Bond Market Buy Signals

After experiencing a sharp decline in the last ~2 months, bond markets is now consolidating. In fact, today it managed to rally above a critical level. If bonds can hold near this level for the next few days, intermediate trend would turn up.

This decline has resulted in multiple bond indicators turning bullish i.e. sentiment turning so pessimistic that it is now bullish. Three widely followed sentiment indicator readings are given below:

1- Hulbert Sentiment Index:
The blue line below represents bond yields. Bond yields move in the opposite direction to the bond prices. Red line indicates the sentiment towards bonds. At this point, it appears that the sentiment is as negative as we have seen in ~2 years. Therefore, there is a good wall of worry to support a bond rally.

2- Bund Sentiment
Bunds are German bonds. Bunds were among the bonds that went into negative yield territory. While they were negative, everyone was bullish on the future of Bunds. However, very few realized that it was more close to the end of the Bunds rise. On the contrary, right now investors are very bearish on Bunds. This suggests that this a good time to increase exposure to bonds

3- Bond Sentiment NDR indicator
According to NDR services, bond sentiment is now extremely pessimistic, which supports the argument that the Bond decline is over-extended and we should anticipate a rise in Bond prices:

Bond Market Trend
While we are seeing some very pessimistic sentiment readings, these are coming at a time when the Bond market remains in a bull market according to our proprietary Market Classification Model. Therefore, the prudent trade right now would be to add or maintain longs in the bond market.

Keep in mind that bond market has been rallying for over 30 years, and yields have been declining for the same period. This trend will eventually come to an end. The question is whether it has already ended or will end with one for decline.

In either case, bond yields will not go up right away. They will go up if the economy continues to improve and Federal Reserves raises interest rates couple of times. Fed's changes to short-term interest rates does not directly impact the longer-term interest rates because those rates are driven by market expectation.

In the next blog post, we will discuss the bond market structure and both Bull and Bear scenarios. Poor bond market is in no one's favor and the central banks will try their utmost to ensure interest rate rise remains in control. From an investment perspective, we might see 1 or 2 more opportunities to fund big capital purchases at a lower interest rate.

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Gold Market Sentiment & Structure Confluence

In the last post we suggested that the trend in the Gold market is about to exhaust itself based on structural analysis (link). Since then the gold declined for a day and helped solidify the pattern, along with pessimism, necessary for a sustainable bounce.

Gold Sentiment
Gold sentiment has dipped to levels last seen near last year's lows. Following snap shots are from Daily Sentiment Index values on Nov 21.

Following chart shows longer-term DSI values (originally published by Taylor Dart). We can see that DSI is at lowest levels seen in last year.

Gold miners are also extremely oversold. They are at levels where we have seen major bounces in the past. This bounce can turn into major rally, dependent on internal market strength.

Hulbert index also shows that the sentiment is now negative 18%, which means that the average newsletter writer is now recommending shorting gold. Even though it is not at the lowest level, we have seen higher lows in the sentiment at the bottom. So it's possible that gold prices might bottom with a little elevated sentiment.

Market Classification Model
Along with all the positive developments on the sentiment front, the Market Classification Model remains in a bull market for Gold. As a result, we should not only expect a bounce but a resumption of the uptrend. This resumption could lead to acceleration to the upside. If the market completes the inverted head and shoulders pattern, we could easily see 1800 in 2017.

In the next blog post, we will discuss Fundamental reasons that could support this rise in Gold prices including asset rotation and Indian decision to restrict currency.

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Gold Market - Approaching a Turn

Gold market has been declining for the past few months. This decline came after a very sharp start of the year rally in Gold. Based on gold market's fundamental, technical and sentiment analysis, Gold is approaching a bottom. From a technical perspective, there are three distinct reasons that point us towards an approaching Gold market bottom:

1. Intermediate term Gold structure
2. Longer-term goal structure
3. Market Classification Model

Intermediate term Gold structure

Gold prices topped in early July. The peak in Gold prices coincided with Brexit panic. Since topping in July, prices have gone down in a choppy manner - characteristic of a market correction.

Even though Gold prices spiked on US election night, they went down and have declined since then. If we look at a slightly longer-term pattern, it seems like that the recent decline is part of a big corrective pattern that started in May. 

As a result, this correction will be wave 2 of the rally that started in Dec 2015. Once this wave ends, we will be in for a very sharp rally in wave 3. This rally will most likelt take the prices to near the all time high. Another evidence in this regard is the inverted head and shoulders pattern being carved out by the precious metal:

Inverted Head and Shoulders

Following chart shows weekly Gold prices over last few years. Once can see a nicely formed inverted head and shoulders forming. Once this pattern is completed, it's target is around 1800 level.

Other reasons to support the fact that Gold is approaching a major bottom is the pervasively negative sentiment as evident from Daily sentiment Index, Bullish Percentage Index or Hulbert Gold Newsletter Index.

Market Classification Model

Our proprietary Market Classification Model remains in a bull market. MCM utilizes prop trend identification algorithm to decipher between bull and bear markets. Currently it is in a Bull market. It entered a Bull in April and has maintained its posture since then. We use MCM to make investment decision and add positions.

In the next blog post, we will review sentiment analysis for Gold and fundamental reasoning for a gold rally.

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Bonds Market Analysis and Impact

After a dynamic and super-charged start of 2016, the long-term bond prices, as measured by TLT, are at the same level where they started the year - 120.6 vs 120.7 (shown below).

 
Above chart shows the amazing ascent and first six months and the sharp decline over past 4 months. Today's news is full of negative articles about the bond market rout, and potential consequences.

Bond market is the life blood of modern economies. There is hardly any developed country in the world that is debt free. Countries issue debt/bonds to implement development projects and repay any interest/payments that are due on existing obligations.

United States is a unique case where the government cannot just keep issuing bonds to raise money without any checks and balances. These checks and balances help keep the government debt in control, which supports the dollar and increases confidence among the lenders that they will get their money back.

This check/balance process is known as the debt-ceiling. Without confidence in the system, creditors might start hesitating in purchasing government treasuries, which could lead to higher bond yields, making it more difficult for US to finance future needs.

Orderly, rise and fall of treasury yield is very normal because it is governed by economic realities and Fed's actions. But sudden sharp rise, can be catastrophic for the overall economy. That being said, we are in a long-term downtrend in the bond yields, which will reverse one day in the near future.

Long-term view
In early 1980s, long-term treasuries were yielding 14%. They went as low as 2% in July 2016 - amazing time to refinance or make a big purchase at next to no interest rate.

However, this kind of decline will not last for ever. Typically, there is a ~30 year bond market cycle and right now we are near the bottom of the yield cycle. Following chart shows the yield decline structure.

Now the question is whether this trend has ended or does it have one last decline left in it? 

From a fundamental perspective, it is difficult to rationalize how the inflation can pick-up with oil, gold and other commodities being hit with higher dollar. If dollar rallies, it will pressure inflation and as a result, yields would come down.

Short-term View
From a short-term perspective, bond market has become extremely oversold. The sentiment is conducive to a sharp rally, as investors start to rationalize higher yields through new post-election economic realities. DSI sentiment is also extremely subdued.

Note - Election or no-election, economic realities don't change randomly. Rather, their interpretation changes but in the end everything cancels out in the direction of the primary trend

Following chart shows the near-term structure of the bond market. There are two ways to decipher this structure, but both ways suggest that this is a corrective structure. Below chart shows both the wave counts.

We will continue to monitor the bond market as we approach next month's Fed FOMC meeting. Fed might not raise the rates after an election surprise, which could give a boost to bond market.

Last Word
A collapse of the bond market will be a very bad scenario for investors and the economy. Abrupt rise in interest rates can destroy US abilities to pay existing obligations and could lead to a significant market impact. This impact might start from the US but could quickly spread through out the world. And once such a spiral starts, it is almost impossible to halt it in the middle.

If you are an investor with a substantial portfolio in bonds, you need to carefully watch for trend change in the bond market. Our proprietary Market Classification Model remains in a bull market for Bonds.

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Post Election Investment World

We have been discussing stock market uptrend and upcoming bottom for the past few weeks (post 1, post 2, post 3). And as of today, DJIA futures are above all time highs (shown below).

Such a market action in the face of presidential uncertainty is amazing. Although it bodes very well for the overall economy, we will talk about potential Trump impact in the upcoming post.

From an investment perspective there are different scenarios that one needs to be aware of.

Stock Market:
As stocks break out into uncharted territory and Nasdaq approaches the vacuum zone, it means that we are on the cusp of a major rally.

Like many rallies before it, this rally will also be debated by market participants as to why would market rally while president's economic plan would mean job losses. However, the pattern suggests that the stock market remains in a bull trend.

In essence, the underlying economy is very strong and would result in strong growth without any external influence. We will discuss internal structure of the market in future posts.

Bond Market:
Bond market's sharp sell-off probably suggests that the long-term bond bull market has ended. We are probably on the cusp of a significant inflation cycle. Near zero bonds are a thing of the past. Even though we might see some respite from the Federal Reserves, which might hold-off on the decision to increase the interest rates, we are surely in for higher rates.

Following chart shows a very long-term bond yields. Post-election rally has broken a long-term down trend line - another confirmation of the trend change. We have been keeping track of this wave count for years now and have discussed potential bond yield bottom with clients.

Many of our clients bought houses, properties etc in the last 2 years!

This market behavior has significant consequences for investors and we will discuss these consequences in detail. However, one should keep in mind that this kind of behavior will not result in bonds going to stratosphere in the near future. In fact, after couple more months of rising yields, yields might see a very sharp correction.

Metals
Copper has rallied very sharply over the past few days. Precious metals rallied on the news of potential Trump win - fear trade, but since then have declined. This decline was a significant intra-day reversal. But the overall trend in metals remains up.

Gold could continue to rally in anticipation of a higher inflationary environment. So will the gold stocks. Gold and Silver are tracing out very interesting patterns and could have significant upside potential if the can break above 1320 in Gold. We will also discuss the gold pattern in the near future. Past analysis on gold accurately predicted the bottom in October.

Portfolio Allocation:
Our proprietary model has performed extremely well in 2016. It not only kept us in the market during relevant bull phases, it also enabled us to maintain our calm whether during Brexit shock or Trump shocker. Any portfolio that can:

1. Yield returns which are uncorrelated to the market
2. Save a lot of heart-burn when the market goes against you by 1000s of points whether in futures or cash
3. Provide you consistent returns AND
4. Mitigate volatility and provides very high Sharp ratio

by the grace of Almighty, is an amazing performance. We will write a white paper on the performance of the model portfolio in 2016 - a year of surprises and nerve wrecking market action!

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Reasons to be Bullish - From Twitter

Market completed longer term corrective pattern - Higher prices ahead? https://t.co/lyQxShgxmX $SPY $DJIA $QQQ pic.twitter.com/SeQjjd6D9P

— U_S_Thrive (@survive_thrive) November 8, 2016

A rerun chart from last week. VIX now now longer above all its futures contracts. Looks therefore like it was a scary dip, not a downtrend. pic.twitter.com/xyklR0F14r

— Tom McClellan (@McClellanOsc) November 7, 2016

$VIX term structure suggests that we are approaching an inflection point but note that it has spiked much higher in a few cases#volatility pic.twitter.com/s36s0ZnGun

— Babak (@TN) November 3, 2016

Options Traders Ramp Up Put Buying As Fear Spikes - https://t.co/bq51yqoc8t blog by @JLyonsFundMgmt $SPY pic.twitter.com/UGvsSzqECd

— See It Market (@seeitmarket) November 7, 2016

Chart Of The Week (by views): Investors (Over?-)Prepared For Election Volatility (11/1) $VXST
Post: https://t.co/p7piJzdNeI pic.twitter.com/lOpF6pMibP

— Dana Lyons (@JLyonsFundMgmt) November 5, 2016

we have yet to see any panic from the CBOE equity put/call ratio (normalized by dividing 10d/150d MA) $OEX P/C ratio still negative for mkt pic.twitter.com/z2wvkaDdmv

— Babak (@TN) November 4, 2016

Elections and the Stock Market

Market rallied very powerfully today and after a long time it sustained the morning gains. Not only did it sustain the morning gains, market was able to build on it.

We have maintained that the stock market remains in an uptrend and no matter how the election results come out, market would continue its uptrend till the time it enters a bear market. Right now there are no indications that the trend has reversed.

In fact, right now, market seems to have completed its ~4 month long sideways action and is on the verge of breaking out of current 2 year old range.

We discussed the market structure in this post few days ago. Following charts shows what was highlighted and what we saw today:

Long-term consolidation along with this pattern and sentiment decline suggests that there is a very good chance we could see a sharp rally from here. This rally could last for few months. Following chart shows the longer-term range bound market:

Portfolio Alignment

Our strategies are aligned with this potential market moving scenario is ready to take advantage of market move. At the same time, it is possible that we might see a surprise in the election and could witness some near-term turbulence in the markets. Keeping this scenario in mind, we are positioned to mitigate any volatility impact. 

Our portfolios take advantage of market moving events by positioning ahead of them and hedging against potential risks. So far in 2016, we are up ~20% YTD with a Beta of 0.36 i.e. these returns are totally uncorrelated with stock market performance.

As for other areas for investment, we will discuss metal and bonds in the next few posts. Bonds might see further sell-off after the election and before Federal Reserves rate announcement in December. 

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Market Approaches Key Levels

Market's decline is now almost 3 months old and sideways action is ~4 months long. In the beginning this action was purely sideways but recently, it has taken a sharper turn to the downside. With this decline comes an opportunity that the sentiment is getting worse by the day, while proprietary indicator remains in a bull state.

This worsening sentiment is essentially fuel for the market. Sentiment is one fuel which really kindles market rallies. Right now sentiment is at level normally seen at significant market bottoms, and the market structure is now supporting a potentially sharp rally.

Market Structure
Recent investigation of the market structure suggests that the SP500 along with other indices is tracing out a potentially corrective structure of 3 wave decline.

Following chart shows this structure. Wave C (3rd leg) seems like an ending diagonal. Ending diagonals take place towards the end of a market move and give way to a sharp rally. So once the market rallying, it could take-out many of the recent highs.

Similar pattern is visible in almost all major indices. Following chart highlights this structure in Dow Jones Industrial Average

Along side this market structure, stock market indices have also traced more than 50% of their rally since Brexit vote. This shows that recent correct is now very substantial and should be treated as a minor wave 2. If this is wave 2, it will give wave to a very sharp wave-3 rally.

Sentiment

Following charts show sentiment as measured through Fear/Greed indicators and AAII. Both of these measures suggest that the sentiment is in areas where we see significant bottoms.

However, the key is to be detached with the market. Know when there is potential for market moving events but stock to your plan. So far in 2016, our strategic investment portfolio has beaten the stock market by ~12%.

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Market Trend Remains Up

Sideways consolidation continued over the last week. The blog wasn't updated because of registration paperwork. We will discuss Investment Advisory registration in one of the upcoming posts.

Markets' sideways action remains intact. Even though in the last couple of days SP500 and US indices saw a relatively sharp decline, it did not impact the overall shape and form of the market.

Market Structure
SP500 is tracing out a diagonal pattern (shown below). One of the criteria of this pattern was to decline below C level, which it did yesterday. Now, the market needs to hold above yesterday's bottom to confirm that this pattern has been completed.

The overall market structure remains very choppy. This choppy action now spans over 4 months, which is a good enough time to correct the market through time. At weekly level this sideways action looks nothing more than a bull flag or pennant formation. And both of these are bullish in nature.

In terms of next market move, there are couple of options and will be determined by how the market participants react to the next rally phase. In either case, the minimum rally requirements would be above July 2016 high or around that level (SP500 = 2190).

Sentiment
Recent decline has also improve sentiment measures to suggest that a more sustainable rally is possible.

Fear/Greed indicator is at levels where it typically signifies a market bottom.

Similar another indicator just generated a buy signal and could mean that the trend is about to turn to the upside.

Market Classification Model:
MCM for stocks continues to be in a bull market. Therefore, the trend remains up and we will soon see a sharp rally. Even with yesterday's sharp decline, our strategy performed well. While SP500 was down 0.72%, we were up 0.20%. Another proprietary model is suggesting a sharp rally in our strategic allocation portfolio. We will see. So far by the grace of almighty, our proprietary portfolio is up ~20% YTD (after 10 months), which SP500 is up ~6%.

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