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.

Portfolio Positions - Dollar Tree

Sideways action continued this week also. This sideways action can be very demoralizing for regular market watchers, as no one really knows what will happen next. But there is a famous phrase on the street, which says that "one should not short a dull market." Although this market is not dull on a day-to-day basis, it has been pretty dull over the last few months.

Good investors make money in these type of markets by selling stocks that have already rallied during this phase and re-distributing proceeds into positions which have not performed so well. In this way, they are better positioned to take advantage of potential rally.

A very good example in this regard is Amazon. Amazon declined throughout 2014 after topping around 400 in late 2013. While Amazon was declining, it was a good opportunity to accumulate. Since Amazon was in a bull market based on proprietary model, adding to long positions paid off big time in 2015 with Amazon rallying from 300 to 430 in just 4 months. Therefore, the gains would have been amplified, as one would have bought multiple shares at lower price.

The goal of the new model is to buy good businesses that actually sell tangible products or services. This would mean that investors are actually investing in good companies.

The most recent example in model portfolio is Dollar Tree stock. Dollar Tree rallied in the first two months of this year, but since then it has been declining. As a result, proprietary allocation model increased the exposure in Dollar Tree in May because it is in a bull market. Model will keep on changing the ratio based on analytic modeling, as long as the stock remains in a bull market.

If the stock is truly in a Bull market, it will rally sooner or later and thus, gains will be amplified. If not in bull market, portfolio will exit the stock position on proprietary triggers. We will see...


 

Lessons from Nasdaq and Beating the Market

Last week was a positive week for the overall market. Blue chips gained some but Nasdaq gained a lot. Nasdaq is now within few points of all time high, which was set in 2000.

Although Nasdaq (the darling of 90s) is now approaching all-time highs after 15 years, many of the companies that were making higher highs in early 2000 are no where to be found in today's market. If one had invested in selected few companies, he would still be at a much lower level.

The story of Nasdaq taking 15 years to reach its all-time highs, teaches us two important lessons:

1. Market can remain below a certain level for eons. Therefore, buy and hold might not be the best strategy
2. Individual stocks are extremely hard to manage because of their individual unique profiles, company cultures and other aspects

Being said that, now the question arises how can one then beat the market and should one hire a money managers, with ton of market experience, to beat the market. Lets tackle both of these questions one by one:

Firstly, over the long-term (~20 years) only 1-2% of the money managers beat the market. This means that the probability of selecting a winning manager is .02. In other words, if you have the choice of investing money with 100 money managers, only 2 will be able to beat the market over the long-run. Furthermore, all of them will take money management fees. So should one invest with money managers with such low odds of success?

This observation gives credence to Warren Buffet's concept that its better to invest in low cost ETFs that follow the market and at least perform better than majority of the money managers because you will be closely following market's performance. But this method does not answer the question of how to beat the market. Although it is a difficult question to answer, it is a very good question to ask!!

In order to beat the markets, one should buy good companies and ride them as long as they perform well. If they enter a bear market, one should start riding another well-performing company. Although this concept seems very simple, it is very difficult to implement. In order to effectively implement this concept one needs following 5 pieces of information:

1. Which companies to invest in?
2. Whether selected stock is in a bull or bear market?
3. How much to invest in each position? 
4. When to exit a certain position?
5. How to protect gains? 

As you know Understand, Survive and Thrive has been performing market analysis over the past several years with the goal to optimize portfolio returns using objective techniques and algorithms to take out emotions from trading. We have recently tried to incorporate above mentioned 5 pieces into our model for long-term investing.

 

IPM Trade Matrix Update - Trade 5 (Part 2)

Markets corrected yesterday (going sideways) and are correcting this morning. This is what we have been expecting - a minor pullback, to setup further rally. If this pull-back continues till the last day of the IPM turn window, IPM Trade Matrix will go leverage long because the risk will be minimized. 

However, at this point, it seems like the market will continue higher and a deeper pull-back will ensue from a higher price level. As along as market can stay above Feb 5 lows, we are in good shape and will most likely see all-time highs.

At the same time, there are certain risks roaming the market and can derail this rally:

1. Debt ceiling issue, which needs to be resolved by Feb 27th (Good progress has been made on the resolution)
2. 1929 analog chart. If true, this chart would mean that the markets are headed for a crash like situation
3. Tapering of the QE. It remains to be seen how will the market react to future tapers.

While on one hand these issues are a source of concern, they have also strengthened the Wall of Worry which Bull markets likes to climb. Therefore, it will be interesting to see how things unfold in the near future. As always, UST's trade decisions will be based on a totally objective IPM Trade Matrix, so that our judgement is not biased by market conditions.   

IPM Trade Matrix 2014 Trades

TRADE - 1: (Long) = +2.6%

TRADE - 2: (Short) = +9.3%

TRADE - 3: (Long) - Non IPM Trade Matrix trade = -0.2%
TRADE - 4: (Short - 1/31/14 to 2/5/14) = +7.25% 

TRADE - 5: Long

Long TNA at 70  
Longs were initiated on 2/11/14 based on IPM Trade Matrix Trigger and Elliott Wave structure 

TRADE CONDITIONS
Condition: Bottom within IPM Turn Window 
Trigger: Rally above SP500 = 1789, DJIA = 15790, Russell 2000 = 111.5, Global Dow = 2401
Supporting Indicators: Up trend (8/4 Test has not been completed), Next IPM can be either Top/Bottom

PROFIT TARGETS
Profit Target 1: 1870
Profit Target 2: 1930

RISK
Stop: Break below 1750
Trailing Stops: Will be identified in 1 week
Typical IPM Trade Matrix Risk: 1.5%
Actual IPM Trade Matrix Risk: 3.5% (Entry = 1813 , Exit = 1750 , Risk = 3.5% )
Risk Reason: There are multiple reasons to be worried: 1929 stock market parallel, 8/4 Test to the downside is in process, and major IPM Bottom window is in process.  

Applicable Rule (There are 7 Rules in the IPM Trade Matrix. Following are applicable to the market right now): 

1. Do not go long or short without trigger to prevent losses by market moving against you.  
2. Exit half at profit objective 1. Exit full at profit objective 1 if proprietary continuation signals are not present.
3. Observe stop-losses to minimize draw-downs

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.

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Another Decline But Why Such Disorder??

So today markets declined yet again, it can be attributed to president's panic button or to relentless bickering in D.C. In any case, market was down sharply in the morning. Although it recouped some of the losses by the end of the day, it still ended sharply in red.

There are two interesting aspects of this decline:

1- Except for DJIA, there is no order in the decline.  Market is going up and down, with some indices near the highs while others near the bottom of the range. This kind of behavior is not consistent with a start of a strong down trend.

DJIA is showing a sharp decline since September 18 peak.

Russell 2000 is showing sideways market action since September 18.

SP500 is showing a sideways to down action since Sept 18 peak. 

Cumulatively there is nothing impulsive about these three markets and their declines, which suggests that we should consider this decline as a correction within a primary up-trend.

2- Over the last 2-3 days, we have seen panic coming back into the market. Sentiment surveys have started to show less optimism. Moreover, we have also received 2 buy signals from VIX and NYMO indicators. Therefore, this is suggesting that market correction is approaching an end.

Based on this analysis in conjunction with the IPM turn window, it is possible that market might be setting up for a stronger rally than what we had anticipated 1 week ago. If DJIA breaks below August lows then rally scenario will take a back seat. 

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