Gauging Risk

I find it helpful to regularly assess global investors willingness to take on risk (it’s a kind of “follow the money” check). Why?  When the there is little perceived risk by investors, markets tend to trend higher and this is reflected when you see the riskiest investments outperforming. Of course, when risk is increasing the first things that get sold are those assets with the greatest risk. As such, investing in these instruments can be a blessing and a curse. In the world of bonds, the riskiest investment is considered to be junk or high-yield fixed income securities. For stocks you would need to look no further than the frontier markets due to their extreme illiquidity. Closely monitoring those investments to access risk in the two major asset classes can act as an early warning of potential future trouble …. a proverbial “canary in the coal mine”.

For those that don’t know, frontier markets have been defined as a developing country which is more developed than the least developed countries, but too small, risky, or illiquid to be generally considered an emerging market. Not perfectly clear or well defined as you will find situations where there is no agreement about which category a specific country fits in to. But it does provide a weak framework and definition but leaves it open to individual interpretation. There are a few ETF’s that invest solely in these markets, my preferred proxy, the biggest and most liquid is FM.

Looking at the current chart of FM, you can see it declined for the majority of 2018, losing more than 25% and like the rest of global stocks, found a bottom on Christmas eve.  Since that time, they rose for 7 weeks, climbing more 13%, consolidated for 13 weeks and eventually busted a move higher. As you can see, that consolidation created a bull flag pattern which points to a target just below Jan 2018’s highs. This tells me that, at least for now, global risk (and most importantly the desire for equities) is still on and we have not yet topped out.

I would be remiss if i didn’t point out the very strong similarities the current price path is following as compared to the one that began in July 2014. While the markets don’t necessarily repeat, they do rhyme.  

It’s All About the Base

Understanding market structure is nothing more than realizing markets do only two things, they trend or they consolidate. When trending the buyers are clearly in charge (assuming it is trending upwards otherwise it is the sellers who are in control). Consolidations or basing is where bulls and bears are in balance. Not perfect equilibrium mind you, but rather a place where neither has control and price action reflects the back and forth choppy fight. We are interested in bases is because eventually they into a new trend and a potential home for cash awaiting deployment.

I wanted to bring to light a couple of current client account holding examples (those that hold individual stocks) where basing took place over a period of time (8-10 weeks) and broke out strongly higher this past week. The first is AMD

The current run was started back at the end of January when the price gapped higher as it blew out the doors on its earnings report. You can see the big (institutional) buying volume (bottom pane) that initially stepped in caused the gap. Since then, price has been trending higher but for the past 43 days has been trading sideways, forming a nice cup and handle pattern. Big buying volume once again stepped up and pushed the price higher, out of the base. Looks to me it wants to test prior highs from September of last year. Notice also that after the earnings gap, the (green) 50 day moving average has acted as support. This is quite typical of momentum stocks.

The next stock, Mongo db, has a similar look to AMD. It too, gapped higher on excellent earnings (note institutional buying volume in bottom pane), moved strongly higher and then began a new base. It took 53 days of sideways “no action” before it broke out to the upside last Friday, climbing more than 15% in a day (check the buying volume confirmation in the lower pane). Like AMD it looks like it wants to go higher, maybe much higher as it has broken out to new, all-time highs from that same cup and handle pattern.

While frustrating, basing action is critical as it unwinds frothy, overbought conditions and allows buyers a chance to take a breather and round up the troops for the next push higher. It’s important to remember, not all stocks move higher after consolidation. But your probability of investment selection success can be improved by looking for those companies who produce outperformance in earnings (and revenue) and confirmed with high volume buying participation.

So remember, when investing, it’s all about the base. No trouble.

Sorry Meghan!

Winning?

First off, this post is not about politics so don’t send me your political views. I learned the hard way a long time ago, politics and the markets don’t mix so I do my best to avoid them at all costs. Not only is it a distraction from making money and keeping focus, but also it does nothing to provide any edge. So why on god’s green earth should investors pay it any attention if it is not a path to greater returns?

The markets are the final arbiter of policy and politics and the chart of US Steel, X, is telling a very compelling story. It’s not something we all did not already know or at least surmise. Tariffs, in most situations are counter-productive, especially to the people/organizations they are most trying to help.

Trump announced tariffs on steel imported to the US on March 8, 2018. Since that time, the price of the United States’ largest steel producer has fallen more than 70%.

What is not clear is if US Steel has benefitted in some way from the tariffs … what is very clear is that US Steel’s investors have not. Further proof that politics and the markets don’t mix.

Anything is Possible

I love analogs. I am not talking vinyl albums vs. CD’s but rather the possibility of repetition in current market action based upon a period in the past. A new and interesting example is in the chart below. It’s pretty self-explanatory but in case it doesn’t jump out at you …  the bottom chart is a look at the price movement of the SP500 during the 2006 climb to its all-time high (at that time) and includes part, but not all, of its decline to its 2009 bottom. You can see the failed breakout in July 2007, which was followed by a quick, sharp decline, ending in August. From August’s bottom, the SP rallied to a point just slightly above July’s high and then turned tail, reversing course. That October failed breakout turned out to be the beginning of the long, 15-month 50%+ decline to March 2009’s bottom.

The top line is what the SP500 has done from 2016 to the present. Note the similarities of the initial breakout, followed by a quick, sharp decline and then a rally to new highs. Where we sit today, the SP500 has followed an eerily similar course as 2007. We just fell under May’s breakout level,

 What the chart implies is that if markets repeat (they often do follow similar paths) and if we follow the 2007 analog, we are in for a really tough market in the months ahead.

Unlike analog music, I find market analogs to be something much more interesting to view than listen to.

Near-Term Weakness

The chart of the SP500 index shows US stocks are in a short-term precarious position. After getting rejected at October 2018’s prior highs, the index has fallen 5% from its peak, made a lower high and now lower low and sits in between the 50 and 200-day moving averages. The head and shoulders pattern is just way to obvious, but if it should break the pattern’s neckline (2800) and not find support at the 200 dma, it’s first downside target is T1.

In the short term, investors need to be aware of the potential for a bigger drawdown, while traders should tighten stops and/or have a hedge(s) for the high probability of continued near-term weakness