Sideways Consolidation nears End

Market's sideways movement continued. This sideways action is now 2.5 months long. SP500 has gone sideways in the last 2.5 months, as shown from teh chart below:

SP500 was at the level where it closed yesterday on July 12, and since then it has gone sideways. It is like a coiled spring, waiting for an explosive move.

At the same time, longer term DJIA structure also looks like a market consolidating before next rally phase.

From market structure perspective, seems like DJIA is tracing out an ending diagonal which is near completion. Market might require one more decline before putting in a substantial bottom.

This sideways action has removed a lot of optimism from the market and pushed many investors on the sidelines. According to Market Classification Model we remain in an uptrend. And this consolidation should be treated as a buying opportunity till the time, market turns and shows that the trend has reversed.

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Inverted Head and Shoulders pattern abound

Even though the market declined in the beginning of this week and scared away many market participants, who had just recently entered the markets, market is now again near all-time highs. But this time, markets are sporting inverted head and shoulders patterns.

Inverted Head and Shoulder patterns are bullish patterns. They either suggest trend reversal or trend continuation after consolidation. Once this pattern is complete, we can assume that the sideways action of the past 2 months has been completed and we are not on the verge of a substantial rally.

Following chart shows the inverted head and shoulders pattern in SP500:

A rally above 2200 level and holding that price will suggest that the market has broken out. Target of this pattern is at least 2275. However, this pattern could result in significantly higher prices because we will enter a very bullish part of the market rally i.e. 3rd wave ascent.

We have been discussing this potential Head and Shoulders pattern for the past few weeks. Following chart was shared on September 20th, highlighting Nasdaq 100 performance and potential Head and Shoulder formation:

Since then the Nasdaq 100 index broke above the neck line and has now completed a successful test of the neck line. Following chart shows the performance of Nasdaq with recent market data filled in:

Overall market trend remain up, as per Market Classification Model. We use MCM to identify the trend and it has kept us on the right side of the market for a very long time now.

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Correction Complete - Approaching Vacuum

Near term market structure suggests that market has just completed a correction. With intermediate trend up and recent sell-off triggering several buy signals, it seems like we are on the cusp of a major rally.

Following chart shows the correction count, since early August.

Since August 8th markets have gone sideways. This sideways action culminated on 9/9 with 400 point decline in DJIA. If the market had rallied right after September 9th bottom, people would have accepted this bottom easily. But sideways action over the past week of so with federal Reserves uncertainty really pushed many market participants out of the market.

Next wave would be wave -3 and a sharp rally. Furthermore, market is now entering Vacuum territory.

Vacuum in Nasdaq
After consolidating near all-time highs for almost 2 years, Nasdaq is about to really break out. This break above 16 year highs, puts Nasdaq in unprecedented territory.

Following chart shows that there is Vacuum above this level and could suck the market higher and leave many of the market participants behind.

Believe me its a very difficult thing to buy at all-time highs. And that's why we developed a strategy to align with the trend with proprietary Market Classification Model, in conjunction with tactical allocation and strategic evaluation. This model has performed amazingly well since it's launch on January 1, 2016 (Performance). 

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Federal Reserves and Market Action

The Fed announced holding the rates and provided guidance for potential increases in future. It wasn't anything out of the ordinary. It was highly unlikely for the fed to raise rates at such time before the elections. However, the more interesting reading came from the dot-plot.

Fed uses this plot to provide guidance regarding future interest rate path. Median of the dots show a curve where Fed officials believe interest rates should be over the next few years.

Following chart shows the plot:

Along with the dot plot, above chart also shows the median projections for the next few years as taken in June and September. As one can see these estimates have come down a lot. As a result, the expectation of interest rise have also decline.

Once this expectation declines, it gives was to higher bond prices and lower yield. At this time, higher bond prices would mean more liquidity, thus being favorable for the overall asset class complex. This situation will surely change one day. For now, we are in an uptrend. In yesterday's analysis on Pre Fed and Bank of Japan announcement, we shared same outcomes

Market Classification Model has been bullish on Bonds for years now. And it seems like there is no reason to bail-out on bonds just yet. Even though many financial gurus have been predicting an inevitable bond demise, which will happen one day, current situation is supportive for a bond rally. As long as trend remains up, forecasts for bond collapse will not come to fruition. Therefore, it's imperative that one remains with the trend.

At Understand, Survive and Thrive, we use Market Classification Model to stay aligned with the trend. MCM is an algorithm based on some of the most time-tested market indicators and their inter-relations to determine when the trend changes, so that we don't stay on the wrong side of the trend for long.

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Strategy Performance

Our proprietary model has been performing very well so far this year. Even with recent 2.5 month sideways consolidation, model is up 22.1% vs 6.3% rise in SP500. We will continue to monitor the performance of this model and share updates. This model will be available for investors to replicate or invest in towards the end of the year.

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Technology getting ready for a Break-Out

While the US markets have been going sideways, Nasdaq has traced out an inverted head and shoulders near all time highs (shown below):

These highs are 16 years old and there is vacuum above this level. If this pattern holds, we can expect a sharp rally in the near future. This rally can start in parallel with central banks announcements or it can start after a decline following Federal Reserves announcement. In any case, this is a very positive development for the market.

If Nasdaq can lead the market, we can be sure that the overall market will follow and that the recession talk will substantially subside. According to Market Classification Model, we remain in an uptrend. Uptrend typically results in rallies and market participants find reasons to be bullish even in front of negative news.

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Bank of Japan and Yen

From Bank of Japan perspective, they would like Yen to decline because that was the catalyst to push Nikkei higher couple of years ago. Right now, Commitment Of Trader data (shown below) shows that the market is ripe for another decline in Yen, which means that its likely Japan will reduce interest rates further or introduce some sort of monetary stimulus.

If BoJ stimulates the market and forces a decline in Yen, we can expect a rally in the indices.

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Pre-Federal Reserves and BoJ Analysis

Sideways Action Continues

This week, so far, has been as uneventful as prior week. Yesterday, markets opened higher but then sold-off towards the end to close slightly negative. Today, markets closed slightly positive. Since last Monday, market has gone net sideways without any major directional move.

Following chart shows that today we closed at the level where we close on Sept 9th, when the world was coming to an end and DJIA had just declined ~4%

Markets are like a coiled spring. And it seems like the entire world is waiting for the Central Banks. Bank of Japan is going to announce its policy statement early in the morning, while Fed announcement will come at 2 PM.


Bank of Japan and Yen

From Bank of Japan perspective, they would like Yen to decline because that was the catalyst to push Nikkei higher couple of years ago. Right now, Commitment Of Trader data (shown below) shows that the market is ripe for another decline in Yen, which means that its likely Japan will reduce interest rates further or introduce some sort of monetary stimulus.

If BoJ stimulates the market and forces a decline in Yen, we can expect a rally in the indices.


Technology getting ready for a Break-Out

While the US markets have been going sideways, Nasdaq has traced out an inverted head and shoulders near all time highs (shown below):

These highs are 16 years old and there is vacuum above this level. If this pattern holds, we can expect a sharp rally in the near future. This rally can start in parallel with central banks announcements or it can start after a decline following Federal Reserves announcement. In any case, this is a very positive development for the market.

If Nasdaq can lead the market, we can be sure that the overall market will follow and that the recession talk will substantially subside. According to Market Classification Model, we remain in an uptrend. Uptrend typically results in rallies and market participants find reasons to be bullish even in front of negative news.


Strategy Performance

Our proprietary model has been performing very well so far this year. Even with recent 2.5 month sideways consolidation, model is up 22.1% vs 6.3% rise in SP500. We will continue to monitor the performance of this model and share updates. This model will be available for investors to replicate or invest in towards the end of the year.

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Market Review and Next Week

After a sharp decline on September 9th where Dow dropped almost 400 points, market went sideways last week. Although the net result was sideways action, extreme marker moves were witnessed. Monday opened negative and then markets rallied hard, while Tuesday saw a sharp sell-off.

As the week came to a close, the volatility and market range had reduced. In fact, market closed +0.5% for the week. Following chart shows gyrating market behavior of last week.

While SP500 and DJIA consolidated towards the bottom of the range, Nasdaq 100 powered to near all-time highs, primarily driven by Apple stock and the demand for the new iphone and Samsung issues. QQQ are now very close to all-time highs!

One thing that we have said many times on this blog is that the market trend determines how the market participants and investors react to headlines. This weekend there were many reasons to sell the market, ranging from bomb blast in NYC to other events in Syria (US and Russia tension). However, if we are in an uptrend all headlines will be interpreted in a positive manner and resolve to the upside.

According to Market Classification Model, stocks remain in an uptrend. And that's the reason why we have neither sold our stock positions nor are planning to sell them till the model turn south. At this point, it will take a sustained substantial decline to do so. However, past week's decline has created enough selling extreme without really damaging the internal structure, that one can treat it as a minor correction in an uptrend.

Next Week
In the coming week, there are many reasons stories that could move the market. Top two news events will be:

1. Fed FOMC meeting
2. Bank of Japan meeting

It's very interesting that Fed and BOJ announcements will come one day before Fall Equinox on Sept 22nd. 

Investment Actions

Staying long in stocks and ignoring news based market gyrations would be two of the most important things one can do. If the market declines, it will provide an even better buying opportunity. But it's possible that the market rallies for next 1-2 days, followed by a decline after Fed announcement, which is quickly reversed. 

In other words, there will be a lot of back and forth, and one should not get caught in such gyrations. Instead, its paramount to remain focused becaus ethat's how you can become successful in the long-term.

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Interesting 5 days in Stock Market

Today's sharp rally wraps up an amazing 5 day period in the markets. Today, Nasdaq 100 closed within 0.4% of all-time highs. It feels like a stealth rally, especially at a time when the entire financial media started proclaiming end of the bull market or a sharp decline, after last Friday's decline.

It has been a period through which we can learn a lot of investment lessons and become better traders. For Example:

1. Do not panic and stay with the trend
2. Market will continue to deliver sharp declines in a bull-market and sharp rallies in bear markets to push market participants on the sidelines or in the wrong direction
3. Always remain aligned with the direction of the trend, no matter what the headlines are

How it started!
Last 5 days have been nothing short of amazing for the markets. On Friday, September 9, markets declined substantially. The decline was so significant that trading range of 40 days was covered in one trading session.

This decline was quite a departure from the dog days of Summer, where market set a record in reduced volatility. By some measures, the volatility was lowest in history. (Charts courtesy of Dana Lyons)

Although many knew that this kind of action is unsustainable, the decline that followed took many by surprise. While everyone was talking about a decline and even we were expecting a decline to shake-out the loose hands, most amusing part was the justification for this decline.

You could see reasons from Fed to emerging markets unwinding, and from valuations to sentiment based complacency. Although all of these reasons are very valid reasons, one needs to thing about these in the context of the market.

Market Trend
According to Market Classification Matrix, a proprietary indicator that uses internal strength indicators that tell us about the strength of the market, we were in a uptrend. And therefore, instead of selling or panicking, we stayed long and kept our cool. No longs were exited.

Our proprietary trading model kept it's long positions. And as September 9th progressed, we realized that this sell-off was generating several buy signals. We will discuss some of the buy signals and the reasons why we think we are just starting the next rally phase, in the next posts. Even though the decline did not result in an immediate bottom for major indices, we saw a sharp rally on Monday after morning decline, which was followed by another two declines on Tuesday and Wednesday.

But the bottom line is that many people panicked while trend remained up. There were very few people who took advantage of the market when it was declining.

IPM Model Review

Market remains in an uptrend. One should not reduce exposure to stocks at this time. This is a new up move and could yield significant gains.

We mentioned in mid August that Inflection Point Model is predicting a August 30 (+/- 4 days) turn window.

Market leading into the turn window went sideways for almost a month and then declined. So far it seems like that the turn window has resulted in a market bottom. The bottom was made on 9/1 at SP500: 2157. Since that bottom, market has rallied ~30 points in few days.

Alongside IPM, there are several other reasons to support market bottom hypothesis:

1. Market Structure
2. Technical buy signals
3. Proprietary trend indicators

Market Structure:

Following chart shows the sideways market action. However, the interesting part is that this sideways action has traced out a corrective 3-wave Elliott Wave pattern, ending with an ending diagonal pattern. Once this patter was completed, it suggested that we can see some sharp gains.

 

Technical Buy Signals

Market generated technical buy signals towards the end of August

Proprietary Trend Indicators:

Prop trend indicators (Market Classification Model) have been signalling that the stock market is in an uptrend. And in uptrend, market consolidations/corrections typically correct to the upside. If they don't, the trend reverses and Market Classification Model will pick it up. MCM defines bull and bear markets and can help any investor stay on the right side of the market.

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