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Gambling Vs Investing

February 5th, 2021

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It has been a crazy couple of weeks in the stock market.  If you haven’t watched the investment news for awhile, you missed a wild ride in a few heavily shorted companies.  Gamestop is one of those companies, and in the chart above you can see that its price was in the $11 range for several months then rose to the mid-upper-teens for a period of time before being pushed up to nearly $500 in a short squeeze before backing down to the $50 level.  This is the essence of volatility and one of the things that you see when stock markets are nearing a top – people forget about basic risk management and turn investing into gambling.

If you are wondering how this sort of thing happens, here is a short explanation in bullet point format:

·  Gamestop as a business historically sold video games in cartridge format

·  Most video games are now downloaded directly over the internet, leading to a significant decrease in revenue over time and a subsequent drop in its stock price

·  Gamestop acquired a new major investor that recently sold their own internet driven business for more than a billion dollars who has said he plans to help Gamestop transition to a new internet-based business model

·  Many large hedge funds were short the stock of Gamestock, which is bet against the company in the belief that it would go down even further in price

·  However, small investors were discussing this change on internet discussion boards and as a group decided to try to drive the stock price higher with buying, forcing the hedge funds to cover their shorts by buying stock, starting a process that feeds upon itself:  buying begets more buying

·  Once the ball got rolling, and the stock price started to move, the discussion boards detailed how the small investors could buy calls on Gamestop which ultimately would move the stock higher because the brokers would have to buy the stock of Gamestock as a risk management measure which put more pressure on the hedge funds to buy as the stock price moved up

·  Here is an Article Posted On Reddit re: Gamestop Investing that helped to fuel the fire, and which the hedge funds missed – there  is another Reddit post out there (I can’t find it now to provide you the link) that told people to sell when the stock reached $480…guess what the high was on that chart:  $483

·  A lot of people who bought at the beginning of this frenzy made good money, but it was still a bet that that the Reddit community could drive the stock to a level where the hedge funds would be forced to buy stock to cover their short position

·  However, many more people lost money because they were a buyer at prices above $50 and didn’t sell into the frenzy – and the hedge funds who were forced to buy at $483 or some other price significantly above today’s $62 price have lots hundreds of millions of dollars, putting two major hedge funds on the brink of bankruptcy

·  This frenzy also forced a number of brokers to halt trading in Gamestop shares, causing a number of investors to lose money, either actually or from an opportunity cost standpoint, and the class action lawsuits against them are starting to come forward

Let me make it clear, what the small investors did was not illegal, but it is not investing.

What is investing?  Let me walk you through a process that I use that entails a significant amount of due diligence.  Due diligence is a process used to find the stock of a company that has the opportunity to outperform the rest of the stock market.  If you invest your own money, I hope you are engaging in a similar process – if not, I would be happy to manager your nest egg so that it follow process.

Due diligence involves research into companies to determine whether they would make a good fit as part of an overall portfolio designed to achieve an objective.  I won’t discuss in this post how you design and develop a portfolio nor how to position a portfolio to achieve an objective, but those will make interesting posts for the future.  However let’s take a look at buying one stock so you get a feel for the process.

Step #1:  you determine that you need to buy a stock – there are many reasons for this, like you have some cash to invest or you want to swap a current stock in which you have lost faith into one that you believe will outperform the market.

Step #2:  you decide on a stock you want to research – there are a number of ways to determine your research candidate, like you hear about it on investment television, from a neighbor, or perhaps you are a fan of their products, to name a few.

Step #3:  examine the macro issues impacting the stock:

·   is the stock market itself in a bull phase or a bear phase;

·   do you believe from a timing standpoint that now is a good time to buy ANY stock;

·   is the industry within which the company operates in a bull or bear phase:

·   are there forces that are acting as catalysts to push the stock price higher or are there headwinds that will exert downward pressure on the stock price (e.g., an example catalyst for an electric vehicle company is the government doing something to cause the price of oil to go higher; an example of a headwind for a retail store is consumers choosing to shop online instead of going to the mall)

Once you determine that the overall market is at a place where buying stock makes sense and that the industry for your company is not facing significant headwinds, then we turn to examining the company itself

Step #4:  examine the fundamentals – this involves math, so be prepared to do it or trust the wall street analysts numbers (I don’t trust them since they are predominantly bullish and will sometimes use unconventional methods to justify a future stock price target higher than today’s price)

 ·   you need to determine an intrinsic value for the company’s stock (this is different than a price target that analysts publish) and compare it to today’s stock price since you want to buy the stock near or hopefully below that intrinsic value – this is complicated

·   an intrinsic value involves examining the company’s cash flows an discounting them so you determine what they are worth today

·   if the stock market is in a bull phase, it can be difficult to find a stock trading below its intrinsic value – so you will have to decide it buying above intrinsic value makes sense or whether it would be better to buy it once the price moves closer to intrinsic value

·   you need to determine if the company’s ongoing operations will support a move higher in stock price

·   you need to examine a company’s earnings growth (historic and projected) and its return on equity (historic and projected) to see if they meet you desired levels

·   there are two ways a stock’s price will move higher or lower:  (1) rising or falling earnings; and (2) how much investors value those earnings – a high level of earnings growth and return on equity will help you make sure you are meeting (1) above

·   you need to examine a company’s financial strength to make sure they will be around for the long term and can withstand a recession when it happens

·   debt levels,  cash on hand, owners equity levels, and free cash flow generation are critical

Step #5:  you need to look at a company’s valuation to determine if it is an acceptable time to buy or whether you should wait until the stock price comes down to acceptable valuation multiples – see (2) above

·   price to earnings multiples, prices to sales multiples, price to book multiples, price to earnings growth multiples, price to intrinsic value multiples all need to be examined at a minimum to see if the stock is trading at an acceptable valuation level to buy it

·   studies show that more money is lost in the stock market buying a company that is over-valued than lost based upon buying those with bad fundamentals

Step #6:  you need to look at a chart to see if technically it is time to buy or not

·   a stock chart is just a visual representation of the collective investor view on this company

·   sentiment and momentum play a big part in the short term outlook for a stock’s price

·   buying a stock when it is near the bottom of its short-term trading range can produce significantly higher long-term returns than buying a stock near the top of its short-term trading range

·   this helps you determine what price you want to pay for the stock and what price you will accept paying for the stock if it never gets to the price you want (if your analysis supports buying it at the higher price

Step #7:  buy that bad boy!

·   if everything aligns and you are satisfied you have a company that you want to own with good fundamentals at an acceptable valuation and current stock price, then buy it

Step #8:  determine what price you want to sell the stock

·   set an upper price target for the stocks – this doesn’t need to be a hard sell target, it might be the price where you want to rerun the steps above to make sure owning the stock makes sense (e.g., an example of this is buying a cyclical stock tied to the ups and downs of the economy – you want to buy it when the economy is a catalyst for the stock price to go higher but you want to sell it before a downturn in the economy becomes a headwind; setting a price target will force you to re-examine your reasons for owning the stock and will tell you whether to continue to hold it or whether to sell it – just remember to set a new target price if you continue to hold it)

·   set a price below your purchase price where you draw the line on losses – a common one is 9% so that you avoid any double digit losses on an investment

·   this can be tricky because many times you hit your loss limit and sell the stock only to see it recover and excel to the price target you set – but it is more important that you maintain standard practices because over the long-term you will be more successful than if you are haphazard in your actions

·   sometimes something can happen and a stock will plummet below your loss limit price (it’s just the way the market works and is typically news related relative to some non-public negative information becoming public) – you have to decide whether to cut your losses and sell at this lower price or you determine that this is an over-reaction by the market and it has provided you an opportunity to buy more shares at this cheaper price

Step #8:  document your analysis and your reason for buying the stock and for ultimately selling the stock

·   one of the major benefits of documentation is so that in the future you know why you bought a company and so that if you sell it you have done a significant portion of your due diligence in case you want to buy it back

Investing is not gambling – due diligence ensures that your stock portfolio will not go to zero and that you will have the best chance possible to meet your objectives

·   yes, some non-public information can become public and drive the price of one stock to zero or close to it, but that is why you build a portfolio and diversify that single company risk away

·   you can also have publicly available information drive a stock’s price to zero or close to it, but that is why we have this due diligence process that forces you to periodically review the company you bought and to sell it if something changes or your analysis was wrong (hey, it can happen, it does to professional investment managers all the time for many different reasons:  if your projections of future earnings and returns do not pan out, if investor sentiment changes, if your view of an acceptable valuation level to buy that stock is wrong, or any of countless other things happen)

Over the years, I have developed spread sheets that automate a significant portion of this due diligence process.  They help guide me to determine if what I want to buy will outperform the overall market and they help guide me to determine if I want to sell it.  However, if you are managing your personal portfolio, it is important for you to follow this process or another one that you develop on your own.  Sticking to a process will help keep you out of trouble, will help you achieve your objectives, and will make the weight of these critical decisions a bit lighter.

–Mark

 

Holly Jolly Market

December 24th, 2020

 

 

 

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As we head into the next week full of holidays and thin stock market trading action, I thought we would take a look at various stock market statistics to give us a feel for where the market is and where it may be headed.

From a valuation standpoint, the market is overvalued.  The graph above shows you the P/E ratio of 37.47 last week compared to the historic median P/E ratio of 14.83.  This is the third highest reading on record after the 2000 Dotcom stock market crash and the 2008 Subprime Loan stock market crash.  This tells me that caution is advised.


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Another valuation measure shown above, the Price to Book ratio is at 4.12 compared to its median reading of 2.78.  This is the highest reading since late 2000 and also advises caution.

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Another valuation measure shown above, Price to Sales ratio is at a record high 2.71 compared to its median reading of 1.50, again advising caution.  The above three graphs are courtesy of Robert Shiller’s website.

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The above grid gives you several other valuation measures with most of them at the 100% percentile reading, or record highs, advising caution.  The credit for this graph goes to Cresent Capital.

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From a sentiment standpoint, based upon the Equity Put/Call Ratio, we are at record levels never before seen.  This ratio measure the amount of bullish stock option buyers compared to bearish stock option buyers, and at the moment it appears almost all are bullish.  This also advises caution because any change in sentiment can cause a volatile reaction in stock prices at all those bulls try to stop the losses in their options and sell, leading to selling in the underlying stocks.  This graph comes credit of Charlie Biello.

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Another sentiment measure is the amount of cash available to continue to fund stock purchases.  The graph above shows that cash levels are low since everyone is bullish, and we are levels that in the past have led to stock market corrections.  This graph comes courtesy of Bank of America and also advises caution.

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Our final sentiment graph shows you the Bull/Bear survey results of the American Association of Individual Investors.  This graph shows you the level of bearish investors compared to the S&P 500 Index.  You can see the steady drop in the height of the red lines as the number of investors bearish this market since summer.  Too many people bullish, as noted above, give us caution.  This graph comes from Helene Meisler’s blog.

So what am I thinking?  We need a healthy correction, maybe in January in the post-Santa Claus Rally period, so that the speculators are shaken out of the market and the investors can take advantage of lower prices for the long term.  However, any correction looks – at least at the moment – like it would be short-lived.

The graph below comes from Clearbridge and gives you a dashboard look at the economy.  All of the factors, as of the past three month-ends, are supportive of a growing economy except Investor Sentiment (they also are noting that too much positivity can lead to stock market corrections and potential recessions) and Initial Jobless Claims are showing caution.

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Because of these factors, the likelihood of a healthy economy in months ahead means that post any correction, we should see a healthy rebound in the market possibly to new highs that are supported by improving corporate earnings.  This years rally has been all valuation expansion and not earnings driven.  A correction will bring those valuations back in line with recent (pre-covid) levels and growing earnings should propel the market forward.

Obviously we do not have a crystal ball, so as we saw in 2020, anything can happen.  Barring the economy closing down again, and our pulling out of the covid recession, we should see a healthy post-correction stock market in 2021.

Take care and Merry Christmas!

–Mark

 

 

Don’t Marry Your Stocks

November 20th, 2020

I recently performed a major rebalancing of client portfolios who have a Growth, Core or Fully Diversified investment objective, buying and selling a number of holdings so that portfolios would be in line with our views on the market (I will get to that in a bit).  Selling a stock holding can be difficult, but as an investor you have to remember that you don’t make any money when you buy a stock – you make it when you sell it.  It is very easy to buy a stock at the right price, ride the price up to new highs, then watch as you turn you big winner into a loss.  It’s why I tell people that you don’t marry your stocks – its OK to make a change when circumstances say it’s time.  

This got me thinking about what stocks were in client portfolios when I started this business in 1991.  Unfortunately we changed our computer system sometime in 1998 so I selected 12/31/1998 to look as some accounts and see what sorts of things we owned and what has happened to them since.  I chose a performance chart format so we can see how the stock price has done in all these years.

Walmart:

I thought we’d start with one of the survivors (or winners, if you will) of the passage of time

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You can see that if you were a patient owner of this stock, you would have done very well over all this time.  However, if we were looking at the performance at the end of a decade, you would not have been a happy investor at the end of 2009:

1For 10 years, you earned a whopping 34% return – I’m not sure any investor would be pleased with that return as it basically kept pace with inflation.

GE, Citigroup, AT&T, Xerox, Del Monte:

Many of the stocks owned in 1998 do not exist today, either because they were merged into another company (e.g., Compaq Computers, Sun Microsystems, Lucent) or because they have gone out of business (Sears, National City Bank).  These five companies still exist and I can guarantee you that there are folks that have owned them all of this time.

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Yes, there have been some companies that we owned in 1998 that have been huge winners for people, some of them are listed in the merged company list above.  But the idea here is that there is no reason to hold onto a stock if you see a catalyst that will likely cause it to flatline in return like the decade-long Walmart chart or to go down in price like GE above.

Why am I telling you this and what does it have to do with the major rebalancing of client portfolios?  Excellent question!

We are at an investment fulcrum where I believe the stocks of many of the market leaders since 2008 will likely flatline in price for a period of time (Two years? Ten years?  No way to know until you reach another fulcrum).

The cause of this investment fulcrum?  Covid, or rather the end of the Covid Recession.   This virus will work its way through the population and eventually we will achieve the herd immunity required for it to die out because you will either be vaccinated against it, you will have already had it (like me – it’s one of the reasons you haven’t heard from me on the blog in the past few weeks), or you have a natural immunity to it.  As we approach that point, the stock market will look forward and start to revalue the stocks of companies that prosper during economic expansions.

I expect that our economy will move from being stimulated by monetary policy to being stimulated by an infrastructure bill.  That infrastructure bill (as long as it goes to actual construction projects – in the past, we have seen state governments take Federal money and spend it elsewhere) will juice the natural growth that comes from an economy opening up again after a recession.  The stocks of companies that prosper coming out of a recession are the cyclical value stocks and the domestic-focused small cap stocks.

Over the past several years, I have focused client portfolios on large cap growth stocks and largely avoided value and small cap stocks based upon the economic policies our country adopted coming out of the 2008/2009 recession.  The massive monetary stimulus pushed down interest rates to zero and made investing in companies with ever-increasing valuations (i.e., expanding Price to Earnings ratios) make sense.  These were the only companies with consistently growing earnings and investors were willing to pay up to own companies with growing businesses.

However, investor face two major problems investing in highly valued large cap growth stocks in an expanding economy, when economic momentum is gaining speed: (1) even if the large cap growth stocks still have expanding earnings, they new have competition of other significantly lower valued companies with significantly lower P/E Ratios whose earnings are growing at the same or higher rates.  This means there is less demand from buyers of their stocks at the high valuations so when the supply of people wanting to sell their shares outpaces the demand of buyers, the stock price has to come down; and (2) as interest rates begin to rise those higher rates put pressure on valuation levels.  The valuations of companies go down as interest rates go up, even if their earnings continue to grow.

Now, I know you are going to say that interest rates will be low for a long time – you’ve heard it on the news, on internet, just about everywhere – you have even watched the Federal Reserve Chairman on TV telling you so.   However, I mean the rates material to corporations that occur in the bond market, not the overnight Fed Funds rate controlled by the Federal Reserve – that rate has been and will likely continue to be held artificially at the zero level for years to come.  However the bond market is totally independent of the rates set by the Fed.  If demand for capital increases because economic activity increases, and corporate America needs to borrow money to fund its growing business, they will go to the bond market and borrow it from investors.  The more demand, the higher the bond market can charge for the borrowing (yet again, supply and demand matter).

Also, as economic activity increases, prices can increase – think of all the businesses that have been nearly shut down or have had to lower their prices just to exist through this recession – once the demand is back for their goods and services and the covid restrictions are eased up, prices will rise.  As prices rise at the same time as demand increases for borrowing money, the lenders (in this case the people who buy the corporate bonds) will keep demanding higher and higher yields on the borrowed money so that they achieve purchasing power parity (or more simply, keep the buying power of their money stable despite the inflation).

All of this means that I expect (1) cyclical value stocks whose fates are tied to the economy to outperform growth stocks, and (2) domestically focused small cap stocks to outperform their internationally-focused large cap brethren who are doing business in places that will not likely have a domestic recovery until well after ours is underway.  Those growth stocks steady earnings and large cap stocks with an international focus will be valued less by investors because they can buy cheaper value stocks with the same or better earnings growth and small cap stocks with better earnings growth than large cap stocks that are less tied to our economic recovery.

Have I sold all of our large cap growth holdings? Absolutely not – however everything I own for clients has some catalyst or story that gives investors a reason to own them, even if their P/E’s are higher than normal.  For the bulk of the large cap growth companies, they will have to grow into their valuations, and that will take time.  It is much like what happened to Walmart all those years ago – it went from its high growth stage where investors drove its stock price up faster than its earnings so that its P/E Ratio was well above the median valuation for retail industry.  Their price didn’t need to fall, and in fact could increase a bit, but to drive down their P/E Ratio and get the resulting valuation of the company in line with the retail industry, their earnings growth had to far outpace their stock price growth.

Since 2008, the prices of large cap growth stocks grew faster than the earnings grew.  When Price was divided by Earnings, the valuation went up as the P got larger relative to the E.  Now, we will likely be watching the E grow faster than the P so that the valuation comes down to a level that will once again entice investors.  It’s sort of math that you have to pay attention to as an investor, otherwise you get stuck with companies in your portfolio that will cause your returns to suffer.

Investment Strategy

>I have rebalanced client portfolios to reduce economic risk, adding a significant allocation of Value and Small Cap stocks and reduced our allocation of Large Cap Growth stocks so that portfolios are in line with the coming economic expansion.

>Portfolios have a strong domestic bias over foreign to reduce the timing risk of foreign economies not recovering as quickly (or ever) as the US economy.

>Every stock I own in client portfolios has some sort of catalyst that I believe will cause investors to want to own their shares as that catalyst helps to drive their earnings higher.

>To reduce the individual company risk of owning stocks based upon projected earnings growth once the economy starts to recover, I have reduced the position size and increased the number of positions in portfolios.

>To make me sleep better at night owning such a large allocation to value and small cap, the projected earnings growth for the portfolio is > 15% and the projected Return on Equity is 25% (just remember that there is not a direct correlation between these numbers and stock price increases – lots of outside factors influence stock price growth, like whether the supply and demand for the company’s stock is favorable or not, whether the discount rate for corporate earnings is rising or falling, etc.  However, as long as earnings and returns are rising at these levels, one major factor in stock price movement is taken care of).

>I have also significantly reduced bond portfolio durations (for clients that are not invested 100% in equities) to protect against interest rate risk, keeping individual bond holdings short-term and bond mutual fund holdings short duration or floating rate.

Note:  In coming blog posts I will discuss the catalysts mentioned earlier in this post.  To give you preview, though, one of those is the Humanization of Pets.  One of the unexpected things to come out of the covid restrictions is an increase in the number of households that own pets.  Our society has moved to the point where pets are members of the family who get good food and medical care.  With the increase in the number of pets, comes increased demand for quality pet food and medical care.  As such, client portfolios own two leaders in the pet pharmaceutical field in client portfolios because of the increased demand for pet medical care.

Have a great weekend!

—Mark

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!

—Mark

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:

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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.

—Mark

The Path of Least Resistance

September 23rd, 2020

spx

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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.

qqq

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.

—Mark

Resistance Is Not Futile

September 16th, 2020

2020-09-16

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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:

2020-09-16 2

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!

—Mark

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

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