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Head and Shoulders Above The Rest

October 15th, 2020



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This blog post is a copy of the Investment Discussion I presented to my board Investment Committee today.  It was written for them, so please read it as such…Thanks!

Since we last met, the market has drawn out a inverse head and shoulders pattern (see graph above).

I’ve annotated the graph so you can see the three inverse head and shoulders moves.  You can also see the neckline of this pattern at 3429 (the horizontal green line I drew).

Typically this pattern is a bullish set up for a move higher in stocks.  Generally, your target higher is the distance of the neckline to the bottom of the head, or in our graph above its roughly 200 points on the S&P 500 Index.  That would give us a target of 3629 +/- (remember, it’s a target not a commandment that it will happen).

However, in the case where the pattern does not turn out to be bullish, then you have to measure your risk as well as your upside potential reward.  Here is how that works:

If we break below the neckline, then you have three targets that are easily seen on the graph:

  1. 33 points down you have the 50 day simple moving average at 3396
  2. 200 points down you have the bottom of the head at 3229
  3. 307 points down you have the 200 day simple moving average at 3122

We should not be surprised that the market pulled back after the fast and furious run higher from the late-September correction low (the bottom of the head).  You can see it ran straight up to resistance zone (highlighted pink) between the All Time High in the market and the beginning of the correction.

The chaotic nature of the news is driving the market right now.  We came off the bottom of the September low based upon news of an almost deal on stimulus and we have pulled back with news that it may be dead until after the election.

Right now?  We are trading in no-mans land – the blue shaded area between the neckline and the broken uptrend line off the bottom of the head.  Ideally, we want to see the neckline hold and the market move back above the uptrend line while heading toward the 3629 measured target of this pattern.  If it doesn’t, then we need to watch for a move to the 50 dma – fortunately, it is less than 1% below the neckline.  Holding that level will be key.

As far as strategy is concerned, remaining opportunistic is key for this market.  When the market bottomed in September, I put some of our cash to work in the growth, core and fully diversified strategies in small cap and value stocks which have underperformed the overall market.  If the neckline doesn’t hold, I will likely sell some growth stocks exposure in anticipation of a move down to the bottom of the pattern or even the 200 dma. I expect we will see increased volatility over coming weeks until the election is decided, so that could very well be the catalyst for a downdraft to the 200 dma that we were looking for prior to this pattern forming.

In terms of the shift into some small cap and value stock exposure in these three strategies, we will discuss that more in depth next month.  The markets have been primarily driven by beta allocations to the top weighted growth stocks in the indices – that appears to be changing, even if for a short period of time – and the lagging areas of the market will start to perform better.

Rising bond yields and a rising dollar both should result from the economy beginning to pull out of the covid shutdown recession which should favor the cyclicals and domestically focused small caps over the large cap growth stocks that outperform during falling interest rates and a slowing economy.

Note:  after I finished my meetings today I checked the market and the S&P ended nearly flat for the day after opening down > 1%.  Most notable, small cap value stocks ended up nearly 2% on the day, which makes me feel positive about the shifts we’ve been making to add value and small cap to portfolios. /msb/

S&P 500 Roars Higher

October 1st, 2020

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Just a quick update as its been a long day and I’m ready for work to stop.

We have very quickly retraced 50% of the recent correction – I’ve drawn a green horizontal line at 3393 which is half way between the high and low.

Over the past few days, we have broken above both the 20 day moving average and the 50 day moving average.  Very strong moves and both buy signals for us to add to stock market exposure in client accounts.  However, you can see that today all of the action took place between the 50dma line and the 3393 horizontal line (see the black candlestick on the far right side of the graph.  Notice it looks like a spinning top – that is a special candle shape and typically represents some indecision on the part of investors which makes sense as the bulls could not push above the 50% retracement level and the bears couldn’t push below the 50dma.

Friday’s action may give us a clue, but the big consideration is the 50dma – if we can close above it for three days in a row then the 3419 level discussed in the last post is the target to watch for – but it also because the flashing yellow caution light because it represents a level of 10% above the 200dma, a level that has always sent markets back down toward the 200dma (see the blog post from immediately prior to the correction for more on this concept).

However, we have had two consecutive buy signals so that means we are buyer and not sellers until the market tells us differently.  As the old saying goes:  “yell and roar and buy some more.”

Many thanks to reader Nan for the hat tip that Ms Ready passed away this week and that this song might work for a blog post – many thanks!


Market Moves Up on Stimulus News

September 28th, 2020

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News of the House of Representatives and Treasury Secretary Mnuchin being close to a new stimulus package allowed the market to gap up and run through the resistance at 3353 (the 50 day moving average line) and stop just shy of 3363 resistance (the thick black horizontal line on the graph above).  You might recognize this graph from previous blog posts, so I’ve updated it for today’s action because I wanted you to see a couple of important things:

1.  First, I’ve annotated in orange the low volume on this two day recovery – for us to say definitively that last weeks low is THE low for this correction (yup, we did have a 10% correction as measured by intraday price action) we’d want to see increasing volume along with rising prices.

2.  Second, today’s action closed right at resistance and above the 50 day moving average.  Moving above the 50dma is a buy signal, and I am treating it as such, putting some money to work in new holdings.  However, the weak volume and not breaking through the next level of resistance means caution is warranted, so we still have plenty of cash available in client accounts to add new holdings if we can sustain the move above the 50dma (we need to close above it for three consecutive market days) and break above 3363 resistance.

3.  Third, I annotated in orange the new target for the market, the rising red 200 day moving average 10% envelope line (remember that rising above that line was the beginning of our cautions market outlook).  That line is at 3419 today, but it is rising and will change everyday as the 200dma changes.  It will take a lot of work for the market to get there as the downward sloping 20 day moving average lies just overhead at 3373.

4.  Finally, the downward sloping 20dma will likely present formidable resistance.  Twice before during this correction, the market has tried to break above the 20dma and was turned back down.  A typical pattern is for three failed attempts at a strong resistance level before finally breaking above it on the fourth attempt.  The odds are we could see that again as we have today’s gap higher (the yellow highlight) to fill at some point in the future.

Below is an annotated graph we’ve looked at before with the black dashed line detailing a typical path to the 200dma – I’ve updated it to show you a new potential path in pink that bounces off the 200dma resistance and then falls to fill the gap:

spx 09-28 2

If it follows this path, then it puts the original path to the 200dma back in play, likely driven by news flow much as today’s move higher was driven by news of more stimulus.  But we will have to wait to see how things play out – right now we have the buy signal detailed above but we are not at the point where there is an all clear to be 100% invested in the stock market.


The Path of Least Resistance

September 23rd, 2020


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In the image above I’ve drawn in a dashed black line.  This is the graph that I presented to our investment committee last week to show what I believe to be the path to the 200 day simple moving average – so far, it has followed the path of least resistance:  down.

If you recall from recent blog posts, I wrote that we were headed for the 200dma based upon various indicators that I discussed.  I haven’t added those to this graph as I didn’t want to make the graph any more confusing.  However, this focus on the S&P 500 seems to be misplaced and we should be watching the NASDAQ.


This is the chart of the NASDAQ that covers the same timeframe.  I have drawn a blue box around where the NASDAQ appears to have taken over dominance in the market.  You can see how the past several days have had all of the action under the red 50 day simple moving average line.  This is key – the index broke below the line in a pretty standard 3 down days followed by two up days followed by a resumption of following the primary trend, down.

What we need to watch for is:

1.  will there be follow through with another down day tomorrow?

2.  will we see another attempt to break above the 50dma? or

3.  Will we trade sideways in a consolidation range, build a base as we wait for valuations to come down and/or earnings to firm up, then move back toward the all time highs.

If we have another down day, we will be watching to see how the pattern develops – most likely it will follow the same path down that the S&P is following to the 200dma.

A break above the 50dma would mean we may have put in the low for the correction – no guarantees – all trading would need to take place above the 50dma for three days for it to be considered support.  But if that were to occur it would give us a buy signal to increase our equity allocation back toward previous levels.

If we trade sideways in a consolidation pattern, we could be in it for some time.  Maybe not as long as Walmart and Microsoft were as discussed in the prior blog post, but certainly long enough for another area of the stock market to take off.  Banks and Oils are both significantly oversold and trading at near-historic low valuations – its possible that the deep value area of the market that has been left behind for so long starts to be the leader while technology experiences a reversion to the mean.

Stay tuned as we work our way through this correction and look for an investable bottom to put cash to work.


Resistance Is Not Futile

September 16th, 2020


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Following up yesterday’s post about the strength of the 20 day moving average line as resistance against the stock market moving higher, yesterday I noted that 3429 was the reading for the 20 dma and today we managed to move up to 3428.92 before the market fell back to close below yesterday’s low.

So far, I am sticking with the original reading of this market – that we have a date with the 200 day moving average line around 3100 (its not shown on this graph), or roughly 10% lower than current readings.  But first the 50 day moving average line will act as support and may allow the market to bounce higher.  We have plenty of cash ready to put to work when the market bottoms.

I have been reviewing a number of companies as purchase candidates, but we need to determine if growth companies with little debt and growing earnings will continue to lead the market in spite of their record high P/E ratios, or will deep value companies rotate back into focus, with huge discounts to book value and shareholder friendly dividends take over.

There is no way to know the answer to that question right now, but at some point the high growth companies stock prices will start to follow the path Walmart took as it transitioned from high growth company to mature sustainable growth company:

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This graph is the stock price of Walmart from 1980 to today.  You can see the box I drew where the stock price flattened out after the long period of strong growth.  That box represents over 13 years with no increase in stock price!  It took work for Walmart to shift to a sustainable growth mode (it added groceries and became THE shopping destination for a huge swath of the country) and it is now a mature company with a respectable and sustainable growth rate.

Another example?  Microsoft with 15 years of flat stock price:

2020-09-16 3

Looks pretty similar, right?  Microsoft also found a way to shift to a sustainable growth mode (it added cloud computing and is the go to source for companies who want to outsource their data to the cloud, second only to Amazon and its Amazon Web Services subsidiary).

What are the new growth stocks that we can catch on that long trajectory higher to capture their early stock price growth?  What companies  do we own now that we should be selling prior to their settling  into a flat stock price for a decade?   What stocks have had flat stock price performance over the past several years that now have a catalyst to move them to a sustainable growth mode that we should consider adding to portfolios?  Even if we find those high growth stocks and sustainable growth stocks, will they be the stock price performance leaders like they have been the past few years or will the deep value stocks take the lead as they have in many prior time periods?

These are all questions I am working on so that clients have the best possible holdings in their portfolios.  The market will tell us what is going to be the top performer and what is going to lag; it’s our job to listen and act accordingly.  Just keep checking here on the blog to find out what we are doing in this crazy market and why!


PS – thanks to reader Nan for the heads up on adding some Patsy Cline to our music video presentation – very good call!

Return To Resistance

September 15th, 2020


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Just a quick update – when we last chatted here on the blog, I noted that we were set to test the 50 day moving average (the red line on the graph above).  We did that and predictably bounced back to the underside of the 20 day moving average (the blue line on the graph above) where we were rejected and pushed back to the 50dma where we broke through it intraday, closing above.  Today, if the market closes at or below the high we put in earlier today, we have formed a pattern of lower highs and lower lows.  Tomorrow is key to knowing what will happen on a going forward basis.

1.  If we can put in a positive day and close above the 20dma, then the market is telling us that this was just a blip of a correction and that we will probably be heading back toward the previous highs.

2.  If we have a down day, we could be working on a third lower low and potentially a close below the 50dma.

My gut feeling is that based upon the movement of the price action, we are going to break below the 50dma and head toward the 200 day moving average (I mentioned this on the blog last week one day).

So what is the strategy?  If we close above the 20dma and can sustain it for three trading days (our Rule of Three for breaking above or below support), then you get a signal that a return the previous highs are likely.  It is relatively safe to commit some liquidity and put some of your money to work.  However, we still have the same issues present from two weeks ago when I wrote that we were due for a correction:  high valuations and the distance from the 200dma.  Today, intraday we popped above the 10% envelope discussed on the blog a couple weeks ago.

More than anything else, this psychologically important level which shows how stretched the market has gotten should keep us in the correction with a falling market headed toward the 200dma which is around 3100 on the S&P 500.


Stormy Markets

September 8th, 2020


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I’ve annotated a graph of the S&P 500 to give you an idea of what I see happening to the market.

If you’ve been reading the blog and the recent posts since I warned that we were getting ready for a pullback, you will recall the solid blue trendline that I said was important.  You will recall that I posted when we broke below that line last week.  Today, we have decisively dropped beneath it (making it now overhead resistance to a recovery to previous highs) and we have an intraday break of major support (horizontal black line) at 3363 on the index based upon previous trading activity.

What you want to watch for today is:

(1) whether we can stage a rally and close above 3363 ( that would be positive and an indication that buyers have begun to emerge from the sidelines and put money to work).  This could set the stage for an assault on the blue trend line and a return to previous highs; or

(2) whether we continue to deteriorate and close below 3363 (that would be negative and an indication that the sellers are still in charge and further downside is likely).  This will set the stage for a move to test the 50 day moving average and further weakness to the 200 day moving average line at 3093.

I’ve also added two key items that indicate number two above is possible:  (1) rising volume on down days in the index; and (2) volatility is rising toward highs seen in May.

We continue to pick our spots to book profits in holdings so we have cash to reinvest once we see a market turn.

Before ending I wanted to provide some color commentary.   I had an email from a reader wanting to know why we don’t just sell everything when the market looks like it is headed lower.  It’s a good question.  The answer is that even if the indicators say that market is headed lower, we are dealing with human emotions and psychology.  I’ve written on this blog in the past that the graphs are really just visual ways to understand the human psychology of the markets.  You can see the emotional turns when the markets move up and down and the indicators we follow are measures of those emotions in the form of price and volume.  Because we are dealing with emotions, plus the added impact of a 24 hour news cycle, the indicators tell us where we are where we are most likely to go subject to nothing being reported in the news that investors find surprising.  Because of this, it is not prudent to make a big bet like selling everything, particularly when our news is so full of surprising things at the current time.  The better move is to incrementally buy and sell, building or deploying cash over time, in order to outperform the market.


Invest What You See – Update

September 4th, 2020

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This is a follow-up to last nights post-market-drop post.

We did open the market up this morning, but it was not a long-lived rally.  You can see on the graph above the blue line discussed last night on the S&P 500 Index graph.  We have moved decisively below it today, and more importantly we are now trading below the also discussed red envelope line.   There is still a long way to go to the 200 day moving average, but the market will be drawn there.

Why do I say that?  The 200 day moving average represents the balance of trades between buyers and sellers over the past year.  A reversion to the mean is inevitable, but you cannot use it as a market timing mechanism.  Just like stock value always reverts to fair market value, whether a company is over priced or under priced by the market – check out earlier posts this week for discussion on Apple and Tesla as well as P/E values – but you cannot use it as a timing mechanism.

We will get a bounce higher once the sellers feel exhausted – right now, you have the situation where selling begets selling as people who have purchased stock at high valuations want out before they lose too much money.  At some point, that will abate and buyers will step in who believe the prices will revert to their former higher level.  That is the time for you to be a seller – or a repositioner of your holdings.

I have had some people ask whether this is the beginning of a move back to the March crash lows.  The only answer I have is that we will have to watch the market and see what it tells us.  We have gotten conservative with client money prior to this move lower, so we are looking forward to buying good companies at lower prices.  However, determining that buy point is key – I’ve run some fair value calculations based upon 2020 estimated earnings, 2021 estimated earnings,  as well as mean Price to Earnings, Price to Sales and Price to Book ratios, and somewhere near the bottom red envelope line represents fair value per these calculations.  Since these calculations are all based upon estimated earnings, they are only as good as the aggregate analyst estimates I used for the calculations.

To start buying, you really need to look at individual companies or funds, calculate what you believe to be an upside target, and whether the current price provides adequate upside margin for you to risk you hard earned money.  It is what I do for clients and it is something you can do as well.  If you overpay for a company, you may not necessarily lose money, but you will not meet your desired return expectations.  So be diligent and pick your market entry points carefully. and everything will be all right.