2017 Investment Themes

There are many prominent investment themes for 2017. Investment themes help investors understand the broader investment landscape based on historical performance of different asset classes and their current catalysts. This analysis helps in properly positioning one's portfolio to take advantage of the winds of change.

US Stock Market

SP500 and DJIA have experienced an amazing 1 year rally. Since Feb 2016, markets are up ~30%. With such a sharp rally, it won't be wrong to expect a sideways/downward market correction. Since corrections can come in different forms, sideways correction with time will help in digesting last year's gains just like a sharp fall in prices.

Lofty price levels can be supported by equally good earning numbers, which can provide further fuel for the rally. However, with the uncertain political dynamics in the U.S. we should be prepared for any sudden decline in the US stock prices like 1987 market crash - not a certainty but a word of caution.

Note: Next earnings will be reported in mid-April 2017


Emerging Markets

On the other hand, emerging markets finished a 5 year long correction in 2016. As US markets rallied, emerging markets corrected from 2011 to 2015. Since bottoming in 2016, emerging markets have rallied and looks like they have formed an inverted head and shoulders pattern. Once they breakout, emerging markets could go up to there 2011 highs. Therefore, this is an area to keep in mind.

Precious Metals

Gold had been declining since 2013. It bottomed in early 2016 and then rallied sharply. However, since mid-2016, Gold has again experienced a major pullback. However, we think that this pullback is a buying opportunity and would result in higher prices. 

Following chart shows a potential inverted head and shoulders pattern being formed by gold. Once this pattern is complete, gold can make an advance towards all-time highs around 1900. However, the first target would be to reach July 2016 highs. Therefore, gold is an area which one should keep on his/her radar for investment opportunities.

Precious metals are also influenced by the US dollar. US dollar has rallied very significantly over the last two years or so. Therefore, as the US Dollar corrects, it will provide fuel for a rally in the precious metals complex.

Bonds

Bond have been in a long-term bull market. In fact, its one of the biggest bull markets in history of bond prices. However, the bond price cycles are turning and so are the prices. Now the question is whether the Bond Bull has ended or it still has some life left.

Bond prices started declining in mid 2016 and have reached a critical area. Prices should reverse to the upside soon or they will mark the end of the Bond bull, which can be disastrous for the debt-laden global economy. We will keep a tab on the Bond market to understand clues for the future of the US economy.

Investment Options

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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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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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The Next Big Opportunity - Emerging Markets

US Markets rallied impressively today. More importantly, they maintained the gains that were achieved at the start of the session. Hallmark of a sustained rally is that it continues and does not fail.

While US stocks are coming out of a consolidation phase (detailed analysis), and have many catalysts that could propel them to higher levels, the next big move might come from the emerging markets.

Long-term Emerging Market structure
Emerging markets have been in a sideways mode since 2011. For the past 5 years, emerging market have consolidated while US markets were making new highs. Following chart shows the performance of EEM (emerging markets ETF) over last 13 years.

Since 2003, emerging markets have gone through 4 phases:

1. Major rally (impulsive move) lasting for several years and culminating in 2007
2. Major correction of 2008, which was caused by global financial crisis
3. Sharp rally out of the financial crisis lows of 2009
4. Correction from 2011 highs that has brought EEM down to levels not seen 2006

Interestingly, both corrections (2 and 4) have a corrective formation i.e. 3-wave structure and both rallies (1 and 3) are impulsive in nature Therefore, it means that the trend remains up. And if the recent correction has ended, we should expect a very sharp and long-lasting rally in the emerging markets.

Short-term Structure

From a shorter term perspective, emerging markets are consolidating in a sideways formation. Once this sideways action ends and the market breaks out to the upside, it will have a lot of momentum. In fact, it could lead emerging markets to reach 2011 highs in the next burst higher.

Emerging market components
Although the EEM components will be adjusted next month, currently Chinese stocks determine the performance of the emerging market ETF. If Chinese markets are break-out, the entire emerging market complex will follow suite.

Market Classification Model
We have developed MCM for emerging markets. We will share the latest finding with subscribers. However, the bottom line is that the trend is approaching a reversal in the emerging markets to the upside. Once the trend reverses, we should expect a long-lasting rally in the emerging markets index.

Persistent investment behavior is critical for longer-term capital gains because that's the best way of gaining preferred tax treatment, which can significantly help your portfolio.

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Market Timing (IPM Model) & Structure

Just re-ran the Inflection Point Model and it seems like the next turn window is approaching fast. It is scheduled for October 21, 2016 (shown in chart below)

As you can see from the above chart, last turn window was on Sept 26, 2016. And the market topped on Sept 22, 2016, followed by ~3 weeks of sideways action. Following chart shows the best market structure representation with latest timing information

Market is still in a sideways correction. In fact, the 2nd portion of this correction took the shape of a triangle (X). Now it is in the final leg of this decline. So far, this last leg of the decline has been tracing out 3 waves, which means that this might turn into an ending diagonal.

Last wave will be sub-divided into 5 parts. 2 of 5 have been completed. The market could bottom in the area of 2090-2065 (SP500).

A signal of bottom will be generated by a buy signal generated within the IPM turn window. Confirmation will be received by a rally above critical proprietary levels.

Overall market trend remains up and this correction should give way to a sharper rally. Seems like market is setting-up for a wash-out to scare enough people out of the market, so that a big year end rally can start.

If your already long, stay long. If you want to go long, wait for another few days and then start adding longs.

Market Classification Model
Market Classification Model (MCM) remains bullish on the US stock market. It turned bullish in July 2016 and has remained bullish through last 3 months. Even though many market pundits have been advocating a sharp decline.

Persistent investment behavior is critical for longer-term capital gains because that's the best way of gaining preferred tax treatment, which can significantly help your portfolio.

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Stock Market Structure

Stock Market and Bond market action suggests that both markets are consolidating. Once this consolidation is complete in the stock market, we should see a rally. 

We discussed about the potential of sideways market action and formation of a head and shoulders pattern on Aug 8th. As of Aug 21, market has traced out the right shoulder. 

Aug 8, 2016

Aug 21, 2016

Now that the right shoulder is almost complete, next step is to analyze the market structure to identify next steps. 

From an Elliott Wave perspective, market is currently in the last wave of the up-move. When we say last wave, it by no means mean that this will end the bull market. Instead, it just means that the current rally phase will give way to relatively large decline.

Recent market consolidation has helped in reducing market participants' optimism over the past few weeks, as evident from recent surveys. This will help in the next short-term rally phase. However, since the market is nearing the end of the larger rally phase which started with Brexit vote, we will see a resurgence of optimism and sharper decline.

In the above chart, a box is placed to show potential price and time range of market top based on Fibonacci relationship and IPM market timing analysis.

Overall market trend remains up. Even if the market declines, it will lead to higher prices till the time Market Classification Model is in Bull territory for the stock market.

                                                                                                                                              

MARKET CLASSIFICATION MODEL
A proprietary algorithm that classifies market conditions i.e. Bull market or Bear market. Currently, this model is suggesting a longer-term up-trend for the US Stock Market. In fact, this model is close to triggering another new Bull trigger.

Bond Market Update and Impact on Stocks -

A very quite week from all perspectives. Even with the Federal Reserves meeting minutes, the overall temp of the week remained slow. All of the major asset classes went sideways. SP500 was up +0.2%, while Bonds were down -0.5%. This kind of market action suggests that last week was very non-eventful and something big is coming-up in the near future.

We have already talked about the next stock market turn window - scheduled for around August 30th. Analysis suggests that the next turn would most likely be a near term top.

Therefore, with a turn window approaching and Jackson Hole summit scheduled for next week, there is a very good potential of market rallying next week.


Bond Market Bear Scenario

Typically if stocks rally, bonds decline. At the same time, bonds have other reasons for a decline. From a technical perspective, bond market is tracing out a bearish pattern. Following chart shows bonds consolidating in a triangular form, after July's sharp decline. Typically, this kind of consolidation is followed by a break in the prior direction.

Another reason to consider this scenario is that blue average can act as magnet on this decline. This decline will have deeper consequences for the entire market for the month of September. We will discuss these consequences in the next post.


Bond Market Bull Scenario

Just to provide a perspective on market action, good investors should also consider all the scenarios. From a bull perspective, market seems to be undergoing a sideways correction in a triangle form. This consolidation will result in an immediate break to the upside.

The problem with this scenario is that, this would mean stocks would go down. However, it seems unlikely because the Jackson Hole meeting and IPM turn window suggest a stock market rally.


Conclusion

A bond market decline and stock market rally makes the most sense. But please keep in mind that Bonds and stocks both are in bull markets, according to our proprietary Market Classification Model. MCM has kept us on the right side of the trade and has resulted in some amazing YTD results in 2016.

Subscription to MCM is open for investors (Services). 

Nasdaq Head and Shoulders Completed

Market is declining and Head and Shoulders have played out exactly in Nasdaq. We are in a #bear and we have been discussing this scenario since August 2015. 

 

Following chart was presented on January 4, 2016 (link).



 

 

Market so far has played out Head and Shoulders pattern to the target, as shown below.

Head and Shoulders patterns are forming in many other asset classes. We will review these in the next few blog posts.

Bonds Rally Analysis and Stocks

Market's decline on Friday was very sharp and was on top of Thursday 250+ point decline in $DJIA. This decline has brought the market to a critical support level in Nasdaq and $DJIA, while in other indices like Russell 2000 and $SPY this critical level has already been broken to the downside.

Downside break means that the near term trend has turned down. Although some technical analysts might take this decline as a trend change signal, at UST we have been suggesting that a sea change has already taken place in the stock markets in August.

Unfortunately, many market participants are still not seeing the bigger picture because they don't follow objective trend analysis. Instead, they follow the market events and try to gauge the markets response to these events. At Understand, Survive and Thrive, we have always used objective market analysis and statistical models to identify market trends and turn points.

In the last post (link), we analyze the significance of recent Federal Reserves action and suggested that although the Federal Reserves thinks that the economy is strong and they can raise rates, this rate increase could not only have negative consequences on the market but also could result in lower rates. Longer term rates are governed by the perception of the economy of market participants and if investors don't believe in the same story of strong fundamentals, they might keep on buying the bonds, resulting in lower bond yields and higher prices.

Although this concept does not make intuitive sense, it was evident in the last few days where the market went down and interest rates also went down even after Fed's rate hike.

We have already discussed the potential fundamental issues with the economy and how its depends on the perception. There are also several technical reasons behind rally in bond prices:

1. Inverted Head and Shoulders Pattern
2. Capital outflow from bond funds
3. Proprietary trend indicator

Current pattern in the bonds suggests that the longer term bonds, as depicted by $TLT below, are carving out an inverted head and shoulders pattern. As you know, inverted head and shoulders pattern is a bullish pattern and shows trend reversal from lower to higher. So it will be interesting to see how the market reacts over the next few weeks when this pattern matures and is about to break-out.

From socio-economic and sentiment perspectives, in anticipation of Fed's announcement many people jumped ship from the bonds and exited in great numbers. This could be interpreted as a potential contrarian buy signal for longer-term bonds.

Finally, as we have been saying for quite some time, bonds are in bull market for some time and will remain till model says otherwise. Therefore, we will find reasons for the bull market to continue which can be either due to economic weakness, technical rally or delay from Fed in raising rates further.

Please note that this analysis is only pertaining to high quality long-term bonds and not related to Junk bonds, which are linked to the economic activity. Weakness in economy would result in a decline in Junk bonds, as we have been witnessing over the past few months.

Markets Overview and Further Decline Possible

Yesterday's sideways action flows very nicely with the wave 4 argument. Wave 4s give way to wave 5. Therefore, we should expect another down draft in the very near future. Following chart shows the updated market structure.

In order for this structure to remain valid, market should stay below 1770. Once we break below recent lows and enter the 1730 area, we will near the end of Wave 3 of a higher degree. SP500 target levels is between 1722 and 1730.

This 5-wave completion could have two possibilities:

1. Immediate sharp rally
2. Immediate rally but more of a sideways market action, followed by another low

• Scenario 1 would mean that markets will likely rally to new all-time highs.
• Scenario 2 would mean that markets have entered a downtrend and one should be careful of rallies. 

From a Market Matrix perspective, it seems like market wants to decline to lower levels and this decline is not over yet. Sentiment is also not showing pessimistic extremes. Above all, one should wait for the IPM Turn Window to pick the bottom. Therefore, we will keep on analyzing the market for further clues and see how things evolve. This analysis will help us in next IPM Trade Matrix trade.

Please note that latest IPM Trade Matrix trades have been updated on the blog at: 

IPM Trade Matrix - Trade 4 (Part 3)

IPM Trade Matrix - Trade 4 (Part 3)

IPM Trade Matrix Trades

TRADE - 1: (Long) = +2.6%

TRADE - 2: (Short) = +9.3%

TRADE - 3: (Long) - Non IPM Trade Matrix trade = -0.2%

TRADE - 4: Short - Still holding short since 1/31/14
Long TZA (short ETF) at 18.23 ==> 18.57 (shorts added) 
Short positions were added on 1/31/14, 2/3/14 and 2/4/14 based on Elliott Wave structure and break below critical levels. 

TRADE CONDITIONS
Condition: Outside IPM Turn Window (Re-entry)
Trigger: Test of ~1785 (SP500) and decline below 1769 (SP500). Decline trigger was based on EW analysis and other proprietary levels. 
Supporting Indicators:  Initial decline was impulsive (5-wave). Next IPM window is a Bottom and is 1-2 weeks away. Details of IPM turn window e-mailed to subscribers. 

PROFIT TARGETS
Profit Target 1: 1725 - 1730
Profit Target 2: 1670 

RISK
Stop: Above 1770
Trailing Stops: 1770 - Based on Elliott Wave analysis (will be updated on a regular basis)
Typical IPM Trade Matrix Risk: 1.5%
Actual IPM Trade Matrix Risk: 0% (Entry = 1785, Exit = 1770, Risk = No Risk)
Risk Reason: No significant risk because upcoming turn date is a bottom.

Applicable Rule: Do not go long or short without trigger to prevent losses by market moving against you.  

Note: IPM Trade Matrix Trades will be posted in the first half of 2014. This is an experiment to understand and enhance the capabilities of this Matrix.

Fed Decision & Gov't Shutdown: This Time Its Real (Part 2)

Part 1

This question suggests that either Fed does not think the economy is strong enough right now, which means there is some thing fundamentally wrong. Or they are anticipating a major shock in the near future. This leads us towards the upcoming budget discussion and possible government shut-down starting on October 1, 2013.

I think Federal Reserves' was looking ahead and they saw a real policy of a government shutdown in October, along with another long-drawn battle on debt-limit increase. That is why, they preemptive these political uncertainties by giving another doze of steroids to the market so that the impact of political stalemate does not ripple through the stock market, and consequently does not derail the nascent economic recovery.

As far as the political stalemate is concerned, this time it will be bad! On all previous occasions politicians started working on the debt-ceiling / government shutdown issues at least ~2 months in advance, with media shouting about this possibility ~3 months in advance. For example, in 2011 debt-ceiling was being discussed in the media in April/May time frame, months before the actual stock market decline in August.

But this time, it is different. Today, was the first time I saw something on the news about a potential government shut-down in a financial news outlet. This means that lawmakers are not taking this shut-down seriously with only 2 weeks left to the the shutdown. This will be followed by debt-ceiling debate, which needs to be settled in less than a month. And finally, since Republican lawmakers have been burnt by sequestration earlier this year, it is highly unlikely they will easily cooperate on this issue.

All of the above mentioned scenarios combined, suggest that there a lot of headwinds for the market in the near future. Under these circumstances, we will analyze the IPM model for trade timing  

Fed Decision & Gov't Shutdown: Logic Behind Fed's Decision (Part 1)

So everyone was surprised by what Fed did yesterday. In fact, it is one of the times after a long time that I have seen so many people caught off-guard. Since I was expecting the market to go up after the announcement of the taper, I was not surprised by the rally after the announcement. I was surprised by the announcement to not taper. And to be sure, this surprise was equally shared between financial news media and economists. Since the surprise decision is now out, the question remains about the context of this decision.

In real world economists, Federal Reserve's officials, treasury analysts and central bankers typically make policy decisions based on fundamental analysis of macro-economic indicators. These indicators tell them how to manage their policy to control inflation, foster job growth and spur economic activity. Therefore, it will be very insightful to analyze the implication of federal reserve's recent decision of "not to taper" from a fundamental & socio-economic perspective.

For one, since everyone was expecting a taper decision. "Not Taper" turned out to be a perfect contrarion trade.

On the other hand, from a fundamental perspective the consensus was that Fed will start tapering its bond buying program in September 2013. And the reason behind this assumption was the language used by Fed's officials over the recent meetings was getting Hawkish. In these meeting's Fed's officials had started becoming "Hawkish" about the fiscal policy i.e. they were getting concerned about the potential increase in the inflation rate due to extremely accommodating monetary policy.

Behind the shift in Fed's language towards stricter monetary policy was recent economic data which was hinting towards robust economic growth in the US economy, along with significant gains in the housing market and stock indices. However, this data was available to the general public all over the world, and the data did not get worse over the last month or so.

Therefore, the question is: "What did the Federal Reserves' see differently during the September's FOMC meeting, which forced them to keep the extraordinarily accommodative monetary policy intact?"

This article will continue in next part ...

Fed's Taper & Market Reaction

Federal Reserves will make a decision about its monetary taper in this upcoming week. Majority of analysts are expecting a taper. The question one should be asking right now is that how will the markets react to Fed's decision to taper. This is because only market's price reaction to the news pays, and not what the news was. As for the market, it has been rising nicely for the past 2 weeks. In fact, after bottoming on August 30 (the IPM Model bottom date), market has rallied to 1690 in 2 weeks i.e. an increase of ~70 points.

As we approach this critical week, markets are over-bought and some sentiment measures are touching optimistic extremes. This type of market behaviors asks us to be cautious over the next week or so.

If we had a Federal Reserves meeting scheduled with possibility of taper at a time when sentiment was pessimistic and market had been over-sold, it would have been a good time to buy the FOMC meeting's outcome. However, current market structure from an Elliott Wave perspective along with Market Matrix's analysis suggests that we might be in for a sideways to down market over the next few days.

From a global perspective, emerging markets are in a very interesting position. These markets have been in a downtrend since January 2013. Although they have seen a sharp rally over the past few weeks, this rally has brought the emerging market index at a critical resistance level.  If EEM fails to break sharply above recent highs, there is a serious potential that downtrend will resume.

Please note that according to proprietary market classification methodology, emerging markets recently entered a bear market in May 2013, and have been in a bear since then. Now the question remains if they will be able to break into a bull market, or the Bear will re-assert itself. Bear's reassertion would lead to widespread consequences. Next week will give us a better picture of how the emerging markets will react to Federal Reserve's monetary policy decision.

Finally, futures are rallying sharply on the decision of Larry Summers withdrawal as Fed's next chairman. This rally has taken most of U.S. indices to all time highs. It falls nicely in line with September Strategy