher high (1) while its momentum (upper pane) made a lower high (2). We also know that when divergence occurs, there is a high probability of a pullback/correction. We all know what happened next, the SP500 fell to its December, Christmas eve low, a 20% correction.

Since that low was made, the price of the SP500 has rallied back and made a new, higher high (3). What should have investors concerned is that, price momentum has made a … lower high (4). The same thing that happened last year. Notice how, in both divergence instances, the indexes price was above a bullishly aligned, rising 50 (green line) and 200 (red line) moving average which is indicative of a “strong bull market”.

The higher probability outcome when divergences occur in “strong bull markets” are they turn into just “pullbacks” (buying opportunities) and NOT reversals. So, the fact we are seeing broad market divergence at the same time we are entering normal weak summer seasonality, I expect it’s likely we see another pullback in the coming weeks/months. As such, It’s likely not the end of the bull, rather just a normal (yes, 20% is considered normal) correction.  How big of one, is the $64,000 dollar question. Unfortunately, divergences don’t tell us the magnitude of any potential pullback but rather just of the increased probability of one occurring.

DomiNick's

A little history - Tom Monaghan and his brother, James, purchase "DomiNick's," a pizza store in Ypsilanti, Mich in 1965. They borrowed $900 to buy the store from the previous owner. A year later, James traded his half of the business to Tom for a Volkswagen Beetle. In 1965 Tom renamed the business "Domino's Pizza, Inc". Ten years after that, Amstar Corp., maker of Domino Sugar, instituted a trademark infringement lawsuit against Domino's Pizza. It took another 5 years before the courts finally ruled the pizza maker did not infringe upon the sugar maker’s trademark. The rest, as they say, is history.

What does this have to with investing you might ask. Come on, admit it you’ve seen the those ridiculous headlines about how much money you would have if you would have only put $10k into Google when they went public back in July of 2004. The answer to that question today is something north of $20M (assuming you just bought and held). A nice, tidy some most of us might be able to squeak by on 😊. Well, it just so happens Dominos went public one month earlier than Google did in 2004 and as you can see in the chart below, which the better investment has (so far) turned out to be (blue=Dominos, red=Google)

Dominos would have turned that $10k into $40M+. Outpacing Google’s return by almost 100%, Dominos has been the better investment. Sometimes the best investments come from places you least expect.

Same Outcome?

You can see in the chart below, the world stock index, ACWI, failed to breakout to new highs 2 weeks ago and continued pulling back last week. It should not come as a surprise the failure occurred where it failed twice before, in that $74-$75 zone. Patterns do repeat price and why as investors, we should anticipate this will occur, before it does. For now, price continues to consolidate between the $74-$75 high and December’s $61 low.

If patterns repeat, what should we anticipate the future holds? Looking left (to plan right) we see price of this index has gone through two other extended consolidations (’11-’12 & ’15-’16), both taking more than 80 weeks to resolve to a continuation to the upside. If this repeats again, we can expect the same outcome with price, in the short term, continuing its consolidation before finally breaking out to new highs, later in the year.  Why later this year? Patterns tend to be time symmetrical so while the current consolidation may not exactly match the prior periods, I expect it needs to further consolidate before we see it eventually break out. Until then, investors need to be prepared for choppy, news-driven volatile markets.

OF course, some major event/news (war with Iran?, trade agreement with China?) can throw a monkey wrench into all the best expectations and why as investors we always need a plan “b” … just in case.

Yawn!

Monday’s 2.4% drop in the SP500 was a punch to the gut for investor’s account but when put into perspective of “worst days” for the index since its inception, it was nothing but an average day at the office.

From False Breaks …

One of the first adage’s I learned from one of my TA mentors was “from false breaks come big moves”. It’s supposed to be a catchy phrase about the potential for big moves in the opposite direction when price breaks out of an area of previous resistance (which now becomes support), moves higher and then reverses back below that prior resistance / (what has now become) support line.  A good example of this occurred in US stocks last year as depicted in the SP500 index chart below.

As you can see price broke eventually above the blue horizontal prior high level. Moved higher for a few weeks then reversed course and fell back below the prior breakout level. What came next, we all know, was our ~20% decline in stock prices that ended on Christmas eve last year.

 With the TrumpTrade volatility dominating the markets of late, it is interesting to see the SP500 has fully recovered and moved back above last Sep 2018’s high (see below). But what is more interesting is to note the SP500’s price ended last week right back on the breakout level. If further volatility is ahead, it could be expected we see the SP500, once again have a second failed breakout.

Of course nothing works 100% of the time, but the “from false breakouts” adage should still be front and center with investors at this time in case the markets want to repeat last year’s false breakout sharp decline.