When The Inevitable Pullbacks Come

December 14, 2016

The tweets below provide some insight into red days, primary trends, and countertrend moves.

Use the links below to see larger versions of the two charts:

More Information

Additional charts and comments can be found here.

These Charts (1982-2016) Paint A Bullish Picture

December 13, 2016

Consolidation And Confusion Often Precede Big Moves In Stocks

The S&P 500 recently broke out of a multiple-year consolidation box, similar to the breakouts in 1995 and 1985 (see three charts below). The possible relevance for 2016-2017 can be seen by reviewing the historical charts in this post (1982-2016).

Since human psychology, greed, and fear have remained consistent throughout human history, markets often trace out similar patterns near key turning points. The three weekly charts above reflect similar human behavior. In all three periods:

  1. Stocks consolidated for roughly two years, which is indicative of a relatively even match between bulls and bears.
  2. When fear dominated in the orange boxes, long-term trends flipped negative for a relatively brief period (red arrows).
  3. Bullish conviction eventually was strong enough to flip the long-term trends back in the bull’s favor (green arrows).
  4. Eventually, the period of consolidation and indecisiveness ended as stocks broke above the orange boxes.

Only Ten Similar Trend Changes Have Occurred Since 1982

While 2016 is radically different in many ways to every year between 1982 and 2015, markets move based on the net interpretation of all the fundamental data of the day. When the net interpretation flips bearish, negative trends tend to form (red arrows). When the net interpretation flips to the bullish end of the spectrum, long-term bullish trends tend to dominate (green arrows). Therefore, while the mix of fundamental data (valuations, earnings, Fed policy,…) varies from period to period, the consistent theme is markets move based on the net interpretation of all the fundamental data. Once the net interpretation flipped bullish in the chart below, stocks rallied for some time.

Keep in mind, the first set of charts in this post showed the similarities between investor psychology in 1985 and 2016; the chart above shows what happened next in 1985.

1991 Was Significantly Different Than 1982

While the mix of fundamental data was different, good things still happened after the net aggregate interpretation of the data flipped bullish in 1991 (green arrow below).

Detailed Look At All Ten Bullish Turns 1982-2015

The historical charts above were first covered in the August 19 video below. Since the bullish signals were published, the S&P 500 has gained 4.2%.

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1994: The Longer A Market Goes Sideways…

The chart below is a textbook example of the expression “the longer a market goes sideways, the bigger the move we can expect after either a bullish breakout or bearish breakdown”. Keep in mind, the first set of charts in this post showed the similarities between investor psychology in 1995 and 2016; the chart below shows what happened next in 1995.

Bearish Breakdowns Are Part Of The Equation

While there is nothing magical about using the 30, 40, and 50-week moving averages, they allow us to illustrate basic concepts about long-term trend shifts. Shifts can be bullish or shifts can be bearish, as shown in the 2000-2002 example below.

2003 Was Radically Different Than 1982

Are the fundamentals in 2016 different from the fundamentals in 1982 and 1994? Yes, just as the fundamentals were different in 2003 relative to 1982. The mix of fundamentals varies from year to year in the markets; a concept that has remained constant through history. Each year follows a unique script, with similarities sprinkled in among the variations.

2007: Aggregate Opinion Turns Bearish

The net aggregate interpretation of all the fundamentals turned bearish in late 2007; stocks did not regain their footing until 2009.

Harder Markets Often Followed By Easier Markets

Given the sideways price action within a wide range between late 2013 and late 2016, it is fair to say 2013-2016 falls into the “harder market” category when viewed from a long-term trend perspective. The easier period below (2013-2014) was preceded by a harder period (2010-2012).

Purpose Is To Understand Rather Than Forecast

This analysis shows the look of the present day chart (below) and compares it to historical charts; nothing more…nothing less. The present day chart is a fact; the historical charts are facts; no opinions or political biases are involved.

Will the harder period (2013-2016) be followed by an easier period (2017-2019) marked by stronger and more decisive trends? Only time will tell. It should also be noted, these are long-term signals that assist us with probabilities looking out weeks, months, and years. These signals tell us very little about shorter-term outcomes (hours, minutes, days).

In our approach, if the trends remain in place, as they are today, we will maintain a growth-oriented stance. If the trends flip via another whipsaw, which is always possible, we will make the necessary defensive adjustments. Right now, the charts from a longer-term perspective look favorable. How they will look in three weeks, three months, or three years falls into the TBD category.

Lower Taxes, Higher Yields Should Boost Earnings Significantly

December 12, 2016

Lower Taxes Should Boost Profits

Markets typically need a catalyst to break out of a multiple-year trading range. One possible candidate is the significant shift in market expectations related to the reliance on monetary policy relative to fiscal policy.

Lower Taxes And Higher Rates

The financial markets have been highly dependent on global central bankers in recent years (monetary policy). After the U.S. election, markets began to anticipate the possible benefits of President-elect Trump’s platform. From Yahoo Finance:

“We estimate that President-elect Trump’s corporate tax plan could boost S&P 500 earnings by $180bn,” writes Barclays’ Jonathan Glionna. “We think the market is underappreciating the likely big boost to S&P EPS from a lower corporate tax rate and the boost to bank profits from rising yields (and lower pension expense) and the much higher chance now of a long lasting economic expansion that rivals the 10-year US record,” Bianco added.

Numerous Longer-Term Market Signals

This week’s stock market video covers a long-term breakout in an economically-sensitive sector (XLB), describes a shift that has resulted in stocks outperforming bonds in the past, and updates the status of numerous long-term signals that have accrued in recent months.

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Goldman’s Take On Trump’s Tax Plan

Sentiment shifts need to be backed by fundamental shifts for market gains to continue. The odds are extremely high corporate taxes are going to be lowered under the Trump administration. Lower taxes will impact earnings; the only question is the magnitude of the impact. From Yahoo Finance:

In a note to clients shortly after the election, analysts at Goldman Sachs outlined a number of tax scenarios that could play out in a Trump administration. Among them is a reduction in the statutory tax rate from the current 39% to 25%, while companies keep their strategies to pay less effective tax. Under this scenario, an effective tax rate falling to 15% could see S&P 500 earnings rise 26% in 2017 compared to 2016.

Investment Implications – The Weight Of The Evidence

Earlier in 2016, the markets were being led by defensive sectors (SPLV). Given the post-election shift in expectations regarding growth, earnings, inflation, and interest rates, demand for economically-sensitive sectors (SPHB) has improved relative to defensive sectors. Details regarding the shift below were outlined in a November 18 analysis.

Numerous Long-Term Signals Support Bullish Case For Stocks

December 9, 2016

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Reliable Contrarian Indicator Says Stocks Could Rise 25%

December 4, 2016

Positive Returns 97% Of The Time

Based on current readings of their “sell side indicator”, Bank of America/Merrill Lynch (BOAML) recently wrote in a research note to clients:

“Historically, when our indicator has been this low or lower, total returns over the subsequent 12 months have been positive 97% of the time, with median 12-month returns of +25%,”

Recommended Stock Allocations Remain Low

The BOAML indicator is based on the recommended stock allocations inside portfolios. A typical benchmark equity allocation is 60%-65% of a portfolio. Presently, the recommended allocation is significantly below that range, coming in at 51%. If the recommendations moved back to the historical mean, as they typically do, money would continue to flow out of bonds and into stocks. More information about the BOAML signal can be found on Yahoo Finance.

A Separate Rare Signal Also Leans Bullish

Has any other longer-term signal appeared recently that aligns with the possibility of double-digit stock gains over the next 12 months? Yes, this week’s stock market video covers a monthly S&P 500 momentum and trend signal that has occurred less than 10 times over the past 23 years. The signal was triggered at the end of November. Even more importantly, the signal was also triggered recently in numerous risk-on ETFs, such as small-caps (IWM), mid-caps (MDY), energy (XLE), copper (JJC), materials (XLB), and the total stock market (VTI), which may be due in part to allocation shifts based on President-elect Trump’s platform. Bearish signals have been triggered in defensive assets such as bonds (TLT), utilities (XLU), consumer staples (XLP), and healthcare (XLV), which may be due in part to post-election shifts regarding growth, earnings, taxes, deficits, and inflation.

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If you do not feel the signals outlined in the video are helpful, there is an easy solution…you can choose to ignore them and continue to make decisions based on your own criteria.

How Can These Signals Help Us?

Since there is no such thing as a perfect signal or indicator, the material covered in the video above and the BOAML indicator help us in two ways: (1) to better understand the probabilities of good things happening relative to bad things happening, and (2) to remain open to all outcomes, even better than expected outcomes given the market’s trendless and whipsaw pattern over the past 2-3 years.

The Weight Of The Evidence

Have any other signals occurred recently that align with the signals presented above? Yes, in recent months we have covered another rare trend signal, an extremely low volatility reading, and breakouts from long-term consolidation patterns.

Since the future is unknown and markets can do anything at any time, as always, we will remain open to all outcomes, including bearish outcomes. The data we have in hand aligns with a favorable risk-on environment; if the data deteriorates, we will make the necessary defensive adjustments.

These Signals Are Based On Facts

As noted in the tweet below, recent events (Brexit, U.S. election) remind us to take any forecast or opinion with a necessary grain of open-minded salt. The BOAML indicator and the broad array of recent monthly bullish MACD signals are based on facts, rather than opinions or forecasts. BOAML has historical data they can compare to present facts in hand. The MACD crosses presented in the video above are observable facts that can also be compared to historical facts, which is quite a bit different than an opinion or forecast of something that may or may not happen. If the facts change, the historical interpretation of the facts will change as well. Time will tell.

Rare Monthly Signals Paint A Clear Picture

December 2, 2016

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Most Recent Comments Via Twitter

December 1, 2016

You can access them here (@CiovaccoCapital). You do not need to know anything about Twitter to view our comments or use the links to view charts.

S&P 500 Index: Rare Bollinger Band Width Worth Monitoring

November 30, 2016

Today’s post can be found on SeeItMarket.

Will The Dollar And Higher Rates Doom Stocks?

November 28, 2016

Dollar Breaks Out

With the Fed flip-flopping on interest rates, the U.S. dollar traded inside a two-year consolidation box, which is indicative of indecisive investor behavior. The dollar was recently able to break to the upside with market participants expecting a Fed rate hike in December.

Impact On Multinationals And Consumers

There are valid concerns tied to a rising U.S. dollar. A strong dollar makes American goods more expensive overseas, which can negatively impact earnings for multinational companies. However, the flip side of that coin is U.S. consumers will pay less for imported goods, allowing them to have more disposable income.

What Can We Learn From History?

This week’s video explores the question:

Is it in the realm of historical possibility for stocks to perform well in periods marked by rising interest rates and a strong U.S. dollar?

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Higher Rates Can Impact Capital Flows

Bonds have recently sold off on expectations for stronger growth, higher inflation, and higher interest rates. The selloff in bonds and the post-election push higher in stocks have allowed the stock/bond ratio to break out of a long-term consolidation box (see chart below). The impact of capital flows between stocks and bonds was covered by The Fat Pitch:

In July, fund managers’ had their highest exposure to bonds in 3-1/2 years. In other words, they expected yields to keep falling. Instead, yields reversed higher and have since risen so sharply that several smart money managers now say that a new secular uptrend in yields is taking place. That is a big call, given that the foregoing secular downtrend has lasted more than 35 years.

Over the past 18 months, investors’ money has been flowing consistently out of equity funds. Where has that money gone? Mostly to bond funds. Money usually follows performance, so it’s a good guess that fund flows might soon begin to favor equities. If past is prologue, then equities should gain and bond yields should continue to rise. Whether that will constitute the start to a new secular uptrend for yields it is far too early to say.

Financials Have Responded

Since bank earnings are impacted by interest rate spreads, higher interest rates tend to be positive for the financial sector. President-elect Trump’s platform also calls for toning down regulations from the post-financial crisis Dodd-Frank legislation. Financial stocks have responded by breaking out from a multiple-year base relative to the S&P 500.

Time Will Tell

As long as the markets are moving based on the higher growth, higher inflation, and higher rates theme, economically-sensitive areas of the market, such as small caps (IWM), mid caps (MDY), metals (JJC), and consumer discretionary (XLY), will most likely continue to outperform more-defensive oriented areas, such as bonds (TLT), gold (GLD), and utilities (XLU). Stocks have come a long way in a short period. Even under longer-term bullish conditions, some “give back” is to be expected.

Will Rates And The Dollar Doom Stocks?

November 25, 2016

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