You Need To Understand NOW What Changed After The Fed Announcement

I’ve always liked to look at certain points during a bull market or bear market where the character of the market could change based on key fundamental news. We were at one of those points on Wednesday as 2 o’clock approached. The Fed was about to deliver their latest policy statement and traders were on pins and needles. Questions were swirling about what the Fed might say, and do, given the February Core CPI and Core PPI numbers that were reported higher than expected. The Fed already has squashed the bulls once recently, when they shot down the possibility of a March 2024 rate cut after expectations were building for exactly that. There were still the 3 rate cuts supposed to occur in 2024, but the Fed told us that higher rates would remain a bit longer.

Most traders are not blessed with great patience. Things could have turned ugly this past Wednesday at 2pm ET if the Fed decided to wait even longer to lower rates, possibly cutting the expected number of rate cuts from 3 down to some lower number. And what might happen if the Fed did an “about face” and said something that might indicate they’d have to reconsider hiking again? After all, this Fed hasn’t exactly been consistent in its discussion about interest rates.

Well, a lot of that anxiety came to an end on Wednesday as the Fed stuck to its previous guidance, despite the higher inflation reports the week prior. The stock market NEVER performs well when uncertainty is rising, but it generally does quite well when that anxiety is diminished. So at the moment the Fed indicated that nothing had really changed in their view, the stock market screamed higher, with the small cap IWM quickly testing overhead price resistance:

This was the chart I sent to EB members in my Daily Market Report on Thursday. Small caps received the news it was looking for and reacted according – to the upside. But the closing breakout never occurred on Thursday and that false breakout led to some profit taking on Friday. It’ll be interesting to see where small caps head this week. Since 1987, the annualized return for the IWM over the next 7 days is 41.20%, more than 4 times its average annual return. This tells us that history suggests a strong week ahead for small caps. But nothing is more important than the combination of price and volume. Before we grow overly excited about IWM’s prospects, we need to clear candle body price resistance, currently at 208.21.

Major Index and Sector Rotation

With this new information (basically the same as the old), and with inflation fears subsiding further, where did the money go from Wednesday 2pm ET through Friday’s close? Shouldn’t we be interested in what the big Wall Street firms were doing with their money after this fundamental announcement? Well, this is what the big boys were favoring after the announcement.

Major Indices

  • NASDAQ 100 (QQQ): +1.74%
  • Russell 2000 (IWM): +1.73%
  • S&P 400 Mid Cap (MDY): +1.55%
  • S&P 500 Large Cap (SPY): +1.11%
  • Dow Jones (DIA): +0.92%

Sectors

  • Industrials (XLI): +1.49%
  • Communication Services (XLC): +1.46%
  • Technology (XLK): +1.34%
  • Consumer Discretionary (XLY): +0.84%
  • Energy (XLE): +0.74%
  • Financials (XLF): +0.73%
  • Health Care (XLV): +0.48%
  • Materials (XLB): +0.42%
  • Real Estate (XLRE): +0.16%
  • Utilities (XLU): +0.05%
  • Consumer Staples: -0.08%

Clearly, money rotated and benefited “risk on” areas of the stock market, which is secular bull market behavior. Aggressive sectors led by a wide margin over defensive sectors. Money also returned to growth as most growth vs. value ratios turned higher after Wednesday 2pm ET as well.

Industry Group Rotation

We now know that money rotated in bullish fashion and to more growth-oriented areas, though industrials’ leadership and the S&P 500’s break to yet another all-time high after the Fed announcement is further evidence of wide participation in this latest advance. And with small caps right up there with the NASDAQ 100, all those breadth arguments can be tossed right out of the window.

Here’s what we should take away from industry group performance after the Fed meeting:

  1. Semiconductors ($DJUSSC) was #1 among ALL industry groups – not too shocking
  2. The Top 10 industry group performers belonged to either technology (XLK), consumer discretionary (XLY), or industrials (XLI)
  3. Heavy construction ($DJUSHV) had broken out a few weeks ago and the Fed announcement saw momentum increase significantly within this group
  4. Trucking ($DJUSTK) bounced off 50-day SMA support and is poised to break further into all-time high territory, a very bullish development for transportation stocks ($TRAN) in general
  5. Gold mining ($DJUSPM) and mining ($DJUSMG) both saw bullish initial reactions, but then gave back most of those gains by Friday

Big Loser

In my mind, it’s once again gold ($GOLD). I think many traders believed that falling rates ahead would trigger a drop in the U.S. Dollar (UUP). Not gonna happen. Any weakness in the dollar of late has been triggered by potential erosion by inflation. The Fed essentially said that inflation isn’t a problem, despite the higher CPI and PPI readings recently. Our economy remains quite resilient and unemployment remains low, especially compared to foreign economies. That’s why the UUP is strong. Another breakout in the UUP could be at hand:

I know many keep pointing to the recent breakout in GLD, but I want to OUTPERFORM the S&P 500 and the above chart shows you that, outside of a few short-term pops to the upside (blue-dotted directional lines), the overall RELATIVE performance line is going down, down, down in a very big way. No thank you.

A Rapidly-Improving Heavy Construction Small Cap Stock

I was focusing on the heavy construction area ($DJUSHV) this weekend, because of its recent strength and then the surge after last Wednesday’s Fed meeting and policy statement. There are a number of stocks that caught my attention, but one in particular that I believe has a LOT more upside given its current technical outlook. I’ll be sending it out to our FREE EB Digest subscriber community before the market opens tomorrow morning. If you’re not already a subscriber, you can CLICK HERE to sign up with your name and email address. There is no credit card required and you may unsubscribe at any time!

Happy trading!

Tom

Tom Bowley

About the author:
Tom Bowley is the Chief Market Strategist of EarningsBeats.com, a company providing a research and educational platform for both investment professionals and individual investors. Tom writes a comprehensive Daily Market Report (DMR), providing guidance to EB.com members every day that the stock market is open. Tom has contributed technical expertise here at StockCharts.com since 2006 and has a fundamental background in public accounting as well, blending a unique skill set to approach the U.S. stock market.

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The Bond Market is Signaling a Potential Short-Term Trading Opportunity

KEY

TAKEAWAYS

  • If treasury yields break out higher, consider selling the breakouts of bear flags and view short-term declines as selling opportunities
  • If yields break down lower, consider buying bull flags and setups.
  • There’s a chance that yields could push higher before correcting.

In our last piece, we presented a long term/secular outlook for intermediate-term Treasuries, where we concluded that the structural break above the secular downtrend from the September 1981 high, coupled with the push above the November 2018 pivot @ 3.25%, has changed the long-term secular trend from lower (a bull market) to neutral. More work is needed to move the secular trend from neutral to bearish. In this piece, we’ll assess how the weekly chart might interact with the monthly chart, and then begin to think about how investors can react to various scenarios as they are set up over the course of the next several weeks and months.

As a warning, my analysis of the shorter perspective time frame didn’t leave me with an actionable trade or even a clear expectation for a probable outcome over the next few weeks. I think the market is ready to move away from the current congestion zone, and I suspect that the direction out of the zone will provide shorter-term traders with ample opportunity for entries. This analysis has allowed me to identify the important chart points/zones around which I will pay particular attention to behaviors and market structure, and to define appropriate trading plans.

10-Year Treasury Yield: Annual Perspective

The chart below is the yearly perspective of the 10-Year Treasury note (INDX).

Chart 1: Annual Chart of the 10-Year Treasury Yield

Note the break of the secular downtrend and the push above the 3.35% pivot. It’s worth noting that the Moving Average Convergence/Divergence (MACD) oscillator has turned higher for the first time since 1985.

 Keep in mind the following points:

  • The basic definition of an uptrend is a market consistently defining higher highs and higher lows. For instance, a great example of a downtrend can be seen in the annual 10-year Treasury chart, where, over several decades, yields consistently made lower lows and lower highs, defining a very clear and obvious bull market (yields down/prices up).
  • For bonds to begin defining a secular bear (bond prices down/yields up), it will require yield to set back from a high pivot, define a higher low pivot, and subsequently make a substantive new high. From that point, you can draw tentative annual and monthly trendlines, and channel projections. You can also make Fibonacci and point-and-figure price projections. Importantly, this structure would define a secular bear and place weekly and monthly momentum harmoniously with annual momentum.  I expect this transition to occur over the next 12–18 months.
  • The biggest question in my mind is whether last October’s 4.98% high print marked the terminal point for the bearish structure that has built since the 0.40% low. I suspect that is indeed the case and that, by mid-year, yields will be falling. However, there is also a reasonable case for one final push higher into the stronger resistance zone at around 5.25%, before subsequently setting back and defining the higher low. Given this view, the evolution of the weekly chart over the next few months becomes particularly important.

10-Year Treasury Yield: Weekly Perspective

 Below is a weekly chart of the 10-Year US Treasury Yield ($TNX).

Chart 2: Weekly Chart of the 10-Year Treasury Yields Note the following points of the chart:

  • Bonds typically build reliable channels and trendlines, but the move from 0.40% is atypical in that a solid trendline or channel is difficult to find.
  • Since the move from the low doesn’t provide a solid trendline or channel, I am focused on the 2.52–3.25% (A-B) trend line. The decline from 4.98% since last October has repeatedly weakened it, and the bounce from the trendline has been very modest.
  • The inability of the trendline to generate selling (higher yields/lower prices) suggests that the pressure isn’t strong.
  • It is likely that a decline below the 3.79% pivot would likely stretch back to the 3.25% pivot, with a higher likelihood of the area around 2.65% (retracing roughly 1/2 of the 0.40% to 4.98% move).
  • The move from 3.79% has generally presented as a bull (lower yield/higher price) flag. Flags are usually corrective against the trend. Note that volume during the period has declined significantly (as would be expected), albeit from the extremely high volumes that developed during the move to last October’s high.
  • One of my favorite patterns is the “three drives to a high or low.” While this chart may technically qualify (3.48% –> 4.33% –> 4.98%) the push to 3.48% only barely qualifies, as it’s not proportional to the first two thrusts. This chart is potentially set up for a final drive higher to complete the sequence, perhaps into the strong resistance at the 5.25–5.35% area.
  • I will also be monitoring the price for a secondary test of 4.98%. A completed secondary test would set up for a significant bull (yield down/price up) market.

The balance of the structural evidence on the weekly chart favors lower yields, but it’s a close call and not particularly actionable from these levels.

Looking At Momentum

The multiple-screen momentum perspective below is a quick filtering method I use. Importantly, momentum is fractal (robust across time frames and markets). I prefer to derive the trend through the tape, so I only use the oscillators as a quick filter.

The chart below displays the annual, monthly, weekly, and daily charts of the 10-Year Treasury Yield. Note that on the chart, we move back to yield again.

Chart 3: Annual, Monthly, Weekly, and Daily Charts of the 10-Year Treasury Yield

An important point to remember: Rising yields = lower price.

  • Yearly momentum has turned toward higher yield/lower price.
  • Monthly momentum has turned toward lower yield/higher price. A slight negative divergence has formed, and the monthly is at odds with the yearly.
  • Weekly momentum is mixed/neutral, but attempting to turn to higher yield/lower price. This struggle around the zero line suggests that behaviors over the next few weeks will likely define the direction of the next 25–50 basis point movement.

I am most interested in the weekly trend (in rates, the weekly perspective is the most important), so I generally defer to the trend of one higher degree. In this case, the monthly is on a lower yield/higher price signal and is just now moving into the MACD quadrant, where significant declines (in yields) are likely to take place; Odds are better that the weekly will also turn to lower yield/higher price to be in harmony.  But, again, the evidence is mixed. Sometimes, you just need to let the price action evolve before drawing a solid conclusion.

A Weekly Perspective of TLT (Bond ETF)

Chart 4: Weekly Chart of TLT

Some important points re. volume:

  • Since we’re viewing the iShares 20+ Year Treasury Bond Fund (TLT), we’re looking at price (a downtrend is a bear market) rather than working with yield. This is because the yield indices we are using have no reported volume. The caveat here is that, in my professional capacity, I prefer to use futures volume, as they better represent institutional-rate investors, while TLT has a distinctly retail focus.
  • The evidence between futures and ETF volume is conflicting. TLT showed clear signs of short-term capitulation last October, but did not display a classic selling climax.
  • Futures are more ambiguous, with no clear surge in volume, but price behaviors are more consistent with a selling climax.
  • Since the October low, the volume in general has remained quite high, and the upward progress is relatively modest. The poor result for the effort expended suggests that the market continues to run into quality supply. The same price/volume relationship is also present in futures.
  • Note the rapid fall in volume over the last three to four weeks as the market tilted higher. This is consistent with a bear flag or pennant.
  • Finally, note the volume spike (arrow) as sellers leaned into the market a few weeks ago.  There are still strong-handed sellers willing to hit bids into strength.

I think the balance of evidence suggests that the market made a selling climax in October. That climax will likely hold for most of this year, but may be retested.

10-Year Treasury Yield Daily

Chart 5: Daily Chart of 10-Year Treasury Yield

 Note the following points:

  • Seasonal Tendency. Yields tend to set significant intermediate highs early in the year before declining into mid-year. We are near the end of the bearish (yields up/prices down) annual period. This would suggest a push lower (yield down/price up).
  • Yields have struggled to move away from the uptrend (A/B) but generally have built a bull (prices up/yields down) flag. Now, they are being squeezed between the internal resistance (gray lateral trendline) and the A-B channel bottom. From this perspective, bears (yields higher/prices lower) have an advantage.
  • If the market breaks higher from this zone, where would resistance materialize? If yields breakout higher from this zone, there isn’t much resistance between 3.50% and last year’s @ 4.89% high. Above 4.89%, 5.25–5.35% is a reasonable target.
  • If the market breaks lower from this zone, a solid support confluence exists in the 3.23–3.30% zone. But it is more likely the 0.50–0.618 retracement zone in the 2.15–2.70% zone would be in play. This would likely come as the result of an economic recession.

The Bottom Line

The next few weeks should represent a significant juncture in the daily and potentially the weekly chart. The market has generally been consolidating over the last several months, and the pattern breakout could be meaningful. For shorter-term traders, the direction out of the consolidation will likely define the direction of travel into the fall. In other words, it is a go-with.

  • If yields break out higher, I will likely begin selling the breakouts of bear (prices down/yields higher) flags and will view short-term declines in yields as selling opportunities. If lower, I will likely be a buyer of bull flags and setups (yields down/prices higher) as they develop.
  • If the market falls away from the trendline with velocity, the first solid support there is found in the 3.79% zone.
  • I continue to see a not-trivial chance of one last push higher into the 5.25–5.50% zone, before beginning a major weekly and monthly perspective correction (yield down/price up) that eventually makes the higher low. And while I see an advantage to being generally bullish over the next few months (falling yields, rising prices), the analysis is tentative, with only a small near-term advantage to the trade. In my trading, I would consider it non-actionable without additional price/volume development or reasonable structure to trade against. 

In deference to my macro work and business cycle work, I will be a better buyer of bullish inflections in the weekly chart over the next few months, as I fully expect a significant economic slowdown to develop into the end of the year.


Disclaimer: Shared content and posted charts are intended to be used for informational and educational purposes only. The CMT Association does not offer, and this information shall not be understood or construed as, financial advice or investment recommendations. The information provided is not a substitute for advice from an investment professional. The CMT Association does not accept liability for any financial loss or damage our audience may incur.

Good Trading.

Stewart Taylor, CMT
Chartered Market Technician

Stewart Taylor

About the author:
Stewart Taylor retired from Eaton Vance Management in January 2020 after a 40-year career in US fixed income with an emphasis on technical analysis and relative value investing. He joined Eaton Vance as the Senior Trader for the Investment Grade Fixed Income team in 2005. During his tenure, he was a portfolio manager for institutional separate accounts and mutual funds, managed the team’s inflation assets, and was the team’s strategist for duration, relative value, and economic positioning. From 1992 to 2005, he provided private investing and trading consultation to institutional buy side, broker-dealers, and hedge funds.
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What’s the Downside Risk for QQQ?

KEY

TAKEAWAYS

  • A bearish momentum divergence and declining Bullish Percent Index suggests rough waters ahead for the QQQ.
  • The 50-day moving average and Chandelier Exit system can serve as trailing stops to lock in gains from the recent uptrend.
  • If stops are broken, we can use Fibonacci Retracements to identify potential downside targets for the Nasdaq 100.

The Nasdaq 100 ETF (QQQ) is beginning to show further signs of deterioration, from bearish momentum divergences between price and RSI to weakening breadth using the Bullish Percent Index. How can we determine whether a pullback could turn into something more disastrous for stocks? Let’s look at how the 50-day moving average, Chandelier exits, and Fibonacci retracements can help anticipate downside risk for the QQQ.

To kick things off, we need to acknowledge how the QQQ has a place of distinction on the growing list of charts showing bearish momentum divergences.

This classic sign of a bull market top is when price continues to trend higher while the RSI (or some other momentum indicator) begins to slope downwards. Think of this pattern as a train running out of steam as it reaches the top of a hill. This weakened momentum usually occurs at the end of a bullish phase, when buyers are exhausted and there just isn’t enough momentum left to push the markets much higher.

But it’s not just about weakening momentum. Breadth conditions, which remain fairly constructive for the broader equity space, have really deteriorated in the past ten weeks.

Here, we’re showing the Bullish Percent Index for the Nasdaq 100. This is a market breadth indicator based on point & figure charts, and basically measures how many stocks in a specific index are currently showing a bullish point & figure signal.

Note how, in late December, this indicator was around 90%, meaning nine out of every ten Nasdaq 100 members were in a bullish point & figure phase. This week, we saw the indicator finished just below 50%. This shows that about 40% of the Nasdaq 100 members generated a sell signal on their point & figure charts in 2024.

What’s very interesting about that particular development is that point & figure charts usually have to show quite a bit of price weakness to generate a sell signal. So names like TSLA, AAPL, and others are breaking down, which suggests that further upside for the QQQ would be limited until this breadth indicator improves.


Are you prepared for further downside for the QQQ and leading growth names? The first item in my Market Top Checklist has already been triggered. Join me for my upcoming FREE webcast on Tuesday, March 19th, where I’ll share the other six items on the checklist and reflect on what signals we’ll be watching for in the coming weeks. Sign up HERE for this free event!


So what if the Nasdaq 100 does continue lower? At what point can we confirm that a corrective phase has truly begun? I like to keep things simple, so, in terms of an initial trigger for a tactical pullback, I always start with the 50-day moving average.

The 50-day moving average currently sits about $6 below Friday’s close, and also lines up pretty well with the February swing low around $425. So as long this level would hold, the short-term trend actually remains in good shape. A break below that 50-day moving average would tell me there is a much higher likelihood of further price deterioration.

But the 50-day moving average, while a simple and straightforward situation, is perhaps not the most effective way to gauge a new downtrend phase. Alexander Elder popularized the Chandelier Exit system in his books, and it represents a more nuanced version of a trailing stop because it is based on Average True Range (ATR).

Look back at the price peak in July 2023, and notice how the price remained above the Chandelier Exit through that price high. Soon after, the price violated the trailing stop to the downside, suggesting the uptrend phase was over and a corrective move had begun. Since the October 2023 low, the QQQ has consistently remained above the Chandelier Exit on pullbacks, as the price achieved higher highs and higher lows into March. After Friday’s drop, the Nasdaq 100 remains just above this effective trailing stop indicator.

So what if the Chandelier Exit is violated next week, and the QQQ begins to drop to a new swing low? What’s next for the Nasdaq 100?

Fibonacci Retracements can be so helpful in identifying assessing downside risk, because they measure how far the price may pull back in relationship to the most recent uptrend. Using the October 2023 low and the March 2024 high, that would give an initial downside target around $408. Further support could be at the 50% level ($395) and the 61.8% level ($382).

Note how well these levels line up with previous swing lows, especially the 61.8% retracement level. That last support level lines up with the swing low in December 2023, as well as the price peak in July 2023. I refer to that sort of level as a “pivot point” because it has served as both support and resistance, and these are often important levels to monitor.

A number of the mega-cap growth stocks, such as TSLA and AAPL, have broken down in recent weeks. But the latest patterns of bearish momentum divergences and declining breadth conditions tell us that there may be further downside in store for the Nasdaq 100. By keeping a watchful eye on trailing stops and potential support levels, we can perhaps navigate choppy market waters using the power of technical analysis.

RR#6,

Dave

P.S. Ready to upgrade your investment process? Check out my free behavioral investing course!


David Keller, CMT

Chief Market Strategist

StockCharts.com


Disclaimer: This blog is for educational purposes only and should not be construed as financial advice. The ideas and strategies should never be used without first assessing your own personal and financial situation, or without consulting a financial professional.

The author does not have a position in mentioned securities at the time of publication. Any opinions expressed herein are solely those of the author and do not in any way represent the views or opinions of any other person or entity.

David Keller

About the author:
David Keller, CMT is Chief Market Strategist at StockCharts.com, where he helps investors minimize behavioral biases through technical analysis. He is a frequent host on StockCharts TV, and he relates mindfulness techniques to investor decision making in his blog, The Mindful Investor.

David is also President and Chief Strategist at Sierra Alpha Research LLC, a boutique investment research firm focused on managing risk through market awareness. He combines the strengths of technical analysis, behavioral finance, and data visualization to identify investment opportunities and enrich relationships between advisors and clients.
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The Hoax of Modern Finance – Part 11: Valuations, Returns, and Distributions

Note to the reader: This is the eleventh in a series of articles I’m publishing here taken from my book, “Investing with the Trend.” Hopefully, you will find this content useful. Market myths are generally perpetuated by repetition, misleading symbolic connections, and the complete ignorance of facts. The world of finance is full of such tendencies, and here, you’ll see some examples. Please keep in mind that not all of these examples are totally misleading — they are sometimes valid — but have too many holes in them to be worthwhile as investment concepts. And not all are directly related to investing and finance. Enjoy! – Greg


Market Valuations

Because secular markets are defined by long-term swings in valuations, let’s look at the Price Earnings (PE) ratio and study its history. Robert Shiller created a valuable measure of PE valuation that uses trailing (actual) earnings, averaged over a 10-year period. Here’s how it is calculated:

  • Use the yearly earning of the S&P 500 for each of the past 10 years.
  • Adjust these earnings for inflation, using the CPI (i.e. quote each earnings figure in current dollars).
  • Average these values (i.e., add them up and divide by 10), giving us e10.
  • Take the current Price of the S&P 500 and divide by e10.

Figure 8.1 shows the S&P Composite on a monthly basis adjusted for inflation, back to 1871, with a regression line so you can get a feel (visually) of where the current price is relative to the long-term trend of prices. The lower plot is the Shiller PE10 plot, with peaks and troughs identified with their values. You can see that all prior secular bears ended with PE10 as a single digit (4.8, 5.6, 9.1, and 6.6). The PE10, on March 9, 2009, only got down to 13.3, which is considerably higher than the level reached by all prior secular bear lows. Based on this simple analogy, I think we have yet to see the secular bear low for this cycle. Remember, it does not mean that the prices have to go lower than they did in 2009; it just means the PE10 should drop to single digits. Remember, PE is a ratio of Price over Earnings. To make the ratio smaller, either the price can decline, the earnings can increase, or a combination of both.

As of December 31, 2012, the PE10 is at 21.3. Referencing the small box in the lower left corner shows that this value is in the fifth quintile of all the PE data. Based on this analysis, the market is overvalued.

So when the financial news noise is constantly parading analysts by touting the PE as overvalued or undervalued, you can count on the fact that they are using the forward PE ratio. The forward ratio is the guess of all the earnings analysts. They are rarely correct. Ignore them.

Finally, Figure 8.2 shows the PE10 in 10 percent increments or deciles. It shows the extreme level reached in the late 1990s from the tech bubble, it shows the 1929 peak, and it shows that, as of December 31, 2012, we are at the 82nd percentile of PE10. This puts the PE10 overvalued on a relative basis, and also on an absolute basis, as shown in Figure 8.1. Remember, PE10 used real reported (trailing) earnings, not forward (guess) earnings. As Doug Short says on his website at dshort.com: A more cautionary observation is that when the PE10 has fallen from the top to the second quintile, it has eventually declined to the first quintile and bottomed in single digits. Based on the latest 10-year earnings average, to reach a PE10 in the high single digits would require an S&P 500 price decline below 540. Of course, a happier alternative would be for corporate earnings to continue their strong and prolonged surge. If the 2009 trough was not a PE10 bottom, when would we see it occur? These secular declines have ranged in length from more than 19 years to as few as three. As of December 31, 2012, the decline in valuations was approaching its 13th year.

Secular Bear Valuation

Figure 8.3 shows the Shiller PE10 monthly for all the past secular bear markets since 1900, with the current secular bear (as of 2013) in bold. What is really interesting about this chart is that most of the secular bears began with PE Ratios in the 20 to 30 range and ended with them in the 5 to 10 range. The current secular bear began with a PE in the mid-40s and is now only back down to the level that the previous secular bears began. That could imply that the secular bear that began in 2000 could be a long one. These charts were created using monthly data; if yearly data were used, the concept would be even more pronounced.

Secular Bear Valuation Composite

In Figure 8.4, the current secular bear market valuation is shown in bold, with the other line representing the average of the previous four secular bears. Again, this type of analysis is just an observation and for educational purposes; you cannot make investment decisions from this. Investment decisions come from actionable information and analysis.

Secular Bull Valuation

Figure 8.5 of secular bull market valuations shows that most of them begin with PE ratios in the 5 to 10 (same as where secular bears end) and they end with PE ratios in the 20 to 30 range. The excessive secular bull of 1982 to 2000 reached unbelievable high valuations. I remember everyone saying that this time was different. Wrong!

Secular Bull Valuation Composite

 The secular bull market valuation composite is shown in Figure 8.6. It is the average of all the secular bull markets since 1900. Since we are currently in a secular bear market, the average of the secular bull markets is shown by itself.

Market Sectors

I use the sector definitions provided by Standard & Poor’s, of which there are 10. The other primary source for sector analysis is Dow Jones. Either is fine, I just prefer the S&P structure because I have been using it for so long. Table 8.1 shows the 10 sectors’ annual price performance since 1990, and Table 8.2 shows the relative performance of the total returns. When viewing a table of relative returns as in Table 8.2, keep in mind that each column (year) is completely independent of the preceding year or following year. Also, the relative ranking shows that those in the top part of the column outperformed those in the lower part of the column, independent of whether the returns were positive, negative, or a combination. Another value of this type of table is to show that picking last year’s top performer is not a good strategy. Remember, you cannot retire on relative returns.

This book does not get into the various uses of sectors as investments, but the book would not be complete without the mention of sector rotation and, in particular, how various sectors rotate in and out of favor based on the phase of the business cycle and the economy. A further delineation of sectors is their propensity to fall within the broad categories of offensive and defensive. This means that when the market is performing poorly, the defensive sectors will generally outperform, and when the market is performing well, it is the offensive sectors that are the top performers.

The phases of the economy known as economic expansions and contractions are affected by many events but generally boil down to recessions and periods of expansion. It should be noted, however, that not all contractions end up being recessions. The phases can then be broken down into early cycle, mid-cycle, and late cycle segments of the full cycle. There is a lot of literature available to cover all these details, but the point of this discussion is to show the rotational movement of the various sectors through the economic cycle.

Figure 8.7 is a graphic showing the sectors and where they fall in the cycle. It shows the rotation of sectors during an average economic cycle for the past 67 years and is courtesy of Sam Stovall, chief equity strategist, S&P Capital IQ. Sam wrote one of the best books on sector rotation years ago, Standard & Poor’s Sector Investing: How to Buy the Right Stock in the Right Industry at The Right Time, but is currently out of print as of 2013.

Another excellent study I have seen on the cycles within the phases and what sectors are affected was put out by Fidelity and dated August 23, 2010 (see Table 8.3). It clearly showed that, from 1963 through 2010, the following sectors were strongest during the various phases. In each cycle, the top-performing sectors are shown, with the first being the best of the four and the last being the worst of the top four, which is still the fourth best out of the 10 sectors.

It was interesting to note in this study that during all of the three cycles, Utilities and Healthcare were the two worst-performing of all 10 of the sectors (not shown). They only ranked in the top four during actual recessions. Since recessions are usually identified by the NBER about a year after they begin and sometime not until they have ended, this is not knowledge that you can make investment decisions with.

However, you can use a momentum analysis and always be in the top four sectors and probably do well. Clearly, this is certainly better than buy-and-hold or index investing.

Figure 8.8 shows the S&P 500 in the top plot and my Offensive-Defensive Measure in the lower plot. The concept of the Offensive-Defensive Measure is simple.

The Offensive Components

  • Consumer Discretionary
  • Financials
  • Industrials
  • Information Technology

The Defensive Components

  • Consumer Staples
  • Utilities
  • Healthcare
  • Telecom

You can see that the rally from the left side of the chart to point A (February, 2011) was strong; however, based on the switch from offensive to defensive sectors that occurred at point A, the investors were clearly concerned about the market. While the market traded sideways for months (see top plot), the defensive sectors were clearly in the lead, causing the offense-defense measure to decline. The measure declined significantly, and it wasn’t until point B (July 2011) that the market finally gave up and headed south.

Sector Rotation in 3D

Julius de Kempenaer has created a novel way of visualizing sector-rotation, or, more generally, “market-rotation,” in such a way that the relative position of all elements in a universe (sectors, asset classes, individual equities, etc.) can be analyzed in one single graph instead of having to browse through all possible combinations. This graphical representation is called a Relative Rotation Graph or RRG. As of 2013, Julius is now working together with Trevor Neil to further research and implement the use of RRGs in the investment process of investment companies, funds, and individual investors. More information can be found on their website www.relativerotationgraphs.com.

A Relative Rotation Graph takes two inputs that together combine into an RRG. I’ll use the S&P Sectors for this discussion. The first step is to come up with a measure of relative strength of a sector versus the S&P 500; this is done by taking a ratio between each sector and the S&P 500. Analyzing the slope and pace of these individual RS lines gives a pretty good clue about individual comparisons versus their benchmark. These raw RS lines answer “good” or “bad.” However, they do not answer “how good” or “how bad” or “best” and “worst.” The reason for this is that Raw RS values (sector/benchmark) for the various elements in the universe are like apples and oranges, as they cannot be compared based on their numerical value.

Taking the relative positions of all elements in a universe into account in a uniform way enables “ranking.” This process normalizes the various ratios in such a way that their values can be compared as apples to apples, not only against the benchmark but also against each other. The resulting numerical value is known as the JdK RS-Ratio—the higher the value, the better the relative strength. Additionally, not only the level of the ratio, but also the direction and the pace at which it is moving, affects the outcome. A concept similar to the well-known MACD indicator is used to measure the Rate of Change or Momentum of the JdK RS-Ratio line. Here also, it is important to maintain comparable values so another normalization algorithm is applied to the ROC; this line is known as the JdK RS-Momentum. The RRG now has JdK RS-Ratio for the abscissa (X axis) and the JdK RS-Momentum for the ordinate (Y axis). Graphically, the rotation looks like Figure 8.9.

In Figure 8.10, the sectors that are showing strong relative strength, which is still being pushed higher by strong momentum, will show up in the top-right quadrant. By default, the Rate of Change will start to flatten first, then begin to move down. When that happens, the sector moves into the bottom-right quadrant. Here, we find the sectors that are still showing positive relative strength, but with declining momentum. If this deterioration continues, the sector will move into the bottom-left quadrant. These are the sectors with negative relative strength, which is being pushed farther down by negative momentum. Once again, by default, the JdK RS-Momentum value will start to move up first, which will push the sector into the top-left quadrant. This where relative strength is still weak (i.e. < 100 on the JdK RS-Ratio axis) but its momentum is moving up. Finally, if the strength persists, the sector will be pushed into the top-right quadrant again, completing a full rotation.

The next step is to add the third dimension, time, to the plot to visualize the data on a periodic basis and in fact, somewhat like watching a flip chart or animation in which you can see the movement of each of the sectors around the chart as shown in Figure 8.10.

This technology, in static form, is available on the Bloomberg professional service since January 2011 as a native function (RRG<GO>) where users can set their desired universes, benchmarks, lookback periods, and so on. On their aforementioned website, Julius and Trevor maintain a number of RRGs, static and dynamic (animated rotation), on popular universes like the S&P 500 sectors (GICS I & II). Several professional as well as retail software vendors and websites are working to embed the RRG technology in their products, which should make this unique visualization tool available to a wider audience.

Asset Classes

Asset classes can be analyzed exactly the same as market sectors. The only limitation is that they are not tied as closely to economic cycles as sectors, so it is more difficult to identify those that are offensive or defensive. Table 8.4 shows the price performance of a multitude of asset classes. Remember, this table is only showing the annual performance of each asset for each year since 1990, while Table 8.5 has the asset classes ranked each year numerically. Normally, this type of table is shown with multiple colors, but somewhat difficult in a black-and-white book, so rankings are shown. Again, remember that the rankings only show the relative performance, and each year is totally independent of the preceding or following year.

The Lost Decade

Figure 8.11 shows the S&P 500 Total Return from December 31, 1998, to December 31, 2008. Two huge bear markets and two good bull markets. If you have a strategy that could capture a good portion of those bull markets and avoid a good portion of those bear markets, you would do really well. Buy and hold has lost money over this period.

I get asked all the time, “Are we going to have another bear market?” I answer that I can guarantee you that we will; I just have no idea when it will be. However, we can turn to another group of very bright people from the third-largest economy in the world (as of 2013) and look at their market. Figure 8.12 is the Japanese Nikkei from December 31, 1985, to December 31, 2011, a period of time of 26 years, over a quarter of a century.

Clearly, buy and hold was a devastating investment strategy, and the really bad news is that it still is. Figure 8.13 shows the up and down moves during this period, in which a good trend following strategy could have protected you from horrible devastation.

The percentage moves up are shown above the plot, and the percentage moves down are below the plot. These are the percentage moves for each of the up and downs you see on the chart. There were five cyclical bull moves of greater than 60 percent during this period. There were also five cyclical bear moves of greater than -40 percent. Remember, a 40 percent loss requires a gain of 66 percent just to get back to even. The small box in the lower right edge shows the decline from the market top in late December 1989 (–73.3 percent). A 73 percent decline requires a gain of 285 percent to get back even. Most people won’t live long enough for that to happen.

Finally, please notice that Figure 8.13 covers approximately 30 years of data and that the point on the right end (most recent value) is approximately equal to the starting point back in the mid-1980s; certainly the lost three decades. Buy and Hold is Buy and Hope.

Market Returns

It is always good to see how the markets have performed in the past. With the advent of the internet, globalization, minute-by-minute news, investors have a natural tendency to focus on the short term. Without a knowledge of the long-term performance of the markets, that short-term orientation can cause one to be totally out of touch with the reality that the market does not always go up. The following charts will show annualized returns for the S&P 500 price, total return, and inflation-adjusted total return over various periods. These types of charts are also known as rolling return charts. As an example, using the 10-year annualized rolling return, the data begins in 1928, so the first data point would not be until 1938 and be the 10-year annualized return from 1928 to 1938. The next data point would be for the 10-year period from 1929 to 1939, the third from 1930 to 1940, and so on.

Figure 8.14 shows the 1-year annualized return for the S&P price. It should be obvious that one-year returns are all over the place, oscillating between highs in the 40 percent to 50 percent range, and lows in the -15 percent to -25 percent range. Following Figure 8.14 are the 3-year (Figure 8.15), 5-year (Figure 8.16), 10-year (Figure 8.17), and 20-year (Figure 8.18) charts of annualized returns, with the average for all the data shown in the chart caption. Following the 20-year chart is a further analysis for the 20-year period.

The 10-year return chart now clearly shows up-and-down trends in the data (see Figure 8.17).

The 20-year rolling return chart (Figure 8.18) continues to reduce the short-term volatility in the chart, and the up-and-down trends become clear.

Since I adamantly believe that most investors have about 20 years to really put money away in a serious manner for retirement, the following two charts show returns over 20 years for total return (Figure 8.19) and inflation-adjusted total return (Figure 8.20).

For most analysis, the Price chart is more than adequate. In the world of finance, there is an almost universal demand for the Total Return chart; however, I think that if you are going to insist on Total Return, you should then also insist on Inflation-Adjusted Total Return. Using the three preceding 20-year charts and the averages shown, you can see that the average for Price is 6.97 percent, Total Return is 11.32 percent, and Inflation-Adjusted Total Return is 7.19 percent. What this says is that the effect of including dividends (Total Return) and the effect of Inflation often neutralize each other.

Table 8.6 shows the annualized returns for the S&P 500 for price, total return, and inflation-adjusted total return for the following periods: 1-year, 2-year, 3-year, 5-year, 10-year, and 20-year.

Table 8.7 shows the minimum and maximum returns, along with the range of returns, their mean, median, and variability about their mean (Standard Deviation).

Distribution of Returns

The range of return data is very easy to calculate because it is simply the difference between the largest and the smallest values in a data set. Thus, range, including any outliers, is the actual spread of data. Range equals the difference between highest and lowest observed values. However, a great deal of information is ignored when computing the range, because only the largest and smallest data values are considered. The range value of a data set is greatly influenced by the presence of just one unusually large or small value (outlier). The disadvantage of using range is that it does not measure the spread of most of the values—it only measures the spread between highest and lowest values. As a result, other measures are required in order to give a better picture of the data spread. The monthly returns for the S&P 500 begin with December 1927, so, as of December 2012, there are 1,020 months (85 years) of data.

Additional charts show the distribution of data in various ways using the 20-year annualized returns of the S&P 500 inflation-adjusted total return data for rolling 20-year periods. Twenty-year returns from the S&P 500 with 1,020 months of data would yield 778 data points. Return distributions can be thought of like this: Each bar represents the proportion of the returns that meet a percentage division of the data, mathematical division of the data, or statistical division of the data. The following are definitions of the various distribution methods, as shown in the title of the following figures.

  • Decile. One of 10 groups containing an equal number of the items that make up a frequency distribution. The range of returns is determined by the difference between the minimum and maximum returns in the series, then divided by 10 to create 10 equal groups.
  • Quartile. The calculation is similar to decile (above), but with only four groupings.

(Note: This use of decile and quartile does not follow the standard definition or calculation method often used in statistics.)

  • Standard deviation. A statistical measure of the amount by which a set of values differs from the arithmetical mean, equal to the square root of the mean of the differences’ squares. Figure 8.21 shows the percentage of the data that is included in a standard deviation. You can see that the mean is the peak and that 68.2 percent of the data is within one standard deviation from the mean, and 95.4 percent of the data is within two standard deviations of the mean.
  • Percentage. A proportion stated in terms of one-hundredths that is calculated by multiplying a fraction by 100.

Figure 8.22 shows the 20-year rolling returns using inflation-adjusted total return data distributed by quartiles. From the chart, you can see that 13.24 percent of the returns fall into the first quartile, or lowest 25 percent, of the data, 28.15 percent in the second, 32.90 percent in the third, and 25.71 percent in the fourth quartile or highest 25 percent of the data.

Figure 8.23 shows the same data, but in a decile distribution where each bar represents 10 percent of the number of data items. For example, 8.23 percent of the data fell in the highest 10 percent of the data.

Figure 8.24 shows the distribution of the data based on variance from the mean or standard deviation. You can see that the two middle bars each represent 34.1 percent of the data (68.2 percent total) that is one standard deviation from the mean. As an example, 33.68 percent of the 20-year rolling returns data was within one standard deviation above the mean of all the data. You can also surmise that the two bars on the right represent 50 percent of all the data and 53.86 percent (33.68 + 20.18) of the returns. Oversimplifying this, one then knows that there were more returns greater than the mean. However, there is an asymmetrical distribution between the returns that are outside of one standard deviation from the mean, with the larger percentage to the downside.

Figure 8.25 shows the 20-year rolling returns of the S&P 500 inflation-adjusted total return within percentage ranges. The bar on the left shows all the returns of less than 8 percent, which accounted for more than 50 percent of all returns (51.41 percent), while the bar on the right shows returns of greater than 12 percent, accounted for only 11.31 percent of all returns. The bar in the middle is the range of returns between 8 percent and 12 percent, which accounted for 37.28 percent of all returns. Recall the discussion in Chapter 4 on the deception of average, and once again the average 8 percent to 12 percent return is not average.

When the market starts to decline significantly, it is not the same as when someone yells “fire” in a theater. In a theater, everyone is running for the exits. In a big decline in the market, you can run for the exits, but first you have to find someone to replace you—you must find a buyer. Big difference! This chapter has attempted to stick to what I believe are market facts and essential information you should understand in regard to how markets work and have worked in the past. If one does not know market history, it would be very difficult to keep a focus on what the possibilities are in the future.

This concludes the first section of this book, where I have attempted to show you the many popular beliefs about the market that are used by academia and Wall Street to help sell their products. Part I also wraps up with what I believe to be truisms about the market. Part II has an introductory chapter on technical analysis and is followed by two chapters on extensive research into trend determination and risk/drawdowns.


Thanks for reading this far. I intend to publish one article in this series every week. Can’t wait? The book is for sale here.

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Flip the Script: Defense as Your New Offensive Playbook

KEY

TAKEAWAYS

  • March is a strong seasonal month for Utilities and Consumer Staples in relation to the broader market
  • Utilities and Consumer Staples are defensive plays which, if timed correctly, can result in a positive market outcome
  • The StockCharts Seasonality charts can help you identify sector plays that may not be readily apparent

Historical and seasonal performance data indicate that the Utilities and Consumer Staples sectors can be effective growth instruments, particularly in March. Technical analysis of the current price action for Utilities Select Sector SPDR Fund (XLU) and Consumer Staples Select Sector SPDR Fund (XLP) supports the thesis that these sectors are poised for growth, offering traders potentially favorable entry points for capitalizing on this seasonal trend.

If the best defense is a strong offense, then sometimes the most effective offense is a defensive tactic used offensively (as Napoleon did when he used the divisional square tactic in the Battle of the Pyramids). It’s a matter of proper placement and timing.

The same can be said when it comes to shifting growth vs. defensive tactics in your trades. Specifically, this article focuses on exploiting the Utilities and Consumer Staples sectors as growth instruments. It’s a matter of timing.

Exploiting Seasonal Growth Opportunities Using Defensive Sectors?

This article takes its queue and slight diversion from Tom Bowley’s insightful article, where he discusses the risk-on and risk-off environment, comparing XLU and XLP with the “ultra-aggressive” Technology Select Sector SPDR Fund (XLK), a Tech sector proxy. Bowley makes a compelling and balanced case to consider risk and caution as the current bull market continues to reach new heights.

This piece takes a bit of a diversion. Here’s the argument: From a seasonality perspective, March is XLU’s best month for growth and XLP’s second-best month for growth. In short, these two defensive plays happen to bring out their most aggressive characteristics (on a seasonal basis) in the month of March.

XLU’s 10-Year Seasonal Performance Against the S&P 500

CHART 1. 10-YEAR SEASONALITY CHART OF XLU VS S&P 500. Against the broader market, March is XLU’s strongest month.Chart source: StockCharts.com. For educational purposes.

On average and over 10 years, the Utilities sector (XLU) has outperformed the S&P 500 with an 89% higher-close rate and a 2.9% average return in March. Looking at all 12 months, you will not find a better-performing month than March.

XLP’s 10-Year Seasonal Performance Against the S&P 500

CHART 2. 10-YEAR SEASONALITY CHART OF XLP VS S&P 500. March is XLP’s second-strongest performance against the S&P following December.Chart source: StockCharts.com. For educational purposes.

On average, over 10 years, XLP has outperformed the S&P 500 with a 56% higher-close rate and a 1.3% average return in March. The average higher-close and return rates are strongest in December, but March is XLP’s second-best performing month.

Using “Safe” Plays as a “Bold” Move

Similar to the analogy mentioned above—using a defensive tactic to achieve an aggressive outcome—might it be prudent to shift trading focus to a “caution play” to get ahead of the broader market? Historically and seasonality-wise, this has played out well on average in the last 10 years, but whether the odds are in your favor this year really depends on the whims of market sentiment and whether you can find a sensible entry point in the current price environment.

After all, March is only a few days away.

XLU’s Price Action Now

CHART 3. DAILY CHART OF XLU. The swing chart makes directionality and entry/exit points clear.Chart source: StockCharts.com. For educational purposes.

The last two lower lows in January and February coincided with a rise in buying pressure, as indicated by the Money Flow Index (MFI), which you can also think of as a volume-weighted RSI. The bullish divergence between declining prices and increasing buying pressure foreshadowed this month’s price rise.

If you take a look at the ZigZag lines, you can see the swing points that define the trend. So, if XLU reverses course and rises to fulfill its seasonality-based projection, it would have to break above the two swing highs (see green dotted lines) at $62.25 and $62.62 to break the current downtrend. It would also have to stay above the most recent swing low (see red dotted line) at $59.15.

If you want to go long XLU, a break above $62.25 on high momentum might be a favorable entry point.

XLP’s Price Action Now

CHART 4. DAILY CHART OF XLP. Just sailing with no clouds in sight? Otherwise, a seemingly boring chart.Chart source: StockCharts.com. For educational purposes.

Consumer Staples (XLP) appears to be chugging along rather serenely. Looking at the Relative Strength Index (RSI), XLP is neither overbought nor oversold. It’s just there in the middle. To get a clearer and volume-weighted reading, look at the  Money Flow Index (MFI), which shows pretty much the same thing but with a slight upward tilt, indicating a slight rise in buying pressure.

The chart plots a trendline to show the main trend plus a Kumo (Ichimoku Cloud) for secondary context. Based on all of these readings, XLP gives every indication that it’s heading higher. So, if you’re looking to go long XLP to take advantage of its seasonality-based expectations, getting in a position near the trendline, say, $73.50 might be a favorable spot. You don’t want to see price fall below the trendline, and a close below $72.36, its most recent swing low, would likely invalidate the bullish thesis.

The Bottom Line

The strategic exploitation of Utilities (XLU) and Consumer Staples (XLP) sectors for seasonality-based opportunities is an interesting case in which you’d use defensive tools to seek growth. The timing, as with all trades, is crucial, and the coming month of March, historically the strongest for these sectors, offers a unique window for this strategy. Of course, seasonality is never a sure thing, so if you’re planning on pursuing this opportunity, be ready to exit upon the first indications that this season might not follow historical patterns.


Disclaimer: This blog is for educational purposes only and should not be construed as financial advice. The ideas and strategies should never be used without first assessing your own personal and financial situation, or without consulting a financial professional.

Karl Montevirgen

About the author:
Karl Montevirgen is a professional freelance writer who specializes in finance, crypto markets, content strategy, and the arts. Karl works with several organizations in the equities, futures, physical metals, and blockchain industries. He holds FINRA Series 3 and Series 34 licenses in addition to a dual MFA in critical studies/writing and music composition from the California Institute of the Arts.
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How Overextended Are You, QQQ?

We’ve highlighted all the warning signs as this bull market phase has seemed to near an exhaustion point. We shared bearish market tells, including the dreaded Hindenburg Omen, and how leading growth stocks have been demonstrating questionable patterns. But despite all of those signs of market exhaustion, our growth-led benchmarks have been pounding even higher.

This week, Nvidia’s blowout earnings report appeared to through gasoline on the fire of market euphoria, and the AI-fueled bullish frenzy appeared to be alive and well going into the weekend. As other areas of the equity markets have shown more constructive price behavior and volatility has remained fairly low, the question remains as to when and how this relentless market advance will finally meet its peak.

I would argue that the bearish implications of weaker breadth, along with bearish divergences and overbought conditions, still remain largely unchanged even after NVDA’s earnings report. The seasonality charts for the S&P 500 confirm that March is in fact one of the weakest months in an election year. So will the Nasdaq 100 follow the normal seasonal pattern, or will the strength of the AI euphoria push this market to even further heights into Q2?

By the way, we conducted a similar exercise for the Nasdaq 100 back in November, and guess which scenario actually played out?

Today, we’ll lay out four potential outcomes for the Nasdaq 100. As I share each of these four future paths, I’ll describe the market conditions that would likely be involved, and I’ll also share my estimated probability for each scenario. And remember, the point of this exercise is threefold:

  1. Consider all four potential future paths for the index, think about what would cause each scenario to unfold in terms of the macro drivers, and review what signals/patterns/indicators would confirm the scenario.
  2. Decide which scenario you feel is most likely, and why you think that’s the case. Don’t forget to drop me a comment and let me know your vote!
  3. Think about how each of the four scenarios would impact your current portfolio. How would you manage risk in each case? How and when would you take action to adapt to this new reality?

Let’s start with the most optimistic scenario, involving even more all-time highs over the next six-to-eight weeks.

Option 1: The Very Bullish Scenario

The most optimistic scenario from here would mean the Nasdaq basically continues its current trajectory. That would mean another 7-10% gain into April, the QQQ would be threatening the $500 level, and leading growth stocks would continue to lead in a big way. Nvidia’s strong earnings release fuels additional buying, and the market doesn’t much care about what the Fed says at its March meeting because life is just that good.

In this very bullish scenario, value-oriented stocks, including Industrials, Energy, and Financials, would probably move higher in this scenario, but would still probably lag the growth leadership that would pound even higher.

Dave’s Vote: 15%

Option 2: The Mildly Bullish Scenario

What if the market remains elevated, but the pace slows way down? This second scenario would mean that the Magnificent 7 stocks would take a big-time breather, and more of a leadership rotation begins to take place. Value stocks outperform as Industrials and Health Care stocks improve, but since the mega-cap growth names don’t lose too much value, our benchmarks remain pretty close to current levels.

Dave’s vote: 25%

Option 3: The Mildly Bearish Scenario

Both of the bearish scenarios would involve a pullback in leading growth names, and stocks like NVDA would quickly give back some of their recent gains. Perhaps some economic data comes in way stronger than expected, or inflation signals revert back higher, and the Fed starts reiterating the “higher for longer” approach to interest rates through 2024.

I would think of this mildly bearish scenario as meaning the QQQ remains above the first Fibonacci support level, just over $400. That level is based on the October 2023 low and also assumes that the Nasdaq doesn’t get much higher than current levels before dropping a bit. We don’t see defensive sectors like Utilities outperforming, but it’s clear that stocks are taking a serious break from the AI mania of early 2024.

Dave’s vote: 45%

Option 4: The Super Bearish Scenario

Now we get to the really scary option, where this week’s upswing ends up being a blowoff rally, and stocks flip from bullish to bearish with a sudden and surprising strength. The QQQ drops about 10-15% from current levels and retests the price gap from November 2023, which would represent a 61.8% retracement of the recent upswing. Defensive sectors outperform and investors try to find safe havens as the market tracks its traditional seasonal pattern. Perhaps gold finally breaks above $2,000 per ounce, and investors start to talk about how a break below the October 2023 low may be just the beginning of a new bearish phase.

Dave’s vote: 15%

What probabilities would you assign to each of these four scenarios? Check out the video below, and then drop a comment there for which scenario you select and why!

RR#6,

Dave

P.S. Ready to upgrade your investment process? Check out my free behavioral investing course!


David Keller, CMT

Chief Market Strategist

StockCharts.com


Disclaimer: This blog is for educational purposes only and should not be construed as financial advice. The ideas and strategies should never be used without first assessing your own personal and financial situation, or without consulting a financial professional.

The author does not have a position in mentioned securities at the time of publication. Any opinions expressed herein are solely those of the author and do not in any way represent the views or opinions of any other person or entity.

David Keller

About the author:
David Keller, CMT is Chief Market Strategist at StockCharts.com, where he helps investors minimize behavioral biases through technical analysis. He is a frequent host on StockCharts TV, and he relates mindfulness techniques to investor decision making in his blog, The Mindful Investor.

David is also President and Chief Strategist at Sierra Alpha Research LLC, a boutique investment research firm focused on managing risk through market awareness. He combines the strengths of technical analysis, behavioral finance, and data visualization to identify investment opportunities and enrich relationships between advisors and clients.
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With The Top 10 Picks In The Stock Market DRAFT, EarningsBeats.com Selects…

We’re one day away from “DRAFT Day”! Every quarter, we select the 10 equal-weighted stocks that will comprise our 3 portfolios – Model, Aggressive, and Income. My background is in public accounting as I audited companies in the Washington, DC – Baltimore, MD metropolitan area for two decades. While most of my teaching generally encompasses technical analysis and how I use it, I still haven’t let go of my “roots” on the fundamental side. Earnings matter to me. I believe that management teams should develop a business plan that works to their strengths and limits the impact of their weaknesses. And the BEST management teams execute their plan to perfection, beating their own expectations and those of Wall Street.

In order to take advantage of this clear competitive advantage in management teams, we created our flagship ChartList at StockCharts.com, our Strong Earnings ChartList (SECL). I believe that management performance and integrity is so important that I won’t select ANY company for our 3 portfolios, unless it’s on our SECL. Currently, we have 390 companies on this ChartList. Roughly 7-8% of them will be “drafted” by us tomorrow afternoon during our “Top 10 Stock Picks” live virtual event. It’s completely FREE and you’re welcome to join us and witness the process that I go through to assess the current stock market environment and then select the stocks in the best position to benefit from that environment. CLICK HERE for more information and to register.

Let’s look at 3 companies that MIGHT make sense in our portfolios and that will be given considerable consideration:

Walt Disney Co (DIS)

It looks like the triple bottom on the long-term DIS chart near 80 has held and a new uptrend has begun. For the first time since 2020, DIS has made a successful 20-week EMA test and then gone on to break out to new high. We hadn’t seen this since the 20-week EMA was tested during Sep/Oct/Nov 2020. Check this out:

That bottom panel is worrisome for sure. The broadcasting & entertainment index ($DJUSBC) has been absolutely horrific vs. the S&P 500 for 3 years now. Can DIS perform well in such an awful industry environment? Will the industry group begin to reverse, with DIS providing leadership? That’s a difficult call. What we do know, however, is that DIS just posted excellent quarterly results. Revenues came in at $23.55 billion, slightly ahead of consensus estimates of $23.41 billion. Earnings were quite strong, however, at $1.22 per share. Expectations were set at just $.97.

Is DIS worthy of a first-round draft pick? We’ll talk about that tomorrow.

Meta Platforms (META)

Many of our scouts are saying that META could be the #1 overall draft pick. Hailing from the incredibly bullish internet space ($DJUSNS), which has been second only to semiconductors ($DJUSSC) in terms of best relative performance to the S&P 500 over the past year, META has had an MVP type of season, leading its industry peers. Here’s the current chart:

META is one of 8 stocks on our Model Portfolio last quarter that still resides on our SECL. There’s a good chance it gets selected in back-to-back drafts. Over the past 3 months, META gained 41.63%, only beaten by Palo Alto Networks (PANW), which gained 51.22%. Not too surprisingly, our Model Portfolio racked up a quarterly gain of 21.87%, which CRUSHED the S&P 500’s gain of 10.08%.

Sure, it’s trendy to say that META is overbought, along with most every other key technology or communication services name. But those who only look at the last year’s STRAIGHT UP move like to conveniently ignore the fact that META dropped 75% the year before during the cyclical bear market. Market makers were able to scoop up this All-Star at dirt cheap prices for their wealthy institutional clients. Maybe those institutions can give the #1 draft pick acceptance speech, thanking everyone who panicked during that manipulation-driven selloff.

What about META’s fundamentals? Well, last quarter the company produced revenues of $40.11 billion, easily surpassing its $38.99 estimate. And instead of the widely-expected profit of $4.83, META blew the doors off that number, instead coming in at $5.33. What’s not to like here?

Let’s see if META has its name called first on Tuesday! Or how about the other 7 Model Portfolio returning starters? Could they be re-drafted? What a great problem to have!

AZEK Company (AZEK)

It’s easy to talk about META, AMZN, NVDA, etc., but our scout team needs to look deeper and take a stand on potential high-flyers from time to time. Yes, their floor might not be nearly as high as a company like META, but the potential to the upside can be staggering for smaller-cap companies. AZEK isn’t part of the scorching-hot technology (XLK) or communication services (XLC) sectors. Instead, AZEK is a $6.6 billion company in the industrials (XLI) sector and designs, manufactures, and sells building products for residential, commercial, and industrial markets in North America. Technically, it’s been an exceptional performer over the past few months:

Like META, AZEK is a relative leader in a leading industry group, building materials & fixtures ($DJUSBD), which I always love to see. The DJUSBD is the 8th best-performing industry group over the past year. But AZEK is also a smaller company and we know that small caps have struggled relative to their larger cap counterparts. Still, it’s hard to ignore the numbers posted by AZEK. Their revenues were $240 million vs. their expected $234 million. And earnings doubled expectations, $.10 vs. $.05. Results like this can change the future projection of earnings, especially when guidance is raised. AZEK raised its Q2 revenue guidance significantly from $381.6 million to a range from $407-$413 million. And then what happens if AZEK beats estimates again?

Is the potential here solid enough to result in a Top 10 selection?

We have our work cut out for us tomorrow. I’ll be secluded for the next 24 hours in our EarningsBeats.com “War Room”, deciding where the stock market may go over the next 3 months and which areas and stocks are poised to benefit from it. If you’re interested, you can find out more information about this FREE event and REGISTER here.

Happy trading!

Tom

Tom Bowley

About the author:
Tom Bowley is the Chief Market Strategist of EarningsBeats.com, a company providing a research and educational platform for both investment professionals and individual investors. Tom writes a comprehensive Daily Market Report (DMR), providing guidance to EB.com members every day that the stock market is open. Tom has contributed technical expertise here at StockCharts.com since 2006 and has a fundamental background in public accounting as well, blending a unique skill set to approach the U.S. stock market.

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The EarningsBeats.com Strategy For Uncovering The New Winners

Earnings and interest rates are always the key drivers to stock market success. There may be other short-term factors that influence price action, but, at the end of the day, rising earnings and interest rates conducive to job and economic growth is what results in secular bull markets.

Organize Your Trading Candidates With ChartLists

While I follow interest rates very closely and consider them when evaluating likely future market direction, it’s really the earnings reports that we follow most closely at EarningsBeats.com. Q4 earnings are not yet complete, but most of the very influential companies in the Dow Jones, S&P 500, and NASDAQ have reported. Our research, including earnings research, is organized into many ChartLists, which I briefly describe below:

  • Strong Earnings (SECL): companies beating both revenue and EPS estimates and meeting other liquidity and performance filters. I view it as a list of companies demonstrating high quality technicals and fundamentals. It’s the ChartList that I trade from most frequently.
  • Strong Future Earnings (SFECL): companies that show excellent relative strength (high SCTR scores) and adequate liquidity that are not already on the SECL. I think of it as a list of excellent companies that simply weren’t able to beat estimates in their prior quarter, but who are trading as though they may do so in the quarter ahead.
  • Strong AD (SADCL): companies showing excellent relative strength (high SCTR scores), adequate liquidity, and rising AD (accumulation/distribution, not advance/decline) lines. The AD lines IGNORES opening gaps and focuses only on price action during the day, with volume being the multiplier. Companies on this ChartList are companies that tend to trade higher into the close, suggesting morning weakness might be bought.
  • Raised Guidance (RGCL): companies that, as the name would suggest, raise guidance – either revenues, EPS, or both. I like management teams that feel confident in their business and raise guidance throughout the quarter.
  • Bullish Trifecta (BTCL): companies that are common to the SECL, SADCL, and RGCL. These companies have produced strong quarterly results, have raised guidance, and show possible accumulation by big Wall Street firms.
  • Earnings AD (EADCL): companies that gain AT LEAST 5% from the opening bell to the closing bell on the day after earnings are reported. I then review every one of these companies and provide my Top 30 – companies that I really want to consider trading in the days and weeks ahead.
  • Short Squeeze (SSCL): companies whose float is heavily shorted. We track those companies with short percentage of float in excess of 20%. High short interest can trigger massive short squeeze rallies.
  • Seasonality (SEASCL): companies that have a history of performing well during certain calendar months.
  • Portfolio ChartLists: every quarter, we provide a list of companies that we “draft” into our 4 portfolios – Model Portfolio, Aggressive Portfolio, Income Portfolio, and Model ETF Portfolio.
  • Relative Strength Industry Groups (RSICL): This is an exclusive ChartList for our annual members that tracks the relative strength of every industry group over the past few years. Trading leading stocks in leading industry groups is how you beat the S&P 500 and this ChartList provides us those leading industry groups.

There are other ChartLists that we create from time to time, but you can see from the above that our research is broad and provides a TON of great information for our members on a regular basis. But before trading anything, it makes sense to evaluate the current state of the market. Is the current rally sustainable?

S&P 500: Is the Current Rally Sustainable?

I say yes. Sure, we’ll have some pullbacks along the way, but right now money is flowing into aggressive areas of the market and that “risk on” environment bodes well for higher prices ahead. Check out this S&P 500 chart with several key “sustainability” ratios in the panels below the S&P 500 price chart:

Is this not obvious? Money continues to POUR INTO aggressive areas. The 6 sustainability ratios above can be summarized as follows:

  • QQQ:SPY – NASDAQ 100 performance vs. S&P 500 performance. The NASDAQ 100 is a much more aggressive index, focusing almost solely on high growth large cap stocks.
  • XLY:XLP – consumer discretionary vs. consumer staples. Two-thirds of our GDP is consumer spending. It just makes sense to see which area of consumer spending, aggressive discretionary vs. defensive staples, Wall Street is favoring. That tells us what the big Wall Street firms are expecting in the months ahead.
  • IWF:IWD – large cap growth vs. large cap value.
  • $DJUSGL:$DJUSVL – another measure of large cap growth vs. large cap value
  • $DJUSGM:$DJUSVM – mid cap growth vs. mid cap value
  • $DJUSGS:$DJUSVS – small cap growth vs. small cap value

Every one of my aggressive vs. defensive ratios is climbing. Personally, I love all the pessimists out there constantly trying to tear apart this bull market. The problem is that many analysts are trying to handpick one or two SECONDARY indicators to determine market direction, which is absolutely wrong in my opinion. We remain extremely bullish if we look at the primary indicator, which is price and volume. Sentiment does a great job of marking market tops and bottoms and my favorite sentiment signal is the equity only put call ratio ($CPCE).

Sentiment Paving The Path To Higher Prices….For Now

Despite the nearly straight-up move that we’ve seen on our major indices since late-October, there is little complacency in the options world. Over the past 11 years, or approximately the duration of this entire secular bull market, the average daily CPCE reading has been in the .60-.65 range. Readings higher than this show an unusually heavy dose of equity put buyers (which coincides with market bottoms or approaching market bottoms), while lower readings suggest an unusually heavy dose of equity call buyers (which coincides with market tops or approaching market tops). While action has been mostly bullish in 2024, the average CPCE reading in 2024 has been .65 – a far cry from the 5-day average readings of .55 and below that typically mark market tops. Check this out:

Those red arrows highlight the very low 5-day CPCE readings and show you where the S&P 500 was at roughly the same time. After reviewing this chart, I’d quickly conclude that this rally may continue until we see options traders start pouring into equity calls. Friday’s CPCE reading was 0.48. If the S&P 500 continues higher through much of next week, it’s possible we could finally get a 5-day CPCE reading below .55 to mark a top. Friday’s 0.48 reading was a good start. Keep an eye on this throughout next week.

What Stocks Are Likely To Lead The Next Market Surge

Well, I believe our Earnings AD ChartList (EADCL) will hold the key. Again, this ChartList comprises 30 names that performed exceptionally well the day after its earnings were released as new fundamental information started to be priced in. I expect many of them to perform very well in the weeks ahead. Most of the companies on this ChartList are leaders among their peers. But others might just be getting started. Let me give you 1 of the 30 stocks featured, and one that might fit this description of just getting started – Allegro Microsystems (ALGM), a $6.1 billion semiconductor company:

ALGM’s relative strength vs. its semiconductors peers has been awful. But is it just starting to reverse higher? The AD line began strengthening a few months ago at the initial bottom and, on Friday, ALGM finally broke above a triple top. Notice that volume that accompanied the post-earnings run. We never have any guarantees of future price direction, but I’d certainly say that ALGM has my attention and is a stock that I’ll be watching as this could be the start of a very powerful advance.

In tomorrow’s EB Digest, our FREE newsletter, I’ll be providing everyone a link to our ENTIRE Earnings AD ChartList. If you’re a StockCharts.com Extra or Pro member, you can download this ChartList right into your SC account. Otherwise, you can view all 30 charts to see which stocks could be our leaders in 2024. If you’re not already a FREE EB Digest subscriber, it’s easy to get started. Simply CLICK HERE and provide us your name and email address and we’ll be happy to send you that Earnings AD ChartList in our Monday EB Digest newsletter. There is no credit card required and you can unsubscribe at any time.

Happy trading!

Tom

Tom Bowley

About the author:
Tom Bowley is the Chief Market Strategist of EarningsBeats.com, a company providing a research and educational platform for both investment professionals and individual investors. Tom writes a comprehensive Daily Market Report (DMR), providing guidance to EB.com members every day that the stock market is open. Tom has contributed technical expertise here at StockCharts.com since 2006 and has a fundamental background in public accounting as well, blending a unique skill set to approach the U.S. stock market.

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The Hoax of Modern Finance – Part 7: The Illusion of Forecasting

Note to the reader: This is the seventh in a series of articles I’m publishing here taken from my book, “Investing with the Trend.” Hopefully, you will find this content useful. Market myths are generally perpetuated by repetition, misleading symbolic connections, and the complete ignorance of facts. The world of finance is full of such tendencies, and here, you’ll see some examples. Please keep in mind that not all of these examples are totally misleading — they are sometimes valid — but have too many holes in them to be worthwhile as investment concepts. And not all are directly related to investing and finance. Enjoy! – Greg


“Those who have knowledge don’t predict. Those who predict don’t have knowledge.” — Lao Tzu

So that there can be no confusion, I want to state my honest heartfelt opinion on forecasting: I adamantly believe there is no one who knows what the market will do tomorrow, next week, next month, next year, or at any time in the future—period.

Hindsight is a wonderful tool to use in order to know why something might have occurred in the past, but rarely is the cause known during the event itself. The prediction business is gigantic. William Sherden, in The Fortune Sellers, claimed that in 1998 the prediction business accounted for $200 billion worth of mostly erroneous predictions. Can you imagine with the growth of the Internet and globalization, what that industry is today? Frightening! As Oaktree Capital Management’s Howard Marks says, “You cannot predict, but you can prepare.”

Dean Williams, then-senior vice president of Batterymarch Financial Management, gave a keynote speech at the Financial Analysts Federation Seminar in August 1981, where he made some almost prophetic comments about investing that are as true today as they were then. He spoke about the relationship between physics and investing, but I have previously discussed that subject. Another comment was, “One of the most consuming uses of our time, in fact, has been accumulating information to help us make forecasts of all those things we think we have to predict. Where’s the evidence that it works? I’ve been looking for it. Really! Here are my conclusions: Confidence in a forecast rises with the amount of information that goes into it. But the accuracy of the forecast stays the same.” Later on, he added, “It’s that you can be a successful investor without being a perpetual forecaster. Not only that, I can tell you from personal experience that one of the most liberating experiences you can have is to be asked to go over your firm’s economic outlook and say, ‘We don’t have one.'” He goes on to talk about using simple approaches versus complex ones, delving into the fact that they also must be consistent approaches. This is a must-read; you can find it from an Internet search on Dean Williams Batterymarch.

Sherden states that the title “second oldest profession” usually goes to lawyers and consultants, but prognosticators are the rightful owners. Early records from 5,000 years ago show that forecasting was practiced in the ancient world in the form of divination, the art of telling the future by seeing patterns and clues in everything from animal entrails to celestial patterns. As Isaac Asimov wrote in Future Days, such was the eagerness of people to believe these augers that they had great power and could usually count on being well supported by a grateful, or fearful, public. I’m not so sure most of this isn’t applicable to today. Sherden did much research into the numbers of people directly involved in forecasting—and this data was from 1998. They are staggering and growing. And let’s not forget that one of the largest-selling newspapers in the country is the National Enquirer. Below are some of the findings on forecasting from Sherden’s book.

  • No better than guessing.
  • No long-term accuracy.
  • Cannot predict turning points.
  • No leading forecasters.
  • No forecaster was better with specific statistics.
  • No one ideology was better.
  • Consensus forecasts do not improve accuracy.
  • Psychological bias distorts forecasters.
  • Increased sophistication does not improve accuracy.
  • No improvement over the years.

A weather forecaster will have an exceptional record if he says simply that tomorrow will be just like today. If I were a weather forecaster, I would tend to err on the side of bad weather instead of good weather. Then, if you are wrong, most will not notice. It is when you forecast good weather, and it is not, that they will notice. Most market prognosticators tend to have a bullish or a bearish bias in their forecasts. Bullish forecasts are generally well-accepted, especially by the Wall Street community, and bearish forecasting is a giant business because it infringes on investors’ fears.

“Given the difficulties forecasting the future, it is very useful to simply know the present.” — Unknown

Barry Ritholtz (The Big Picture blog) recently pointed out how ridiculous the forecasting business has become. In particular, the end-of-the-year forecasts for the next year or the best stocks to own. Here is an example from the August 14, 2000, issue of Fortune magazine by David Rynecki on “10 Stocks to Last the Decade.”

August 14, 2000

  • Nokia (NOK: $54)
  • Nortel Networks (NT: $77)
  • Enron (ENE: $73)
  • Oracle (ORCL: $74)
  • Broadcom (BRCM: $237)
  • Viacom (VIA: $69)
  • Univision (UVN: $113)
  • Charles Schwab (SCH: $36)
  • Morgan Stanley Dean Witter (MWD: $89)
  • Genentech (DNA: $150)

Closing Prices December 19, 2012

  • Nokia (NOK: $4.22)
  • Nortel Networks ($0)
  • Enron ($0)
  • Oracle (ORCL: $34.22)
  • Broadcom (BRCM: $33.28)
  • Viacom (VIA: $54.17)
  • Univision ($?)
  • Charles Schwab (SCH: $14.61)
  • Morgan Stanley Dean Witter (MWD: $14.20)
  • Genentech (Takeover at $95 share)

Ritholtz goes on to say, “The portfolio managed to lose 74.31 percent, with three bankruptcies, one bailout, and not a single winner in the bunch. Even the Roche Holdings takeover of Genentech was for 37 percent below the suggested purchase price. Had you merely bought the S&P 500 Index ETF (SPY), you would have seen a gain of over 23 percent.”

On March 11, 2008, CNBC’s Mad Money host, Jim Cramer, emphatically said it was foolish to move money out of Bear Stearns. He claimed that Bear Stearns was just fine. He was totally wrong. A week later, JPMorgan agrees on March 16 to buy Bear for $236 million, or $2 a share, representing just over 1 percent of the firm’s value at its record high close just 14 months earlier. The deal essentially marked the end of Bear’s 85-year run as an independent securities firm. On Monday, March 17, Bear shares closed at $4.81 on optimism another buyer may emerge. The average target price: $2. Don’t confuse advice from someone in the entertainment business with advice from someone who manages money. In fact, don’t pay attention to anyone’s predictions. No one knows the future!

The Reign of Error

In 1987, a book was written entitled The Great Depression of 1990, by Dr. Ravi Batra, an SMU professor of economics. Sadly, I bought and read that book. Batra was claimed as one of the great theorists in the world and ranked third in a group of 46 superstars selected from all economists in American and Canadian universities by the learned journal Economic Inquiry (October 1978). The foreword was written by world-renowned economist Lester Thurow, who said The Great Depression of 1990 is crucial reading for everyone who hopes to survive and prosper in the coming economic upheaval. The title for one chapter was “The Great Depression of 1990–96.” Not only did he pronounce the beginning of it, he also proclaimed to know the end.

The 1990s saw the largest bull market in history, with the Dow Industrials rising from 2,700 to over 11,000 during the decade of the 1990s. By the end of the decade, we were flooded with books about the never-ending bull market, such as Dow 40,000 by Elias, Dow 36,000 by Glassman and Hassett, and Dow 100,000 by Kadlec. From 2000 until early 2003, we witnessed a bear market that removed most of the gains of the previous 10 years, with the Dow Industrials back down to about 7,350.

“We are making forecasts with bad numbers, but bad numbers are all we have.” — Michael Penjer

 These forecasts were dead wrong; however, I ‘m sure the authors sold a lot of books. The bad news in the stock market did not end after the bear market from 2000 to 2003; by March 2009, the Dow Industrials was below the level of the previous bear by another 8 percent. Agencies whose duty is to make forecasts were almost universally wrong during the 2006 to 2007 period, with forecasts of the economy, the markets, and the world outlook all positive; even the ones that weren’t quite as rosy were only modestly so. The business magazines were the same. How many forecasts do you find yourself reading and listening to? Did you ever research to see if any of them ever turned out to be correct? Or even close?

Finance is not the same as physics, in that no mathematical model can fully capture the large number of always changing economic factors that cause big market moves—the financial meltdown of 2008 is an example. Emanuel Derman says, “In physics, you’re playing against God; in finance, you’re playing against people.” The parallelism between physics and finance has gained support from author Nassim Taleb, who says, “It doesn’t meet the very simple rule of demarcation between science and hogwash.” Whether invoking the physicist Richard Feyman or the late Fischer Black, the use of mathematical models to value securities is an exercise in estimation. Derman further states, “You need to think about how to account for the mismatch between models and the real world.”

“Science is a great many things, but in the end they all return to this: Science is the acceptance of what works and the rejection of what doesn’t. That needs more courage that we might think.” — Jacob Bronoski

Long Term Capital Management (LTCM) was started by John Meriwether, who had a great following along with Myron Scholes and Robert Merton, two famous economists. Together, they grew LTCM into assets of more than $130 billion, using a model they claimed would achieve exceptional returns without the usual risk. That alone should have been all the warning anyone needed. In 1997, their model did not do well, and by mid-1998 they had lost all of it; they had borrowed more than a trillion dollars to make investments. The story ended in September 1998, when the New York Federal Reserve Bank led a group of organizations to step in and bail them out; shortly thereafter, there was no more LTCM. Academics with sophisticated models are a dangerous lot. And here’s the best part—just before the demise, Scholes and Merton won the Nobel Prize for economics for their efforts in financial risk control.

LTCM was not alone; stories of hundreds of funds have gone out of business after short periods of exceptional success. Rogue trades were rampant. Remember Nick Lesson of Barings Bank? How about Jerome Kerviel of Societe Generale, or a host of large banks during the period? The list is long and growing. Enron, WorldCom, and Global Crossing were just a few large companies that went bankrupt, taking their employees’ pensions and investments with them. I don’t recall anyone ever anticipating any of these failures; forecasters never do.

After the inflationary decade of the 1970s, the price of gold was soaring. In the early 1980s, forecasts of gold reaching unbelievable heights were everywhere. They were supported with the facts that gold’s fixed value was released in 1971 and it was free to trade, and trade it did. The Hunt Brothers had bought a large portion of the silver market. No forecaster saw anything but higher prices. I recall buying three 100-ounce bars and wishing I had more money to buy more. You will see in Chapter 11 on drawdowns that gold plummeted in 1981, and it took more than 25 years to get back to its peak. And by 2013, the forecasts of gold going to the moon were everywhere.

At what point will we start to believe that forecasting is a hoax? This book is about the stock market, where the forecasting business is huge. I can tell you this: stock market forecasters are no different than economic forecasters. The ones who get lucky with a forecast are the ones who have yet to be wrong. I think the worst of them are the ones I call outliers (not to be confused with outlaws); these are the ones who, through some stroke of luck, make a forecast about something big and it turns out to actually happen. However, it is rarely in the exact manner of the forecast, but that is soon forgotten as he or she is paraded through the financial media as the guru of the year. They start newsletters, hold conferences, and embark on periods of more and more forecasts because they are now experts. Yet, most rarely make another correct forecast. John Kenneth Galbraith said: “When it comes to the stock market, there are two kinds of investors: those who do not know where it is going, and those who do not know that they do not know where it is going.”

An Investment Professional’s Dilemma

When speaking to investment advisors, I often remind them that they must deal with two realities:

  1. Your clients expect you to have answers.
  2. The market is unpredictable.

Once you have your clients believing #2, then the questions for #1 will be easier to answer. Most advisors, and especially their clients, get caught up in the moment and are easily swayed into believing that some expert actually knows the future. Or that they focus on the recent past and extrapolate that ad infinitum.

“Mind you, you should take economic forecasts—even my own—with a big grain of salt.” John Kenneth Galbraith may have been more right than econometricians like to think when he said that “The only function of economic forecasting is to make astrology look respectable.”

Nobel Prize-winning economist Kenneth Arrow has his own perspective on forecasting. During World War II, he served as a weather officer in the U.S. Army Air Corps, working with individuals who were charged with the particularly difficult task of producing month-ahead weather forecasts. As Arrow and his team reviewed these predictions, they confirmed statistically what you and I might just as easily have guessed: The Corps’ weather forecasts were no more accurate than random rolls of a die. Understandably, the forecasters asked to be relieved of this seemingly futile duty. Arrow’s recollection of his superiors’ response was priceless: “The commanding general is well aware that the forecasts are no good. However, he needs them for planning purposes.” (Peter Bernstein, Against the Gods)

“You don’t need a weatherman to know which way the wind blows.” — Bob Dylan

The book Dance with Chance by Spyros Makridakis (an author who wrote a wonderful business-forecasting book a couple of decades ago) gives a short story about Karl Popper. Popper was a philosopher of science born in Austria. In the 1930s, he leveled a charge against Sigmund Freud, whose psychoanalytical theories had gained widespread acceptance. Popper pointed out that real scientists start with conjectures, which they then try to refute—as well as seeking evidence to support them. Only by failing to disprove their hypotheses, can they prove they were correct. Meanwhile pseudoscientists, as Popper called them, only look for events that prove their theories correct. Theories like this are little more than untested assertions. That’s not to say the assertions can’t eventually turn out to be right, but we can only reach this conclusion once someone has tested them.

“Forecasting the future is much more difficult than forecasting the past.” — Unknown

Forecasting the future of monetary, economic, financial, or political possibilities has a serious flaw in that regardless of if your forecast is close to being correct, or even if it is spot on, the assumption about how the market will react is where the big problem lies. There is a flawed belief that positive events from political, economic, and monetary news will reflect positively on the markets. Conversely, negative news events will reflect negatively on the markets. This simply is not true. You can see that there is hardly any usable correlation to these events and the markets; earnings announcements are a perfect example. How many times have they been positive and the stock market did not react accordingly? The gap between a good economic or monetary forecast and the reality of what the market does is huge.

“There is always a reason for a stock acting the way it does. But also remember that chances are you will not become acquainted with that reason until sometime in the future, when it is too late to act on it profitably.” — Jesse Livermore

The following (slightly modified) comes from Gary Anderson, who wrote the must-read book entitled The Janus Factor. The link between fundamentals and price is elastic, and rarely still. At times, good earnings reports cause the price of a stock to rise, while at other times traders use positive earnings news to sell the same stock. Will a global crisis increase the value of the dollar or send it lower? The linkage between change in the world and change in the market is often ambiguous and sometimes just plain mysterious. In most cases, human beings are clever enough to create plausible stories to account for the market’s response to events, but too often only with the aid of hindsight. There is a constant shift in the fundamental reasoning used to support decisions to buy and sell. The financial media is constantly justifying each move in the market with whatever recent event they can find that supports that move. Fundamental conventions supporting buy/sell decisions can vary from period to period and have no place in rational investing.

We can draw a useful distinction between reasons and causes. Earnings do not cause prices to move, nor do research reports, news bulletins, talking heads, dividends, stock splits, the economy, peace, or war. These factors may be reasons motivating traders to buy and sell, but the direct cause of a stock’s price movement is the buying and selling activity of traders and investors. We focus on causes, not reasons—on what traders do, not why. This is accomplished by measuring price and price derivatives (breadth, relative strength) of price movement.

Gurus/Experts

What would we do without all the experts, gurus, pontificators, purveyors of gloom and doom, and, of course, the perma-bulls and perma-bears?

First of all, a giant industry would be gone, an industry that generates billions of dollars in the USA alone. I’m not going to spend a great deal of time on this, because the website of CXO Advisory Group LLC, CXOadvisory.com , does all the heavy lifting. They have an entire section devoted to GURUS. Here are the two questions they ask at the beginning of that section: “Can experts, whether self-proclaimed or endorsed by others (publications), provide reliable stock market timing guidance? Do some experts clearly show better intuition about overall market direction than others?” They address these questions with a logical and transparent process. After following more than 60 experts and thousands of observations, near the end of the Guru section, they conclude: “The overall accuracy of the group, based on both raw forecast count and on the average of forecaster accuracies (weighting each individual equally) is 47 percent. In summary, stock market experts as a group do not reliably outguess the market. Some experts, though, may be better than others.” Hmmm! It seems like a coin toss, on average, would do better.

Additionally, CXOadvisory.com reviews numerous academic papers, and then does its own backup analysis to determine if the paper’s author and they agree. An excellent piece, when reviewing Charles Manski’s July 2010 paper entitled “Policy Analysis with Incredible Certitude,” categorizes incredible analytical practices and underlying certitude. These four are:

  1. Conventional certitudes (conventional wisdom)—Predictions (indicators) that experts generally accept as accurate, but are not necessarily accurate.
  2. Dueling certitudes—Two contradictory predictions that competing experts present as exact, with no expression of uncertainty (leading to conflicting strong investment strategy recommendations).
  3. Conflating science and advocacy—Developing arguments (assumptions) that support an investment strategy rather than an investment strategy that supports evidence-based arguments, while portraying the deliberative process as scientific.
  4. Wishful extrapolation—Drawing a conclusion about some future situation based on historical tendencies and untenable assumptions (ignoring differences between the historical and future situations, and emphasizing in-sample over out-of-sample testing).

If you have ever watched television, read a newsletter, or attended a seminar, I’m sure the above sounds familiar. People who appear as experts generally aren’t any better than the masses; however, when they are wrong, they are rarely held accountable, and never admit it (generally). They will respond that their timing was just off or some catastrophic event caught them off guard, or worse—wrong for the right reasons.

There is a book by Philip Tetlock, Expert Political Judgement: How Good Is It? How Can We Know?, that deals with the business of prediction. Tetlock claims that the better-known and more frequently quoted they are, the less reliable their guesses about the future are likely to be. The accuracy of their predictions actually has an inverse relationship to his or her self-confidence, renown, and depth of knowledge. Listen to experts at your own risk.

Larry Williams was an active and renowned trader before I even began to show interest in the markets. There is one significant point that Larry has made consistently that needs to be repeated here. If you are going to be mentored by someone, if you are going to read someone’s book on trading/investing, if you are going to sign up for a course of instruction from someone, please make sure they are qualified to teach the subject. This does not always translate into how they trade or invest. Like Larry says in his Trading Lesson 16, Kareem Abdul-Jabbar tried coaching and was a disaster at it; Mark Spitz’s swimming coach could not swim. However, the bottom line is that the best teachers are probably the ones who actually trade and invest, as they have firsthand experience to the nuances of the skill. This argument is not unlike the one between the ivory tower academics and those involved in the real world applying their craft every day. While they may have considerable talent to offer, your chances are probably better with a real practitioner.

Masking an Intellectual Void

My formal education was in aerospace engineering. My education in “The World of Finance” came and continues to come from people in the investment industry I have grown to respect. I hate to list some as fear of leaving someone out, but Ed Easterling, John Hussman, and James Montier are certainly at the top of the list. Are these professionals always correct? Of course not, but they usually admit it and they write in such a manner that they know the uncertainty is always there and yet present valid arguments on a wide range of topics and concepts. The rest of the learning comes for reading literally hundreds and hundreds of white papers in finance and economics. This process caused my concern at the insane use of advanced mathematics, usually in the form of partial differential equations, to supposedly assist in making the point that the paper was addressing. I cannot tell you how many times I thought that most of the math was unnecessary and more often than not the paper would have stood alone without the math. In many instances I think there is an attempt by most to overly complicate their work with mathematics with the belief that it brings credibility to their work. Another reason, and one I certainly cannot prove, is that they also know that most people who read their paper, other than their peers, will not grasp the math and just assume it is valid and necessary.

The senior special writer, Carl Bialik, of The Wall Street Journal, who writes a section called “The Numbers Guy”, is one of my favorite reads. As I was wrapping up research for this book and thinking that I had included enough opinions about things without substantial evidence, I was delighted to find support from Carl for this section on “Masking an Intellectual Void.” On January 4, 2013, he wrote two articles entitled, “Don’t Let Math Pull the Wool Over Your Eyes,” and “Awed by Equations.” Those articles referenced two papers that gave support to my belief in the overuse of mathematics, and how readers of white papers generally were impressed with what they actually did not understand. Research was conducted using only the abstracts of two papers, one without math, and one with math; the catch being that the one with math was bogus, totally unrelated to the paper. Yet the highest percentage of participants who gave the highest rating to the abstract with added math, based on the participants’ educational degree, was as follows:

Math, Science, Technology      46 percent 

Humanities, Social Science     62 percent 

Medicine            64 percent 

Other           73 percent 

I think this shows that those who had a high probability of not understanding the math gave the paper with the bogus math a higher rating, while those who possibly did understand the math did not.

This is just my lame attempt at humor. The financial academics have almost universally used partial differential equations in their white papers; I think, more often than not just to hide an intellectual void. Many times, the difficult math is not necessary, but by including it, they know most will never be able to question their work. Sad, indeed! Incidentally, the equation can be simplified to 1 + 1 = 2.

Earnings Season

For decades, I have watched the parade of earnings announcements and how the media hangs on each one as if it actually had some value other than filling dead air. Figure 5.1 shows the stock price of Amazon back in the 2000-2001 bear market. The annotations are from actual earnings forecasts from analysts. If you yell “buy” all the way down, the odds are good that you will eventually be correct. Hopefully, you will still have some money.

“In our view, security analysts as a whole cannot estimate the future earnings pattern of one or more growth stocks with sufficient accuracy to provide a firm basis for valuation in the majority of cases.” — Benjamin Graham

It seems that the media is so focused on earnings reports that they forget to report the actual earnings. Instead, their focus is on where the earnings came in relative to the analysts’ estimate. After beating up on experts, it is hard to imagine that someone would actually make an investment decision based on an analyst’s (expert) guess as to what earnings should be. These analysts are constantly wined and dined by the companies they analyze, so, in general, I think they are biased, and almost always to the upside. In fact, I think most are really just trend followers, in that they are always forecasting better earnings as markets rise and, once a market rolls over and begins to decline, they eventually begin to forecast lower earnings.

Figure 5.1

When asked what investors’ greatest problems are, the late Peter Bernstein said, “Extrapolation! They believe the recent past is how the future will be.”

Are Financial Advisors Worth 1% of AUM (Assets Under Management)?

“People who need advice are least likely to take it.” — Unknown

Many asset managers hold entirely too many stocks and have become closet benchmark trackers. If they beat their benchmark, they call it alpha, and when they do not beat their benchmark, they call it tracking error. If your investment manager rebalances your portfolio periodically based on a few questions that he required you to answer when setting up the account, here are some things to think about. Usually, the risk tolerance and objective questionnaire is much more involved, but here are two questions typically asked:

  1. What percentage of current income will you need when you retire?
  2. On a scale from 1 to 7, what is your risk tolerance?

Do you honestly believe a person knows the answers to those questions? No way! They will try to answer based on what the advisor has told or suggested to them. The law requires this type of action for advisors, so pick an advisor you think will actually meet your needs and, if you are unsure, can point you in the right direction.

Economists Are Good at Predicting the Market

“The economy depends about as much on economists as the weather does on weather forecasters.” — Jean Paul Kauffman

Just to put this into perspective, the stock market is a component of the index of leading indicators. If the stock market is a good leading indicator of the economy, why ask an economist what the market is going to do? Yet they are paraded daily across the financial media, making forecasts about the markets, political policy, fiscal policy, monetary events, and, yes, occasionally about the economy. When they are correct, they won’t let you forget it; when they are wrong, no one remembers. Many economists are good when dealing with the economy, but rarely are they good when they stray into other areas.

News Is Noise

Here is a humorous attempt to portray some of the daily noise often referred to as news. On Wall Street today, news of lower interest rates sent the stock market up, but then the expectation that these rates would be inflationary sent the market down, until the realization that lower rates might stimulate the sluggish economy pushed the market up, before it ultimately went down on fears that an overheated economy would lead to once again an imposition of higher interest rates.

Rolf Dobelli, writing for The Guardian, on April 12, 2013, in an article entitled “News is bad for you—and giving up reading it will make you happier,” listed these problems with news:

  • News misleads.
  • News is irrelevant.
  • News has no explanatory power.
  • News is toxic to your body.
  • News increases cognitive errors.
  • News inhibits thinking.
  • News works like a drug.
  • News wastes time.
  • News makes us passive.
  • News kills creativity.

He claims he has gone without news for four years and says it isn’t easy, but it’s worth it. Since he wrote for a news organization, I would imagine he is also looking for work.

“If you can distinguish between good advice and bad advice, then you don’t need advice.” — VanRoy’s Second Law

When asked at seminars what is the single most important concept to understand when investing, I respond simply that it is to know thyself. The human mind is a horrible investor, and the use of heuristics does not help. The next chapter deals with human behavior as it relates to the market.


Thanks for reading this far. I intend to publish one article in this series every week. Can’t wait? The book is for sale here.

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S&P 500, Dow Jones Hit All-Time Highs Again; Tech Stocks Back in the Spotlight

KEY

TAKEAWAYS

  • The S&P 500, Dow Jones Industrial Average, and Nasdaq 100 closed at all-time highs
  • Tech stocks are back in focus as mega-tech companies wrap up their Q4 earnings
  • Investors should take advantage of pullbacks if they want to add positions to their portfolios

What a week! Mega-cap tech stocks, the Fed meeting, and January’s nonfarm payrolls made headlines this week, creating an exhilarating week for investors. Friday’s stock market price action was an unexpected, but optimistic end to the trading week.

Jobs, Jobs, Jobs

The January jobs report came in way better than expected, and you’d think that would lead to a selloff after Fed Chairman Powell’s comments on Wednesday. Yet investor optimism prevailed, and the broader stock market indices closed higher, with the S&P 500 ($SPX), Dow Jones Industrial Average ($INDU), and Nasdaq 100 ($NDX) closing at an all-time high. It’s beginning to sound like a broken record, almost as if the stock market is waiting for the Nasdaq Composite to catch up and notch a new record high.

The blowout jobs report from the Bureau of Labor Statistics showed that the US economy added 353,000 jobs, well above the 185,000 estimate. The unemployment rate was 3.7%, slightly lower than the expected 3.8%. Wage growth also rose.

Thus, a combination of more jobs and higher wages buries even the slightest probability of a March rate cut. May is still a ways away, and plenty of data will come out before then, but it would be surprising if anything moves the needle enough to warrant a rate cut in March.

A strong labor market is great for the economy. The question is whether it aligns with what the FOMC wants to see—a rebalancing of the labor market. It’s possible that a rebalance between supply and demand of jobs will occur, given that hours worked per week fell to 34.1. If that continues to fall, and companies start cutting jobs, that would indicate a rebalancing. Another data point to focus on is the number of people working or available for work. If that also declines, it would be further confirmation that the supply and demand forces of the labor market are coming more into equilibrium. But we won’t know that for a while, and investors seem to have shifted their focus to the present.

Tech Stocks Back In Focus

The stock market didn’t seem worried about the stellar jobs report, and Chairman Powell’s comments are now in the rearview mirror. The broader market indices closed higher, with big tech stocks in the spotlight. Earnings from Alphabet (GOOGL), Microsoft (MSFT), Amazon (AMZN), Apple (AAPL), and Meta Platforms (META) were mixed, but that didn’t stop tech stocks from being the stars at the tail end of the trading week. AI is still the buzzword that fuels this market.

Consumer demand is strong, as reflected by Amazon’s earnings on Thursday. And META, which reported strong Q4 earnings and positive Q1 guidance, soared after Thursday’s close. But that wasn’t all; META will be issuing a quarterly dividend of $0.50 per share for the first time. This news boosted the stock price higher, and META closed at $474.99 per share, up 20.32%, hitting an all-time high. That’s a $197 billion addition to its market cap.

CHART 1. META STOCK SOARS ON EARNINGS AND DIVIDENDS. Meta notches an all-time high on strong earnings, guidance, and news of dividends to shareholders.Chart source: StockCharts.com. For educational purposes.

One area of the market that struggles to keep up with the broad indices is small caps. Small-cap stocks tend to perform better in a lower interest rate environment, and since rate cuts aren’t on the Fed’s radar at the moment, the S&P 600 Small Cap Index ($SML) was one of the few reds in the Market Overview panel in the StockCharts dashboard.

Speaking of interest rates, the  10-year US Treasury yield chart paints a good picture (see below). The 10-year yield is back above 4% after sharply falling and hitting a low of 3.817%.

CHART 2. 10-YEAR TREASURY YIELD SPIKES. The strong January jobs report sent the benchmark 10-year US Treasury Yield Index spiking. In spite of the big jump, the yield closed lower for the week.Chart source: StockCharts.com. For educational purposes.

Today’s move in yields didn’t help bond prices. The iShares 20+ Year Treasury Bond ETF (TLT) was down 2.21%.

The Bottom Line

Overall, 2024 has started positively, which is good for stocks. Hearing some of the takeaways from the Fed speeches next week will be interesting. After this week’s performance, maybe the market won’t be impacted by rate cut delays. This stock market just keeps going and going; if delaying rate cuts isn’t going to stop it, what will?

Next week is another week. If you’re considering adding positions to your portfolio, take advantage of any pullbacks while the market trends higher. Only if there’s a drastic turn of events should you think otherwise.

End-of-Week Wrap-Up

  • S&P 500 closes up 1.07% at 4,958.61, Dow Jones Industrial Average up 0.35% at 38,654.42; Nasdaq Composite up 1.74% at 15,628.95
  • $VIX down 0.22% at 13.85
  • Best performing sector for the week: Consumer Discretionary
  • Worst performing sector for the week: Energy
  • Top 5 Large Cap SCTR stocks: Super Micro Computer, Inc. (SMCI); Affirm Holdings (AFRM); CrowdStrike Holdings (CRWD); Veritiv Holdings, LLC (VRT); Nutanix Inc. (NTNX)

On the Radar Next Week

  • Earnings week continues with Walt Disney Co. (DIS), Gilead Sciences (GILD), Alibaba Group Holding (BABA), Eli Lilly (LLY), and Snap Inc. (SNAP) reporting.
  • January PMI and ISM
  • Fed speeches
  • November S&P/Case-Shiller Home Price
  • Fed Interest Rate Decision

Disclaimer: This blog is for educational purposes only and should not be construed as financial advice. The ideas and strategies should never be used without first assessing your own personal and financial situation, or without consulting a financial professional.

Jayanthi Gopalakrishnan

About the author:
Jayanthi Gopalakrishnan is Director of Site Content at StockCharts.com. She spends her time coming up with content strategies, delivering content to educate traders and investors, and finding ways to make technical analysis fun. Jayanthi was Managing Editor at T3 Custom, a content marketing agency for financial brands. Prior to that, she was Managing Editor of Technical Analysis of Stocks & Commodities magazine for 15+ years.
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