The Canary

I have written many times in the past about how the semiconductor index, SMH, is an excellent tell on the current strength of the US Stock market and investors willingness to take on risk. The semis tend to be leaders (the proverbial canary in the coal mine) in both up and downtrends so it’s an excellent vehicle to get an “early” take on which way the market will go if it’s in consolidation (which it currently is).

As you can see in the longer-term, weekly chart of SMH, the 50-day moving average has a positive slope and sits above a rising 200- day moving average. With price sitting above both moving averages, this is exactly how bull markets (uptrends) are supposed to look. When you combine this with the fact this week the index broke out to new, all-time highs and of course is making higher highs and higher lows, the message is clear. The current setup in the semiconductor index is making one heck of a bullish argument to be invested in US stocks regardless of the external daily noise trying to divert your attention away from their message.

As usual, the semi stocks are leading the rest of the market and the broader US stock market has yet to confirm the strong bullish argument. It seems logical based upon historical patterns that if the semis hold this week’s breakout and continue higher, it would be expected to see new highs for the broader US stock indexes not too far in the distant future. The argument becomes even stronger when combined with the fast-approaching bullish seasonal time of year.

A Couple of (conflicting) Sentiment Data Points

As you can see, US corporate CEO’s have historically been very accurate in being pessimistic (predicting a recession) at just the right time in the past. While not quite below the line, it looks like we are just a whisker away based upon the most recent data.

Optimism among individual investors about the short-term direction of the stock market fell to its lowest level in three and a half years. The latest AAII Sentiment Survey also shows a jump in pessimism and lower neutral sentiment.

Bullish sentiment, expectations that stock prices will rise over the next six months, declined by 1.1 percentage points to 20.3%. Optimism was last lower on May 25, 2016 (17.8%). Bullish sentiment is below its historical average of 38.0% for the 33rd time this year and the 21st time in 22 weeks.

Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, pulled back by 3.5 percentage points to 35.7%. Even with the decrease, neutral sentiment is above its historical average of 31.5% for the 20th time in 21 weeks.

Bearish sentiment, expectations that stock prices will fall over the next six months, rose 4.5 percentage points to 44.0%. Pessimism was last higher on August 14, 2019 (44.8%). Bearish sentiment is above its historical average of 30.5% for the 10th time in 12 weeks.

Bullish sentiment is at an unusually low level for a second consecutive week. Pessimism is at an unusually high level for the first time in six weeks. Historically, such readings have been followed by higher-than-median six- and 12-month S&P 500 index returns. The link is stronger with unusually low optimism than it is with unusually high pessimism.

 For bulls this is great news as we know individual investors are usually wrong, so sentiment readings at the lowest levels since 2016 is very bullish. Historically, such readings have been followed by higher-than-median six- and 12-month S&P 500 index returns. The link is stronger with unusually low optimism than it is with unusually high pessimism.

Elevator Down?

Having been schooled by one of the greatest chart pattern traders ever (Peter Brandt), has given me a love and appreciation of the art. For those who don’t know, little of mastering and succeeding at the skill is about pattern recognition but instead, risk management. As it turns out, that is no different than anything when it comes to the investment world.  

As you can see in the PAGS chart below, a textbook head and shoulders pattern with negative RSI momentum divergence is screaming out “SHORT ME”. Well, not immediately because every pattern needs a confirmation before entry, this one being when price falls and stays below the green horizontal support line. If that were to occur, the pattern’s target is down at T1, a nice 30+% decline. As ideal as this setup is, the probabilities of failure are good because the overall trend of the stock market over time is up and any short would be taking a position against the longer-term trend. So, a decision has to be made either and then decide whether to avoid the lower probability setup (even as good as the setup looks) or take it and keep a shorter leash (minimizing losses) in case you are wrong.

The fun thing about shorting is that when they work, they typically work much faster than from the long side. As they say, stairs up, elevator down.

An Interesting Look at Money

Besides being interesting and helping put money into perspective, there are lots of stories and answers contained in this chart. The one that jumped out at me first is it explains why bitcoin or gold will never replace physical money, at least for now.

What do you see?

Avoidance

The last few months has been frustrating bulls and bears alike. Most breakouts have failed, if not immediately soon thereafter. Breakdowns for the bears have been equally as exasperating. While there has been a bit more success being on the short side, for the most part with a few exceptions (software stocks) confirmed breakdowns have shown little follow through.

Biotech has been weak for a year now and shows no signs of changing character. Looking at the chart of IBB, the (larger cap) biotech index, you can see it continues to stay below its downtrend resistance and currently sits precariously on an important level of support. The path of the last 6 months of its price movement has formed a bearish descending triangle and its breakdown seems eminent. Further weakness in the coming weeks opens the door for the possibility of a much bigger decline, a likely target is at down near last December’s lows.

Its rarely talked about but outperforming is as much about avoiding big losses as it is about picking and staying invested in the winners. With that in mind and at least for now, biotech is a place most investors should be avoiding.